The Six Parts of the Financial System, According to a University Course in Money & Banking
I am currently taking a course in Money and Banking, and I found this lecture to be very thought-provoking, especially concerning how cryptocurrencies will fit in or change this model of the financial system. My professor actually alluded to Bitcoin more than once throughout the lecture which made me very optimistic about the nature of the course. After laying out the six components as outlined in the lecture I will offer a few of my thoughts about how cryptocurrencies could change this model, but I would love to hear from others on how they see this structure changing or evolving as cryptocurrencies see mainstream adoption.
Money
The first key component of the financial system, not surprisingly, is money. Money is defined as an asset to make payments and as a store of wealth. We discussed how "money" has changed over the years from shells to metal coins to the paper currency and cards that we use today.
Financial Instruments
Financial instruments are used to transfer resources from savers to investors and to transfer risk to those best equipped to bear it. Examples of these include stocks, bonds, options, futures, insurance contracts, and more. We discussed how these used to be reserved primarily for the wealthy but now nearly everyone has access to these through online services.
Financial Markets
Financial markets facilitate the buying and selling of financial instruments. These started in coffee houses and taverns and have evolved into the well organized markets we have today, such as the New York Stock Exchange. Transactions today are mostly handled via electronic markets, which has greatly reduced the cost of processing transactions and made way for a much broader assortment of financial instruments available to the public.
Financial Institutions
The purpose of financial institutions is to provide access to financial markets, collect information & provide financial services. Financial institutions are made up of a variety of businesses providing a large variety of services, but for the sake of this discussion we focused on banks. Banks began as simply vaults to store money, developed into institutions that both accepted deposits and gave loans, and finally evolved into the "financial supermarkets" that they have become today, offering a wide array of services from insurance to stock brokerage and other investment options.
Government Regulatory Agencies
The role of government regulatory agencies in the financial system, as described in this lecture, is to make sure the system operates safely and reliably. These agencies provide wide-ranging financial regulations, rules, and supervision, including over the systems banks are using to manage risk. We discussed how the 2007-09 financial crises led governments to look into greater regulation, such as the Dodd-Frank Wall Street Act of 2010 and the Consumer Protection Act.
Central Banks
The purpose of central banks is to monitor and stabilize the economy. They control the availability of money and credit to promote low inflation, high growth, and the stability of the financial system. According to this lecture today's policymakers strive for transparency in their operations and the financial crises of 2007-09 led the U.S. central bank to try many new policy tools.
The thing I found most interesting about this lecture on the key components of the financial system was the focus on how this system has changed since the financial crises of ten years ago. This is because Bitcoin was born as a response to the shady practices of banks that led to the situation. Bitcoin and other cryptocurrencies obviously fit in to the system as a more efficient form of money for a globalized world, but the real question is how far they will go in revolutionizing this current model. Do we really need central banks? Will decentralized exchanges disrupt the financial markets? Could many of the services provided by financial institutions be replaced by smart contracts? The answers to these questions remain up in the air, but bitcoin and other cryptocurrencies have certainly opened the door to conversation.
I'd love to hear your thoughts on the topic, and if you would like to read more about our discussions as the course continues please let me know.
Cheers!
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Cheers!
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