Financial Structure and Institutions

STRUCTURE OF INDIAN FINANCIAL SYSTEM

Financial structure refers to shape, components and
their order in the financial system.

The Indian financial system can be broadly

classified into formal (organized) financial system
and the informal (unorg anised) financial system.

The informal financial system consists of individual

money lenders, groups of persons operating as
funds or associations, partnership firms consisting
of local brokers, pawn brokers
 Financial System
 An institutional framework existing in a country to
enable financial transactions
 Three main parts
 Financial assets (loans, deposits, bonds,
equities, etc.)
Financial institutions (banks, mutual funds,

insurance companies, etc.)
Financial markets (money market, capital

market, forex market, etc.)
 Regulation is another aspect of the financial
system (RBI, SEBI, IRDA,)
DIAGRAMMATIC REPRESENTATION OF
INDIAN FINANCIAL SYSTEM
 FUNCTIONS OF FINANCIAL SYSTEM
 The financial system transfer resources across
time, sectors, and regions.
 The financial system manages risks for the
economy-(Fire Insurance)
 The financial system pools and subdivides
funds depending upon the need of the individual
saver or investor.
 Performs an important clearinghouse function,
which facilitates transactions between payers
and payees.
 Financial Assets/Instruments

Enable channelising funds from surplus units to deficit nits


There are instruments for savers such as deposits,
equities, mutual fund units, etc.

There are instruments for borrowers such as loans,
overdrafts, etc.

Like businesses, governments too raise funds through
issuing of bonds, Treasury bills, etc.

Instruments like PPF, KVP, etc. are available to savers
who wish to lend money to the government

 Major Financial Instruments

 Money
 Savings account
 Credit market Instruments-bonds, mortgages
 Common Stocks
 Money market funds and mutual funds
 Pension funds
 Financial Derivatives
The formal financial system comprises financial
institutions, financial markets, financial instruments
an d financial services
 FINANCIAL INSTITUTIONS

Financial institutions are the participants in a financial

market. They are business organizations dealing in
financial resources. They collect resources by
accepting deposits from individuals and institutions
and lend them to trade, industry and others. They buy
and sell financial instruments.
 Financial institutions classified as:-
a) Regulatory and financial institutions :
The two major Regulatory and Promotional Institutions in India
are Reserve Bank of India (RBI) and Securities Exchange Board of
India (SEBI).
 Both RBI and SEBI administer, legislate, supervise, monitor,
control and discipline the entire financial system.

 RBI is the apex of all financial institutions in financial

institutions are under the control of RBI .
 The financial markets are under the control of SEBI.
 Banking institutions
b) Banking institutions :-
-Banking institutions mobilize the savings
of the people.
-They provide a mechanism for the smooth
exchange of goods and services.
-Basic categories of banking institutions are
commercial banks, co-operative banks,
developmental banks
 Non banking financial institutions
- Nonbanking financial institutions also mobilize financial
resources directly or indirectly from the people.

-They lend funds but not create credit

-Companies like LIC, GIC, UTI, Development Financial

Institutions, Organisation o Funds etc. fall in this category.

-Nonbanking financial institutions can be categorized as

investment companies, housing companies, leasing
companies, hire purchase companies, specialized financial
institutions (EXIM Bank etc.) investment institutions, state
level institutions etc
FINANCIAL MARKETS
 FINANCIAL MARKETS
Financial market deals in financial securities (or
financial instruments) and financial services.
Financial markets are the centers or arrangements
that provide facilities for buying and selling of financial
claims and services.
These are the markets in which money as well as
monetary claims is traded in. Financial markets exist
wherever financial transactions take place. Financial
transactions include issue of equity stock by a company,
purchase of bonds in the secondary market, deposit of
money in a bank account, transfer of funds from a
current account to a savings account etc.
 FUNCTIONS OF FINANCIAL MARKETS
•To facilitate creation and allocation of credit and
liquidity.
•To serve as intermediaries for mobilization of savings
•To help in the process of balanced economic growth
•To provide financial convenience
•To cater to the various credits needs of the business
organizations.
•To provide information and facilitate transactions at low
cost
• Financial market can be classified in 2 on basis of maturity of claims
1.Money Market and
2.Capital Market

1.Money Market:
A market where short term funds are borrowed and lend is called
money market. It deals in short term monetary assets with a
maturity period of one year or less. Liquid funds as well as highly
liquid securities are traded in the money market.
Examples of money market are Treasury bill market, call money
market, commercial bill market etc.

2.Capital Market:
Capital market is the market for long term funds. This market deals
in the long term claims, securities and stocks with a maturity
period of more than one year. The stock market, the government
bond market and derivatives market are examples of capital
market.
• Financial market can be classified in 2 on basis of seasoning of
claim
1.Primary Market and
2.Secondary Market

1.Primary Market:
Primary markets are those markets which deal in the new
securities. Therefore, they are also known as new issue markets.
These are markets where securities are issued for the first time. In
other words, these are the markets for the securities issued
directly by the companies.

2.Secondary Market:
Secondary markets are those markets which deal in existing
securities. Existing securities are those securities that have already
been issued and are already outstanding. Secondary market
consists of stock exchanges.
• Financial market can be classified in 2 on basis of timing of
delivery:
1.Cash / Spot market and
2.Forward/Future market

1.Cash / Spot market:

This is the market where the buying and selling of
commodities happens or stocks are sold for cash and
delivered immediately after the purchase or sale of
commodities or securities.
2.Forward/Future market:
This is the market where participants buy and sell
stocks/commodities, contracts and the delivery of
commodities or securities occurs at a pre-determined time in
future.
• Financial Market is further classified into 2.
1. Foreign exchange market:
Foreign exchange market is simply defined as a market in which
one country’s currency is traded for another country’s
currency. It is a market for the purchase and sale of foreign
currencies.
1. Derivatives market:
The derivatives are most modern financial instruments in
hedging risk. The individuals and firms who wish to avoid or
reduce risk can deal with the others who are willing to accept
the risk for a price. A common place where such transactions
take place is called the derivative market.
The important types of derivatives are forwards, futures,
options, swaps, etc.
COMPONENTS OF MONEY MARKET
1. Call money:
Call Money is required mostly by banks. Commercial banks
borrow money without collateral from other banks to maintain
a minimum cash balance known as cash reserve ratio (CRR). This
interbank borrowing has led to the development of the call
money market.
Call money market is the market for very short period loans. If
money is lent for a day, it is called call money. If money is lent
for a period of more than one day and upto 14 days is called
short notice money.
•Participants or Players in the Call Money Market are Scheduled
commercial banks and RBI, Non-Scheduled commercial banks,
Co-operative banks, Foreign banks, Discount and Finance House
of India, Primary dealers
2. Commercial bill market:
Commercial bill market is another segment of money market. It is
a market in which commercial bills (short term) are bought and
sold.
Commercial bill are widely used in both domestic and foreign
trade to discharge the business obligations.
There are specialized institutions known as discount houses for
discounting commercial bills accepted by reputed acceptance
houses.

3. Treasury Bills Market:

Treasury bill market is a market which deals in treasury bills.
In this market, treasury bills are bought and sold. Treasury bill is an
important instrument of short term borrowing by the Govt.
Treasury Bills are the promissory notes or a kind of finance bill
issued by the Govt. for a fixed period not extending beyond one
year. Treasury bill is used by the Govt. to raise short term funds
for meeting temporary Govt. deficits.
 FUNCTION OF PRIMARY MARKET
1.Origination: Origination refers to the work of investigation,
analysis and processing of new project proposals. The function of
origination is done by merchant bankers who may be commercial
banks.

2.Underwriting: The act of ensuring the sale of shares or

debentures of a company even before offering to the public is called
underwriting. It is a contract between a company and an
underwriter (individual or firm of individuals) by which he agrees to
undertake that part of shares or debentures which has not been
subscribed by the public.

3.Distribution: This is the function of sale of securities to ultimate

investors. This service is performed by brokers and agents. They
maintain a direct and regular contact with the ultimate investors.
 METHODS OF RAISING FUND IN THE
PRIMARY MARKET (METHODS OF FLOATING
NEW ISSUES)
• Public Issue:
Under this method, the company invites subscription from
the public through the issue of prospectus (and issuing
advertisements in news papers). On the basis of offer in the
prospectus, the investors apply for the number of securities
they are willing to take.
Initial Public Offering (IPO): This is an offering of either a fresh
issue of securities or an offer for sale of existing securities or
both by an unlisted company for the first time in its life to
the public.
Follow-on Public Offering (FPO): This is an offer of sale of
securities by a listed company.
• Offer for Sale Method:
Under this method, instead of offering shares directly to the
public by the company itself, it offers through the intermediary
such as issue houses / merchant banks / investment banks or
firms of stock brokers.
The issuing company sells the shares to the intermediaries such
as issue houses and brokers at an agreed price. And then the
intermediaries resell the securities to the ultimate investors at a
market related price. This price will be higher. The difference
between the purchase price and the issue price represents
profit for the intermediaries.
• Private Placement of Securities:
Private placement is the issue of securities of a company direct
to one investor or a small group of investors. Generally the
investors are the financial institutions or other existing
companies or selected private persons such as friends and
relatives of promoters.
Thus, private placement refers to the direct sale of newly issued
securities by the issuer to a small number of investors through
merchant bankers.

• Right Issue
Right issue is a method of raising funds in the market by an
existing company. Under this method, the existing company
issues shares to its existing shareholders in proportion to the
number of shares already held by them.
 CHARACTERISTICS OF A STOCK EXCHANGE
1. It is an organized capital market.
2. It may be incorporated or non-incorporated body
(association or body of individuals).
3. It is an open market for the purchase and sale of securities.
4. Only listed securities can be dealt on a stock exchange.
5. It works under established rules and regulations.
6. The securities are bought and sold either for investment or
for speculative purpose.
 DISTINGUISH BETWEEN MONEY MARKET
AND CAPITAL MARKET
Money market
1.Short term funds
2.Operational/WC needs
3.Instruments are: bills, CPs,
T-bills, CDs etc.,
4.Huge face value for single
instrument
5.Central and coml. banks are
major
players
6.No formal place for transactions
7.Usually no role for brokers
Capital market
1. Long term funds
2. FC/PC requirements
3. Shares, debentures, bonds etc.,
are
main instruments in capital market
4. Small face value of securities
5. Development banks, investment
institutions are major players
6. Formal place, stock exchanges
7. Brokers playing a vital role
Financial Instruments
 FINANCIAL INSTRUMENTS
• Financial instruments are the financial assets, securities and
claims.
• They may be viewed as financial assets and financial liabilities.
1.Financial assets:
represent claims for the payment of a sum of money sometime
in the future (repayment of principal) and/or a periodic
payment in the form of interest or dividend.
2.Financial liabilities:
are the counterparts of financial assets. They represent
promise to pay some portion of prospective income and
wealth to others.
 TYPES OF FINANCIAL INSTRUMENTS
• The financial instruments may be capital market instruments or
money market instruments or hybrid instruments.
• Capital Market Instruments:
Financial instruments that are used for raising capital through
the capital market. It includes include equity shares,
preference shares, warrants, debentures and bonds.
• Money Market Instruments:
financial instruments that are used for raising and supplying
money in a short period not exceeding one year through
money market are called money market instruments.
It includes treasury bills, commercial paper, call money, short
notice money, certificates of deposits, commercial bills, money
market mutual funds.
 MONEY MARKET INSTRUMENTS
1. Call and Short Notice Money
These are short term loans. Their maturity varies between one
day to fourteen days. If money is borrowed or lent for a day it
is called call money or overnight money. When money is
borrowed or lent for more than a day and up to fourteen
days, it is called short notice money.
2. Commercial Bills
A bill of exchange contains a written order from the creditor
(seller) to the debtor (buyer) to pay a certain sum, to a certain
person after a certain period.
According to Negotiable instruments Act, 1881, a bill of exchange
is ‘an instrument in writing containing an unconditional order,
signed by the maker, directing a certain person to pay a certain
sum of money only to, or to the order of a certain person or to
the bearer of the instrument’.
3. Treasury Bill
Treasury bills are credit instruments used by the Govt. to raise
short term funds to meet the budgetary deficit. Treasury bills
are popularly called Tbills.
These are negotiable instruments. Hence, these are freely
transferable.

4. Certificate Of Deposit
CD is a certificate in the form of promissory note issued by banks
against the short term deposits of companies and institutions,
received by the bank.
It is payable on a fixed date. It has a maturity period ranging from
three to twelve months.
5. Commercial Paper
• It is a finance paper like Treasury bill. It is an
unsecured, negotiable promissory note.
• It has a fixed maturity period ranging from three
to six months. It is generally issued by leading,
nationally reputed credit worthy and highly rated
corporations.
•It is quite safe and highly liquid.
•It is issued in bearer form and on discount. It is also
known as industrial paper or corporate paper.
CAPITAL MARKET INSTRUMENTS

• DEEP DISCOUNT BONDS

A bond that sells at a significant discount from par value and has
no coupon rate or lower coupon rate than the prevailing rates of
fixed-income securities with a similar risk profile. They are
designed to meet the long term funds requirements of the issuer
and investors who are not looking for immediate return and can
be sold with a long maturity of 25-30 years at a deep discount on
the face value of debentures.

• SWEAT EQUITY
Sweat equity usually takes the form of giving options to
employees to buy shares of the company, so they become part
owners and participate in the profits, apart from earning salary.
• FOREIGN CURRENCY CONVERTIBLE BONDS(FCCBs)
A convertible bond is a mix between a debt and equity
instrument. It is a bond having regular coupon and principal
payments, but these bonds also give the bondholder the
option to convert the bond into stock. FCCB is issued in a
currency different than the issuer's domestic currency.

• DERIVATIVES
A derivative is a financial instrument whose characteristics and
value depend upon the characteristics and value of some
underlying asset typically commodity, bond, equity, currency,
index, event etc.
• GLOBAL DEPOSITORY RECIEPT / AMERICAN DEPOSITORY
RECIEPT
A negotiable certificate held in the bank of one country
(depository) representing a specific number of shares of a
stock traded on an exchange of another country. GDR facilitate
trade of shares, and are commonly used to invest in
companies from developing or emerging markets.
However a company may get listed on these stock exchanges
indirectly – using ADRs and GDRs. If the depository receipt is
traded in the United States of America (USA), it is called an
American Depository Receipt, or an ADR. If the depository
receipt is traded in a country other than USA, it is called a
Global Depository Receipt, or a GDR.
• EQUITY SHARES WITH DETACHABLE WARRANTS
A warrant is a security issued by company entitling the holder to
buy a given number of shares of stock at a stipulated price
during a specified period. These warrants are separately
registered with the stock exchanges and traded separately.
Warrants are frequently attached to bonds or preferred stock as a
sweetener, allowing the issuer to pay lower interest rates or
dividends.
• FULLY CONVERTIBLE DEBENTURES WITH INTEREST
This is a debt instrument that is fully converted over a specified
period into equity shares. The conversion can be in one or
several phases. When the instrument is a pure debt instrument,
interest is paid to the investor. After conversion, interest
payments cease on the portion that is converted.