Flow of Funds Matrix – Surplus to Deficit Sectors
Introduction
The financial system is essentially a "Flow of Funds" mechanism. It moves money from those who have excess (Surplus) to those who need it (Deficit).
1. The Two Sectors
A. Surplus Sector (Savers)
- Who: Households (Mainly), Individuals.
- Behavior: Income > Expenditure.
- Role: They supply the funds.
B. Deficit Sector (Borrowers)
- Who: Business Firms (Corporate), Government.
- Behavior: Investment Needs > Internal Savings.
- Role: They demand the funds.
2. Methods of Flow
How does money move from Surplus to Deficit?
Method 1: Direct Finance
- Mechanism: Borrowers borrow directly from lenders in financial markets by selling securities.
- Example: Reliance Industries issuing shares (IPO). You buy the shares. Money goes directly to Reliance.
Method 2: Indirect Finance (Financial Intermediation)
- Mechanism: A financial intermediary stands between the lender and borrower.
- Example: You deposit money in SBI. SBI lends that money to Reliance. Reliance pays interest to SBI. SBI pays interest to you.
- Advantages: Lower risk, expert management, liquidity.
graph LR
A["Savers<br/>(Households)"] -- Indirect Finance --> B["Intermediaries<br/>(Banks)"]
B -- Loans --> C["Borrowers<br/>(Corporate)"]
A -- "Direct Finance<br/>(Shares/Bonds)" --> D["Financial Markets"]
D --> C
Flow of Funds Mechanism
3. Flow of Funds Matrix
| From \ To | Households | Business Firms | Government | Rest of World |
|---|---|---|---|---|
| Households | - | Invest in Shares/Deb | Buy Gov Bonds | Remittances |
| Business Firms | Dividends/Wages | - | Tax Payments | Exports |
| Government | Subsidies/Welfare | Contracts/Subsidy | - | Foreign Aid |
| Rest of World | Tourism/Gifts | FDI/FII | Loans | - |
(Simplification: The main flow is Households -> Intermediaries -> Business/Govt).
Summary
- Movement: Surplus to Deficit.
- Route: Direct (Markets) or Indirect (Intermediaries).
- Primary Saver: Household Sector.
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