Financial markets provide a number of key services that are so important for a successful economy.

1. ​Allowing consumers and firms a safe and secure place to save money.  The reward here is interest payments.
2. Lending money to consumers and firms.  In essence financial markets act as facilitators between those that save and those that borrow.
3. Facilitate the exchange of goods and services through providing payment infrastructure e.g. debit and credit cards.
4. Provide futures markets to aid the stability of commodity prices.
5. Provide a space for stocks and shares can be traded.

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Functions of a Central Bank

Central banks are key to many of the operations of both the financial markets and the wider economy.

The key functions of a central bank that are appropriate to A Level economics are,

1. ​Managing inflation through implementation of monetary policy.
2. Main banker to the government. Facilitating spending for government departments and providing advanced funds.
3. Banker to the banks including being lender of last resorts when banks are strugglin gwith liquidity.
4. Regulation in the banking industry. One key regualtion is the reserve asset ratio which determines the level of loans a bank can issue.

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Market Failure in Financial Markets

Many of the market failures that you studied in year 12 still apply to financial markets in this year 13 topic.  A brief outline of the key market failures applicable to financial markets are,

1. Asymmetric information - consumers and more importantly regulators often have insufficient information compared to financial institutions to ensure stable financial markets.
2. Externalities - External costs from transactions taking place in the financial sector can be very high.  Just take a look at the amount the UK government had to spend bailing out the banks in 2009. 
3. Moral hazard - Each time a financial institution is bailed out or rescued it signals to the institution that 'profits will be kept and losses will be recompensed by government'. This causes financial institutions to undertake much riskier activities.
4. Speculation - Poor lending decisions can lead to market bubbles where assets prices grow much beyone their perceived value.  Excessive lending in the housing market can cause houses to become overpriced. the real problems occur when the bubble bursts.
5. Market rigging - There can be cases where financial markets are not working efficiently as rogue agents have colluded to rig, or fix, interest or exchange rates in order to benefit themselves.  This can be seen in the LIBOR scandal in the UK.