INDIAN FINANCIAL SYSTEM

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 System

System: Set of complex and closely connected

or interlinked institutions, agents, practices, markets, transactions, claims, and liabilities in the economy

Financial System: Money, Credit, Finance

A financial system functions as an intermediary and facilitates the flow of funds from the areas of surplus to the areas of the deficit.

Indian Financial System An Overview

Process of Capital Formation Involves three distinct, although inter-related activities. (i) Savings: The ability by which resources are set aside and become available for other purpose. (ii) Finance: The activity by which claims to resources are either assembled from those released by domestic savings, obtained from abroad, or specially created usually as bank deposits or notes and then placed in the hands of the investor. (iii) Investments: The activity by which resources are actually committed to production. The financial system is a link between the savers (savings surplus economic units) and the investors (savings deficit economic units). It is made up of all those channels through which savings become available for investment.

Indian Financial System An Overview

Orderly mechanism & structure in economy. Mobilises the monetary resources/capital from surplus sectors.

Distributes resources to needy sectors.

Transformation of savings into investment & consumption. Financial Markets Places where the above activities take place.
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Financial System of any country consists of financial markets, financial intermediation and financial instruments or financial products
Flow of funds (savings)
Seekers of funds (Mainly business firms and government) Suppliers of funds (Mainly households)

Flow of financial services Incomes , and financial claims

Financial System

Financial assets/instruments

Enable channelizing funds from surplus units to deficit units 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(public provident fund, KVP(kisan vikas patra), etc. are available to savers who wish to lend money to the government

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 Markets
Defined

as the market in which financial assets are created or transferred.

These

assets represent 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.

Financial Markets

Money Market- for short-term funds (less than a year)

Organised (Banks) Unorganised (money lenders, chit funds, etc.)

Capital Market- for long-term funds

Primary Issues Market Stock Market Bond Market

Classification

Money market (Short term instrument)

Capital markets (Long term instrument)

The

two:

most important distinction between the

The difference in the period of maturity.

Indian Financial System An Overview

ORGANISATION Financial System consists of
What they do Financial Intermediotories (a) Collect Savings (b) Issue claim against themselves (c) Use Funds, thus raised, to purchase ownership or debt-claims . (ii) Financial Markets (a) Not a Source of funds (b) Act as a facilitating organisation and link saver & investor (c) Based on nature of work they are classified as (1) Money Market (2) Capital/Security Markets. (a) Financial Product innovation (b) Three broad categories (1) Direct/Primary e.g. Share, Debt., Pref. Share etc. (2) Indirect MF, Security Receipts, Securitized Debt Investment. (3) Derivatives Forward, Future, Options. Call Market T-Bill Market CP-Market Report Market Stock Exchange Who They Are

Banks, NBFC, MF insurance organisations etc.

(iii) Financial Asset/Instrument/ Security

Shares, Debt Instruments Debentures etc.

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Indian Financial System

Non- Organized Organized Money lenders Regulators Financial Institutions Financial Markets Financial services Local bankers Traders Landlords Pawn brokers Chit Funds

Organized Indian Financial System

Regulators

Financial Instruments

Financial Markets

Financial Intermediaries

Forex Market

Capital Market

Money Market

Credit Market

Primary Market Secondary Market

Money Market Instrument

Capital Market Instrument

Indian Financial System An Overview

STRUCTURE OF FINANCIAL MARKETS IN INDIA Financial Markets in India

Debt Market Primary / Secondary

Forex Market

Capital Market Primary / Secondary & Depository

Insurance Life/General

Banks (including RRB(regional rural banks, co-op etc)

Mutual Funds, Venture Funds, Investment Bonds

RBI

RBI

SEBI

IRDA(insurance regulatory and development authority of India

RBI

RBI/SEBI

REGULATORY AUTHORITY

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Financial System

Functions

Saving Function Liquidity Function Payment Function Risk Function Policy Function

Saving Function

Public saving find their way into the hands of those in production through the financial system. Financial claims are issued in the money and capital markets which promise future income flows. The funds with the producers result in production of goods and services thereby increasing society living standards.

Liquidity Function

The financial markets provide the investor with the opportunity to liquidate investments like stocks, bonds, debentures, etc. whenever they need the fund.

Payment Function

The financial system offers a very convenient mode for payment of goods and services. Cheque system, credit card system etc are the easiest methods of payments. The cost and time of transactions are drastically reduced.

Risk Function

The financial markets provide protection against life, health and income risks. These are accomplished through the sale of life and health insurance and property insurance policies. The financial markets provide immense opportunities for the investor to hedge himself against or reduce the possible risks involved in various investments

Policy Function

The government intervenes in the financial system to influence macroeconomic variables like interest rates or inflation. so if country needs more money, government would cut rate of interest through various financial instruments and if inflation is high and too much money is there in the system then government would increase rate of interest.

Role of Financial System: It serves as a link between savers and investors. It helps in utilizing the mobilized savings of scattered savers in more efficient and effective manner. It channelizes flow of saving into productive investment.

* It assists in the selection of the projects to be financed and also reviews the performance of such projects periodically. * It provides payment mechanism for exchange of goods and services.

It provides a mechanism for the transfer of resources across geographic boundaries.

* It provides a mechanism for managing and controlling the risk involved in mobilizing savings and allocating credit. * It promotes the process of capital formation by bringing together the supply of saving and the demand for investible funds. * It helps in lowering the cost of transaction and increase returns. Reduced cost motivates people to save more. * It provides detailed information to the operators/ players in the market such as individuals, business houses, Governments etc.

Major participants in financial markets

1. 2. 3.

1.

2.

3.

4.

The individuals: These are net savers and purchase the securities issued by corporate. Individuals provide funds by subscribing to these security or by making other investments. The Firms or corporate: The corporate are borrowers. They require funds for different projects from time to time. They offer different types of securities to suit the risk preferences of investors Sometimes, the corporate invest excess funds, as individuals do. The funds raised by issue of securities are invested in real assets like plant and machinery. The income generated by these real assets is distributed as interest or dividends to the investors who own the securities.

Government: Government may borrow funds to take care of the budget deficit or as a measure of controlling the liquidity, etc. Government may require funds for long terms (which are raised by issue of Government loans) or for short-terms (for maintaining liquidity) in the money market. Government makes initial investments in public sector enterprises by subscribing to the shares. Regulators: Financial system is regulated by different government agencies. The relationships among other participants, the trading mechanism and the overall flow of funds are managed, supervised and controlled by these statutory agencies. In India, two basic agencies regulating the financial market are the Reserve Bank of India (RBI ) and Securities and Exchange Board of India (SEBI). Reserve Bank of India, being the Central Bank, has the primary responsibility of maintaining liquidity in the money market.SEBI has a primary responsibility of regulating and supervising the capital market. Besides, there is an array of legislations and government departments also to regulate the operations in the financial system.

Market Intermediaries: The objective of these intermediaries is to smoothen the process of investment and to establish a link between the investors and the users of funds. Corporations and Governments do not market their securities directly to the investors. Instead, they hire the services of the market intermediaries to represent them to the investors. Investors, particularly small investors, find it difficult to make direct investment, may not find a willing and desirable borrower,may not be able to diversify across borrowers to reduce risk,may not be equipped to assess and monitor the credit risk of borrowers. Market intermediaries help investors to select investments by providing investment consultancy, market analysis and credit rating of investment instruments.

In order to operate in secondary market, the investors have to transact through share brokers. Mutual funds and investment companies pool the funds(savings) of investors and invest the corpus in different investment alternatives. Some of the market intermediaries are: Share brokers, Underwriters, Portfolio Managers, Mutual Funds. These market intermediaries provide different types of financial services to the investors. They provide expertise to the securities issuers. They are constantly operating in the financial market. Small investors in particular and other investors too, rely on them. It is in their (market intermediaries) own interest to behave rationally, maintain integrity and to protect and maintain reputation, otherwise the investors would not be trusting them next time. In principle, these intermediaries bring efficiency to corporate fund raising by developing expertise in pricing new issues and marketing them to the investors.

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The Financial System

Intermediation via institutional investors
Insurance policies Retirement plans Shares in funds CASH PRIVATE PLACEMENT

Insurance companies, pension funds, Investment funds & venture capitalists

CASH CASH SHARES CASH

S U P P L I E R S OF F U N D S

BONDS

Money Market Instruments CASH SHARES CASH BONDS CASH

CASH SHARES CASH BONDS CASH Commercial paper

The equity market

(Trading in shares of common stocks)

The corporate market

(Trading in corporate bonds)

The money market

(Trading in money market instruments)
Bank certificates of deposit (CD)

F I R M S

Commercial paper

CASH

BANK DEPOSITS

Intermediation via banks

and other lending institutions

DEBT OWED TO BANKS

CASH

CASH