What is the function of the financial system?

Among the factors that affect the financial system, transaction cost and information asymmetry play a very important role. Several main functions of the financial system are related to these two factors. Transaction cost refers to the time and money spent in financial transactions, which is the main factor affecting the efficiency of the financial system. For individuals, the transaction cost of issuing loans is very high. In order to protect their own funds, before issuing loans, it is necessary to investigate the project, examine the borrower's credit level, and hire specialized legal personnel to design a complete loan contract. The existence of high transaction costs has become an obstacle to the flow of funds between borrowers and lenders. Financial intermediaries such as banks have great advantages in solving this problem. They have economies of scale, so they can save transaction costs. Financial intermediaries collect funds from individuals and enterprises and then lend them out. Due to the formation of economies of scale, financial intermediaries can reduce transaction costs. Information asymmetry will lead to adverse selection before trading and moral hazard after trading. If we want to minimize adverse selection in the loan market, we need lenders to identify good projects from the risks of non-performing loans. The existence of moral hazard reduces the possibility of repayment and the expected income of lenders, thus reducing their desire to provide loans. This problem also exists between shareholders and managers. Shareholders expect the company to maximize profits, thus increasing the owner's rights and interests. In fact, managers' goals often deviate from shareholders' goals. Due to the large and scattered number of shareholders in the company, it is impossible to effectively monitor managers, who have private information, and shareholders cannot avoid managers hiding information and implementing behaviors that are beneficial to themselves and unfavorable to shareholders. Financial intermediaries also show their own advantages in solving moral hazard and adverse selection caused by information asymmetry. Because it is an expert in making company information, it can distinguish the level of credit risk to a certain extent. Banks and other financial intermediaries obtain funds from depositors and then lend them to good companies, which ensures the bank's income. After the loan is issued, the bank will supervise the project on behalf of the depositors. Once a bank signs a long-term loan contract with an enterprise, the cost of supervising the enterprise is lower than that of directly supervising the enterprise. The role of financial intermediaries is "agent supervision". The principal-agent problem between debtors and creditors can be solved to some extent. Of course, banks can't completely solve the problems caused by information asymmetry. Compared with depositors, banks have the advantage of mastering information, while borrowers know the most about themselves and the nature of the project. Therefore, banks often face the problems of moral hazard and adverse selection, and the bad assets of banks illustrate this point. The relevant institutional arrangements and mechanisms of the securities market, especially the stock market, will reduce the agency cost and partially overcome the moral hazard and adverse selection in capital allocation. Moreover, the development of the stock market is also conducive to the control of the company. Owners will combine the performance of the company in the stock market with the remuneration of managers, thus effectively linking the interests of managers and owners. At the same time, liquidity will reduce the transaction cost and uncertainty of financial assets. Some high-return projects need long-term capital investment, but depositors can't bet their savings on long-term investment. Therefore, if the financial system cannot increase the liquidity of long-term investment, the investment in long-term projects will be insufficient. Thus, the main difference between using bank financing and using capital market financing focuses on solving the moral hazard and adverse selection problems caused by transaction costs and information asymmetry. Banks have more advantages than the securities market in reducing transaction costs; Under the condition of asymmetric information, the ability of banks to solve the principal-agent problem is also stronger than that of the securities market. This can also explain why people once thought that the bank-led financial system was more conducive to economic development than the market-led financial system. However, in the past 20 years, market-oriented countries, especially the United States, have experienced sustained economic prosperity, while the competitiveness of bank-oriented countries has been significantly weakened. Not only that, bank-led countries are still vigorously developing market mechanisms and have a tendency to integrate into the market-oriented system. Among them, the role of technological progress can not be ignored.