Anda di halaman 1dari 15

India has a financial system that is regulated by independent regulators in the sectors of banking, insurance, capital markets, competition

and various services sectors. In a number of sectors Government plays the role of regulator. Ministry of Finance, Government of India looks after financial sector in India. Finance Ministry every year presents annual budget on February 28 in the Parliament. he annual budget proposes changes in ta!es, changes in government policy in almost all the sectors and budgetary and other allocations for all the Ministries of Government of India. he annual budget is passed by the Parliament after debate and takes the shape of la". #eserve bank of India $#%I& established in '()* is the +entral bank. #%I is regulator for financial and banking system, formulates monetary policy and prescribes e!change control norms. he %anking #egulation ,ct, '(-( and the #eserve %ank of India ,ct, '()- authori.e the #%I to regulate the banking sector in India. India has commercial banks, co/operative banks and regional rural banks. he commercial banking sector comprises of public sector banks, private banks and foreign banks. he public sector banks comprise the 01tate %ank of India2 and its seven associate banks and nineteen other banks o"ned by the government and account for almost three fourth of the banking sector. he Government of India has ma3ority shares in these public sector banks. India has a t"o/tier structure of financial institutions "ith thirteen all India financial institutions and forty/si! institutions at the state level. ,ll India financial institutions comprise term/lending institutions, speciali.ed institutions and investment institutions, including in insurance. 1tate level institutions comprise of 1tate Financial Institutions and 1tate Industrial 4evelopment +orporations providing pro3ect finance, e5uipment leasing, corporate loans, short/term loans and bill discounting facilities to corporate. Government holds ma3ority shares in these financial institutions. 6on/banking Financial Institutions provide loans and hire/purchase finance, mostly for retail assets and are regulated by #%I. Insurance sector in India has been traditionally dominated by state o"ned 7ife Insurance +orporation and General Insurance +orporation and its four subsidiaries. Government of India has no" allo"ed F4I in insurance sector up to 289. 1ince then, a number of ne" 3oint venture private companies have entered into life and general insurance sectors and their share in the insurance market in rising. Insurance 4evelopment and #egulatory ,uthority $I#4,& is the regulatory authority in the insurance sector under the Insurance 4evelopment and #egulatory ,uthority ,ct, '(((. #%I also regulates foreign e!change under the Foreign :!change Management ,ct $F:#,&. India has liberali.ed its foreign e!change controls. #upee is freely convertible on current account. #upee is also almost fully convertible on capital account for non/residents. Profits earned, dividends and proceeds out of the sale of investments are fully repatriable for F4I.

here are restrictions on capital account for resident Indians for incomes earned in India. 1ecurities and :!change %oard of India $1:%I& established under the 1ecurities and :!change aboard of India ,ct, '((2 is the regulatory authority for capital markets in India. India has 2) recogni.ed stock e!changes that operate under government approved rules, byla"s and regulations. hese e!changes constitute an organi.ed market for securities issued by the central and state governments, public sector companies and public limited companies. he 1tock :!change, Mumbai and 6ational 1tock :!change are the premier stock e!changes. ;nder the process of de/mutuali.ation, these stock e!changes have been converted into companies no", in "hich brokers only hold minority share holding. In addition to the 1:%I ,ct, the 1ecurities +ontracts $#egulation& ,ct, '(*8 and the +ompanies ,ct, '(*8 regulates the stock markets.
Financial System of any country consists of financial markets, financial intermediation and financial instruments or financial products. This paper discusses the meaning of finance and Indian Financial System and focus on the financial markets, financial intermediaries and financial instruments. The brief review on various money market instruments are also covered in this study.

The term "finance" in our simple understanding it is perceived as equivalent to !oney . "e read about !oney and banking in #conomics, about !onetary Theory and $ractice and about "$ublic Finance". %ut finance e&actly is not money, it is the source of providing funds for a particular activity. Thus public finance does not mean the money with the 'overnment, but it refers to sources of raising revenue for the activities and functions of a 'overnment. (ere some of the definitions of the word finance , both as a source and as an activity i.e. as a noun and a verb. The )merican (eritage* +ictionary of the #nglish ,anguage, Fourth #dition defines the term as under./"The science of the management of money and other assets."0 1/ "The management of money, banking, investments, and credit. "0 2/ "finances !onetary resources0 funds, especially those of a government or corporate body" 3/ "The supplying of funds or capital." Finance as a function 4i.e. verb5 is defined by the same dictionary as under./"To provide or raise the funds or capital for"/ financed a new car 1/ "To supply funds to"/ financing a daughter through law school. 2/ "To furnish credit to". )nother #nglish +ictionary, ""ord6et * ..7, 8 .99:$rinceton ;niversity " defines the term as under./"the commercial activity of providing funds and capital" 1/ "the branch of economics that studies the management of money and other assets" 2/ "the management of money and credit and banking and investments" The same dictionary also defines the term as a function in similar words as under./ "obtain or provide money for0" " <an we finance the addition to our home="

1/"sell or provide on credit " )ll definitions listed above refer to finance as a source of funding an activity. In this respect providing or securing finance by itself is a distinct activity or function, which results in Financial !anagement, Financial Services and Financial Institutions. Finance therefore represents the resources by way funds needed for a particular activity. "e thus speak of finance only in relation to a proposed activity. Finance goes with commerce, business, banking etc. Finance is also referred to as "Funds" or "<apital", when referring to the financial needs of a corporate body. "hen we study finance as a sub>ect for generalising its profile and attributes, we distinguish between personal finance" and "corporate finance" i.e. resources needed personally by an individual for his family and individual needs and resources needed by a business organi?ation to carry on its functions intended for the achievement of its corporate goals. 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. "hile 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. ) 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. ) 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 comple& 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. These are briefly discussed below0 FINANCIAL MARKETS ) Financial !arket can be defined as the market in which financial assets are created or transferred. )s against a real transaction that involves e&change of money for real goods or services, a financial transaction involves creation or transfer of a financial asset. Financial )ssets 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. Forex Market - The Fore& market deals with the multicurrency requirements, which are met by the e&change of currencies. +epending on the e&change 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. Cre it Market- <redit market is a place where banks, FIs and 6%F<s purvey short, medium and longterm loans to corporate and individuals. Constit!ents o" a Financial System

FINANCIAL INTERMEDIATI#N (aving designed the instrument, the issuer should then ensure that these financial assets reach the ultimate investor in order to garner the requisite amount. "hen the borrower of funds approaches the financial market to raise funds, mere issue of securities will not suffice. )dequate 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. To serve this purpose, Financial interme iaries came into e&istence. Financial intermediation in the organi?ed sector is conducted by a widerange of institutions functioning under the overall surveillance of the Aeserve %ank 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. (owever, 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 include0 investment bankers, underwriters, stock e&changes, registrars, depositories, custodians, portfolio managers, mutual funds, financial advertisers financial consultants, primary dealers, satellite dealers, self regulatory organi?ations, etc. Though the markets are different, there may be a few intermediaries offering their services in move than one market e.g. underwriter. (owever, the services offered by them vary from one market to another. Interme iary Market Role

Stock #&change Investment %ankers ;nderwriters Aegistrars, +epositories, <ustodians $rimary +ealers Satellite +ealers Fore& +ealers FINANCIAL INSTR$MENTS Money Market Instr!ments

<apital !arket <apital !arket, <redit !arket <apital !arket, !oney !arket <apital !arket

Secondary !arket to securities <orporate advisory services, Issue of securities Subscribe to unsubscribed portion of securities Issue securities to the investors on behalf of the company and handle share transfer activity !arket making in government securities #nsure e&change ink currencies

!oney !arket Fore& !arket

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 below0 .. 1. 2. 3. B. <all@6otice !oney Treasury %ills Term !oney <ertificate of +eposit <ommercial $apers

%& Call 'Notice(Money Market <all@6otice money is the money borrowed or lent on demand for a very short period. "hen money is borrowed or lent for a day, it is known as <all 4Cvernight5 !oney. Intervening holidays and@or Sunday are e&cluded for this purpose. Thus money, borrowed on a day and repaid on the ne&t working day, 4irrespective of the number of intervening holidays5 is "<all !oney". "hen money is borrowed or lent for more than a day and up to .3 days, it is "6otice !oney". 6o collateral security is required to cover these transactions. )& Inter(*ank Term Money Inter-bank market for deposits of maturity beyond .3 days is referred to as the term money market. The entry restrictions are the same as those for <all@6otice !oney e&cept that, as per e&isting regulations, the specified entities are not allowed to lend beyond .3 days. +& Treas!ry *ills& Treasury %ills are short term 4up to one year5 borrowing instruments of the union government. It is an

IC; of the 'overnment. It is a promise by the 'overnment to pay a stated sum after e&piry of the stated period from the date of issue 4.3@9.@.D1@273 days i.e. less than one year5. 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. ,& Certi"icate o" Deposits <ertificates of +eposit 4<+s5 is a negotiable money market instrument nd issued in dematerialised form or as a ;sance $romissory 6ote, for funds deposited at a bank or other eligible financial institution for a specified time period. 'uidelines for issue of <+s are presently governed by various directives issued by the Aeserve %ank of India, as amended from time to time. <+s can be issued by 4i5 scheduled commercial banks e&cluding Aegional Aural %anks 4AA%s5 and ,ocal )rea %anks 4,)%s50 and 4ii5 select all-India Financial Institutions that have been permitted by A%I to raise short-term resources within the umbrella limit fi&ed by A%I. %anks have the freedom to issue <+s depending on their requirements. )n FI may issue <+s within the overall umbrella limit fi&ed by A%I, i.e., issue of <+ together with other instruments vi?., term money, term deposits, commercial papers and intercorporate deposits should not e&ceed .EE per cent of its net owned funds, as per the latest audited balance sheet. -& Commercial .aper <$ is a note in evidence of the debt obligation of the issuer. Cn issuing commercial paper the debt obligation is transformed into an instrument. <$ is thus an unsecured promissory note privately placed with investors at a discount rate to face value determined by market forces. <$ is freely negotiable by endorsement and delivery. ) company shall be eligible to issue <$ provided - 4a5 the tangible net worth of the company, as per the latest audited balance sheet, is not less than As. 3 crore0 4b5 the working capital 4fund-based5 limit of the company from the banking system is not less than As.3 crore and 4c5 the borrowal account of the company is classified as a Standard )sset by the financing bank@s. The minimum maturity period of <$ is : days. The minimum credit rating shall be $-1 of <AISI, or such equivalent rating by other agencies. 4for more details visit faculty column5 Capital Market Instr!ments The capital market generally consists of the following long term period i.e., more than one year period, financial instruments0 In the equity segment #quity shares, preference shares, convertible preference shares, non-convertible preference shares etc and in the debt segment debentures, ?ero coupon bonds, deep discount bonds etc. /y0ri Instr!ments

(ybrid instruments have both the features of equity and debenture. This kind of instruments is called as hybrid instruments. #&amples are convertible debentures, warrants etc. Concl!sion In India money market is regulated by Aeserve bank of India and Securities #&change %oard of India 4S#%I5 G regulates capital market. <apital market consists of primary market and secondary market. )ll Initial $ublic Cfferings 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 #&change. Secondary market comprises of equity markets and the debt markets. In the

secondary market transactions %S# and 6S# plays a great role in e&change of capital market instruments. 4visit and 5. (The author acknowledges Prof. R K Mishra, Director, Institute of Public Enterprise, s!ania "ni#ersit$, %$derabad, for his i!!ense help and encourage!ent through out this stud$ and Dr. & & & Ku!ar, 'ssistant Professor, (inance and 'ccounting 'rea, Indian Institute of Manage!ent, Ko)hikode, for his !oti#ation and inspiration*

Financial deepening and broadening: A well functioning financial system helps in promoting the process of financial deepening and broadening. Financial deepening refers to an increase of financial assets as a percentage of the gross domestic product. Financial broadening refers to building an increasing number and a variety of participants and instruments.

Read more: 0/0!/indian"financial" system.html#i$%%2i&'()*wr eaning and definition of financial system: +he financial system is possibly the most important institutional and functional vehicle for economic transformation. Finance is a bridge between the present and the future and whether the mobili%ation of savings or their efficient, effective and e-uitable allocation for investment, it the access with which the financial system performs its functions that sets the pace for the achievement of broader national ob.ectives. According to Christy, the ob.ective of the financial system is to /supply funds to various sectors and activities of the economy in ways that promote the fullest possible utili%ation of resources without the destabili%ing conse-uence of price level changes or unnecessary interference with individual desires.0 According to Robinson, the primary function of the system is / to provide a lin1 between savings and investment for the creation of new wealth and to permit portfolio ad.ustment in the composition of the e$isting wealth.

A financial system or financial sector functions as an intermediary and facilitates the flow of funds from the areas of surplus to the deficit. 2t is a composition of various institutions, mar1ets, regulations and laws, practices, money manager analyst, transactions and claims and liabilities. Features of financial system +he features of a financial system are as follows . Financial system provides an ideal lin1age between depositors and investors, thus encouraging both savings and investments. 2. Financial system facilitates e$pansion of financial mar1ets over space and time. 3. Financial system promotes efficient allocation of financial resources for socially desirable and economically productive purposes. &. Financial system influences both the -uality and the pace of economic development. CONSTITU NTS OF FINANCIA! S"ST # +he financial system consists of four segments or components. +hese are: financial institutions, financial mar1ets, financial services. . Financial institutions: Financial institutions are intermediaries that mobili%e savings 4 facilitate the allocation of funds in an efficient manner. Financial institutions can be classified as ban1ing 4 non"ban1ing financial institutions. 5an1ing institutions are creators of credit while non"ban1ing financial institutions are purveyors of credit. 6hile the liabilities of ban1s are part of the money supply, this may not be true of non"ban1ing financial institutions. 2n 2ndia, non"ban1ing financial institutions, namely, the developmental financial institutions 78F2s9 4 non"ban1ing financial companies 7:5F;s9 as well as housing finance companies 7<F;s9 are the ma.or institutional purveyors of credit. Financial institutions can also be classified as term"finance institutions such as the industrial development ban1 of 2ndia 728529, industrial credit 4 2nvestment ;orporation of 2ndia 72;2;29, industrial financial

corporation of 2ndia 72F;29, small industries development ban1 of 2ndia 7=28529 4 industrial investment ban1 of 2ndia 722529. $% Financial mar&ets: Financial mar1ets are a mechanism enabling participants to deal in financial claims. +he mar1ets also provide a facility in which their demands 4 re-uirements interact to set a price for such claims. +he main organi%ed financial mar1ets in 2ndia are the money mar1et 4 capital mar1et. +he first is a mar1et for short"term securities. >oney mar1et is a mar1et for dealing with financial assets 4 securities which have a maturity period of upto one year. 6hile the second is a mar1et for long term securities, that is, securities having a maturity period of one year or more. +he capital mar1et is a mar1et for financial assets which have a long or indefinite maturity. >oney mar1et consists of: Call money mar&et: ;all money mar1et is a mar1et for e$tremely short period loans say one day to fourteen days. 2t is highly li-uid. Commercial bills mar&et: 2t is a mar1et for bills of e$change arising out of genuine trade transactions. 2n the case of credit sale, the seller may draw a bill of e$change on the buyer. +he buyer accepts such a bill promising to pay at a later date the amount specified in the bill. +he seller need not wait until the due date of the bill. 2nstead, he can get immediate payment by discounting the bill. Treasury bills mar&et: 2t is a mar1et for treasury bills which have ?short"term@ maturity. A treasury bill is a promissory note or a finance bill issued by the government. 2t is highly li-uid because its repayment is guaranteed by the government. Short'term loan mar&et:

2t is a mar1et where short" term loans are given to corporate customers for meeting their wor1ing capital re-uirements. ;ommercial ban1s play a significant role in this mar1et. ;apital mar1et consists of: Industrial securities mar&et: 2t is a mar1et for industrial securities namely e-uity shares or ordinary shares, preference shares 4 debentures or bonds. 2t is a mar1et where industrial concerns raise their capital or debt by issuing appropriate instruments. 2t can be further subdivided into primary 4 secondary mar1et. (o)ernment securities mar&et: 2t is otherwise called gilt"edged securities mar1et. 2t is a mar1et where government securities are traded. 2n 2ndia there are many 1inds of govt securities" short"term 4 long"term. Aong"term securities are traded in this mar1et while short term securities are traded in the money mar1et. !ong'term loans mar&et: 8evelopment ban1s 4 commercial ban1s play a significant role in this mar1et by supplying long term loans to corporate customers. Aong"term loans mar1et may further be classified into: +erm loans mar1et >ortgages mar1et Financial guarantees mar1et 3% Financial Instruments: Financial instruments refers to those document which represents financial claims on assets. As discussed earlier, financial assets refers to a claim to the repayment of certain sum of money at the end of specified period together with interest or dividend. B$amples : bills of e$change, promissory notes, treasury bills, government bonds, deposit receipts, shares debentures etc.

Financial instruments can also be called financial securities. Financial securities can be classified into: i. Crimary or direct securities ii. =econdary or indirect securities. Primary securities +hese are securities directly issued by the ultimate investors to the ultimate savers. B$amples, shares and debentures issued directly to the public. Secondary securities +hese are securities issued by some intermediaries called financial intermediaries to the ultimate savers. B.g. unit trust of 2ndia and >utual funds issue securities in the form of units to the public and money pooled is invested in companies. Again these securities may be classified on the basis of duration as follows: i. =hort"term securities ii. >edium"term securities iii. Aong"term securities. =hort"term securities are those which mature within a period of one year. B.g. 5ills of e$change, treasury bills, etc. medium term securities are those which have a maturity period ranging between one and five years. e.g. 8ebentures maturing within a period of ! years. Aong"term securities are those which have a maturity period of more than five years. B.g. government 5onds maturing after 0 years.

Characteristic Features of Financial Instruments

'enerally spea1ing, financial instruments possess the following characteristic features: i. >ost of the instruments can be easily transferred from one hand to another without many cumbersome formalities. ii. +hey have a ready mar1et, i.e., they can be bought and sold fre-uently and thus, trading in these securities is made possible. iii. +hey possess li-uidity, i.e., some instruments can be converted into cash readily. For instance, a bill of e$change can be converted into cash readily by means of discounting and rediscounting. iv. >ost of the securities posses security value, i.e., they can be given as security for the purpose of raising loans. v. =ome securities en.oy ta$ status, i.e., investment in these securities are e$empted from income ta$, wealth ta$, etc., sub.ect to certain limits. B.g. public sector ta$ free bonds, magnum ta$ saving certificates. vi. +hey carry ris1 in the sense that there is uncertainty with regard to the payment of principle or interest or dividend as the case may be. vii. +hese instruments facilitates future trading so as to cover ris1s due to price fluctuations, interest rates, etc. viii. +hese instruments involve less handling costs since e$penses involved in buying and selling these securities are generally much less. i$. +he return on these instruments is directly in proportion to the ris1 underta1en. $. +hese instruments may be short"term or medium term or long term depending upon the maturity period of these instruments. &% Financial Ser)ices:

Financial intermediaries provide 1ey financial services such as merchant ban1ing, leasing hire purchases, credit"rating, and so on. Financial services rendered by the financial intermediaries bridge the gap between lac1 of 1nowledge on the part of investors and increasing sophistication of financial instruments and mar1ets. +hese financial services are vital for creation of firms, industrial e$pansion, and economic growth. 5efore investors lend money, they need to be reassured that it is safe to e$change securities for funds. +his reassurance is provided by the financial regulator, who regulates the conduct of the mar1et, and intermediaries to protect the investors@ interests. +he Reserve 5an1 of 2ndia regulates the money mar1et and =ecurities B$change 5oard of 2ndia 7=B529 regulates capital mar1et. FUNCTIONS OF FINANCIA! S"ST # (ood financial system search in the follo*ing *ays : +% ,romotion of li-uidity: +he ma.or function of financial system is the provision of money and monetary assets for the production of goods and services. +here should not be any shortage of money for productive ventures. 2n financial language, the money and monetary assets are referred to as li-uidity. +he term li-uidity refers to cash or money and other assets which can be converted into cash readily without loss of value and time. $% !in& bet*een sa)ers and in)estors: )ne of the important functions of financial system is to lin1 the savers and investors and thereby help in mobili%ing and allocating the savings effectively and efficiently. 5y acting as an efficient medium for allocation of resources, it permits continuous up gradation of technologies for promoting growth on a sustained basis. .% Information a)ailable:

2t ma1es available price" related information which is a valuable assistance to those who need economic and financial decision. /% 0elps in pro1ects selection: A financial system not only helps in selecting pro.ects to be funded but also inspires the operators to monitor the performance of the investment. 2t provides a payment mechanism for the e$change of goods and services, and transfers economic resources through time and across geographic regions and industries. 2% Allocation of ris&: )ne of most important function of the financial system is to achieve optimum allocation of ris1 bearing. 2t limits, pools, and trades the ris1s involved in mobili%ing savings and allocating credit. An effective financial system aims at containing ris1 within acceptable limit and reducing cost of gathering and analy%ing information to assist operators in ta1ing decisions carefully. 3% #inimi4es situations of Asymmetric information: A financial system minimi%es situations where the information is Asymmetric and li1ely to affect motivations among operators or when one party has the information and the other party does not. 2t provides financial services such as insurance and pension and offers portfolio ad.ustments facilities. 5% Reduce cost of transaction and borro*ing: A financial system helps in creation of financial structure that lowers the cost of transactions. +his has a beneficial influence on the rate of return to the savers. 2t also reduces the cost of borrowings. +hus , the system generates an impulse among the people to save more. 6% Financial deepening and broadening:

A well functioning financial system helps in promoting the process of financial deepening and broadening. Financial deepening refers to an increase of financial assets as a percentage of the gross domestic product. Financial broadening refers to building an increasing number and a variety of participants and instruments. 525A2)'RAC<D Financial >ar1ets and =ervices, 'ordon,, <imalaya Cublishing <ouse, &th revised edition, 200E.

Read more: 0/0!/indian"financial" system.html#i$%%2i&'Rd%>F