Indian Financial Institutions and Markets Unit 1 Basis of Financial System
Indian Financial Institutions and Markets Unit 1 Basis of Financial System
Indian Financial Institutions and Markets Unit 1 Basis of Financial System
Unit 1
BASIS OF FINANCIAL SYSTEM
Finance is defined as the management of money and includes activities such as investing,
borrowing, lending, budgeting, saving, and forecasting. Finance not only focuses on raising
funds by the business enterprise but also its effective usage in an organisation.
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.
Financial dualism means the co-existence of organised and unorganised money market in the
Less developed countries/ developing countries.
6. Other objectives:
To establish financial control and clear accounting procedures which ensure that funds are
used for intended purposes.
ROLE/ IMPORTANCE OF FINANCIAL SYSTEM IN THE ECONOMIC
DEVELOPMENT OF A COUNTRY. (6/ 15 marks)
1. Savings-investment relationship
To attain economic development, a country needs more investment and
production. This can happen only when there is a facility for savings. As, such
savings are channelized to productive resources in the form of investment. Here,
the role of financial institutions is important, since they induce the public to save
by offering attractive interest rates. These savings are channelized by lending to
various business concerns which are involved in production and distribution.
7. Venture Capital
There are various reasons for lack of growth of venture capital companies in India.
The economic development of a country will be rapid when more ventures are
promoted which require modern technology and venture capital.
Venture capital cannot be provided by individual companies as it involves more
risks. It is only through financial system, more financial institutions will contribute
a part of their investable funds for the promotion of new ventures. Thus, financial
system enables the creation of venture capital.
The following are the four major components that comprise the Indian Financial
System:
1. Financial Institutions
2. Financial Markets
3. Financial Instruments/ Assets/ Securities
4. Financial Services.
1. Financial Institutions
The Financial Institutions act as a mediator between the investor and the borrower.
The investor’s savings are mobilised either directly or indirectly via the Financial
Markets.
The financial institutions can further be divided into two types:
2. Financial Assets
The products which are traded in the Financial Markets are called the Financial
Assets. Based on the different requirements and needs of the credit seeker, the
securities in the market also differ from each other.
Short term securities: these includes with maturity of one year or less.
Medium term securities: these includes with maturity from 1 to 5 year.
Long term securities: these includes with maturity of more than 5 years.
Primary securities: like Equity shares, preference shares & Debentures and
used for to raise fixed capital by the business or institutions only in the primary
market.
Innovative instruments: these are those only to suit the need of corporates or
Investors group. For example: Derivatives, loans, insurance, foreign currency
mortgages and so on.
Banking Services – Any small or big service provided by banks like granting a
loan, depositing money, issuing debit/credit cards, opening accounts, etc.
Insurance Services – Services like issuing of insurance, selling policies,
insurance undertaking and brokerages, Reinsurance etc. are all a part of the
Insurance services
Investment Services – It mostly includes asset management, Hedge fund
Management etc.
Foreign Exchange Services – Exchange of currency, foreign exchange, etc.
are a part of the Foreign exchange services
The main aim of the financial services is to assist a person with selling, borrowing
or purchasing securities, allowing payments and settlements and lending and
investing.
4. Financial Markets
The marketplace where buyers and sellers interact with each other and participate
in the trading of money, bonds, shares and other assets is called a financial
market.
These organised markets can be further classified into two they are:
a) Capital market
The capital market is a market for financial assets which have a long or indefinite
maturity. Generally, it deals with long term securities which have a maturity
period of above one year.
It can be further subdivided into two. They are:
Primary market or New issue market
Primary Market Primary market is a market for new issues or new financial claims.
Hence, it is also called New Issue market. The primary market deals with those
securities which are issued to the public for the first time.
Secondary Market
Secondary market is a market for secondary sale of securities. In other words,
securities which have already passed through the new issue market are traded in
this market. Generally, such securities are quoted the Stock Exchange and it
provides a continuous and regular market to buying and selling of securities.
b) Money market is a market for dealing with financial assets and securities
which have a maturity period of up to one year. In other words, it is a market
for purely short term funds. The money market includes the following types:
Treasury Bills – Also known as T-Bills, These are Government bonds or debt
securities with maturity of less than a year. Buying a T-Bill means lending
money to the Government.
Certificate of Deposits – It is a dematerialised form (Electronically generated)
for funds deposited in the bank for a specific period of time.
Commercial Paper – It is an unsecured short-term debt instrument issued by
corporations.