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INDIAN FINANCIAL SYSTEM:

INTRODUCTION:
Well organized financial system supports economic development
of the country. Financial system is the system which supplies financial inputs for
the production of goods and services to promote the well being and standard of
living of the people of a country.
Financial system is the broader term which includes Financial
Market and Financial Institutions which support
the system of providing financial inputs for production and productivity. The major
assets traded in the Financial market
are Money and monetary Assets. The responsibility
of financial market is to mobilize the savings in the forms of money and
monetary assets and invest them in to the productive venture for overall economic
development of the nation.
The study of the above reveals that the financial system
acts as mediator between saver and investors
to promote faster economic development.

Functions of Indian Financial System:


Provision of Liquidity
Mobilization of Savings

Concepts used in Indian Financial System.


Financial Assets.
Financial Intermediaries
Financial Markets
Financial Rate of Return
Financial Instruments.

Financial Assets:
Financial assets are those which are used for
Production or consumption or for further creation of assets. Financial assets are
different from physical assets as physical assets are not useful for further production
of goods or for earning income.
Classification of Financial Assets:
A: Marketable Assets B: Non-Marketable Assets
a. Shares a. Bank Deposits
b. Government Securities b. Provident Fund
c. Bonds c. LIC Schemes
d. MFs d. PO Certificates

Financial Intermediaries;
These are the organizations which intermediate and facilitate
financial transaction for both individuals
and companies. Therefore, financial intermediaries
are financial institutions and investing institutions
to facilitate financial transactions in financial markets which may be organized or un-
organized.
Classification of financial Intermediaries:
Capital Market intermediaries : Financial corporation/LIC
Money Market Intermediaries. : Commercial banks/Co-
operative banks

Financial Markets:
The Places where financial transactions take place. Therefore, financial
market may be centre or arrangement which
facilitates buying and selling of financial assets.
Classification of Financial Markets:
a. Unorganized Market
b. Organized Market
Organized Market:
In this market, standardized rules and regulation exists
to govern the financial dealings of participants.
These markets are under direct control of RBI and other regulatory bodies.
Classification of Organized market:
a. Capital Market
b. Money Market

CAPITAL MARKET:
This is the market for financial assets which have
a long and indefinite maturity. Hence, this market deals with long term securities.
Capital market is again divided in to three types, viz,
a. Industrial Securities Market
b. Government Securities Market
c. Long Term Loan Market

Long Term Loan market:


Term Loan market
Market for Mortgage
Market For Financial guarantees
Industrial Securities Market:
Primary Market
Secondary Market

Primary Market:
It is new issue market which deals with those securities
which are issued to the public for the first time and borrower issues new
securities for long term funds. This market facilitate capital formation.
Company raises capital in primary Market in three ways;
a. Public Issue (IPO)
b. Right Issue
c. Private Placement.

Instruments in Primary Market:


SPN (Secured Premium Note)
Equity Share
Preference Share
Debentures
Zero Interest Bond
Deep Discount Bond
Option Bond
Bonds with Warrants.

Players in the Primary Markets:


Merchant Bankers
Registrars
Collecting and co-coordinating Bankers
Underwriters and Brokers
Advertising Agency.

Functions of New Issue Market:


Origination
Underwriting
Distribution.
Regulations of New Issue Market:
Company must have been registered under the Companies act;1956

Company must have obtained the permission from the comptroller of Capital Issue.

Company must have appointed Bankers and Underwriter for the issue

Company must have been listed in the recognized Stock Exchange in India

Company must have raised the minimum issue within the prescribed period.

Company will have to attach the Prospectus with every application


for Share Subscription.

Company shall have to return the share money deposited by


the public in the collection centre if share are not allotted within the prescribed
period.

Allotment shall have to be made as per the direction of the SEBI.

Issue of shares will be only at par if the Company is completely new one.

Issue of shares by new company established by existing


company (with 5 year Track record) can freely issue shares at premium

Private and closely held company shall be permitted to price their issue freely.

Existing listed company will be allowed to raise fresh


capital by freely pricing issue provided promoter’s contribution is 50% on 1st
100 Corers, 30% on next 100 corers and 15% on the balance issue.

SECONDARY MARKET:
Introduction:
The market where existing securities are traded is
referred to Secondary Market or Stock Market. In this market, purchases and
sale of securities of Government, semi-government,
public bodies and Shares and Debentures of Joint stock Companies are effected.
The securities of Government are traded in the stock market as a separate
component called Guilt Edged market. Another
component of stock market deals with stock
and share of joint stock companies called market for stock and shares or STOCK
MARKET.

Definition of Stock Exchange:


As per SCR Act,1956 “ A Stock Exchange is an association, organization or body
of individuals whether incorporated or not, established for the purpose of assisting,
regulating and controlling business in buying, selling and dealing in securities”
From the above definition, it is clear that the stock exchange is not involved in
buying and selling of securities. It establishes set of rules which must be followed
by all the participants in buying and selling of securities to systematize and
control the trading process.

Functions of Stock Exchange:


It provides liquidity and Marketability of securities
It provides safety of funds
It helps to supply long term funds
It helps to provide flow of capital to profitable venture.
It motivates to improve performance
It promotes investment
It reflects the Economic conditions of the country
It provides information of continuous price movement of stock in the market.
It helps investors to take suitable decision for investment or withdrawal.

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, FMC)
Financial Institutions
Includes institutions and mechanisms which
Affect generation of savings by the community
Mobilisation of savings
Effective distribution of savings
Institutions are banks, insurance companies, mutual funds- promote/mobilise savings
Individual investors, industrial and trading companies- borrowers
FINANCIAL SYSTEM
It is an orderly mechanism and structure that is
available in an economy to mobilize the
monetary resources/capital from various surplus
sectors of the economy and allocate and distribute the same to various needy sectors.
The term financial system is a set of inter-related
activities/services working together to achieve
some predetermined purpose or goal. It includes different markets, the institutions,
instruments, services and mechanisms which
influence the generation of savings, investment capital formation and growth.
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Van Horne defined the financial system as the purpose of financial markets to
allocate savings efficiently in an economy to ultimate users either for investment in
real assets or for consumption.
Christy has opined that the objective of the financial system is to "supply funds to
various sectors and activities of the economy in ways that promote the fullest possible
utilization of resources without the destabilizing consequence of price level changes
or unnecessary interference with individual desires.“
According to Robinson, the primary function of the system is "to provide a link
between savings and investment for the creation of new wealth and to permit portfolio
adjustment in the composition of the existing wealth."
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Inter-relationship in the Financial System
Policy
Risk
Payment
Liquidity
Savings
Financial
System
FUNCTIONS OF FINANCIAL SYSTEM
CLASSIFICATION OF FINANCIAL MARKETS
Financial Markets: Market in which financial assets are created or transferred.
Financial Markets can be classified as:

1. Money Market: Deals with transactions related to short-term instruments with


maturity period less than one year
2. Capital Market: Deals with transactions related to long-term instruments with
maturity period greater than one year.
MONEY MARKET INSTRUMENTS
Call money

Commercial Papers

Certificate of Deposits
CALL MONEY/NOTICE MONEY
Call money : Money lent for 1 day
Notice money: Money lent for 2-14 days.

Purpose: - To help commercial banks by discounting commercial bills. - To help the


banks in meeting the CRR requirement - To meet the sudden demands for funds
- To meet the temporary mismatches.
Can both lend and borrow: (e.g. Commercial banks, DFHI, STCI etc.)
Can only lend
(e.g. LIC, UTI, Mutual funds etc.)
Participants:

CALL MONEY/NOTICE MONEY


cntd…
COMMERCIAL PAPERS
Short-term, unsecured promissory notes issued at a discount
to face value by well known companies with a high credit- rating.
Commercial Paper (CP) is popular, among highly rated entities, as a tool for
diversifying their sources of short term borrowings and for reducing the cost of such
borrowings.
It was introduced in India in 1990.
Corporates, primary dealers (PDs) and the All-India Financial Institutions (FIs) are
eligible to issue CP.
Maturity period: 15 days – 1 year.
Issued in multiples of Rs. 5 lakh ;the amount invested by a single investor should not
be less than Rs. 5 lakh.
They usually have a buy-back facility.
Negotiable by endorsement and delivery
Highly flexible instruments.
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CERTIFICATE OF DEPOSIT
This scheme was introduced in July 1989, to enable
the banking system to mobilise bulk deposits from the market, which they can have
at competitive rates of interest.
Issued by banks in the form of usance promissory notes.
The major features are:
Who can issue: Scheduled commercial banks (except RRBs) and All India Financial
Institutions within their `Umbrella limit’.
CRR/SLR: Applicable on the issue price in case of banks
Investors: Individuals (other than minors), corporations, companies, trusts, funds,
associations etc
Maturity Min: 7 days Max : 12 Months (in case of FIs minimum 1 year and maximum
3 years).
Amount Min: Rs.1 lac, beyond which in multiple of Rs.1 lac

continued
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Interest Rate: Market related. Fixed or floating
Loan Against collateral of CD not permitted
Pre-mature cancellation Not allowed
Transfer Endorsement & delivery. Any time
Nature Usance Promissory note. Can be issued in Dematerialisation form only only
wef June 30, 2002
Other conditions
If payment day is holiday, to be paid on next preceding business day
Issued at a discount to face value
Duplicate can be issued after giving a public notice & obtaining indemnity
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Money Market Mutual Funds
MMMFs were set up to make available the benefits of
investing in money markets to small investors.
MMMFs invest primarily in money market instruments of very high quality and of
very short maturities.
MMMFs can be set up by commercial banks,RBI and public financial institutions
either directly or through their existing mutual fund subsidiaries.
MMMfs are regulated and governed by SEBI.
Schemes offered can either be open- ended or close –ended.
CAPITAL MARKETS
They deal with securities with maturity period > 1 year.
CAPITAL MARKETS
PRIMARY MARKETS
SECONDARY MARKETS
PRIMARY MARKETS
Helps companies in raising funds through issue of securities
like shares and debentures.
Governed by SEBI (Securities and Exchange Board of India).
Methods of issuing securities in Primary Market:
- Public Issue
- Rights Issue
- Bonus Issue
- Private Placement
- Bought-out Deals
SECONDARY MARKET
Securities already issued in the primary market are traded in the secondary market.

Provides liquidity to the securities held by the investors.

Operates through stock exchanges that regulate the trading activities in this market.
STOCK EXCHANGES
They are auction markets for securities.
Transaction at stock exchange occur by placing an order.
Types of Orders:
Limit Orders
Best Rate Order
Immediate or cancel order
Limited Discretionary Order
Stop Loss Order
Open Order
Delivery of share certificate after execution of order may be spot, specified or hand
delivery
GOVERNMENT SECURITIES MARKET
Securities that are issued by the Central government,
state governments and entities that are wholly owned by the government.

Fully secured in nature.


Forms in which government securities can be held:
- Stock Certificate
- Promissory Notes
- Bearer Bonds
Examples of Government Securities:
-Treasury Bills
-Public Sector Bonds
GOVERNMENT SECURITIES MARKET cntd…
TREASURY BILLS
Short-term promissory notes issued by the government to meet their short-
term obligations.
They are useful in managing short-term liquidity.
At present, the Government of India issues three types of treasury bills through
auctions, namely, 91-day, 182-day and 364-day.
There are no treasury bills issued by State Governments.
The RBI acts as an agent for issuing T-Bills.
Subscribers: Banks, primary dealers, financial institutions, insurance companies,
provident funds, NBFCs, FIIs and state governments.
Treasury bills are available for a minimum amount of Rs.25,000 and in multiples of
Rs. 25,000.
Treasury bills are issued at a discount and are redeemed at par.
Issued for a minimum amount of Rs. 25,000 and in multiples of 25,000 thereof.

Maturity Period: 91 days and 364 days

TREASURY BILLS
cntd…
PUBLIC SECTOR BONDS
Bonds issued by public sector companies
Secured in nature.
Maturity Period: 5 to 7 years.
Investors: Banks, Insurance Companies, Corporate, Provident Funds, Mutual Funds,
Individuals.
Interest income eligible for deduction under Section 80L of I.T. Act.
Summary
Financial System And Its Function
Classification Of Financial Markets
Money Market Instruments
Capital Markets Instruments
Government Securities Market