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Indian Financial System


Financial System of any country consists of financial markets, financial intermediation and financial instruments or financial products. INDIAN FINANCIAL SYSTEM The economic development of a nation is reflected by the progress of the various economic units, broadly classified into corporate sector, government and household sector. While performing their activities these units will be placed in a surplus/deficit/balanced budgetary situations. There are areas or people with surplus funds and there are those with a deficit. A financial system or financial sector functions as an intermediary and facilitates the flow of funds from the areas of surplus to the areas of deficit. A Financial System is a composition of various institutions, markets, regulations and laws, practices, money manager, analysts, transactions and claims and liabilities. Financial System;

The word "system", in the term "financial system", implies a set of complex and closely connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities in the economy. The financial system is concerned about money, credit and finance-the three terms are intimately related yet are somewhat different from each other. Indian financial system consists of financial market, financial instruments and financial intermediation.

Indian Financial System

Constituents of Indian Financial system:

These are briefly discussed below; FINANCIAL MARKETS A Financial Market can be defined as the market in which financial assets are created or transferred. Financial assets also called as securities are financial papers or instruments such as As against a real transaction that involves exchange of money for real goods or services, a financial transaction involves creation or transfer of a financial asset. They are not a source of funds but they are a link and provide a forum in which suppliers of funds and demanders of loans / investments can transacts business directly. Financial Assets or Financial Instruments represents a claim to the payment of a sum of money sometime in the future and /or periodic payment in the form of interest or dividend. Money Market- The money market ifs a wholesale debt market for low-risk, highly-liquid, short-term instrument. Funds are available in this market for periods ranging from a single day up to a year. This market is dominated mostly by government, banks and financial institutions. Capital Market - The capital market is designed to finance the long-term investments. The transactions taking place in this market will be for periods over a year. Again the capital market can be classified on the basis of claims representing new Issue or outstanding issue as Primary market or secondary market.

Indian Financial System


It is the market which provides the channel for sale of new issues. Resources are required for both new as well as existing projects with a view to expansion, modernisation, diversification & upgradation. it is the market where resources are mobilised by companies through issue of new securities. SECONDARY MARKET :

A Market where investors trade outstanding securities/ issues are called secondary market. Secondary market comprises of stock exchanges, which provide platform for purchase & sale of securities by investors, where the trading is accessible only through brokers & trading is confied only to stock exchanges.

FOREX MARKET The Forex market deals with the multicurrency requirements, which are met by the exchange of currencies. Depending on the exchange rate that is applicable, the transfer of funds takes place in this market. This is one of the most developed and integrated market across the globe. CREDIT MARKET Credit market is a place where banks, FIs and NBFCs purvey short, medium and long-term loans to corporate and individuals.

Indian Financial System

Money Market Instruments The money market can be defined as a market for short-term money and financial assets that are near substitutes for money. The term short-term means generally a period upto one year and near substitutes to money is used to denote any financial asset which can be quickly converted into money with minimum transaction cost. Some of the important money market instruments are briefly discussed below; 1. Call/Notice Money 2. Treasury Bills 3. Term Money 4. Certificate of Deposit 5. Commercial Papers 1. Call /Notice-Money Market Call/Notice money is the money borrowed or lent on demand for a very short period. When money is borrowed or lent for a day, it is known as Call (Overnight) Money. Intervening holidays and/or Sunday are excluded for this purpose. Thus money, borrowed on a day and repaid on the next working day, (irrespective of the number of intervening holidays) is "Call Money". When money is borrowed or lent for more than a day and up to 14 days, it is "Notice Money". No collateral security is required to cover these transactions. 2. Inter-Bank Term Money Inter-bank market for deposits of maturity beyond 14 days is referred to as the term money market. The entry restrictions are the same as those for Call/Notice Money except that, as per existing regulations, the specified entities are not allowed to lend beyond 14 days.

Indian Financial System

3. Treasury Bills. Treasury Bills are short term (up to one year) borrowing instruments of the union government. It is an IOU of the Government. It is a promise by the Government to pay a stated sum after expiry of the stated period from the date of issue (14/91/182/364 days i.e. less than one year). They are issued at a discount to the face value, and on maturity the face value is paid to the holder. The rate of discount and the corresponding issue price are determined at each auction. 4. Certificate of Deposits Certificates of Deposit (CDs) is a negotiable money market instrument nd issued in dematerialised form or as a Usance Promissory Note, for funds deposited at a bank or other eligible financial institution for a specified time period. Guidelines for issue of CDs are presently governed by various directives issued by the Reserve Bank of India, as amended from time to time. CDs can be issued by (i) scheduled commercial banks excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs); and (ii) select all-India Financial Institutions that have been permitted by RBI to raise short-term resources within the umbrella limit fixed by RBI. Banks have the freedom to issue CDs depending on their requirements. An FI may issue CDs within the overall umbrella limit fixed by RBI, i.e., issue of CD together with other instruments viz., term money, term deposits, commercial papers and intercorporate deposits should not exceed 100 per cent of its net owned funds, as per the latest audited balance sheet. 5. Commercial Paper CP is a note in evidence of the debt obligation of the issuer. On issuing commercial paper the debt obligation is transformed into an instrument. CP is thus an unsecured promissory note privately placed with investors at a discount rate to face value determined by market forces. CP is freely negotiable by endorsement and delivery. A company shall be eligible to issue CP provided - (a) the tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs. 4 crore; (b) the working capital (fund-based) limit of the company from the banking system is not less than Rs.4 crore and (c) the borrowal account of the company is classified as a Standard Asset by the financing bank/s. The minimum maturity period of CP is 7 days. The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other agencies.

Indian Financial System

Capital Market Instruments The capital market generally consists of the following long term period i.e., more than one year period, financial instruments; In the equity segment Equity shares, preference shares, convertible preference shares, non-convertible preference shares etc and in the debt segment debentures, zero coupon bonds, deep discount bonds etc. EQUITY SEGMENTS : EQUITY SHARES. PREFERENCE SHARES. CONVERTIBLE PREFERENCE SHARES. NON-CONVERTIBLE PREFERENCE SHARES. DEBT SEGMENTS : DEBENTURES. ZERO-COUPON BOND DEEP DISCOUNT BOND

Hybrid Instruments Hybrid instruments have both the features of equity and debenture. This kind of instruments is called as hybrid instruments. Examples are convertible debentures, warrants etc. Conclusion In India money market is regulated by Reserve bank of India ( and Securities Exchange Board of India (SEBI) [ ] regulates capital market. Capital market consists of primary market and secondary market. All Initial Public Offerings comes under the primary market and all secondary market transactions deals in secondary market. Secondary market refers to a market where securities are traded after being initially offered to the public in the primary market and/or listed on the Stock Exchange. Secondary market comprises of equity markets and the debt markets. In the secondary market transactions BSE and NSE plays a great role in exchange of capital market instruments.

Indian Financial System

FINANCIAL INTERMEDIATION Having designed the instrument, the issuer should then ensure that these financial assets reach the ultimate investor in order to garner the requisite amount. When the borrower of funds approaches the financial market to raise funds, mere issue of securities will not suffice. Adequate information of the issue, issuer and the security should be passed on to take place. There should be a proper channel within the financial system to ensure such transfer. Financial intermediary acts as link between savers and investors. Their main function is to convert direct financial assets into indirect securities. To serve this purpose, financial intermediaries came into existence. Financial intermediation in the organized sector is conducted by a wide range of institutions functioning under the overall surveillance of the Reserve Bank of India. In the initial stages, the role of the intermediary was mostly related to ensure transfer of funds from the lender to the borrower. This service was offered by banks, FIs, brokers, and dealers. However, as the financial system widened along with the developments taking place in the financial markets, the scope of its operations also widened. Some of the important intermediaries operating ink the financial markets include; investment bankers, underwriters, stock exchanges, registrars, depositories, custodians, portfolio managers, mutual funds, financial advertisers financial consultants, primary dealers, satellite dealers, self regulatory organizations, etc. Though the markets are different, there may be a few intermediaries offering their services in move than one market e.g. underwriter. However, the services offered by them vary from one market to another. Intermediary Stock Exchange Investment Bankers Underwriters Registrars, Depositories, Custodians Primary Dealers Satellite Dealers Forex Dealers Market Capital Market Capital Market, Capital Market, Market Capital Market Role Secondary Market to securities Corporate advisory services, Credit Market Issue of securities Money Subscribe to unsubscribed portion of securities Issue securities to the investors on behalf of the company and handle share transfer activity Market making in government securities Ensure exchange ink currencies

Money Market Forex Market

Indian Financial System

The main function of financial intermediary is to convert direct financial assets into indirect securities. The indirect securities offer to the individual investor better investment opportunity than the direct/ primary secutity by pooling of funds by intermediaries for examples units of mutual funds. The services / benefits that tailor indirect financial assets to the requirement of the investors are: 1. Convenience 2. Lower risk 3. Expert management 4. Lower cost Convenience: Financial intermediaries convert direct/ primary securities into a more convenient vehicle of investment. They divide primary securities of higher denomination into indirect securities of lower denomination. They also transform a primary security of a certain maturity into an indirect security of a different maturity. For instances as a result of the redemption / repurchase facility available to the unit holders of mutual funds, maturities on units would conform more with the desires of the investors than those on primary securities.

Lower risk: The lower risk associated with indirect securities results from the benefits of diversification of investments. In effect the financial intermediaries transform the small investments in matters of diversification into large institutional investors

Indian Financial System

Expert management:

indirect securities give to the investors the benefit of

trained experienced and specialized management together with continuous supervision. In effect the financial intermediaries place the individual investors in the same position in the matter of expert management as large institutional investors

Low cost: The benefits of investment through financial intermediaries are available to the individual investors at relatively lower cost due to the economies of scale.

Types of Financial Intermediaries

Money needs to be circulated for an economy to be productive. If all savings are hoarded, the surpluses of the community will not be available for investments and this in turn would lead to economic stagnation. Financial intermediaries play an important economic function by facilitating a productive use of the community's surplus money. There are various types of financial intermediaries and their structure comprises of both organized and unorganized sectors. The dominance in terms of financial flows handled by these sectors differs from country to country. In India, the players in the unorganized sector are: Money lenders Indigenous bankers Chit funds Nidhis or mutual benefit funds Self Help Groups

Indian Financial System

In the current scenario, there is no estimate of the volume of business handled by the unorganized sector. While the volume of business handled by them in the urban sector may be small, their role in rural India is very significant. One of the negative effects of the sway of the unorganized sector is that it reduces the efficacy of a country's monetary policy. A lot of initiatives have been undertaken over the years both by central and state governments to reduce the adverse impact. Some of these initiatives are: All India Development Financial Institutions [DFIs] State level Financial Corporations [SFCs] Insurance Companies Mutual Funds [MFs] Non Banking Finance Corporations [NBFCs]

All India Development Financial Institutions The following are the various institutions covered under all India DFIs: Industrial Finance Corporation of India [IFCI] Industrial Development Bank of India [IDBI], which merged with IDBI Bank in 2004 Industrial Credit and Investment Corporation of India [ICICI], which merged with ICICI Bank in 2002 Industrial Investment Bank of India [IIBI]. The former Industrial Reconstruction Corporation of India was converted into Industrial Reconstruction Corp of India [IRCI] and was later converted into IIBI in 1995 Small Industries Development Bank of India [SIDBI], which is a wholly owned subsidiary of IDBI curved out through an act of parliament in 1990.


Indian Financial System

State Level Financial Corporations These are state level bodies that mainly concentrate on industrial development in a state. They are legal bodies created under the State Finance Corporations Act, 1951 and are funded through an issue of shares in which the state governments, banks, financial institutions, and private investors participate. SFCs are also permitted to raise funds through the issue of bonds and debentures. The main focus of SFCs is financing the local industrial units, which are usually small and medium units, situated in backward regions of the state. Insurance Companies Insurance companies concentrate on fulfilling the insurance needs of the community, both for life and non life insurance. With the globalization of the Indian economy, a large number of private players have entered into this field, offering products that allow investors to select the kind of policies to suit their financial planning needs. Many of these organizations are formed as subsidiaries of banks that enable the banks to cross sell insurance products to their existing customers. Banks benefit by way of fee income through referrals and enhanced relationships with insurance companies for their banking needs. Mutual Funds These organizations satisfy the needs of individual investors through pooling resources from a large number with similar investment goals and risk appetite. The resources collected are invested in the capital market and money market securities and the returns generated are distributed to investors.


Indian Financial System

The fund managers of MFs are specialists in the fields of investment analysis and are able to diversify and even out risks through portfolio mix. MFs offer a wide variety of schemes, such as, growth funds, income funds, balanced funds, money market funds and equity related funds designed to cater to the different needs of investors. Non Banking Finance Corporations NBFCs are commonly known as finance companies and are corporate bodies, which concentrate mainly on lending activities in a well defined area. The Reserve bank of India [RBI] Amendment Act, 1997 defines an NBFC as a financial institution or non banking institution, which has its principal business of receiving deposits under any scheme or arranging and lending in any manner. There are 4 broad categories of NBFCs: Finance Companies Leasing Companies Loan finance companies

Financial Regulators:
Securities and Exchange Board of India (SEBI) Reserve Bank of India Ministry of Finance


Indian Financial System

Securities and Exchange Board of India (SEBI) was first established in the year 1988 Its a non-statutory body for regulating the securities market It became an autonomous body in 1992.

Functions of SEBI: Regulates Capital Market. Checks Trading of securities. Checks the malpractices in securities market. It enhances investor's knowledge on market by providing education. It regulates the stockbrokers and sub-brokers. To promote Research and Investigation

Objectives of SEBI: It tries to develop the securities market. Promotes Investors Interest. Makes rules and regulations for the securities market.


Indian Financial System

Reserve Bank of India:

Established on April 1, 1935 in accordance with the provisions of the RBI Act, 1934. The Central Office of the Reserve Bank has been in Mumbai. It acts as the apex monetary authority of the country.

Function of RBI

Monetary Authority: Formulation and Implementation of monetary policies. Maintaining price stability and ensuring adequate flow of credit to the Productive sectors. Issuer of currency: Issues and exchanges or destroys currency and coins. Provide the public adequate quantity of supplies of currency notes and coins. Regulator and supervisor of the financial system: Prescribes broad parameters of banking operations Maintain public confidence, protect depositors' interest and provide cost-effective banking services. Authority On Foreign Exchange: Manages the Foreign Exchange Management Act, 1999. Facilitate external trade, payment; promote orderly development and maintenance of foreign exchange market. Developmental role: Performs a wide range of promotional functions to support national objectives.


Indian Financial System

Related Functions: Banker to the Government: performs merchant banking function for the central and the state governments. Maintains banking accounts of all scheduled banks Monetary Measures: (a) Bank Rate: The Bank Rate was kept unchanged at 6.0 per cent. (b) Reverse Repo Rate: The Repo rate is around 7 per cent and Reverse repo rate is around 6.10 per cent. (c) Cash Reserve Ratio: The cash reserve ratio (CRR) of scheduled banks is currently at 5.0 per cent.

Role/ Functions of Financial System:

A financial system performs the following functions:

It serves as a link between savers and investors. It helps in utilizing the mobilized savings of scattered savers in more efficient and effective manner. It channelises flow of saving into productive investment. It assists in the selection of the projects to be financed and also reviews the performance of such projects periodically. It provides payment mechanism for exchange of goods and services. It provides a mechanism for the transfer of resources across geographic boundaries.


Indian Financial System

It provides a mechanism for managing and controlling the risk involved in mobilizing savings and allocating credit. It promotes the process of capital formation by bringing together the supply of saving and the demand for investible funds. It helps in lowering the cost of transaction and increase returns. Reduce cost motives people to save more. It provides you detailed information to the operators/ players in the market such as individuals, business houses, Governments etc.

In short it can be said that Functions of Indian Financial system can be summarized as:

Main Functions of Indian Financial System

Saving Function Liquidity Function Payment Function Risk Function Policy Function