Indian Financial System An Introduction

INDIAN FINANCIAL SYSTEM: AN INTRODUCTION  Banking – creators and purveyors of credit
 Non-banking – Only purveyors, ex. DFIs,

Introduction NBFCs,
 Financial system intermediates between  Term Finance
 IDBI, ICICI, IFCI, SIDBI, IIBI
the flow of funds belonging to those who
 Specialized
save a part of their income and those
 EXIM, TFCI, ICICI Venture, IDFC, NABARD,
who invest in productive assets.
NHB
 It mobilizes and usefully allocates scarce
 Sectoral
resources of a country.
 UTI, LIC, GIC
 A financial system is a complex, well
 Investment
integrated set of sub systems of financial
 State-Level
institutions, markets, instruments & services  State Financial Corporations, State
which facilitates the transfer and allocation of Industrial Development Corporations
funds efficiently & effectively.
FORMAL/ORGANIZED INFORMAL/ FINANCIAL MARKET

FINANCIAL SYSTEM UNORGANIZED
FINANCIAL SYSTEM Types
It is characterized by the presence It is an unorganized,
of an organized, institutional and non-institutional MONEY MARKET
regulated system which caters to and non-regulated
the financial needs of the modern system dealing with  Treasury Bills
spheres of economy. traditional and rural  Call Money Market
spheres of the  Notice Money Market
economy
 Commercial Papers
Regulators Components Individual money  Certificate of Deposit
MoF 1. Financial lenders
Institutions Group of persons CAPITAL MARKET
SEBI 2. Financial Markets operating as
RBI 3. Financial funds  Equity Market
Instruments Partnership firms  Debt Market
IRDA 4. Financial Services
Segments
Pros and Cons of Informal Financial System  Primary Market

 Secondary Market
Advantages Disadvantages
 Low transaction cost  Wide range of
interest rates
 Minimum default risk  Higher rates of
interest
 Transparency of  Unregulated
procedures
FINANCIAL INSTITUTIONS
They are the intermediaries that mobilize savings and

facilitate the allocation of funds in efficient manner.
Classification of Financial Institutions
 Banking & Non-banking

MONEY MARKET PRIMARY MARKET AND SECONDARY MARKET
 It is market for short term debt instruments.  The primary market creates long-term
 A highly liquid market. instruments for borrowings.
 Ex. Call money market, certificates of  The secondary market provides liquidity
deposits, commercial paper and treasury and through the marketability of these
bills instruments
o It is also known as stock market
Functions:
LINK BETWEEN PRIMARY MARKET AND
 Provide a balancing mechanism to even out
SECONDARY MARKET
the demand for and supply of short-term
funds  A buoyant secondary market is indispensable
 Provide a focal point for central bank for the presence of a vibrant primary capital
intervention for influencing liquidity market
 The secondary market provides a basis for the
CAPITAL MARKET
determination of prices of new issues
 It is a market for long-term securities like  Depth of the secondary market depends on
equity or debt. the primary market
 Bunching of new issues affects prices in the
Functions: secondary market.
 Mobilize long term savings to finance long- FINANCIAL INSTRUMENTS

term investments
 Enable quick valuation of financial  A financial instrument is a claim against a
instruments - both equity and debt person or an institution for payment, at a
 Disseminate information efficiently for future date, of a sum of money, and/or a
enabling participants to develop an informed periodic payment in the form of interest or
opinion about investment, disinvestment, dividend
reinvestment or holding a particular financial  Many financial instruments are marketable as
asset. they are denominated in small amounts and
 Provide liquidity with a mechanism enabling traded in organized markets.
the investors to sell financial assets.  Distinct features of financial instruments:
o Marketable
o Tradable
o Tailor Made
LINK BETWEEN CAPITAL MARKET AND
MONEY MARKET
 Often, financial institutions actively involved

in the capital market are also involved in the
money market
 Funds raised in the money market are used to
provide liquidity for long-term investment and
redemption of funds raised in the capital
market
 In the development proves of financial
markets, the development of the money
market typically precedes the development of
capital market
FINANCIAL SERVICES
 MARKET BASED
 Categories of financial services: o Financial markets play an important role
o Funds intermediation whole the banking industry is much less
o Payment mechanism concentrated
o Provision of liquidity o US, UK
o Risk management
o Financial engineering – ex. off-balance sheet
items, development of synthetic securities
BANK BASED
 Need for financial services
o Borrowing and Funding  Banks play a pivotal role in mobilizing savings,
o Lending and Investing allocation of capital, overseeing the investment
o Buying and selling securities decisions of corporate managers and providing
o Payment and settlements risk management facilities
 It is tend to be stronger in countries where
governments have a direct hand in industrial
INTERACTION among FINANCIAL SYSTEM development.
COMPONENTS Advantages
 Interdependent and interact continuously o Close relationship with parties

 Interactive o Provides tailor-made contracts
 Close link o No free-rider problem
 Competing with each other
Disadvantages
FUNCTIONS OF FINANCIAL SYSTEM
o Retards innovation and growth
 Mobilize and allocate savings o Impedes competition
Monitor corporate performance
Provide payment and settlement system
 Optimum allocation of risk - bearing
MARKET BASED
and reduction
 Disseminate price-related information  The securities markets share centre stage with
 Portfolio adjustment facility banks in mobilizing the society’s savings for firms,
exerting corporate control and easing risk
KEY ELEMENTS OF WELL FUNCTIONING
management
FINANCIAL SYSTEM
Advantages
 Strong legal and regulatory environment
 Stable money o Providers’ attractive terms to both investors
 A central bank and borrowers
 A sound banking system o Facilitates diversification
 An information system o Allows risk sharing
 A well-functioning security market o Allows financing of new technologies
FINANCIAL SYSTEM DESIGN Disadvantages
 BANK BASED o Prone to instability

o A few large banks play a dominant role o Exposure to market risk
and the stock market is not important o Free-rider problem
o E.g. Germany, India

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INDIAN FINANCIAL SYSTEM: AN INTRODUCTION  Banking – creators and purveyors of credit

 Non-banking – Only purveyors, ex. DFIs,

FORMAL/ORGANIZED INFORMAL/ FINANCIAL MARKET

Pros and Cons of Informal Financial System  Primary Market

They are the intermediaries that mobilize savings and

Classification of Financial Institutions

 Banking & Non-banking

 Mobilize long term savings to finance long- FINANCIAL INSTRUMENTS

 Often, financial institutions actively involved

 Interdependent and interact continuously o Close relationship with parties

FINANCIAL SYSTEM DESIGN Disadvantages

 BANK BASED o Prone to instability

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