How the modern financial system works

You receive your salary into an account, pay bills on your phone, take out a loan or buy a bond. Behind each of these actions there is a network of institutions, rules and systems that almost never shows. That network is the financial system.

This article lays out the overall structure: what the system does, who takes part, how money flows and who supervises it. The specific role of the central bank (interest rates, inflation, currency issuance) is covered in the companion piece on what central banks are and how they work.

What a financial system is for

The Central Bank of Brazil (BC) defines the National Financial System (SFN) as a set of entities and institutions that carry out financial intermediation: bringing together those who have funds to lend or invest and those who need them (BC, SFN page).

In practice, the system performs three functions:

• holding and moving money: accounts, payments and transfers;
• turning savings into credit and investment: one person’s idle money finances another’s consumption, home or business;
• distributing risk: insurance, pensions and instruments that let each party take on only the risk they chose.

According to the BC, it is through the financial system that people, companies and government move most of their assets, pay debts and make investments.

The three layers: who sets the rules, who supervises, who operates

The BC organizes the SFN into three types of participant (SFN page):

• normative bodies, which set the general rules;
• supervisory entities, which check that the rules are being followed;
• operators, the institutions that serve the public as intermediaries.

The BC’s chart divides the system into three branches, each with its own set:

Branch	Who sets the rules	Who supervises	Examples of operators
Money, credit, capital and foreign exchange	National Monetary Council (CMN)	Central Bank and Securities and Exchange Commission of Brazil (CVM)	banks, savings banks, credit unions, brokerage firms, stock exchange
Private insurance	National Council of Private Insurance (CNSP)	Superintendence of Private Insurance (Susep)	insurers, reinsurers, open pension entities, capitalization companies
Closed pension plans	National Council of Supplementary Pensions (CNPC)	National Superintendence of Supplementary Pensions (Previc)	pension funds

The legal basis for this architecture is Law No. 4,595/1964, which created the CMN and the Central Bank. The same law defines a financial institution as a legal entity whose activity is the collection, intermediation or investment of its own or third-party financial resources (art. 17), and requires prior authorization from the BC for it to operate in the country (art. 18).

The CMN is the body that formulates monetary and credit policy. According to the BC, it is there that the inflation target, the guidelines for foreign exchange and the main rules for how financial institutions operate are decided. It is made up of the Minister of Finance, who chairs it, the president of the BC and the Minister of Planning and Budget (BC, institutional page).

Intermediation: what a bank does with your money

The BC describes a bank as an institution specialized in intermediating money between those who save and those who need a loan, as well as keeping that money safe (BC, banks and savings banks).

The most common picture is of a bank that takes deposits and lends that same money on. It oversimplifies. A Bank of England study explains that, in the modern economy, most money is created by banks themselves when they make loans: when it approves credit, the bank creates a new deposit in the borrower’s account (Bank of England, “Money creation in the modern economy”, 2014).

That capacity is not unlimited. It depends on demand for credit, on the risk of each borrower, on the capital requirements set by regulation and on the central bank’s interest rate policy.

A bank earns mainly from the difference between what it charges borrowers and what it pays those who leave money invested with it, the so-called spread. The core risk of this activity is that borrowers do not pay. That is why regulation requires banks to hold their own capital and to be continuously supervised.

What protects depositors

If a member institution fails, the Credit Guarantee Fund (FGC), Brazil’s deposit insurance scheme, covers up to R$ 250,000 per individual or company taxpayer number (CPF or CNPJ), per institution or conglomerate, with an overall limit of R$ 1 million every four years (FGC, about the guarantee). The list includes, for example, checking accounts, savings accounts, CDBs (bank certificates of deposit), LCIs and LCAs (real estate and agribusiness credit notes). Amounts above the limit and products not on the list do not have this coverage.

Not every company that offers an account is a bank. Payment institutions have a different license and different protections. The difference is explained in the article on neobanks versus traditional banks.

Payments: the rails money runs on

Moving money requires dedicated infrastructure. In Brazil it is called the Brazilian Payment System (SPB). According to the BC, the SPB has two segments:

• financial market infrastructures: systems that handle settlement (the final transfer of funds or assets), central depository services and the registration of financial assets;
• payment arrangements: sets of rules governing payment services to the public, such as Pix and credit cards.

The BC states that the proper functioning of these infrastructures is essential to financial stability and for monetary policy to reach the economy. When you make a Pix payment (Pix is Brazil’s instant payment system), the money leaves your account and reaches the recipient’s through accounts that institutions hold at the BC itself. The details are in Pix: architecture and how it works.

Capital markets: financing without a bank in the middle

Not all financing goes through a bank’s balance sheet. In the capital markets, companies raise funds directly from investors by selling shares (a stake in the business) or debt securities, such as debentures. The BC describes this market as the one that allows companies to raise funds from third parties and thus share gains and risks.

The difference from bank credit matters to you. With a deposit, the bank bears the borrower’s risk. In the capital markets, the investor bears it. A share can lose value, and a company that issued debt may fail to pay. In those cases there is no FGC: the loss may be partial or total.

This market is supervised by the CVM, created by Law No. 6,385/1976 as a special-regime autonomous agency, with fixed terms and job security for its directors. Brokerage and dealer firms bridge the investor and the stock exchange and, depending on the activity, answer to both the BC and the CVM.

The BC also lists two other markets in the main branch of the SFN: the money market, which supplies the economy with paper currency and book-entry money (money held in accounts), and the foreign exchange market, for buying and selling foreign currency.

Where the system’s risks lie

Financial institutions depend on one another: they lend to each other, settle payments together and share infrastructure. That is why a problem in one can spread. This is known as systemic risk.

The architecture described above exists, to a large extent, to contain that risk:

• prior authorization to operate, granted by the BC (Law No. 4,595/1964, art. 18);
• continuous supervision of banks by the BC and of the securities market by the CVM;
• specific guarantees, such as the FGC, with clear limits;
• supervised payment and settlement infrastructures.

None of this eliminates risk. Institutions can fail, scams use the names of real companies, and products outside the regulated perimeter do not have these protections. See how to recognize fraud in digital financial scams.

Where fintechs and new technologies fit in

Fintechs did not create a parallel system. They operate within this same structure, with licenses granted by the BC, and often use the same payment rails. To understand how they sustain themselves, see how fintechs make money. Data sharing between institutions is the subject of Open Finance: how it works.

Projects such as Drex and asset tokenization test new ways of recording and settling transactions. The underlying logic remains the same: someone sets the rules, someone supervises and someone operates.

Key takeaways

• The financial system connects savings to credit and investment and keeps money moving through payment infrastructures.
• In Brazil, councils set the rules (CMN, CNSP, CNPC), entities supervise (BC, CVM, Susep, Previc) and authorized institutions operate.
• Before putting money into any product, check who the institution is, what license it holds and what protection exists. A deposit covered by the FGC and a capital market investment carry very different risks.