UNIT-1 INTRODUCTION OF INDIAN FINANCIAL SYSTEM

Meaning of Indian financial system

The financial system enables lenders and borrowers to exchange funds. India has a financial system
that is controlled by independent regulators in the sectors of insurance, banking, capital markets and
various services sectors. Thus, a financial system can be said to play a significant role in the
economic growth of a country by mobilizing the surplus funds and utilizing them effectively for
productive purposes.

FEATURES OF INDIAN FINANCIAL SYSTEM:

• It plays a vital role in economic development of a country.

• It encourages both savings and investment.

• It links savers and investors.

• It helps in capital formation.

• It helps in allocation of risk.

• It facilitates expansion of financial markets.

FUNCTIONS OF THE FINANCIAL SYSTEM

1. Provision of liquidity

The major function of the financial system is the provision of money and

monetary assets for the production of goods and services. There should not

be any shortage of money for productive ventures. In financial language, the

money and monetary assets are referred to as liquidity. The term liquidity

refers to cash or money and other assets which can be converted into cash

readily without loss of value and time. Hence, all activities in a financial

system are related to liquidity — either provision of liquidity or trading in

liquidity. In fact, in India the RBI has been vested with the monopoly power

of issuing coins and currency notes. Commercial banks can also create cash

(deposit) in the form of ‘credit creation’ and other financial institutions also

deal in monetary assets. Over supply of money is also dangerous to the

economy. In India, the RBI is the leader of the financial system and hence it

has to control the money supply and creation of credit by banks and regulate

all the financial institutions in the country in the best interest of the nation. It

has to shoulder the responsibility of developing a sound financial system by

strengthening the institutional structure and by promoting savings and

investment in the country.

2. Mobilisation of savings

Another important activity of the financial system is to mobilise savings

and channelise them into productive activities. The financial system should

offer appropriate incentives to attract savings and make them available for

more productive ventures. Thus, the financial system facilitates the

transformation of savings into investment and consumption. The financial

intermediaries have to play a dominant role in this activity.

3. Size transformation function

Generally, the savings of millions of small investors are in the nature of

a small unit of capital which cannot find any fruitful avenue for investment

unless it is transformed into a perceptible size of credit unit. Banks and other

financial intermediaries perform this size transformation function by collecting

deposits from a vast majority of small customers and giving them as loan of

a sizeable quantity. Thus, this size transformation function is considered to

be one of the very important functions of the financial system.

4. Maturity transformation function

Another function of the financial system is the maturity transformation

function. The financial intermediaries accept deposits from public in different

maturities according to their liquidity preference and lend them to the

borrowers in different maturities according to their need and promote the

economic activities of a country.

5. Risk transformation function

Most of the small investors are risk-averse with their small holding of

savings. So, they hesitate to invest directly in stock market. On the other

hand, the financial intermediaries collect the savings from individual savers

and distribute them over different investment units with their high knowledge

and expertise. Thus, the risks of individual investors get distributed. This

risk transformation function promotes industrial development. Moreover,

various risk mitigating tools are available in the financial system like hedging,

insurance, use of derivatives, etc.

Classification of Indian Financial System

The Indian financial system can be classified into the formal financial system and the informal
financial system

Formal Financial System

The formal financial system comprises of network of banks, other financial and investment
institutions and a range of financial instruments

Components of Formal Financial System

The formal financial system comprises of four major components:

Financial Institutions

Financial Markets

Financial Instruments

Financial Services

Informal Financial System

The informal financial system comprises of moneylenders, indigenous bankers, lending pawn
brokers, landlords, traders etc

COMPONENTS/ CONSTITUENTS OF INDIAN FINANCIAL SYSTEM

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.

FINANCIAL INSTITUTIONS

Financial institutions are the intermediaries who facilitate smooth functioning of the financial system
by making investors and borrowers meet. They mobilize savings of the surplus units and allocate
them in productive activities promising a better rate of return. Financial institutions also provide
services to entities (individual, business, government) seeking advice on various issue ranging from
restructuring to diversification plans. They provide whole range of services to the entities who want
to raise funds from the markets or elsewhere.Financial institutions are also termed as financial
intermediaries because they act as middle between savers by accumulating Funds them and
borrowers by lending these fund.It is also act as intermediaries because they accept deposits from a
set of customers (savers lend these funds to another set of customers (borrowers). Like - wise
investing institutions such ICCIC, mutual funds also accumulate savings and lend these to borrowers,
thus perform the role of financial intermediaries.

TYPES OF FINANCIAL INSTITUTIONS

Financial institutions can be classified into two categories:

A. Banking Institutions

B. Non - Banking Financial InstitutionsA.

BANKING INSTITUTIONS (Reserve Bank of India)

Indian banking industry is subject to the control of the Central Bank. The RBI as the apex institution
organises, runs, supervises, regulates and develops the monetary system and the financial system of
the country. The main legislation governing commercial banks in India is the Banking Regulation Act,
1949.

The Indian banking institutions can be broadly classified into two categories:

1. Organised Sector

2. Unorganised Sector.

1. Organised Sector

The organised banking sector consists of commercial banks, cooperative

banks and the regional rural banks.

(a) Commercial Banks: The commercial banks may be scheduled banks or non – scheduled banks. At
present only one bank is a non - scheduled hank. All other banks are schedule banks. The
commercial banks consist of 27 public sector banks, private sector banks and foreign banks. Prior to
1969, all major banks with the exception of State Bank of India in the private sector. An important
step towards public sector banking was taken in July 1969, when 14 major private banks with a
deposit base of 50 crores or more were nationalised. Later in 1980 another 6 were nationalised
bringing up the total number banks nationalised to twenty.

(b) Co-operative banks: An important segment of the organized sector of Indian banking is the co-
operative banking. The segment is represented by a group of societies registered under the Acts of
the states relating to co-operative societies. In fact, co-operative societies may be credit societies or
non-credit societies.Different types of co-operative credit societies are operating in Indian economy.
These institutions can be classified into two broad categories:

(a) Rural credit societies which are primary agriculture,

(b) Urban credit societies which are primarily non-agriculture.For the purpose of agriculture credit
there are different co-operative credit institutions to meet different kinds of needs.

(c) Regional Rural Banks (RRBs): Regional Rural Banks were set by the state government and
sponsoring commercial banks with the objective of developing the rural economy. Regional rural
banks provide banking services and credit to small farmers, small entrepreneurs in the rural areas.
The regional rural banks were set up with a view to provide credit facilities to weaker sections. They
constitute an important part of the rural financial architecture in India. There were 196 RRBs at the
end of June 2002, as compares to 107 in 1981 and 6 in 1975.
(d) Foreign Banks: Foreign banks have been in India from British days. Foreign banks as banks that
have branches in the other countries and main Head Quarter in the Home Country. With the
deregulation (Elimination of Government Authority) in 1993, a number of foreign banks are entering
India. Foreign Banks are: Citi Bank. Bank of Ceylon.

2. Unorganised Sector.

In the unorganised banking sector are the Indigenous Bankers, Money Lenders.

1. Indigenous Bankers

Indigenous Bankers are private firms or individual who operate as banks and as such both receive
deposits and given loans. Like bankers, they also financial intermediaries. They should be
distinguished professional money lenders whose primary business is not banking and money
lending. The indigenous banks are trading with the Hundies, Commercial Paper.

2. Money Lenders:

Money lenders depend entirely to on their one funds. Money Lenders may be rural or urban,
professional or non-professional. They include large number of farmer, merchants, traders. Their
operations are entirely unregulated. They charge very high rate of interest.

B. NON – BANKING INSTITUTIONS

The non – banking institutions may be categorized broadly into two

groups:

(a) Organised Non – Banking Financial Institutions.

(b) Unorganised Non – Banking Financial Institutions.

(a) Organised Non – Banking Financial Institutions

The organised non - banking financial institutions include:

1. Development Finance Institutions.

These include: The institutions like IDBT, ICICI, IFCI, IIBI, IRDC at all India level.The State Finance
Corporations (SFCs), State Industrial Development Corporations (SIDCs) at the state level.Agriculture
Development Finance Institutions as NABARD,LDBS etc.Development banks provide medium and
long term finance to the corporate and industrial sector and also take up promotional activities for
economic development

2. Investment Institutions.

These include those financial institutions which mobilise savings at the public at large through
various schemes and invest these funds in corporate and government securities. These include LIC,
GIC, LTT, and mutual funds.The non - banking financial institutions in the organised sector) have
been discussed at length in detail in separate chapters of this book.

(b) Unorganised Non - Banking Financial Institutions

The unorganised non - banking financial institutions include number of non -

banking financial companies (NBFCs) providing whole range of financial services. These include hire -
purchase 300 consumer finance companies, leasing companies, housing finance companies,
factoring companies,Credit rating agencies, merchant banking companies etc. NBFCs mobilise public
funds and provide loanable funds.

FINANCIAL MARKET.

. Financial markets refer to the institutional arrangements for dealing in financial assets and credit
instruments of different types such as currency, cheques, bank deposits, bills, bonds etc.

Functions of financial markets are:

(i) To facilitate creation and allocation of credit and liquidity

(ii) To serve as intermediaries for mobilisaton of savings.

(iii) To assist the process of balanced economic growth.

(iv) To provide financial convenience.

(v) To cater to the various credit needs of the business houses.

FINANCIAL MARKETS

Generally speaking, there is no specific place or location to indicate afinancial market. Wherever a
financial transaction takes place, it is deemed tohave taken place in the financial market. Hence,
financial markets are pervasivein nature since, financial transactions are themselves very
pervasivethroughout the economic system. For instance, issue of equity shares, granting of loan by
term lending institutions, deposit of money into a bank, purchase

of debentures, sale of shares and so on.However, financial markets can be referred to as those
centres and arrangements which facilitate buying and selling of financial assets, claims and services.
Sometimes, we do find the existence of a specific place or location for a financial market as in the
case of stock exchange.

Classification of financial markets

Unorganised markets

In these markets, there are a number of moneylenders, indigenousbankers, traders, etc., who lend
money to the public. Indigenous bankers also collect deposits from the public. There are also private
finance companies, chit funds, etc., whose activities are not controlled by the RBI. Recently, the RBI
has taken steps to bring private finance companies and chit funds under its strict control by issuing
non-banking financial companies (Reserve Bank)Directions, 1998. The RBI has already taken some
steps to bring the unorganised sector under the organised fold. They have not been successful.The
regulations concerning their financial dealings are still inadequate and their financial instruments
have not been standardised.

Organised markets

In the organised markets, there are standardised rules and regulations governing their financial
dealings. There is also a high degree of institutionalisation and instrumentalisation. These markets
are subject to strict supervision and control by the RBI or other regulatory bodies.These organised
markets can be further classified into two. They are:

(i) Capital market.

(ii) Money market.

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 havea maturity period of above one year. Capital
market may be further dividedinto three namely:

(i) Industrial securities market.

(ii) Government securities market, and

(iii) Long-term loans market.

(i) Industrial securities market

As the very name implies, it is a market for industrial securities namely:

(i) Equity shares or ordinary shares, (ii) Preference shares, and (iii) Debenturesor bonds. It is a
market where industrial concerns raise their capital or debt by issuing appropriate instruments. It
can be further subdivided into two.

They are:

(i) Primary market or New issue market.

(ii) Secondary market or Stock exchange.

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. In the primary market, borrowers exchange new financial securities for long-term funds.Thus,
primary market facilitates capital formation.There are three ways by which a company may raise
capital in a primary market. They are:

(i) Public issue.

(ii) Rights issue.

(iii) Private placement.

The most common method of raising capital by new companies is through

sale of securities to the public. It is called public issue.

When an existing company wants to raise additional capital, securities are first offered to the
existing shareholders on a pre-emptive basis. It is called rights issue.

Private placement is a way of selling securities privately to a small group of investors.

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 in the Stock Exchange and it provides a continuous and regular market for buying and
selling of securities. This market consists of all stock exchanges recognised by the Government of
India. The stock exchanges in India are regulated under the Securities Contracts (Regulation) Act,
1956. The Bombay Stock Exchange is the principal stock exchange in India which sets the tone of the
other stock

markets.

(ii) Government securities market

It is otherwise called Gilt-edged securities market. It is a market where Government Securities are
traded. In India, there are many kinds of Government securities — short-term and long-term. Long-
term securities are traded in this market while short-term securities are traded in the money market.
Securities issued by the Central Government, State Governments, Semi-government authorities like
City Corporations, Port Trusts, etc.Improvement Trusts, State Electricity Boards, All India and State
level financial institutions and public sector enterprises are dealt in this market.Government
Securities are issued in denominations of ` 100. Interest is payable half-yearly and they carry tax
exemptions also. The role of brokers in marketing these securities is practically very limited and the
major participant in this market is the ‘commercial banks’ because they hold a very

substantial portion of these securities to satisfy their SLR requirements.The secondary market for
these securities is narrow since, most of the institutional investors tend to retain these securities
until maturity.The Government Securities are in many forms. These are generally:

(i) Stock certificates or inscribed stock.

(ii) Promissory notes.

(iii) Bearer bonds which can be discounted.

Government Securities are sold through the Public Debt Office of the

RBI while Treasury Bills (short-term securities) are sold through auctions.Government Securities
offer a good source of raising inexpensive finance for the Government exchequer and the interest on
these securities influences the prices and yields in this market. Hence, this market also plays a vital
role in monetary management

(iii) Long-term loans market

Development banks and commercial banks play a significant role in this market by supplying long-
term loans to corporate customers. Long-term loans market may further be classified into:

(i) Term loans market.

(ii) Mortgages market.

(iii) Financial guarantees market.

Term loans market

In India, many industrial financing institutions have been created by the Government both at the
national and regional levels to supply long-term and medium-term loans to corporate customers
directly as well as indirectly. These development banks dominate the industrial finance in India.
Institutions likeIRBI, IFCI, and other state financial corporations come under this category.These
institutions meet the growing and varied long-term financial requirements of industries by supplying
long-term loans. They also help in identifying investment opportunities, encourage new
entrepreneurs and support modernisation efforts.

Mortgages market
The mortgages market refers to those centres which supply mortgage loan mainly to individual
customers. A mortgage loan is a loan against the security of immovable property like real estate. The
transfer of interest in a specific immovable property to secure a loan is called mortgage. This
mortgage may be equitable mortgage or legal one. Again, it may be a first charge or second charge.
Equitable mortgage is created by a mere deposit of title deeds to properties as security, whereas in
the case of a legal mortgage the title in the property is legally transferred to the lender by the
borrower. Legal mortgage is less risky.

Similarly, in the first charge, the mortgager transfers his interest in the specific property to the
mortgagee as security. When the property in question is already mortgaged once to another
creditor, it becomes a second charge when it is subsequently mortgaged to somebody else. The
mortgagee can also further transfer his interest in the mortgaged property to another. In such a
case, it is called a sub-mortgage.The mortgage market may have primary market as well as
secondarymarket. The primary market consists of original extension of credit and secondary market
has sales and resales of existing mortgages at prevailingprices.

Financial guarantees market

A guarantee Market is a centre where finance is provided against the guarantee of a reputed person
in the financial circle. Guarantee is a contract to discharge the liability of a third party in case of his
default. Guarantee acts as a security from the creditor’s point of view. In case the borrower fails to
repay the loan, the liability falls on the shoulders of the guarantor. Hence,the guarantor must be
known to both the borrower and the lender and he must have the means to discharge his
liability.Though there are many types of guarantees, the common forms are:

(i) Performance guarantee, and (ii) Financial guarantee. Performance

guarantees cover the payment of earnest money, retention money, advance payments, non-
completion of contracts, etc. On the other hand, financial guarantees cover only financial
contracts.In India, the market for financial guarantees is well organised. The

financial guarantees in India relate to:

(i) Deferred payments for imports and exports.

(ii) Medium and long-term loans raised abroad.

(iii) Loans advanced by banks and other financial institutions.

These guarantees are provided mainly by commercial banks,development banks, Governments, both
Central and States and other specialised guarantee institutions like ECGC (Export Credit Guarantee
Corporation) and DICGC (Deposit Insurance and Credit Guarantee Corporation). This guarantee
financial service is available to both individual

and corporate customers. For a smooth functioning of any financial system,this guarantee service is
absolutely essential.

IMPORTANCE OF CAPITAL MARKET

Absence of capital market acts as a deterrent factor to capital formation

and economic growth. Resources would remain idle if finances are not funneled

through the capital market. The importance of capital market can be briefly

summarised as follows:
(i) The capital market serves as an important source for the productive use of the economy’s savings.
It mobilises the savings of the people for further investment and thus, avoids their wastage in
unproductive uses.

(ii) It provides incentives to saving and facilitates capital formation by offering suitable rates of
interest as the price of capital.

(iii) It provides an avenue for investors, particularly the household sector to invest in financial assets
which are more productive than physical

assets.

(iv) It facilitates increase in production and productivity in the economy and thus, enhances the
economic welfare of the society. Thus, it facilitates ‘the movement of stream of command over
capital to thepoint of highest yield’ towards those who can apply them productively and profitably to
enhance the national income in theaggregate.

(v) The operations of different institutions in the capital market induce economic growth. They give
quantitative and qualitative directions to the flow of funds and bring about rational allocation of
scarce resources.

(vi) A healthy capital market consisting of expert intermediaries promotes stability in values of
securities representing capital funds.

(vii) Moreover, it serves as an important source for technological upgradation in the industrial sector
by utilising the funds invested by the public.Thus, a capital market serves as an important link
between those who save and those who aspire to invest their savings.

MONEY MARKET

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 may be subdivided into four.

They are:

(i) Call money market.

(ii) Commercial bills market.

(iii) Treasury bills market.

(iv) Short-term loan market.

Call money market

The call money market is a market for extremely short period loans say one day to fourteen days. So,
it is highly liquid. The loans are repayable on demand at the option of either the lender or the
borrower. In India, call money markets are associated with the presence of stock exchanges and
hence, they are located in major industrial towns like Mumbai, Kolkata, Chennai, Delhi, Ahmedabad,
etc. The special feature of this market is that the interest rate varies from day-to-day and even from
hour-to-hour and centre-to-centre. It is very sensitive to changes in demand and supply of call loans.

Commercial bills market

It is a market for bills of exchange arising out of genuine trade transactions. In the case of credit sale,
the seller may draw a bill of exchange on the buyer. The buyer accepts such a bill, promising to pay
at a later date the amount specified in the bill. The seller need not wait until the due date of the bill.
Instead, he can get immediate payment by discounting the bill. In India, the bill market is
underdeveloped. The RBI has taken many steps to develop a sound bill market. The RBI has enlarged
the list of participants in the bill market. The Discount and Finance House of India was set-up in 1988
to promote secondary market in bills. In spite of all these, the growth of the bill market is slow in
India. There are no specialised agencies for discounting bills. The commercial banks play a significant
role in this market

Treasury bills market

It is a market for treasury bills which have ‘short-term’ maturity. A treasury bill is a promissory note
or a finance bill issued by the Government. It is highly liquid because its repayment is guaranteed by
the Government. It is an important instrument for short-term borrowing of the Government. There
are two types of treasury bills namely: (i) Ordinary or Regular and

(ii) ad hoc treasury bills popularly known as ‘ad hocs’. Ordinary treasury bills are issued to the public,
banks and other financial institutions with a view to raising resources for the Central Government to
meet its short-term financial needs. Ad hoc treasury bills are issued in favour of the RBI only. They
are not sold through tender or auction. They can be purchased by the RBI only. Ad hocs are not
marketable in India but holders ofthese bills can sell them back to RBI. Treasury bills have a maturity
period of 91 days or 182 days or 364 days only. Financial intermediaries can park their temporary
surpluses in these instruments and earn income.

Short-term loan market

It is a market where short-term loans are given to corporate customers for meeting their working
capital requirements. Commercial banks play a significant role in this market. Commercial banks
provide short-term loans in the form of cash credit and overdraft. Overdraft facility is mainly given to
business people, whereas cash credit is given to industrialists. Overdraft is purely a temporary
accommodation and it is given in the current account itself. But, cash credit is for a period of one
year and it is sanctioned in a

separate account.

FOREIGN EXCHANGE MARKET

The term foreign exchange refers to the process of converting home currencies into foreign
currencies and vice versa. According to Dr. Paul Einzing, ‘Foreign exchange is the system or process
of converting one national currency into another, and of transferring money from one country to
another’. The market where foreign exchange transactions take place is called aforeign exchange
market. It does not refer to a marketplace in the physical sense of the term. In fact, it consists of a
number of dealers, banks and brokers engaged in the business of buying and selling foreign
exchange. It also includes the central bank of each country and the treasury authorities who enter
into this market as controlling authorities. Those engaged in the foreign exchange business are
controlled by the Foreign Exchange Maintenance Act (FEMA).

Functions

The most important functions of this market are:

(i) To make necessary arrangements to transfer purchasing power from one country to another.

(ii) To provide adequate credit facilities for the promotion of foreign trade.
(iii) To cover foreign exchange risks by providing hedging facilities. In India, the foreign exchange
business has a three-tiered structure consisting of:

(i) Trading between banks and their commercial customers.

(ii) Trading between banks through authorised brokers.

(iii) Trading with banks abroad.

Brokers play a significant role in the foreign exchange market in India. Apart from authorised
dealers, the RBI has permitted licensed hotels and individuals (known as Authorised Money
Changers) to deal in foreign exchange business. The FEMA helps to smoothen the flow of foreign
currencyand to prevent any misuse of foreign exchange which is a scarce commodity

.FINANCIAL INSTRUMENTS

Financial instruments refer to those documents which represent financial claims on assets. As
discussed earlier, financial asset refers to a claim to the repayment of a certain sum of money at the
end of a specified period together with interest or dividend. Examples: Bill of Exchange, Promissory
Note, Treasury Bill, Government Bond, Deposit Receipt, Share, Debenture, etc. Financial instruments
can also be called financial securities. Financial

securities can be classified into:

(i) Primary or direct securities.

(ii) Secondary or indirect securities.

Primary securities

These are securities directly issued by the ultimate investors to the ultimate savers, e.g., shares and
debentures issued directly to the public.

Secondary securities

These are securities issued by some intermediaries called financial intermediaries to the ultimate
savers, e.g., Unit Trust of India and Mutual Funds issue securities in the form of units to the public
and the money pooled is invested in companies.Again these securities may be classified on the basis
of duration as

follows:

(i) Short-term securities.

(ii) Medium-term securities.

(iii) Long-term securities.

Short-term securities are those which mature within a period of one year, e.g., Bill of Exchange,
Treasury Bill, etc. Medium-term securities are those which have a maturity period ranging between
one to five years, e.g., Debentures maturing within a period of five years. Long-term securities are
those which have a maturity period of more than five years, e.g., GovernmentBonds maturing after
ten years.

Characteristic features of financial instruments

Generally speaking, financial instruments possess the following

characteristic features:

(i) Most of the instruments can be easily transferred from one hand to another without many
cumbersome formalities.

(ii) They have a ready market, i.e., they can be bought and sold frequently and thus, trading in these
securities is made possible.

(iii) They possess liquidity, i.e., some instruments can be converted into cash readily. For instance, a
bill of exchange can be converted into cash readily by means of discounting and rediscounting.

(iv) Most of the securities possess security value, i.e., they can be given as security for the purpose of
raising loans.

(v) Some securities enjoy tax status, i.e., investments in these securities are exempted from Income
Tax, Wealth Tax, etc., subject to certain limits, e.g., Public Sector Tax Free Bonds, Magnum Tax
Saving Certificates.

(vi) They carry risk in the sense that there is uncertainty with regard to payment of principal or
interest or dividend as the case may be.

(vii) These instruments facilitate futures trading so as to cover risks due to price fluctuations, interest
rate fluctuations, etc.

(viii) These instruments involve less handling costs since expenses involved in buying and selling
these securities are generally much less.

(ix) The return on these instruments is directly in proportion to the risk undertaken.

(x) These instruments may be short-term or medium-term or long-term depending upon the
maturity period of these instruments.

FINANCIAL ASSETS

In any financial transaction, there should be a creation or transfer of financial asset. Hence, the basic
product of any financial system is the financial asset. A financial asset is one which is used for
production or consumption or for further creation of assets. For instance, A, buys equity shares and
these shares are financial assets since they earn income in future. In this context, one must know the
distinction between financial assets and physical assets. Unlike financial assets, physical assets are
not useful for further production of goods or for earning income. For example, X purchases land and
buildings, or gold and silver. These are physical assets since they cannot be used for further
production. Many physical assets are useful for consumption only. It is interesting to note that the
objective of investment decides the nature of the asset. For instance, if a building is bought for
residence purposes, it becomesa physical asset. If the same is bought for hiring, it becomes a
financial asset.

Classification of financial assets

Financial assets can be classified differently under different

circumstances. One such classification is:

(i) Marketable assets

(ii) Non-marketable assets

Marketable assets

Marketable assets are those which can be easily transferred from one person to another without
much hindrance. Examples: Shares of Listed Companies, Government Securities, Bonds of Public
Sector Undertakings, etc.

Non-marketable assets

On the other hand, if the assets cannot be transferred easily, they come under this category.
Examples: Bank Deposits, Provident Funds, Pension Funds, National Savings Certificates, Insurance
Policies, etc.

Cash asset

In India, all coins and currency notes are issued by the RBI and the Ministry of Finance, Government
of India. Besides, commercial banks can also create money by means of creating credit. When loans
are sanctioned, liquid cash is not granted. Instead, an account is opened in the borrower’s name and
a deposit is created. It is also a kind of money asset.

Debt asset

Debt asset is issued by a variety of organisations for the purpose of raising their debt capital. Debt
capital entails a fixed repayment schedule with regard to interest and principal. There are different
ways of raising debt capital. Example: issue of debentures, raising of term loans, working capital
advance, etc.

Stock asset

Stock is issued by business organisations for the purpose of raising thei fixed capital. There are two
types of stock-namely equity and preference. Equity shareholders are the real owners of the
business and they enjoy the fruits of ownership and at the same time they bear the risks as well.
Preference shareholders, on the other hand get a fixed rate of dividend (as in the case of debt asset)
and at the same time they retain some characteristics of equity.

FINANCIAL INTERMEDIARIES

The term financial intermediary includes all kinds of organisations which intermediate and facilitate
financial transactions of both individuals and corporate customers. Thus, it refers to all kinds of
financial institutions and investing institutions which facilitate financial transactions in financial
markets. They may be in the organised sector or in the unorganised sector as showin Chart 1.2
displayed in page 8. They may also be classified into two:

(i) Capital market intermediaries.

(ii) Money market intermediaries.

Capital market intermediaries

These intermediaries mainly provide long-term funds to individuals and corporate customers. They
consist of term lending institutions like financial corporations and investing institutions like LIC.

Money market intermediaries

Money market intermediaries supply only short-term funds toindividuals and corporate customers.
They consist of commercial banks, co-operative banks, etc.
FINANCIAL SERVICES

Efficiency of emerging financial system largely depends upon the quality and variety of financial
services provided by financial intermediaries. The term financial services can be defined as
“activities, benefits, and satisfactions, connected with the sale of money, that offer to users and
customers, financial related value. within the financial services industry the main sectors are banks,
financial institutions, and non-banking financial companies.

KINDS OF FINANCIAL SERVICES

Financial services provided by various financial institutions, commercial banks and merchant bankers
can be broadly classified into two categories.

1. Asset based/fund based services.

2. Fee based/advisory services.

Asset based/fund based services

The asset/ fund based services provided by banking and non - banking

financial institutions as discussed below briefly.

1. Equipment Leasing/ Lease Financing

Leasing is a arrangement that provides a firm with the use and control over assets without buying
and owning the same. It is a form of renting assets. However, in making an investment, the firm
need not own the asset. It is

basically interested in acquiring the use of the asset. Thus, the firm may consider leasing of the asset
rather than buying it.In comparing leasing with buying, the cost of leasing the asset should be
compared with the cost of financing the asset through normal sources of financing, i. e. debt and
equity. Since payment of lease rentals is similar to payment of interest on borrowings and lease
financing is equivalent to debt.

2. Hire Purchase and Consumer Credit

Hire purchase means a transaction where goods are purchased and sold on the terms that (i)
payment will be made it installments, (ii) the possession of the goods is given to the buyer
immediately, (iii) the property ownership) in the goods remains with the vendor till the last
installment is paid,(iv) the seller can repossess the goods in case of default in payment of any
instalment, and (v) each instalment is treated as hire charges till the last instalment is
paid.Consumer credit includes all asset based financing plans offered to individuals to help them
acquire durable consumer goods. In a consumer credit transaction the individual/ consumer/ buyer
pays a part of the cash purchase price at the time of the delivery of the asset and pays the balance
with interest over a specified period of time.

3.VENTURE CAPITAL

In the real sense, venture capital financing is one of the most recent entrants in the Indian capital
market. There is a significant scope for venture capital companies in our country because of
increasing emergence of technocrat entrepreneurs who lack capital to be risked. These venture
capital companies provide the necessary risk capital to the entrepreneurs so as to meet the
promoters contribution as required by the financial institutions. In addition to providing capital,
these VCFS (venture capital firms) take an active interest in guiding the assisted firms.

4. Insurance Services

Insurance is a contract where by the insurer e. insurance company agrees/ undertakes, in

consideration of a sum of money (premium) to make good the loss suffered by the insured (policy
holder) against a specified risk such as fire or compensate the beneficiaries (insured) on the
happening of a specified event such as accident or death. The document containing the terms of
contract, in black and white, between the insurer and the insured is called policy. The property
which is insured is the subject matter of insurance. The interest which the insured has in the subject
matter of insurance is known as

insurable interest. Depending upon the subject matter, insurance services aredivided into (i) life (ii)
general.

5. Factoring

Factoring, as a fund based financial service provides resources to finance receivables as well as it
facilitates the collection of receivables. It is another method of raising short - term finance through
account receivable credit offered by commercial banks and factors. A commercial bank may provide
finance by discounting the bills or invoices of its customers. Thus, a firm gets immediate payment for
sales made on credit. A factor is a financial institution which offers services relating to management
and financing of debts arising out of credit sales.

B. FEE BASED ADVISORY SERVICES

(i) Merchant Banking

Fee based advisory services includes all these financial services rendered by Merchant Bankers.
Merchant bankers play an important role in the financial services Sector. The Industrial Credit and
Investment Corporation of India (ICICI) was the first development finance institution to initiate such
service in 1974. After mid - seventies, tremendous growth in the number of merchant banking
organisations les taken place. These include banks financial institutions, non - banking financial
companies (NBFCS), brokers and so on. financial Services provided by these organisations include
loan syndication portfolio management, corporate counselling project counselling debenture
trusteeship, mergers acquisitions.

(ii) Credit Rating

Credit rating is the opinion of the rating agency on the relative ability and willingness of the issuer of
debt instrument to meet the debt service obligations as and when they arise. As a fee based
financial advisory service, credit rating useful to investors, corporates (borrowers), banks and
financial institutions. For the investors, it is an indicator expressing the underlying credit quality of a
(debt) issue programme. The investor is fully formed about the company as any effect of changes in
business/ economic conditions on the agency company is evaluated and published regularly by the
rating agency.

(iii) Stock - Broking

Prior to the setting up of SEBI, stock exchanges were being supervised by the

Ministry of Finance under the Securities Contracts Regulation Act (SCRA) and were operating more
or less self-regulatory organisations.The need to reform stock exchanges was felt, when malpractices
crept into Trading and in order to protect investor's interests, SEBI was set up to ensure that stock
exchange perform their self - regulatory role properly. Since then, stock broking has emerged as a
professional advisory service Stockbroker is a member of a recognised stock exchange who buys,
sells or deals in shares/

securities. It is mandatory for each stockbroker to get him/ herself registered with SEBI order to act
as a broker. SEBI is empowered to impose conditions while granting the certificate of registration.