FINANCIAL SYSTEM

The term financial system includes a

complex of institutions and mechanisms
which affect the generation of savings
and their transfer to those who will
invest.
FEATURES OF THE FINANCIAL
SYSTEM
 Ideal linkage between depositors and investors
 Facilitates expansion of financial markets
 Promotes efficient allocation of financial
resources for socially desirable and
economically productive purposes
 Influences both the quality and the pace of
economic development
 Financial Institutions
Funds Funds
Commercial banks
Deposits/ Insurance Cos
Loans
shares Mutual Funds
Provident Funds
Non Banking Financial Cos

Suppliers of Funds Demanders of funds

Individuals
Individuals
Businesses
Businesses
Governments
Governments

Funds Financial Markets Funds

Securities Money Market Securities

Capital Market
 The institutions include

1. Financial institutions / intermediaries like

banks, insurance org., mutual funds and so
on which collect capital from savers and
distribute them to entrepreneurs/ productive
enterprises.
2. Financial markets comprising of capital
/securities market , the money market and the
foreign exchange market
3. Financial assets/instruments like shares,
debentures, units etc
The main function of financial systems
is the collection of savings and their
distribution for industrial investment,
thereby stimulating capital formation
and to that extent accelerating the
process of economic growth
 ORGANISATION OF THE FINANCIAL SYSTEM

FINANCIAL ASSETS/
FINANCIAL
FINANCIAL MARKETS
INTERMEDIARIES
INSTRUMENTS
 FINANCIAL
INTERMEDIARIES

BANKS NBFC’s MUTUAL FUNDS INSURANCE COS

1. Leasing Companies
2. Hire purchase/Consumer Finance Cos
3. Housing Finance Cos
4. Venture Capital Funds
5. Merchant Banking Organisations
6. Credit Rating Agencies
7. Factoring and Forfeiting organisations
8. Stock Broking Firms
9. Depositories
 FINANCIAL
INTERMEDIARIES
Their relevance to the flow of savings is derived
from what is called the TRANSMUTATION
EFFECT.
Transmutation refers to the ability of the
financial intermediaries to convert contracts
with a given set of characteristics into
contracts with different features.
 FINANCIAL
INTERMEDIARIES
The services that tailor financial assets to the desires of
savers- investors are:
1. Convenience
 Divisibility
 Maturity
2. Lower Risk
 Diversification eg. Mutual Funds
3. Expert management
 Benefits of trained, experienced and specialised mgt along
with continuous supervision
4. Economies of scale
 Lower cost
 Main financial intermediaries
 Commercial Banks
 NBFC
 Mutual Funds
 Insurance Organisations
 Commercial Banks

Traditional practice
 Short term funds for working capital needs

Emerging needs of economic and financial system

 Term lending particularly in infrastructure sector
 Capital market
 Retail finance such as housing finance, consumer
finance etc
 Enlarged their geographical and functional coverage
in terms of rural/ agriculture and other priority sector
financing like exports, small enterprises etc.
 NBFC
 Provide a variety of fund/asset based and non fund
based /advisory services
Types of services
 Leasing Companies
 Hire purchase/Consumer Finance Cos
 Housing Finance Cos
 Venture Capital Funds
 Merchant Banking Organisations
 Credit Rating Agencies
 Factoring and Forfeiting organisations
 Stock Broking Firms
 Depositories
 Mutual Funds

 Pools the savings of relatively small

investors and invest in a well diversified
portfolio of sound invt.
 A mutual fund is set up in the form of a trust
which has
1. A Sponsor
2. Trustees
3. Asset Management Company (AMC)
4. Custodian
 Insurance Organisations

 Protection against risk

 Contractual Nature contributes to mobilisation of
funds as it tends to commit the policyholder
 Desire to save due to
1. Emergency fund to guard his family
2. Build a potential family estate
3. Accumulation of fund for retirement
 Peculiar combination of savings and family
protection
 FINANCIAL MARKETS

Money Market Capital/ Securities Market

Primary /New Issue Secondary /Stock

Market Market/Exchange
 FINANCIAL MARKETS

A link between the savers and investors both

individual as well as institutions
 FINANCIAL MARKETS
Based on the nature of the funds which are stock
in trade, the financial markets are classified
into

 Money Market
 Capital Market
 Money Market
 Dealing in monetary assets of short term
nature ie namely working capital finance
 Major participants are
1. RBI
2. Commercial Banks
 Money Market
The broad objectives are
1. Equilibrium for balancing out short term surpluses and
deficiencies
2. Focal point for intervention by RBI for influencing liquidity
3. A reasonable access to the users of short term funds at
reasonable cost
Egs- Commercial paper market, Treasury bills market,
Certificate of deposit market etc
Negotiated dealing system (NDS) is an electronic platform for
facilitating dealing in Govt. Securities and Money Market
Instruments
 Capital
Market

Primary Secondary
Market/ New Stock Market
Issue Market /Exchange
 Capital Market

1. Primary market / New Issue Market (NIM)

 Capital formation takes place
 Triple function
1. Origination
2. Underwriting
3. Distribution
2. Secondary Stock Market /Exchange (SE)
 Market for old/existing securities

 Three Vital functions

1. Nexus between savings and investments
2. Liquidity to investors
3. Continuous price formation
 FINANCIAL ASSETS/

INSTRUMENTS

Primary /Direct Indirect Derivatives

Equity/Ordinary Innovative Debt

Preference Shares Debentures
Shares instruments

Forward Futures Options

1. Mutual Fund Units

1. Convertible debenture
2. Security Receipts
2. Non convertible deb
3. Pass Through
3. Secured Premium Notes
Certificates
4. Warrants
 FINANCIAL ASSETS/
INSTRUMENTS
 Direct / Primary
 Indirect
 Derivatives
 Direct / Primary
1. Ordinary / equity shares
2. Preference Shares
3. Debentures/ bonds including innovative debt
instruments
 Innovative debt instruments
 Participating Debentures
 Convertible Debentures with options
 Third party convertible debentures
 Convertible debentures redeemable at premium
 Debt Equity swaps
 Zero coupon convertible notes
 Zero interest fully convertible debentures
 Warrants either with equity or debentures
 Fully convertible debentures with interest (Optional)
 Indirect Securities
 Financial assets issued by financial
intermediaries
1. Units of Mutual Funds
2. Policies of insurance cos
3. Deposits of banks etc
 Better suited to small investors
 Derivatives/Derivative instrument
 Used to partially/ fully transfer price risks by
locking in asset prices.
 Derivative is a product whose value is derived
from the value of one/more basic variables
called base( underlying asset/index/reference
rate) in a contractual manner
 Derivatives/Derivative instrument
The most commonly used derivative contracts are:
 Forward Contract
 An agreement to exchange an asset, for cash, at a
predetermined future date specified today
 Not typically tradeable and has to be settled by delivery of asset
 Futures/ Future contract
 They are transferable specific delivery forward contracts.
 They are agreement between two counterparties to fix the terms
of an exchange/lock in price today of an exchange that will take
place between them at some fixed future date.
 Options
Options are contracts that give the holder the right (but
not the obligation) to buy (call option) or sell (put option)
securities at a pre determined price (strike /exercise price)
within /at the end of a specified period (expiration period)
INDIAN FINANCIAL SYSTEM
INDIAN FINANCIAL SYSTEM
The evolution of the Indian Financial system falls into
three distinct phases
1. Up to 1951,corresponding to the post independence
scenario, on the eve of the initiation of planned
economic development.
2. Between 1951 and the mid eighties reflecting the
imperatives of planned economic growth
3. After the early nineties responding to the
requirements of liberalised/deregulated/globalised
economic environment.
 PHASE I
PRE -1951 ORGANISATION
Features
 Closed circle character of industrial entrepreneurship
 A semi organised and narrow industrial securities
market
 Devoid of issuing institutions
 Virtual absence of participation of intermediary
financial institutions in the long term financing of the
industry
 PHASE II
1951 TO MID-EIGHTIES
Features
1. Public/ Government ownership of financial
institutions
2. Fortification of the institutional structure

3. Protection to investors

4. Participation of financial institutions in

corporate management
 Public/ Government ownership of
financial institutions
 Nationalisation of the RBI in 1948
 Setting up of SBI in 1956 by taking over Imperial Bank of
India
 245 Life insurance cos were nationalised and merged with LIC
 14 Major Banks were nationalised in 1969
 GIC in 1972
 6 more banks were nationalised in 1980
 DFIs / term lending institutions were set up
 UTI was created
 The entire instutional structure was owned and controlled by
Government.
 Fortification of the institutional
structure
Establishment of
 DFIs and financial lending institutions
 Industrial Finance Corporation of India (IFCI) in 1948
 State Financial Corporation
 Industrial Credit and Investment Corporation of India (ICICI) in 1955
 Pioneer in many aspects like underwriting of shares, channelisation of foreign
currency loans from World Bank to private industry etc
 Industrial Development Bank of India (IDBI) in 1964 as a subsidiary of
RBI and was delinked in 1976
 Small Industrial Development Bank of India as a subsidiary of IDBI
 LIC in 1956
 UTI in 1964
 Diversification in forms of financing of
commercial banks such as Term Lending,
underwriting of new issues.
 Enlargement of functional coverage
 Protection to investors
Enactment of
1. Companies Act of 1956

2. Capital Issues (control) Act, 1947

3. Securities Contracts (Regulation) Act, 1956

4. Monopolies and Restrictive Trade Practices

Act, 1970
5. Foreign Exchange Regulation Act (FERA),
1973
 Phase II- Organisation of Indian Financial System

Public/Govt. Fortification of Investor Protection

Ownership of Institutional
Financial Structure
Institutions Companies Foreign
Act Exchange
Reglulation
Nationalisation
Capital Issues Act
of:
New (Control) Act
RBI
Institutions
SBI
DFIs Securities
LIC
UTI Contracts Participation by
Banks
(Regulations) Act Financial
GIC
Institutions
Banks: Monopolies In
DFIs:
1.Diversification And Restrictive Corporate
IFCI
Of forms of Trade Practices Management
SFCs
Financing Act
ICICI
2. Enlargement LIC UTI
IDBI
of functional
SIDCs
Coverage
SIICs
3. Innovative
IIBI
 NOTABLE DEVELOPMENTS
POST 1991
 Privatisation of financial institutions
 Reorganisation of institutional structure
 Investor protection
 Post 1991 Phase Organisation of the Indian Financial System

Privatisation of Re organisation of Structure

Financial
Institutions
1. Banks
2. Mutual Funds
3. Insurance DFIs Mutual Capital Money Investor
Banks NBFCs
companies PFI’s funds Market market Protection
SEBI

Stock
Primary
Exchange
 Privatisation of financial institutions
 Conversion of Industrial Finance Corporation of
India in to a public company. (IFCI Ltd.)
 IDBI and IFCI offered equity to public investors
 Pvt. mutual funds set up
 Pvt. Banks have come up
 With the enactment of IRDA, 1999 pvt. Insurance
Cos set up by both domestic and foreign promoters
 Establishment of Pension Fund Regulation and
Development Authority, pvt. Entities are posed to
enter this field.
 Reorganisation of institutional
structure
 Development/Public Financial Institutions
1. Greater reliance of industry on capital market.
2. Giving core working capital to industry in addition to traditional
loan
3.Growing focus on non fund based financial activities like
merchant banking etc
4. Pattern of financing changed
5. Change in the nature of institutions sponsored from TCO, MDI to
CRISIL, CARE,ICRA
6. Extension of internationally accepted accounting std has
improved the bottomline
7. With conversion of ICICI Ltd and IDBI into banks, DFI’s and
PFI’s have disappeared.
 Commercial Banks
 Geographically wide and functionally diverse
banking system
 But gross profits progressively declined
 Factors affecting Profitability

Macro aspects of Envt. Internal Factors

Couldn’t cope with
Interest on SLR load of servicing more
very low branches
Credit to priority sector Diluted the quality of
resulted in deterioration in manpower
quality and growth of over dues Accounting practices not
Political and adm. in conformity with
interference international stds.
Escalation in interest cost Lack of autonomy
 NBFCs
 Fund based activities
 Hire purchase
 Bills discounting

 Venture capita

 Stock broking

 Loans/investments

 Equipment leasing
 Fee based/advisory services
 Issue management
 Portfolio management

 Loan /lease syndication

 Merging and acquisition

 Main elements of regulation
1. Chapter III B of the RBI Act amended in 1998
2. RBI Acceptance of Deposits Regulations, 1998
3. NBFCs Prudential Norms (RBI) Directions, 1998
4. NBFCs Auditor Reports (RBI) Directions , 1998
5. RBI has set up Department of Non Banking
Supervision which undertakes both on site and off
site surveillance over the institutions
 Mutual Funds
 A remarkable development post 1991
 Vehicle for institutionalisation of security
invts for the relatively small investors
 Domestic mutual funds sponsored by UTI,
bank subsidiaries, insurance organisations,
private sector with foreign collaboration and
foreign institutional investors/ merchant banks
 Several off shore/overseas/country funds
sponsored by Indian Financial institutions as
well as Foreign institutional investors
 A variety of schemes focusing on income
 Capital/Securities Market
 Dormant till mid 1980s
 After that it has emerged as the most important
mechanism for allocating resources
 Shown by rapid expansion in quantum of funds raised
 the number of investors in primary market

 Increase in number of stock exchanges and listed

securities
 Speedy rise in market capitalisation and volume of
trade
 Entry of FIIs and mutual funds
 Capital Market

Primary Secondary
Market Market
 Primary Market
 New Issue Market
 One component of the organisation, namely, the
market intermediaries comprise of
 Specialist merchant banks/ lead manager
 Underwriters

 Bankers to an issue

 Registrars to an issue

 Share transfer agents

 Porfolio managers

 Brokers, FIIs etc

 Rigorous compliance to SEBI

 Secondary Market
 A few stock exchanges , dominated by Bombay
Stock Exchange provided the trading platforms
for secondary market transactions
 NSE introduced Screen based trading in 1992
 The Depositories Act, 1996- Central Depository
services Ltd(CDSL) and National Securities
Depository Ltd.(NSDL) were set up
 Successful dematerialisation of shares upto 99
percent of total market capitalisation
 Shortening of settlement cycle from 14 days
to T + 2
 Introduction of securities related derivatives
 FIIs have been allowed to invest in India
 Money Market
 Sophisticated and articulate money market has
emerged
 Emergence of specialised institutions – Primary
Dealers and money market mutual funds
 Consists of inter related sub markets
 Call/notice mkt, Commercial bills mkt, T-bills mkt,
Commercial paper mkt, Certificates of deposits
market and Repo market
Protection of investors: Securities
and Exchange Board of India
 The Capital Issues (Control) Act was repealed
in 1992
 The office of the Controller of Capital Issues
was abolished
 SEBI was set up in 1988
 Mandate of SEBI
1. Protect the interest of the investors in
securities
2. Promote the development of the securities
market
3. Regulate the securities market
 SEBI exercises power under
 The SEBI Act
 Securities Contract s(Regulation) Act
 Depositories Act
 The delegated powers under the Companies
Act
The SEBI regulates and supervises the securities
markets through 1. regulation 2. guidelines and
schemes
FINANCIAL MARKET
 FINANCIAL MARKET

Capital Market Money Market

 Capital Market

Primary Market/ Secondary Market/

New Issue Market Stock Exchange
Two stages are involved in purchase
and sale of securities
First stage- Securities are acquired from the issuing
companies

Second stage- Purchased and sold continuously among

investors without involvement of the companies
except for registering ownership

The section of the market dealing with first stage is

referred to as the NIM, while the secondary market
covers the second stage of the dealings in securities
Difference between Stock Exchange
and Primary Market
 New Issue Stock Exchange
Market
1 Types of New Existing/ old
security
2 Nature of Direct Indirect
Financing
3 Organisation No Physical
geographical existence
existence
4 Functions Specialist Nexus
institutional between savings
triple services and investments
Origination Market place

Underwriting Continuous
 Similarities between NIM and the
stock exchanges
 Stock exchange Listing
 Stock Exchange exercise considerable control
over new issues
 Economic Interdependence – Has two
dimensions
 Behaviour of Stock Exchange has significant
bearing on the level of activity in the NIM
 Prices of new issues are influenced by the price
movements on the stock market
 Functions of Stock/Secondary
Markets/ Exchanges
1. Nexus between Savings and Investments
2. Market Place
3. Continuous price formation
 Nexus between Savings and
Investments
 Savings of the community are mobilised and channelled
by stock exchanges for investment into those sectors and
units which are favoured by the community
 Stock Exchanges render this service thru new issues and
sale of existing securities
 Ensures that the various listing rules are complied with
 Members of stock exchange help by acting as
 As brokers – try to procure invts from all over the country
 As underwriters
 Market Place
 Provide market place for purchase and sale of
shares thereby ensuring transferability
 Continuous price formation
 Large number of buyers and sellers has the
effect of bringing about changes in the levels
of security prices in small graduations
 Ever changing demand and supply conditions
result in continuous revision of assets
 Stock exchanges act as a barometer of the state
of health of the nations economy , by
constantly measuring its progress or otherwise
 Functions of New Issues/ Primary
Market
 Transfer of resources from sav ers to entrepreneurs
 Is a complex set of institutions thru which funds can
be obtained directly or indirectly by those who
require the, from investors have savings
 The Securities issued by the company for the first
time either after the incorporation or conversion from
Private to Public companies are designated as initial
issues, while those issued by cos which already have
stock exchange quotation either public issue or by
rights to existing shareholders, are referred to as old
 Two types of issues are excluded
from the category of new issues
 Bonus issues
 Exchange issues by which shares are
exchanged for securities in another co.
General function of NIM can be split
into three services
 Origination
 Underwroters
 Distribution
 Origination
 Refers to the work of investigation as analysis
and processing of new proposals
 Are performed by specialist agencies which act
as the sponsors of issues
 A careful study of technical, economic , financial
and legal aspects of the issuing companies
 In this process, the sponsoring institutions render
some services of an advisory nature which go to
improve quality of capital issues
 Services include
 Determination of the class of security to be
issued and prices of the issues in the light of
market conditions
 The timing and magnitude of issue
 Methods of floatation
 Technique of selling etc
 Underwriting
 A form of guarantee that issues would be sold
by eliminating the risk arising from
uncertainty of public response
 Distribution
 The sale of securities to the ultimate investors
is known as distribution
 Issue Mechanism
 Public issue through prospectus
 Tender / Book building
 Offer for sale
 Placement
 Rights issue
 Public issue through prospectus
 Issuing companies offer directly to the public
 Issues are underwritten
 Minimum contents of a issue are prescribed by
the Companies Act, 1956.
 FINANCE

FINANCIAL FINANCIAL
MANAGEMENT SERVICES
Financial Management is concerned with duties of the financial managers in
the business firm who perform varied tasks such as
•Budgeting
•Financial forecasting
•Cash management
•Credit management
•Investment analysis etc