Role of Financial System in Economic Development

Prove that financial system plays a significant role in development.

Contents

Role of Financial System in Economic Development

Financial system plays a significant role in economic development. Its importance in economic development is increasing day by day.

Financial system is helpful in economic development in the following ways. These are those arguments which prove that the financial system plays an important role in economic development:

1. Increase in Savings: Financial system is helpful in increasing the savings.

Saving is a function of income. It refers to a part of money income which is not spent on consumption. All money income is not spent by the persons on consumption.. Money income which is not spent on consumption is saving. It is excess of income over consumption expenditure.

Rate of Savings = Total Savings / Gross National Income × 100

Rate of Savings in First Plan = 10%

Rate of Savings in 2000-01 = 24%

Its sources can be classified into following parts:

(a) Household Savings or Savings from Household Sector: It includes the savings of families, non-profit making institutions and non company business etc. Part of these in gross savings is about 82%.

(b) Government Sector: Governments and departments, railway, power and transport etc. are included in it.

(c) Corporate Sector: Private companies, public companies, public sector and co-operative sector are included in it. Corporate sector’s contribution in the aggregate saving is about 6%.

(d) Personal Saving: It is equal to the personal disposable income minus the personal consumption expenditure of all individuals.

(e) Gross Business Saving: It represents the retained profits of all business units consisting of depreciation allowances and undistributed profits. Financial system increases the savings from various sources.

2. Mobility in Savings : Savings are collected by the banks and financial institutions. Banks and financial institutions provide funds to entrepreneurs.

3. Investment: Investment can influence the level of output, income and employment in an economy. Investment refers to the value of part of the aggregate output which is used for the creation of new structures, new capital equipment and changes in business inventories, a new capital equipment and changes in business inventories. A new capital asset must come into existence by the aggregate amount of investment. Shares and debentures purchased by individuals directly shall be investment.. Investment must generate income in the economy. Income generated in the economy in constructing of acquiring these capital assets may be taken as the value investment.

The internal sources of savings may be :

1. Household Sector: The household sector includes non-profit making institutions rural and urban business enterprises etc.

2. Public or Government Sector: The public or government sector includes Central Government, state governments, local authorities / boards, government corporations etc.

3. Private or Corporate Sector: Private or corporate sector includes financial institutions like banks, non-financial public and private limited companies, all types of co-operative institutions. Household sector is most important component and biggest saver.

4. Helpful in Monetary Control: Financial system is helpful in the implementation of credit and monetary policies. It is helpful in growth with stability.

5. Useful in Various Sectors of Economy: Financial system is helpful in the various sectors of economy e.g. household sector, business sector.