What Is the Financial Sector?
The financial sector is a section of the economymade up offirms and institutions that provide financial services to commercial and retail customers. Thissector comprises a broad range of industries including banks, investment companies, insurance companies, and real estate firms.
Key Takeaways
- The financial sector is a section of the economymade up offirms and institutions that provide financial services to commercial and retail customers.
- A strong financial sector is a sign of a healthy economy.
- The financial sector generates a good portion of its revenue from loans and mortgages and thrives in a low-interest-rate environment.
- The sector is comprised of many different industries including banks, investment companies, insurance companies, and real estate firms.
Understanding the Financial Sector
A large portion of this sector generates revenue from mortgages and loans, which gain value as interest rates drop. The health of the economy depends, in large part, on the strength of its financial sector. The stronger it is, the healthier the economy. A weak financial sector typically means the economy is weakening.
Many people equate the financial sector with Wall Street and the exchanges that operate on it. But there's much more to it than that. The financial sector is one of the most important parts of many developed economies. It is made up of brokers, financial institutions, and money markets—all of which provide the services needed to help keep Main Street functioning every day.
In order for an economy to remain stable, it needs to have a healthy financial sector. This sector advances loans for businesses so they can expand, grants mortgages to homeowners, and issues insurance policies to protect people, companies, and their assets. It also helps build up savings for retirement and employs millions of people.
The financial sector generates a good portion of its revenue from loans and mortgages. These gain value in an environment where interest rates drop. When rates are low, the economic conditions open up the doors for more capital projects and investment. When this happens, the financial sector benefits, meaning more economic growth.
Financial Sector Makeup
As mentioned above, the financial sector is made up of many different industries ranging from banks, investment houses, insurance companies, real estate brokers, consumer finance companies, mortgage lenders, and real estate investment trusts (REITs).
The financial sector is one of the largest portions of the . The largest companies within the financial sector are some of the most recognizable banking institutions in the world, including the following:
- JPMorgan Chase (JPM)
- Wells Fargo (WFC)
- Bank of America (BAC)
- Citigroup (C)
While these large companies dominate the sector, there are other, smaller companies that participate in the sector as well. Insurers are also a major industry within the financial sector, being made up of such companies as American International Group (AIG) and Chubb (CB).
Investing in the Financial Sector
Economists often tie the overall health of the economy with the health of the financial sector. If financial companies are weak, this is a detriment to the average consumer. Financial companies provide loans for businesses, mortgages to homeowners, and insurance to consumers. If these activities are restricted, it stunts growth in both small businesses and real estate.
Financial stocks are very popular investments to own within a portfolio. Most companies within the sector issue dividends and are judged on the overall strength of their financial health. During the financial crisis of 2007-2008, the financial sector was one of the hardest hit, with companies like Lehman Brothers filing for bankruptcy. After an influx of government regulation and restructuring, the financial sector is considerably stronger.
Financial ETFs, such as the Financial Select Sector SPDR Fund (XLF)—the largest financial ETF—can provide investors with broad exposure to the sector.
As of the close of trading on Sept. 29, 2020, the financial sector had a combined market capitalization of $5.59 trillion. The sector has underperformed the S&P 500 index in the trailing 12 months (TTM), where the S&P 500 is up 14.3% while the S&P 500 Financials Sector has fallen 13.7%.
Special Considerations
Some of the positive factors that affect the financial sector include:
- Moderately rising interest rates. As rates rise, financial services companies can earn more on the money they have and on credit they issue to their customers.
- Reducing regulation. Whenever the government decides to cut back on red tape, members of the financial sector will benefit. This means it could lessen the burden while increasing profits.
- Lower consumer debt levels. as consumers decrease their debt loads, they lessen the risk of defaults. This lighter load also means they may have a tolerance for more debt, further increasing profitability.
Conversely, investors should consider some of the negative factors that affect this sector as well:
- Rapid interest rate increases. If rates rise too quickly, demand for credit such as mortgages could drop, which could negatively affect certain parts of the financial sector.
- Yield curve flattening. If the spread between long- and short-term interest rates drop too far, the financial sector could start to struggle.
- More legislation. Government regulation can have a big impact on the financial sector. While it may help protect consumers, more red tape can bog down a business that operates in financial services.
FAQs
The financial sector is one of the most important parts of many developed economies. It is made up of brokers, financial institutions, and money markets—all of which provide the services needed to help keep Main Street functioning every day.
Why are financial markets so important to the economy? ›
Financial markets facilitate the interaction between those who need capital with those who have capital to invest. In addition to making it possible to raise capital, financial markets allow participants to transfer risk (generally through derivatives) and promote commerce.
How does the financial system matter to the economy? ›
Financial markets provide liquidity, capital, and participation that are essential for economic growth and stability. Without financial markets, capital could not be allocated efficiently, and economic activity such as commerce and trade, investments, and growth opportunities would be greatly diminished.
What is finance and its importance? ›
What Is Finance? Finance is a term for matters regarding the management, creation, and study of money and investments. It involves the use of credit and debt, securities, and investment to finance current projects using future income flows.
Why are finance jobs important to the economy? ›
It provides the necessary capital to businesses, individuals, and governments to invest in new projects and expand their operations. The finance industry also offers financial services that enable economic growth and development. It plays a crucial role in the overall health and stability of the economy.
Why is financial economics important? ›
Financial economics is important in making investment decisions, identifying risks, and valuing securities and assets.
What is the role of the financial system in an economy? ›
The five key functions of a financial system are: (i) producing information ex ante about possible investments and allocate capital; (ii) monitoring investments and exerting corporate governance after providing finance; (iii) facilitating the trading, diversification, and management of risk; (iv) mobilizing and pooling ...
How does financial services help the economy? ›
The financial services sector is the primary driver of a nation's economy. It provides the free flow of capital and liquidity in the marketplace. When the sector is strong, the economy grows, and companies in this industry are better able to manage risk.
What is the financial role in the economy? ›
The essential role of finance is to channel savings to investment. Financial prices such as interest rates, exchange rates or stock prices serve to adjust the individual plans of economic agents to be consistent with equilibrium for the aggregate.
How does economics impact finance? ›
The national and global economies can have a big effect on personal finances because they change everything from the number and kind of job opportunities to the prices of goods and services, which affect personal budgets.
It's not just about making ends meet but about maximizing your financial potential. Whether it's planning for retirement, saving for a major purchase, or simply ensuring you can handle unexpected expenses, personal finance helps you prepare for life's many financial challenges and opportunities.
What is the main goal of finance? ›
Typically, the primary goal of financial management is profit maximization. Profit maximization is the process of assessing and utilizing available resources to their fullest potential to maximize profits. This has the greatest benefit for company shareholders hoping for the highest possible return on their investment.
What is the main point of finance? ›
Finance is concerned with the art and science of managing money. The finance discipline considers how business firms raise, spend, and invest money and how individuals divide their limited financial resources to achieve personal and family goals.
Why is the financial sector important to the economy? ›
In order for an economy to remain stable, it needs to have a healthy financial sector. This sector advances loans for businesses so they can expand, grants mortgages to homeowners, and issues insurance policies to protect people, companies, and their assets.
How does finance benefit society? ›
Finance is meant to extend support to social goals – greater employment, economic welfare, wider education, skill development and equality, among several other things. It should be seen as a tool that can, in fact, ensure a more prosperous and unregimented society.
How are financial markets important to the economy? ›
They facilitate the flow of funds, enabling businesses to grow, governments to fund public projects, and individuals to achieve their financial goals. This injection of capital is essential for innovation, development, and economic expansion. Lastly, the financial markets are a powerhouse of employment opportunities.
Why are markets important to an economy? ›
Markets are an important part of the economy. They allow a space where governments, businesses, and individuals can buy and sell their goods and services. But that's not all. They help determine the pricing of goods and services and inject much-needed liquidity into the economy.
Why are financial systems and markets important? ›
They enable individuals and institutions to save, invest, manage risks, and conduct transactions efficiently. Financial systems also play a role in price discovery, ensuring fair prices for assets and commodities.
What do the financial markets play an important role in? ›
The financial markets play an important role in channeling funds from savers to borrowers. Which of the following illustrates this function of financial markets? Investors purchase securities that are issued by firms and governments.
What is the main purpose of financial markets quizlet? ›
What is the purpose of financial markets? they match people who want money to spend now (buyers) with people who want to save their money for later (sellers).
