This lesson establishes the foundational understanding of financial systems, their components, and their critical role in the economy. A financial system comprises financial markets, institutions, and instruments that facilitate the flow of funds from savers to borrowers, supporting economic growth and stability . By the end of this lesson, students will be able to explain the principles of financial intermediation and the role of financial institutions .

1.1 The Functions of Financial Systems
The primary functions of the financial system are to channel funds from economic agents with surplus funds to those with deficits, support consumption and investment spending, and facilitate risk management through diversification . Financial markets are essential for price discovery and capital formation . The modern financial system distinguishes between the functional and empirical approaches to defining money, reflecting the complexity of financial flows in a modern economy .

1.2 Classification of Financial Markets
Financial markets can be classified in several ways. By Maturity: Money markets deal in short-term debt instruments (maturity less than one year), while capital markets handle long-term debt and equity securities . By Trading: Primary markets are where new securities are issued; secondary markets are where existing securities are traded . By Structure: Anglo-Saxon financial systems are characterised by a greater reliance on capital market financing, while continental European systems rely more heavily on bank-based intermediation .

1.3 Key Financial Institutions
The financial services industry comprises commercial/retail banking, investment banking, asset management, and insurance . Banks are deposit-taking institutions that transform liquid liabilities into illiquid assets . Investment institutions include asset managers, mutual funds, pension funds, and hedge funds . Central banks oversee monetary policy and financial stability .