INTRODUCTION

The financial system, a set of composite and closely interconnected financial institutions/intermediaries, markets, services, assets and
regulatory bodies, is the most significant institutional and functional medium for economic transformation. Financial systems are of
essential significance to formation of capital in financing corporate. Savings, investments and finance are the three interrelated activities
in the process of capital formation.

SAVINGS, INVESTMENTS AND FINANCE: INTER-RELATED ACTIVITIES

The financial system plays a vital role to economy for formation of capital. The formation of capital is made through financi al system
involving collection of savings and their distribution for investment in industry in order to a ccelerate the process of economic growth in the
economy. Therefore, there are three inter-related activities in the process of formation of capital: (a) savings; (b) investments; and (c)
finance.

Exhibit 1: Savings, Investments and Finance: Inter-Related Activities

Finance

Savings Investments
Capital Formation―
Three Inter-related
Activities

Truly speaking, savings and investments are considered to be significant macro-economic variables with micro-economic foundations for
promoting sustainable economic growth in the economy. However, the quantum of capital generation in the economy depends upon potency
and effectiveness of these three inter-related activities. Hence, the proficiency of savings mobilization, the competence of financial system
and the channelization of these savings into attractive and productive forms of investment are all inter-linked for the economic development.

DIFFERENT FINANCIAL INNOVATIONS AND DEVELOPMENTS IN THE FINANCIAL SYSTEM

The functions of financial system are gone through various financial innovations and developments in the financial system of an economy,
which truly refers to financial techniques. Here, we need to understand: (i) rudimentary finance; (ii) direct finance; and
(iii) indirect finance.

Exhibit 2 : Different financial innovations and developments in the financial system

Indirect
Finance

Financial Innovations Direct Finance

Rudimentary and Developments in
Finance the Financial System
Exhibit 3: Direct Finance without Intermediation

Flow of Funds
Suppliers of Funds Users of Funds
 Households  Business Firms
Financial
 Business Firms  Governments
Markets
 Governments  Foreign Investors
 Foreign Investors

Flow of Direct Securities

Exhibit 4: Indirect Finance Process with Intermediation

Flow of Flow of
Funds Funds
Suppliers of Funds Financial Users of Funds
 Households (Demanders)
Intermediaries
 Business Firms  Business Firms
(Mutual Funds; Insurance
 Governments Companies; Financial  Governments
 Foreign Investors
Institutions; and Other  Foreign
Intermediaries)
Investors

Flow of Indirect Securities Flow of Direct Securities

FINANCIAL SYSTEM IN INDIA

Financial system assists to channelize funds from surplus to deficit units. Deficit units are those where current expenditure exceeds
current income; surplus units are those where current income exceeds current expenditure. An efficient financial system efficiently
mobilizes savings (i.e. money resources) into different investment avenues and helps in accelerating the rate of economic development. It
also plays a crucial role in allocating scarce capital resources to productive use. It provides a link between savings and investments for the
creation of new wealth and allows portfolio adjustment in the composition of the existing wealth. Indian financial system consists of
regulatory bodies, financial institutions/intermediaries, financial markets, financial instruments, and financial services.

STRUCTURE OF INDIAN FINANCIAL SYSTEM

The financial system in India comprises financial regulators; financial institutions/intermediaries; financial markets; financial services and
financial instruments. Financial regulators in India mainly include: (i) the Department of Economic Affairs (DEA);
(ii) the Department of Company Affairs (DCA); (iii) SEBI; (iv) Stock Exchanges; (v) RBI; and (vi) IRDA. Financial institutions mainly
consist of: (i) commercial and co-operative banks; (ii) Regional Rural Banks (RRBs); (iii) Non-banking Financial Companies (NBFCs);
and (iv) development financial institutions including: all-India financial institutions, state-level financial institutions and other financial
institutions like: public sector mutual funds, private sector mutual funds, life insurance and general insurance companies. The financial
market, in India, comprises: (i) the money market; (ii) the Government securities market; (iii) the foreign exchange market; (iv) the capital
market; and (v) the derivatives market. There are diverse financial services operating in India. These are: (i) fee-based services; (ii) fund-
based services; and (iii) insurance services. Financial instruments comprise: direct/primary instruments; indirect instruments; and derivatives
instruments. Exhibit 1. 5 depicts the structure of the financial system in India. Let us have a brief idea of the structure of the Indian
financial system.

Financial Markets
A Financial Market can be defined as one in which financial assets are created or transferred. While a real transac tion involves exchange of
money for real goods or services; a financial transaction involves the creation or transfer of a financial asset. Financial Assets, or
Financial Instruments, 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. The salient features of financial markets are stated below:
(a) Financial market is a market where lenders of funds and the borrowers of funds come together for mobilization of funds;
(b) Corporate sectors raise short-term as well as long-term funds from financial markets (i.e. money market as well as primary capital
market)
(c) Financial instruments/products are exchanged or traded from one investors to another;
(d) Institutions that facilitate the trade in financial instruments /products are stock exchanges (BSE, NSE, and others);
(e) It deals with the multicurrency requirements, which are met by the exchange of currencies called foreign exchange market. The
transfer of funds takes place in this market depending upon the exchange rate.
 Exhibit 5: Structure of Indian Financial System

Exhibit 6: Financial Markets in India

FINANCIAL SYSTEM AND ECONOMIC DEVELOPMENT IN INDIA
However, the economic development of any country can be viewed on the basis of growth in the national and per capita income. An
increase in the national income indicates the economic growth of a country.

The sum total of gross value added at factor cost for all the sectors (i.e. agriculture and allied activities, industry and services sectors)
represents the Gross Domestic Product (GDP) at factor cost. The Gross National Product (GNP) is obtained by adding net property
(factor) income from abroad to the GDP at factor cost. The Net National Product (NNP) is calculated by deducting depreciation of the capital
stock from GNP at factor cost. This Net National Product is known as the National Income.
Exhibit 7: Financial System and Economic Development

Components of GDP by expenditure approach: GDP (Y) is the sum of Personal Consumptions (C), Business Investments (I),
Government Spending (G) and X (net exports of goods and services, or imports minus exports). To calculate the components of GNP,
GNP = C + I + G + X + Z. Z stands for (net income earned by domestic residents from overseas investments ― net income earned by
foreign residents from domestic investments.). NNP =GNP― Deprecation on capital stock. Per capita income=NNP (i.e. NI) ÷ Population
of the nation.

It is needless to mention that the National Income is measured on the basis of the Gross Domestic Product (GDP) of a country. Therefore, GDP
is the yardstick of measuring the growth performance of an economy. However, the impact of economic reforms, which is reflected in
the GDP, ultimately indicates the economic growth and development of a country. On the other hand, the growth of the GDP, in any
economy, depends upon the increase in the proportion of savings and investment to the GDP of a nation.

Securities markets/ financial markets as a part of financial system contribute a significant role to continual economic growth. It is evident that
movement of funds always flows from surplus sectors to deficit sectors. In other words, those having surplus of funds lend it to those requiring
funds to meet their requirement. Broadly speaking, in corporate sectors the surplus funds is mobilized from the investors or lenders to the
corporate sectors for the purpose of production or sale of goods and services. This is done with the help of financial markets where there are
mainly two different groups, one investing or lending funds and the others, who borrow or use the funds. These two groups meet and transact
with each other through a mechanism called financial markets. So, the financial markets operate as a link between lenders of funds and the
borrowers or users of funds. It basically plays an intermediary role between the borrowers and lenders of funds.

FINANCIAL MARKETS IN GLOBALISED FINANCIAL SYSTEM

Globalization involves creation of networks and activities in excelling economic, social and geographical boundaries, which brings out
integration of the economy of the country with the world economy. It is an outcome of the set of various policies aimed at transforming the globe
towards greater interdependence and integration. In 1991, a crisis in the balance of payments in India led to the introduction of economic
reforms in the country. India became part of the globalization process and entered into the liberalized economy in 1991 as
a part of economic reforms. Since the early 1990s, the introduction of financial sector reforms in India provided a strong impetus to the
development of financial markets.

THE COMMITTEE ON THE GLOBAL FINANCIAL SYSTEM (CGFS)

The Euro-Currency Standing Committee (ECSC) was established to monitor international banking markets in 1971. Primary focus of ECSC was
on the monetary policy implications of the rapid growth of off-shore deposit and lending markets. However, the ECSC was renamed as the
Committee on the Global Financial System (CGFS) by the G10 Governors on 8 th February 1999. With the passage of time, the CGFS shifted its
concentration gradually more to financial stability questions and to structural change in the financial system. Members of CGFS comprise deputy
governors, other senior officials of central banks, and the Economic Adviser of the Bank for International Settlements (BIS). The member
institutions are: (a) Reserve Bank of Australia; (b) Bank of Korea; (c) National Bank of Belgium; (d) Central Bank of Luxembourg; (e) Central
Bank of Brazil ; (f) Bank of Mexico; (g) Bank of Canada; (h) Netherlands Bank; (i) People's Bank of China; (j) Monetary Authority of
Singapore; (k) European Central Bank; (l) Bank of Spain; (m) Bank of France; (n) Sveriges Riks bank; (o) Deutsche Bundesbank; (p) Swiss
National Bank; (q) Hong Kong Monetary Authority; (r) Bank of England; (s) Reserve Bank of India; (t) Board of Governors of the Federal
Reserve System; (u) Bank of Italy; (v) Federal Reserve Bank of New York; and (w) Bank of Japan. The main functions of the CGFS are as
follows:
(i) monitoring developments in global financial markets for central bank Governors;
(ii) identifying and assessing potential sources of stress in global financial markets;
(iii) promoting the understanding of the structural underpinnings of financial markets;
(iv) encouraging improvements to the functioning and stability of these markets;
(v) promoting the development of well-functioning and stable financial markets and systems through an examination of alternative
policy responses and the elaboration of corresponding policy recommendations;
(vi) paying attention to the nexus between monetary and financial stability, to the linkages between institutions, infrastructures and
markets, to the actual and potential changes in financial intermediation.

FEATURES OF DEVELOPED CAPITAL MARKET: THE INTERNATIONAL ORGANIZATION OF SECURITIES COMMISSIONS (IOSCO)
In 1998, a comprehensive set of Objectives and Principles of Securities Regulation (IOSCO Principles) was adopted by the IOSCO. IOSCO
Principles was recognized as the international regulatory benchmarks for all securities markets. In 2003, the organization endorsed a
comprehensive methodology (IOSCO Principles Assessment Methodology). In 2002, a multilateral memorandum of understanding (IOSCO
MMoU) was adopted by the IOSCO in order to facilitate cross-border enforcement and exchange of information among international securities
regulators. In 2005, the IOSCO endorsed the IOSCO MMoU as the benchmark for international cooperation among securities regulators.
The SEBI is also one of the signatory to IOSCO MMoU. The MMoU sets an international benchmark for cross-border co-operation critical to
combating violations of securities and derivatives laws. It represents a common understanding amongst its signatories about how they will
consult, cooperate, and exchange information for securities regulatory enforcement purposes.

IOSCO Objectives
(i) To cooperate in developing, implementing and promoting adherence to internationally recognized and consistent standards of regulation,
oversight and enforcement in order to protect investors, maintain fair, efficient and transparent markets, and seek to address systemic risks;
(ii) To enhance investor protection and promote investor confidence in the integrity of securities markets, through strengthen information
exchange and cooperation in enforcement against misconduct and in supervision of markets and market intermediaries; and
(iii) To exchange information at both global and regional levels on their respective experiences in order to assist the development of markets,
strengthen market infrastructure and implement appropriate regulation.

The Financial System in the United States (U.S.)

The United States, a federal republic and a representative democracy, is oldest surviving federation in the world. It is a federal republic and a
representative democracy. The U.S. is a founding member of the United Nations, World Bank, International Monetary Fund, Organization of
American States (OAS), and other international organizations. The financial system in U.S. is the most widespread and composite in the globe.
The U.S., a capitalist mixed economy, is a highly developed country, with the world's largest economy by nominal GDP accounting for
approximately a quarter of global GDP. Services and knowledge-based activities are the main features of the U.S. economy, while it has an
important manufacturing base representing the second-largest in the world. It holds the largest share of global wealth with 31% of the total
wealth in the world, while its population is only 4.3% of the total population in the world. Though it shows a wide income and wealth
disparities, it continues to rank very high in terms of socioeconomic performance, comprising average wage, human development, per capita
GDP, and worker productivity.

All the financial sector institutions in the U.S. are grouped into four categories: (a) Depository Institutions; (b) Insurance Companies and Pension
Funds; (c) Government and Government- Sponsored Agencies, including the Federal Reserve; and (d) Non-Bank Intermediaries,
i.e. the institutions that correspond to the shadow banking system. The details are as follows:

Sl.No. Categories Financial Sector Institutions

1 Depository Institutions and Affiliates  U.S. Chartered Depository Institutions
 Foreign Banking Offices in U.S.
 Credit Unions
 Banks in U.S. Affiliated Areas
2 Insurance Companies and Pension Funds  Life Insurance
 Private Pension Funds
  State and Local Govt. Retirement Funds
 Federal Govt. Retirement Funds
 Property-Casualty Insurance
3 Government and Government-Sponsored Agencies  Government-Sponsored Enterprises(GSE)
 Federal Reserve
 Agency and GSE-Backed Mortgage Pools
4 Non-Bank Intermediaries  Mutual Funds
 Holding Companies
 Money Market Mutual Funds
 Funding Companies
 Brokers and Dealers
 Asset-Backed Securities Issuers
 Finance Companies
 Exchange-Traded Funds
 Real Estate Investment Trusts
 Closed-End Funds

The Financial System in China

The socialist market economy of the People's Republic of China is the second largest economy in the world based on nominal GDP. As a largest
manufacturing economy and exporter of goods, it has fastest-growing consumer market and second-largest importer of goods in the world. Most
of financial institutions in China are owned and governed by the government. The Central Bank of China was replaced by the People's Bank of
China (PBC) in 1950 and it gradually took over private banks. With a view to fulfilling many of the functions of other central and commercial
banks, the PBC issues the currency, controls circulation, and plays a significant role in disbursing budgetary expenditures. Moreover,
international trade and other overseas transactions are also made by the PBC. On the other hand, the Bank of China (BOC) manages remittances
by overseas Chinese. However, the chief instruments of financial and fiscal control are the People's Bank of China (PBC) and the Ministry of
Finance and both are under the authority of the State Council. There are other financial institutions comprising (a) the China Development Bank
(CDB); (b) the Agricultural Bank of China (ABC); (c) the China Construction Bank (CCB); and (d) the Industrial and Commercial Bank of
China (ICBC).

The Financial System in Germany

The economy of Germany, a highly developed social market economy, has the fourth-largest economy by nominal GDP in the world. Germany
is a founding member of the European Union and the Eurozone. There are two key features of the development of the German financial system.
The first one is that Germany is a prime example of a bank based financial system. The second key feature is that the publicly owned savings
banks and the cooperative banks that are not primarily motivated by making a profit are integral part of German financial system. Both of which
have their origin in the pattern of industrialization in the second half of the nineteenth century.

As far as Securities markets are concerned, the big banks were keen to develop new business opportunities pertaining to investment banking. In
the mid-1980s, an initiative was taken by a group of big banks to persuade the development of securities markets in Germany and to promote
Frankfurt as a financial centre. Though there are also five smaller exchanges in other cities, the main securities market in Germany is in
Frankfurt. The Frankfurt Stock Exchange originated in the 16th century, continued until 1991 by the Frankfurt Chamber of Commerce. In 1990,
the Frankfurter Wertpapier AG was founded as a new company, which was renamed the Deutsche Börse (German stock exchange) AG in 1992.
In 1988, the big banks took initiative to establish the Deutsche Terminbörse (German Derivatives Exchange, DTB) as a screen based futures and
options exchange, its trading started in 1990. However, the DTB and the Swiss Options and Financial Futures Exchange were merged to form
Eurex in 1998. In 2007, Eurex took over the International Securities Exchange in Chicago.

The Financial System in United Kingdom

The economy of the United Kingdom, highly developed and market-oriented, is the fifth-largest national economy in the world based on nominal
gross domestic product (GDP). In the 18th century, the UK became the first country to industrialize and it had a leading role in the global
economy during the 19th century. The pound sterling, the world's fourth largest reserve currency, is the currency of the UK followed by the
United States Dollar, the Euro and the Japanese Yen. Its currency is one of the 10 most-valued currencies in the globe as well. The UK has
become a member of the Commonwealth, the European Union, the G7, the G20, the International Monetary Fund, the Organization for Security
and Co-operation in Europe, the World Bank, the World Trade Organization, Asian Infrastructure Investment Bank and the United Nations.

The central part of the financial system in U.K. is the essential intermediation between households and non-financial corporate. A significant
user of the financial system is also the government not only for the financing of government debt, but also for savings. Moreover, the
household’s sector services are of short and long term finance. Short term finance comprises basic retail banking services including current
accounts, short term deposit accounts and payments system, whereas long term services consist of the provision of long term savings and
borrowing mechanisms. Long terms savings comprise pensions, mutual funds, long term deposits and insurance, including life and housing
insurance.

The Italian Financial System

The Italian economy, the third largest national economy in the eurozone has become the ninth largest by nominal GDP in the world. Significant
variety of products including machinery, vehicles, pharmaceuticals, furniture, food, clothing, and robots are largely
manufactured and those are exported in the foreign market. There are three main phases of Italian economic history
comprising (a) an initial period of struggle after the unification of the country in 1861; (b) a central period of robust catch-
up from the 1890s to the 1980s; and (c) a final period of sluggish growth. An initial period of struggle after the unification
of the country was represented by high emigration and stagnant growth, while central period of economic scenario was
interrupted by the Great Depression of the 1930s and the two world wars. However, final period of economic scenario
witnessed a slow growth due to a double-dip recession following the 2008 global financial crisis. Since then the country is
slowly recovering only in recent years. In 2017, Italian economic growth came to enhance considerably, while economic
expansion became more balanced across demand components and economic sectors.