Indain Financial System

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Indian Financial System

INDIAN FINANCIAL SYSTEM

Financial System of any country consists of financial markets, financial intermediation and

financial instruments or financial products.

INDIAN FINANCIAL SYSTEM

The economic development of a nation is reflected by the progress of the various economic

units, broadly classified into corporate sector, government and household sector. While

performing their activities these units will be placed in a surplus/deficit/balanced budgetary

situations.

There are areas or people with surplus funds and there are those with a deficit. A financial

system or financial sector functions as an intermediary and facilitates the flow of funds from

the areas of surplus to the areas of deficit. A Financial System is a composition of various

institutions, markets, regulations and laws, practices, money manager, analysts,

transactions and claims and liabilities.

Financial System;

The word "system", in the term "financial system", implies a set of complex and closely

connected or interlined institutions, agents, practices, markets, transactions, claims, and

liabilities in the economy. The financial system is concerned about money, credit and

finance-the three terms are intimately related yet are somewhat different from each other.

Indian financial system consists of financial market, financial instruments and financial

intermediation.


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Constituents of Indian Financial system:

These are briefly discussed below;

FINANCIAL MARKETS

A Financial Market can be defined as the market in which financial assets are created or

transferred. Financial assets also called as securities are financial papers or instruments

such as As against a real transaction that involves exchange of money for real goods or

services, a financial transaction involves creation or transfer of a financial asset. They are

not a source of funds but they are a link and provide a forum in which suppliers of funds

and demanders of loans / investments can transacts business directly. Financial Assets or

Financial Instruments represents 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.

Money Market- The money market ifs a wholesale debt market for low-risk, highly-liquid,

short-term instrument. Funds are available in this market for periods ranging from a single

day up to a year. This market is dominated mostly by government, banks and financial

institutions.

Capital Market - The capital market is designed to finance the long-term investments. The

transactions taking place in this market will be for periods over a year.Again the capitalmarket can be classified on the basis of claims representing new Issue or outstanding issue

as Primary market or secondary market.


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PRIMARY MARKET :It is the market which provides the channel for sale of new issues. Resources are required

for both new as well as existing projects with a view to expansion, modernisation,

diversification & upgradation. it is the market where resources are mobilised by companies

through issue of new securities.

SECONDARY MARKET :A Market where investors trade outstanding securities/ issues are called secondary market.

Secondary market comprises of stock exchanges, which provide platform for purchase &

sale of securities by investors, where the trading is accessible only through brokers &

trading is confied only to stock exchanges.

FOREX MARKET

The Forex market deals with the multicurrency requirements, which are met by the

exchange of currencies. Depending on the exchange rate that is applicable, the transfer of

funds takes place in this market. This is one of the most developed and integrated market

across the globe.

CREDIT MARKET

Credit market is a place where banks, FIs and NBFCs purvey short, medium and long-term

loans to corporate and individuals.


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FINANCIAL INSTRUMENTS

Money Market Instruments

The money market can be defined as a market for short-term money and financial assetsthat are near substitutes for money. The term short-term means generally a period upto

one year and near substitutes to money is used to denote any financial asset which can be

quickly converted into money with minimum transaction cost.

Some of the important money market instruments are briefly discussed below;

1. Call/Notice Money

2. Treasury Bills

3. Term Money

4. Certificate of Deposit

5. Commercial Papers

1. Call /Notice-Money Market

Call/Notice money is the money borrowed or lent on demand for a very short period. When

money is borrowed or lent for a day, it is known as Call (Overnight) Money. Intervening

holidays and/or Sunday are excluded for this purpose. Thus money, borrowed on a day and

repaid on the next working day, (irrespective of the number of intervening holidays) is "Call

Money". When money is borrowed or lent for more than a day and up to 14 days, it is

"Notice Money". No collateral security is required to cover these transactions.

2. Inter-Bank Term Money

Inter-bank market for deposits of maturity beyond 14 days is referred to as the term money

market. The entry restrictions are the same as those for Call/Notice Money except that, as

per existing regulations, the specified entities are not allowed to lend beyond 14 days.
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3. Treasury Bills.

Treasury Bills are short term (up to one year) borrowing instruments of the union

government. It is an IOU of the Government. It is a promise by the Government to pay a

stated sum after expiry of the stated period from the date of issue (14/91/182/364 days i.e.

less than one year). They are issued at a discount to the face value, and on maturity the

face value is paid to the holder. The rate of discount and the corresponding issue price are

determined at each auction.

4. Certificate of Deposits

Certificates of Deposit (CDs) is a negotiable money market instrument nd issued in

dematerialised form or as a Usance Promissory Note, for funds deposited at a bank or other

eligible financial institution for a specified time period. Guidelines for issue of CDs are

presently governed by various directives issued by the Reserve Bank of India, as amended

from time to time. CDs can be issued by (i) scheduled commercial banks excluding Regional

Rural Banks (RRBs) and Local Area Banks (LABs); and (ii) select all-India Financial

Institutions that have been permitted by RBI to raise short-term resources within the

umbrella limit fixed by RBI. Banks have the freedom to issue CDs depending on their

requirements. An FI may issue CDs within the overall umbrella limit fixed by RBI, i.e., issue

of CD together with other instruments viz., term money, term deposits, commercial papers

and intercorporate deposits should not exceed 100 per cent of its net owned funds, as per

the latest audited balance sheet.

5. Commercial Paper

CP is a note in evidence of the debt obligation of the issuer. On issuing commercial paper

the debt obligation is transformed into an instrument. CP is thus an unsecured promissory

note privately placed with investors at a discount rate to face value determined by market

forces. CP is freely negotiable by endorsement and delivery. A company shall be eligible to

issue CP provided - (a) the tangible net worth of the company, as per the latest audited

balance sheet, is not less than Rs. 4 crore; (b) the working capital (fund-based) limit of thecompany from the banking system is not less than Rs.4 crore and (c) the borrowal account

of the company is classified as a Standard Asset by the financing bank/s. The minimum

maturity period of CP is 7 days. The minimum credit rating shall be P-2 of CRISIL or such

equivalent rating by other agencies.


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Capital Market Instruments

The capital market generally consists of the following long term period i.e., more than one

year period, financial instruments; In the equity segment Equity shares, preference shares,

convertible preference shares, non-convertible preference shares etc and in the debt

segment debentures, zero coupon bonds, deep discount bonds etc.

EQUITY SEGMENTS : DEBT SEGMENTS :

EQUITY SHARES. DEBENTURES.

PREFERENCE SHARES. ZERO-COUPON BOND

CONVERTIBLE PREFERENCE SHARES. DEEP DISCOUNT BOND

NON-CONVERTIBLE PREFERENCE SHARES.

Hybrid Instruments

Hybrid instruments have both the features of equity and debenture. This kind of

instruments is called as hybrid instruments. Examples are convertible debentures, warrants

etc.

Conclusion

In India money market is regulated by Reserve bank of India (www.rbi.org.in) and

Securities Exchange Board of India (SEBI) [www.sebi.gov.in ] regulates capital market.Capital market consists of primary market and secondary market. All Initial Public Offerings

comes under the primary market and all secondary market transactions deals in secondary

market. Secondary market refers to a market where securities are traded after being

initially offered to the public in the primary market and/or listed on the Stock Exchange.

Secondary market comprises of equity markets and the debt markets. In the secondary

market transactions BSE and NSE plays a great role in exchange of capital market

instruments.
http://www.rbi.org.in/http://www.sebi.gov.in/http://www.sebi.gov.in/http://www.rbi.org.in/


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FINANCIAL INTERMEDIATION

Having designed the instrument, the issuer should then ensure that these financial assets

reach the ultimate investor in order to garner the requisite amount. When the borrower of

funds approaches the financial market to raise funds, mere issue of securities will not

suffice. Adequate information of the issue, issuer and the security should be passed on to

take place. There should be a proper channel within the financial system to ensure such

transfer. Financial intermediary acts as link between savers and investors. Their main

function is to convert direct financial assets into indirect securities. To serve this purpose,

financial intermediaries came into existence. Financial intermediation in the organized

sector is conducted by a wide range of institutions functioning under the overall surveillance

of the Reserve Bank of India. In the initial stages, the role of the intermediary was mostly

related to ensure transfer of funds from the lender to the borrower. This service was

offered by banks, FIs, brokers, and dealers. However, as the financial system widened

along with the developments taking place in the financial markets, the scope of its

operations also widened. Some of the important intermediaries operating ink the financial

markets include; investment bankers, underwriters, stock exchanges, registrars,

depositories, custodians, portfolio managers, mutual funds, financial advertisers financial

consultants, primary dealers, satellite dealers, self regulatory organizations, etc. Though the

markets are different, there may be a few intermediaries offering their services in move

than one market e.g. underwriter. However, the services offered by them vary from one

market to another.

Intermediary Market Role

Stock Exchange Capital MarketSecondary Market to

securities

Investment Bankers Capital Market, Credit MarketCorporate advisory services,

Issue of securities

UnderwritersCapital Market, Money

MarketSubscribe to unsubscribed

portion of securities

Registrars, Depositories,

CustodiansCapital Market

Issue securities to the

investors on behalf of the

company and handle share

ransfer activityPrimary Dealers SatelliteDealers

Money MarketMarket making ingovernment securities

Forex Dealers Forex MarketEnsure exchange inkcurrencies


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function of financial intermediary is to convert direct financial assets into indirect

securities. The indirect securities offer to the individual investor better investment opportunity

than the direct/ primary secutity by pooling of funds by intermediaries for examples units of

mutual funds.

The services / benefits that tailor indirect financial assets to the requirement of the investors

are:

1. Convenience2. Lower risk3. Expert management4. Lower cost

Convenience: Financial intermediaries convert direct/ primary securities into amore convenient vehicle of investment. They divide primary securities of higher

denomination into indirect securities of lower denomination. They also transform

a primary security of a certain maturity into an indirect security of a different

maturity. For instances as a result of the redemption / repurchase facility

available to the unit holders of mutual funds, maturities on units would conform

more with the desires of the investors than those on primary securities.

Lower risk: The lower risk associated with indirect securities results from thebenefits of diversification of investments. In effect the financial intermediaries

transform the small investments in matters of diversification into large

institutional investors


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Expert management: indirect securities give to the investors the benefit oftrained experienced and specialized management together with continuous

supervision. In effect the financial intermediaries place the individual investors in

the same position in the matter of expert management as large institutional

investors

Low cost: The benefits of investment through financial intermediaries areavailable to the individual investors at relatively lower cost due to the economies

of scale.

Types of Financial Intermediaries

Money needs to be circulated for an economy to be productive. If all savings are hoarded, the

surpluses of the community will not be available for investments and this in turn would lead to

economic stagnation. Financial intermediaries play an important economic function by

facilitating a productive use of the community's surplus money.

There are various types of financial intermediaries and their structure comprises of both

organized and unorganized sectors. The dominance in terms of financial flows handled by

these sectors differs from country to country.

In India, the players in the unorganized sector are:

Money lenders Indigenous bankers

Chit funds

Nidhis or mutual benefit funds Self Help Groups


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In the current scenario, there is no estimate of the volume of business handled by the

unorganized sector. While the volume of business handled by them in the urban sector may be

small, their role in rural India is very significant.

One of the negative effects of the sway of the unorganized sector is that it reduces the efficacy

of a country's monetary policy. A lot of initiatives have been undertaken over the years both by

central and state governments to reduce the adverse impact. Some of these initiatives are:

All India Development Financial Institutions [DFIs] State level Financial Corporations [SFCs] Insurance Companies Mutual Funds [MFs] Non Banking Finance Corporations [NBFCs]

The following are the various institutions covered under all India DFIs:

Industrial Finance Corporation of India [IFCI] Industrial Development Bank of India [IDBI], which merged with IDBI Bank in 2004 Industrial Credit and Investment Corporation of India [ICICI], which merged with ICICI

Bank in 2002

Industrial Investment Bank of India [IIBI]. The former Industrial ReconstructionCorporation of India was converted into Industrial Reconstruction Corp of India [IRCI]

and was later converted into IIBI in 1995

Small Industries Development Bank of India [SIDBI], which is a wholly owned subsidiary

of IDBI curved out through an act of parliament in 1990.


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These are state level bodies that mainly concentrate on industrial development in a state. They

are legal bodies created under the State Finance Corporations Act, 1951 and are funded

through an issue of shares in which the state governments, banks, financial institutions, and

private investors participate.

SFCs are also permitted to raise funds through the issue of bonds and debentures. The main

focus of SFCs is financing the local industrial units, which are usually small and medium units,

situated in backward regions of the state.

Insurance companies concentrate on fulfilling the insurance needs of the community, both for

life and non life insurance. With the globalization of the Indian economy, a large number of

private players have entered into this field, offering products that allow investors to select the

kind of policies to suit their financial planning needs.

Many of these organizations are formed as subsidiaries of banks that enable the banks to cross

sell insurance products to their existing customers. Banks benefit by way of fee income through

referrals and enhanced relationships with insurance companies for their banking needs.

These organizations satisfy the needs of individual investors through pooling resources from a

large number with similar investment goals and risk appetite. The resources collected are

invested in the capital market and money market securities and the returns generated are

distributed to investors.


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The fund managers of MFs are specialists in the fields of investment analysis and are able to

diversify and even out risks through portfolio mix. MFs offer a wide variety of schemes, such as,

growth funds, income funds, balanced funds, money market funds and equity related funds

designed to cater to the different needs of investors.

NBFCs are commonly known as finance companies and are corporate bodies, which concentrate

mainly on lending activities in a well defined area. The Reserve bank of India [RBI] Amendment

Act, 1997 defines an NBFC as a financial institution or non banking institution, which has its

principal business of receiving deposits under any scheme or arranging and lending in any

manner.

There are 4 broad categories of NBFCs:

Finance Companies Leasing Companies Loan finance companies

Financial Regulators:

Securities and Exchange Board of India (SEBI) Reserve Bank of India Ministry of Finance


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SEBI

Securities and Exchange Board of India (SEBI) was first established in the year 1988 Its a non-statutory body for regulating the securities market It became an autonomous body in 1992.

Regulates Capital Market. Checks Trading of securities. Checks the malpractices in securities market. It enhances investor's knowledge on market by providing education. It regulates the stockbrokers and sub-brokers. To promote Research and Investigation

It tries to develop the securities market. Promotes Investors Interest. Makes rules and regulations for the securities market.


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Reserve Bank of India:

Established on April 1, 1935 in accordance with the provisions of the RBI Act, 1934. The Central Office of the Reserve Bank has been in Mumbai. It acts as the apex monetary authority of the country.

Monetary Authority:

Formulation and Implementation of monetary policies. Maintaining price stability and ensuring adequate flow of credit to the Productive

sectors.

Issuer of currency:

Issues and exchanges or destroys currency and coins. Provide the public adequate quantity of supplies of currency notes and coins.

Regulator and supervisor of the financial system:

Prescribes broad parameters of banking operations

Maintain public confidence, protect depositors' interest and provide cost-effectivebanking services.

Authority On Foreign Exchange:

Manages the Foreign Exchange Management Act, 1999. Facilitate external trade, payment; promote orderly development and maintenance of

foreign exchange market.

Developmental role:

Performs a wide range of promotional functions to support national objectives.


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Related Functions:

Banker to the Government: performs merchant banking function for the central and thestate governments.

Maintains banking accounts of all scheduled banks

Monetary Measures:

(a) Bank Rate:

The Bank Rate was kept unchanged at 6.0 per cent.

(b) Reverse Repo Rate:

The Repo rate is around 7 per cent and Reverse repo rate is around 6.10 per cent.

(c) Cash Reserve Ratio:

The cash reserve ratio (CRR) of scheduled banks is currently at 5.0 per cent.

Role/ Functions of Financial System:

A financial system performs the following functions:

It serves as a link between savers and investors. It helps in utilizing the mobilized savingsof scattered savers in more efficient and effective manner. It channelises flow of saving

into productive investment.

It assists in the selection of the projects to be financed and also reviews theperformance 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.


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It provides a mechanism for managing and controlling the risk involved in mobilizingsavings and allocating credit.

It promotes the process of capital formation by bringing together the supply of savingand the demand for investible funds.

It helps in lowering the cost of transaction and increase returns. Reduce cost motivespeople to save more.

It provides you detailed information to the operators/ players in the market such asindividuals, business houses, Governments etc.

In short it can be said that Functions of Indian Financial system can be summarized as:

Main Functions of Indian Financial System

Saving Function Liquidity Function Payment Function Risk Function Policy Function

Documents

Indain Financial System