The financial system performs the essential economic function of channelling funds from those who are net savers (ie who spend less than their income) to those who are net spenders (ie who wish to spend more than their income). In other words, the financial system allows net savers to lend funds to net spenders.
The most important lenders are normally households, but firms, the government and foreigners may also lend out excess funds. The principal borrowers are typically firms and the government, but households and non-residents also sometimes borrow to finance their purchases.
Funds flow from lenders to borrowers via two routes. In direct or market-based finance (top of the Chart), debtors borrow funds directly from lenders in financial markets by selling them financial instruments, also called securities (such as debt securities and shares), which are claims on the borrower's future income or assets. If financial intermediaries play an additional role in the channelling of funds, one refers to indirect finance (bottom of the Chart).
Financial intermediaries can be classified into credit institutions, other monetary financial institutions and other financial intermediaries. Financial markets and financial intermediaries are not separate entities but are strongly interlinked.
Source: The monetary policy of the ECB, 2004.