Financial Services

UNIT-I

BY: DR. FEEROJ PATHAN

 THE FINANCIAL SYSTEM IN INDIA

 The economic development of any country depends

upon the existence of a well organised financial
system.
 Financial system supplies the necessary financial
inputs for the production of goods and services
which in turn promote the well being and standard
of living of the people of a country.
 Financial system is broader term which brings
under its fold the Financial Markets and Financial
Institutions which support the system.
 An efficient functioning of the financial system
facilitates the free flow of funds to more productive
activities and thus promotes investment.
 Financial system provides the intermediation
between savers and investors and also promotes
faster economic development.
 Indian Financial System

Un-Organized
Organized

Regulators Money lenders

Financial Institutions Local bankers

Financial Markets Traders

Financial services Landlords

Financial Instruments
 Organized Indian Financial System

Regulators Financial Financial Financial

Instruments Markets Intermediaries
1.MoF
2.SEBI
3.RBI Forex Capital Money Credit/debt
Market Market Market Market
4.IRDA

Primary Market

Secondary Market

Money Market Capital Market

Instrument Instrument
 FUNCTIONS OF THE FINANCIAL
SYSTEM
 Provision of Liquidity- The major function of the
financial system is the provision of money and
monetary assets for the production of goods and
services. There should not be any shortage of
money for productive ventures.
 Mobilisation of Savings- Another important
activity of the financial system is to mobilise
savings and channelize them into productive
activities. System should offer appropriate
incentives to attract savings and make them
available to more productive ventures. It should
transfer savings into investment and consumption.
 Size Transformation Function- Savings of millions of small
investors are in the nature of a small unit of capital which
cannot find any fruitful avenue for investment unless it is
transformed into a sensible size of credit unit. Banks and
other financial intermediaries perform this size
transformation.
 Maturity Transformation Function- Financial
intermediaries accept deposits from public in different
maturities according to their liquidity preference and lend
them to the borrowers in different maturities.
 Risk Transformation Function- most small investors don’t
want to take risk so they hesitate to invest directly in stock
market. Therefore financial intermediaries collect the
savings from individual and distribute them in different
investment units with their high knowledge and expertise.
 FINANCIAL CONCEPTS

An understanding of the financial system requires an

understanding of the following concepts
1. Financial Assets
2. Financial Intermediaries
3. Financial Markets
4. Financial rates of return
5. Financial Instruments
6. Market players
 1. Financial Assets

 In any financial transaction there should be creation

or transfer of financial asset. “A financial asset is one
which is used for production or consumption or for
further creation of assets”.
 Classification of Financial Assets:
i. Marketable assets- Easy to Transfer,
e.g. shares, Government securities, Bonds, Mutual
fund Units, UTI Units, Bearer Debentures
i. Non Marketable assets- e.g. Bank deposits, P.F.,
LIC Schemes, P.O. Certificate.
 2. Financial Intermediaries

 The term financial intermediary includes all kinds of

organizations which intermediate and facilitate
financial transactions of both individuals and
corporate customers. Thus it refers to all kinds of
financial institutions and investing institutions in
financial markets they may classified into
i. Capital market intermediaries e.g. Financial
corporations, LIC
ii. Money market intermediaries- e.g. Commercial
banks, co-operative banks etc.
3. Financial Markets
 4. Financial Rates of Return

 Most households in India still prefer to invest on

physical assets like land, buildings, gold, silver etc.
But studies shown that investment in financial assets
like equities has more return than investments on
gold.
 5. Financial Instruments

 Financial instruments refer to those documents

which represent financial claims on assets.
 Financial asset refers to a claim to the repayment
of a certain sum of money at the end of a specified
period together with interest or dividend.
 It includes equity, debt and hybrid. These
instruments are written evidences of ownership
and they give the holders the right to demand and
receive property not in their possession.
 6. Market players

 The players in the market include:

I. Commercial banks: The commercial banking in the developed
countries provide term loans to corporate sector by
participating in the capital and equipment finance.
II. Financing companies: The participation of finance
organizations can stimulate the economic growth. They inject
new blood to the corporate sector. the Non- Banking Finance
Corporations sector has recorded marked growth in the recent
past.
III. Stock brokers: Stock Brokers play an important role in the
stock market. They involve in buying and selling of securities
in a recognized stock exchange. If any one wants to work as a
broker, a certificate of registration from the SEBI is
mandatory after satisfying all the terms and conditions.
IV. Consultants: Consultants are the professionals in the area of
Finance can be providing best solutions to the problems
faced by the corporate sector. Their services are intangible
and show greater impact on the functioning of the company.
They provide tailor made solution to all the problems
irrespective of any area.
V. Underwriters: Underwriters are the intermediaries in the
primary market. They render valuable services to the newly
started companies, which require believable advice.
Underwriters assure the company full subscriptions for a
commission.
VI. Market makers: Market makers are associated with the
stock exchanges. The market making system is very much
popular in London, New York and Chicago stock exchanges.
Their basic function is to provide the needed liquidity to a
particular scrip. They help in eliminating the temporary
disparity between the supply and demand of scrip. They
help in maintaining a fair and orderly market.
 MEANING OF FINANCIAL SERVICES

 In general, all types of activities, which are of a

financial nature could be brought under the term
'financial services'. The term financial services' in a
broad, sense means "mobilizing and allocating
savings". Thus it includes all activities involved in the
transformation of savings into investment.
 Financial services can also be called 'financial inter
mediation'. Financial intermediation is a process by
which funds are mobilizing from a large number of
savers and make them available to all those who are
in need of it and particularly to , corporate
customers.
 Thus, financial services sector is a key area and it is
very vital for industrial developments. A well
developed financial services industry is absolutely
necessary to mobilize the savings and to allocate
them to various invest able channels and thereby to
promote industrial development in a country
 Scope of Financial Services

 Financial services cover a wide range of activities.

They can be broadly classified into two, namely
i. Traditional. Activities
ii. Modern activities.
 Traditional Activities

 Traditionally, the financial intermediaries have been

rendering a wide range of services encompassing
both capital and money market activities. They can
be grouped under two heads, viz.
 a. Fund based activities and
 b. Fee based activities.
 Fund based activities : The traditional services which
come under fund based activities are the following :
i. Underwriting or investment in shares, debentures,
bonds, etc. of new issues (primary market activities).
ii. Dealing in secondary market activities.
iii. Participating in money market instruments like
commercial papers, certificate of deposits, treasury
bills, discounting of bills etc .
iv. Involving in equipment leasing, hire purchase,
venture capital, seed capital, dealing in foreign
exchange market activities. Non fund based activities
 Sources of Revenue in Fund based & Fee
based Services

 Fund based income comes mainly from interest

spread (the difference between the interest earned
and interest paid), lease rentals, income from
investments in capital market and real estate.
 On the other hand, fee based income has its sources
in advisory services, custodial services, loan
syndication, etc.
 Fee based income does not involve much risk. But, it
requires a lot of expertise on the part of a financial
company to offer such fee-based services.
 Fee based activities-
Financial intermediaries provide services on the
basis of non-fund activities also.
This can be called 'fee based' activity. Today
customers, whether individual or corporate, are not
satisfied with mere provisions of finance.
They expect more from financial services companies.
Hence a wide variety of services, are being provided
under this head.
e.g. management of pre issue and post-issue activities,
Arrangement of funds from financial institutions for
the clients' project cost or his working capital
requirements, Assisting in the process of getting all
Government and other clearances.
 Modern Activities

 Beside the above traditional services, the financial

intermediaries render innumerable services in recent
times.
 Most of them are in the nature of non-fund based
activity.
 In view of the importance, these activities have been
in brief under the head 'New financial products and
services'.
 However, some of the modern services provided by
them are given in brief hereunder.
 Rendering project advisory services right from the
preparation of the project report rill the raising of funds
for starting the project with necessary Government
approvals.
 Planning for M&A and assisting for their smooth carry
out.
 Guiding corporate customers in capital restructuring
 Recommending suitable changes in the management
structure and management style with a view to achieving
better results.
 Structuring the financial collaborations / joint ventures
by identifying suitable joint venture partners and
preparing joint venture agreements
 Advising the clients on the questions of selecting the
best source of funds.
 Guiding the clients in the minimization of the cost of
debt and in the determination of the optimum
debtequity mix.
 GROWTH AND EVOLUTION OF
FINANCIAL SERVICES IN INDIA

Financial services sector is blooming in India and it

has passed through various phases as mentioned
below:
 Initial phase (1960-80)
 Second phase (1980-90)
 Third phase (1990-2002)
 Initial phase:

 Financial services at the initial phase introduced

many innovative services such as merchant banking,
Insurance and leasing finance.
 The term merchant banking was not known till 1960.
 LIC, GIC and UTI initiated to enter into this segment
during this period. Leasing activities was started in
the year 1970.
 Second phase:

 Financial services entered the second stage and it

covered the period of 10 years approximately. In this
phase it introduced many innovative value added
services such as over the counter share transfers,
pledging of shares, mutual funds, factoring,
discounting, venture capital and credit rating.
 Third phase:
 This phase in financial services include the setting
up of new institutions and instruments. This
period started after post liberalization. The
depositories, the stock lending schemes, online
trading, paperless trading, dematerialization, book
buildings are the contemporary issues of this
phase.
 In this phase government has taken initiatives to
allow foreign institutional investors into the capital
market. The government of India is revamping
companies‘ act, income tax act, MRTP act etc, for
delivering effective financial services.
 PRESENT SCENARIO:

1. Conservatism to dynamism:
At present it is adopting the changing needs. the
financial system in India is in a process of rapid
transformation to promote an efficient, competitive
and diversified financial system in the country.
2. Emergence of Primary Equity Market:
 Primary market in India is now very active. India is
now witnessing the emergence of many private
sector financial services.
 The aggregate funds raised in the Indian capital
market have doubled over a decade.
3. Concept of Credit Rating: The facility of credit rating
helps the investors in finding a profitable and safe debt
capital.
4. Process of Globalization: Globalization has given way
for the entry of innovative and sophisticated financial
products into our country. Government of India is very
keen in removing all the obstacles in the financial
sector.
5. Process of liberalization: Government of India has
initiated many steps to reform the financial services
industry. The interest rates have been deregulated.
The private sector has been permitted to participate in
banking and mutual fund sectors. The Finance Act of
Government of India is bringing various amendments
every year to keep the financial sector very flexible.
 FUNCTIONS OF FINANCIAL SERVICE
INSTITUTIONS:

 They assist in deciding the financing mix

 They provide services like bill discounting, factoring
of debtors, parking of short-term funds in the money
market, e-commerce, securitization of debts, and so
on to ensure an efficient management of funds.
 These firms provide some specialized services like
credit rating, venture capital, lease financing,
factoring, mutual funds, merchant banking.
 Financial system/services works as an effective medium for
optimum allocation of financial resources in an economy.
 It helps in establishing a link between the savers and the
investors.
 Financial system/services allows ‘asset-liability transformation’.
Banks create claims (liabilities) against themselves when they
accept deposits from customers but also create assets when they
provide loans to clients.
 Economic resources (i.e., funds) are transferred from one party to
another through financial system.
 The financial system/services ensures the efficient functioning of
the payment mechanism in an economy. All transactions between
the buyers and sellers of goods and services are effected smoothly
because of financial system/services .
 Financial system enhances liquidity.
 Financial system helps price discovery of financial assets
resulting from the interaction of buyers and sellers. For example,
the prices of securities are determined by demand and supply
forces in the capital market.
 Financial system helps reducing the cost of transactions.