What is Finance?

   Finance is the branch of economics concerned with providing funds (money and credit) to individuals, business firms, and governments. Books on finance deal with such subjects as the money market, stocks and bonds, banking, credit, taxation, and government spending. If you receive an allowance, lend or borrow money now and then, or put money in the bank, you are taking a part in one of the three large areas of finance.

   Private finance is concerned with providing funds to individuals (consumer finance) and to business firms (business finance). All the goods and services that individuals and business firms want to buy must ultimately be provided, or paid for, out of the income that flows from productive effort. But finance permits them to anticipate the income and thus to speed up and expand their production. This is done by arranging for the transfer of funds from some individuals and business firms at times when they do not urgently need them to other individuals and business firms that consider their needs to be more urgent, generally with the understanding that the funds will be repaid with interest at a later date.

   Commercial banks play perhaps the leading role in this process, but important supporting parts are played by savings banks, investment banks, savings and loan associations, consumer finance companies, insurance companies, investment companies, and government credit agencies. The instruments by which they perform their functions include the hand-to-hand currency, of course, but also checking and savings deposit accounts, promissory notes (some unsecured, some secured by collateral, some by real estate mortgages), bonds (which are just formal long-term promissory notes), and stock.

   Public finance is concerned with providing funds to federal, state, and local governments. Like individuals and business firms, governments must provide, or pay for, the goods and services they want out of income—revenues from taxes paid by individuals and business firms out of the incomes flowing from their productive efforts. But finance permits the governments to anticipate their income and thus speed up and expand their activities. Commercial banks, savings banks, investment banks, the federal reserve banks, and insurance companies assist in accomplishing this; and they do it through the use of such instruments as short-term bills and notes and long-term bonds.

   Sometimes the provision of funds by the individuals, business firms, and governments of one nation to those of other nations is regarded as a separate realm: international finance. Formerly this was done entirely by individuals and business firms. English investors, for example, provided the funds with which the railroad corporations in the young and vigorous but poor United States were able to build the railroads in the 19th century. Nowadays, however, a great deal of international finance is accomplished by the governments of some nations providing funds directly to those of others. Foreign-aid programs, for example, are carried out largely through such intergovernmental loans.