What Is the Meaning of the Financial System?

••• exchanging us dollars and British pounds image by Kirill Kurashov from Fotolia.com

The term financial system has two widely understood meanings. When "financial system" refers to a relatively self-contained entity, such as a corporation, it refers to the various processes used within that corporation to exercise financial control and to assure desired outcomes. When the term refers to larger entities, financial markets within the Euro Zone, for example, it describes both the complex of institutional and market activity within the Euro Zone, and the various funding and payment systems that facilitate that activity.


Ancient Babylonians began their relatively complex counting system around 3,000 B.C. About one thousand years later, they had developed banking activities sufficiently complex to require written standards of practice. Medieval European banking, the predecessor to modern financial activities, began in Italy, and centered around individual families, like the Medicis, and individual cities like Florence, Venice and Genoa. As financial historian Fernand Braudel has described in great detail, once a counting system exists, financial transactions occur. The financial apparatus for that system, at first transitory and local (town markets and fairs), stabilizes and spreads outward. The longer time-frame and wider reach of these financial transactions begin to require systemic organization.

Exchange Economies and Capitalism

Braudel describes the evolution of two systems, the exchange economy, which eighteenth century writers would have described as "the natural economy," and another economy, not yet fully recognized, which, Braudel comments, eighteenth century writers would have thought of as "artificial." We call this second system "capitalism." The first system, the exchange economy, has its base in the exchange of goods. The second relies upon the artificial system of money. Exchange economies have limitations that make a fully developed financial system unlikely.

Capitalism Is a Financial System

Capitalism, as Braudel notes, arose to solve the problems of exchange economies. When money becomes fully viable as a medium of exchange, the limitations of time and place begin to disappear. Capitalism is the largest financial system. Within it, smaller financial systems coexist and cooperate.

Smaller Financial Systems

Any well-run business has its own financial system. The traditional elements of that system include inventory control, transactional record-keeping, and the establishment and verification of income, expense, assets and liabilities.

Larger Financial Systems

Larger financial systems comprise the smaller financial systems within it, and the various links between these systems: funding, investment, payment, accounting, reporting and other facilitating systems. Just as smaller systems have rules of governance, such as terms of incorporation, larger financial systems have rules of governance, the legal system of its city, state, country or economic zone.