Financial assets/instruments represent the financial obligations that arise when the borrower raises funds in the financial market. In exchange for the funds lent, the supplier will have a claim on the income/wealth of the borrower which may be a corporate, a government body or a household. This financial claim will be packaged in the form of a certificate, receipt or any other legal document.
Financial assets play a key role in developing the financial markets in particular and the financial system in general. Their importance to the system can be understood while distinguishing these assets from the real assets. All assets are financed by liabilities as the accounting concept advocates. While the assets can be either financial or real assets, the liabilities will be either in the form of savings or financial liabilities. Financial assets represent the obligations on the part of the issuer of such financial asset. Hence, all financial assets will be equal to the financial liabilities. The funding of assets will be done either by using savings or by borrowing. Since borrowings represent financial liabilities, the accounting equation can be altered as follows:
Assets = Liabilities + Capital
Financial Assets + Real Assets = Financial Liabilities + Savings
Since financial assets equal to financial liabilities, the real assets will be financed by savings. This relationship has the following implicit assumptions:
There are no external borrowings in the system.
Financial liabilities include stock issued to the outsiders.
From the above equation, it can be understood that the surplus funds of an economic unit will either be used by the saver to purchase a real asset or will be lent to other economic units to buy real assets. Thus, all real asset purchases within the system will be made from the savings in the system.
An important aspect that is to be noted here is the process through which the savings are transformed into real assets since it has an important bearing on the economic progress. This can be explained by the fact that savings can be transformed into real assets for consumption purpose or they can also be transformed into real assets through the investment channel. Though these two activities, i.e. consumption and investment are essential for the economy, using excess of savings for consumption purpose will be detrimental for the economic progress since it will result in scarcity of funds for investment purpose. While both demand and supply are necessary for economic growth, the deployment of savings should be such that it ensures equilibrium.