TYBBA Sem 6 2022-23 onwards

Financial Institutions and Markets

Unit 1 Financial Institutions (25%)
● Financial System, Financial System and Economic Development,
● Financial Sector reforms (Brief Overview),
● Financial inclusion (Meaning) Regulatory and Promotional Institutions: Functions and
Role of RBI, The Role and Functions of SEBI

Financial System, Financial System and Economic Development,

What is a Financial System?
A financial system is a set of institutions, such as banks, insurance companies, and stock
exchanges that permit the exchange of funds. A financial system is a system that allows
the exchange of funds between financial market participants such as lenders, investors,
and borrowers.
A financial system is a complex network of institutions, markets, regulations, and
mechanisms that facilitate the flow of funds and financial resources within an economy.
Its primary function is to efficiently allocate resources, transfer funds between savers and
borrowers, and provide a framework for financial activities. The financial system
encompasses various components, each playing a specific role in supporting economic
activities. Here are the key elements of a financial system:
1. Financial Institutions: These are entities that provide financial services to individuals,
businesses, and governments. Common financial institutions include banks, credit
unions, insurance companies, pension funds, and investment firms. These institutions act
as intermediaries between savers and borrowers, mobilizing funds and facilitating the
transfer of financial assets.
2. Financial Markets: Financial markets are platforms where buyers and sellers come
together to trade financial assets such as stocks, bonds, currencies, and commodities.
The two main types of financial markets are capital markets (where long-term securities
are traded) and money markets (where short-term debt instruments are traded). Stock
exchanges and bond markets are examples of financial markets.
3. Financial Instruments: Financial instruments are contracts or documents that represent
a financial claim. Examples include stocks, bonds, derivatives, certificates of deposit, and
insurance policies. These instruments provide a way for individuals and institutions to
invest, save, and manage risk.

4. Regulatory Authorities: Regulatory bodies and government agencies oversee and

regulate the financial system to ensure its stability, integrity, and fair operation. Regulatory
authorities establish rules, standards, and guidelines for financial institutions and market
participants. Central banks, securities commissions, and banking regulators are
examples of regulatory authorities.
5. Payment Systems: Payment systems enable the transfer of funds between individuals,
businesses, and financial institutions. Electronic funds transfer, wire transfers, credit and
debit card transactions, and automated clearing systems are examples of payment
systems that facilitate the movement of money.
6. Central Banks: Central banks play a critical role in the financial system by regulating
the money supply, setting interest rates, and maintaining monetary stability. They often
act as lenders of last resort and oversee the overall health of the financial system.
7. Financial Infrastructure: Financial infrastructure includes the technological and physical
systems that support financial transactions. This includes computer networks,
clearinghouses, settlement systems, and other infrastructure that facilitates the smooth
functioning of financial markets.
8. Financial Services: Financial services encompass a wide range of activities provided
by financial institutions, including banking services, insurance, investment advisory, and
wealth management. These services contribute to the overall efficiency and functionality
of the financial system.
Financial System and Economic Development
The financial system is a vital component of any modern economy, as it provides the
necessary tools and infrastructure for economic development, investment, and risk
management. The effectiveness of a financial system is often measured by its ability to
allocate resources efficiently, promote economic growth, and maintain stability.
1. Resource Allocation: The financial system helps allocate resources by channeling
funds from savers to borrowers. This intermediation function is primarily carried out by
financial institutions such as banks and capital markets. Efficient allocation of capital is
vital for businesses to expand, invest in new projects, and create employment
opportunities.
2. Savings and Investment: A well-functioning financial system encourages savings by
providing individuals and businesses with various savings and investment instruments.
These instruments, such as savings accounts, bonds, and equities, offer returns that
attract savers. The funds mobilized through these channels can then be channeled into
productive investments, fostering economic growth.
3. Risk Diversification: The financial system allows for the diversification of risk, which is
essential for economic development. Financial markets provide a platform for the trading
of financial instruments, allowing investors to spread their risk across different assets and
sectors. This risk diversification helps stabilize the economy and promotes long-term
investment.
4. Entrepreneurship and Innovation: Financial institutions play a key role in supporting
entrepreneurs and innovative businesses. Start-ups and new ventures often require
financing to develop and bring new products or services to the market. Venture capital,
angel investors, and other financial tools support these entrepreneurial activities, fostering
innovation and economic development.
5. Infrastructure Development: Financing major infrastructure projects, such as roads,
bridges, and utilities, is crucial for economic development. The financial system facilitates
the funding of these projects through various mechanisms, including public-private
partnerships, government bonds, and loans from financial institutions.
6. Monetary Policy: The financial system is closely linked to monetary policy, which is
controlled by central banks. Through the manipulation of interest rates and money supply,
central banks can influence inflation, unemployment, and overall economic stability. A
well-managed monetary policy contributes to a stable financial environment conducive to
economic development.
7. Financial Inclusion: Ensuring that a broad segment of the population has access to
financial services is vital for economic development. Financial inclusion, achieved through
measures like the expansion of banking services and the use of digital financial
technologies, enables more individuals to participate in the formal economy, save, invest,
and access credit.
8. Currency Stability: A stable financial system contributes to currency stability. A stable
currency is essential for international trade and investment, as it reduces uncertainty and
risk for businesses and investors.
In summary, a well-functioning financial system is a cornerstone of economic
development. It provides the necessary mechanisms for efficient resource allocation,
encourages savings and investment, supports entrepreneurship and innovation, and
contributes to overall economic stability. Policymakers often focus on creating and
maintaining a sound financial system to foster sustainable economic growth.

Financial Sector reforms (Brief Overview)

In January 2022, financial sector reforms in India have been ongoing and have taken
place over several decades. Reforms have been aimed at promoting efficiency,
transparency, and stability in the financial system. Here is a brief overview of some key
financial sector reforms in India:
1. Liberalization and Deregulation (1991): One of the landmark events in India's financial
sector reforms was the liberalization and deregulation initiated in 1991. The government,
under Prime Minister P.V. Narasimha Rao and Finance Minister Dr. Manmohan Singh,
introduced economic reforms to open up the Indian economy. This included liberalizing
foreign direct investment (FDI), reducing trade barriers, and encouraging competition.
2. Banking Sector Reforms: Several reforms have been introduced to strengthen the
banking sector. Notable initiatives include:
- Nationalization and Recapitalization: In 1969 and 1980, major banks were nationalized
to enhance financial inclusion. Subsequently, efforts were made to recapitalize and
modernize these banks.
- New Private Sector Banks: In the 1990s and 2000s, new private sector banks were
permitted to enter the market, introducing competition and improving service quality.
- Asset Quality Review (2015): The Reserve Bank of India (RBI) conducted an asset
quality review to address non-performing assets (NPAs) and enhance the transparency
of banks' balance sheets.
3. Capital Market Reforms:
- SEBI Reforms: The Securities and Exchange Board of India (SEBI) has implemented
various reforms to enhance transparency and investor protection in the capital markets.
Reforms include dematerialization of securities, introduction of online trading, and
implementation of corporate governance norms.

- Derivatives Market Development: Reforms have been introduced to develop and

regulate the derivatives market, including stock index futures and options.
4. Insurance Sector Reforms:
- Liberalization: The insurance sector was opened up to private participation in 2000,
breaking the monopoly of the state-owned Life Insurance Corporation (LIC) and General
Insurance Corporation (GIC).
- Increase in FDI Limit: The foreign direct investment (FDI) limit in the insurance sector
has been increased over the years to attract foreign capital and expertise.
5. Pension Sector Reforms:
- Introduction of New Pension System (NPS): The NPS was introduced to provide a
sustainable and long-term solution for the retirement needs of individuals.
- Atal Pension Yojana (APY): A social security scheme, APY, was launched to address
the retirement income needs of workers in the unorganized sector.
6. Digital Financial Inclusion:
- Jan Dhan Yojana: Launched in 2014, this scheme aimed to provide financial inclusion
by promoting the opening of bank accounts for the unbanked population.
 - Digital Payment Initiatives: The government has actively promoted digital payment
systems and cashless transactions to reduce the reliance on cash and improve financial
inclusion.
It's important to note that financial sector reforms are ongoing, and the regulatory
landscape may have evolved since my last update in January 2022. Please refer to the
latest sources or official government releases for the most up-to-date information on
financial sector reforms in India.

Financial inclusion (Meaning)

Financial inclusion refers to the accessibility and availability of financial services and
products to all segments of society, particularly to individuals who are traditionally
excluded from the formal financial system. The goal of financial inclusion is to ensure that
people have access to a range of financial services that can help them manage their
finances, save money, make transactions, and access credit and insurance services. It is
a key component of broader efforts to reduce poverty, promote economic development,
and enhance social well-being.

Key elements of financial inclusion include:

1. Access to Banking Services: Financial inclusion involves providing individuals with

access to basic banking services, such as savings accounts, checking accounts, and
payment services. This allows people to securely store their money, make transactions,
and build a financial history.
2. Credit Access: Financially inclusive practices aim to make credit services available to
a wider population. This involves providing affordable and accessible credit to individuals
and small businesses, empowering them to invest in education, entrepreneurship, and
other income-generating activities.
3. Insurance Services: Financial inclusion also encompasses providing access to
insurance products, including life insurance, health insurance, and other types of
coverage. Insurance helps individuals and families mitigate financial risks associated with
unexpected events.
4. Savings and Investments: Promoting savings and investment opportunities is another
aspect of financial inclusion. Encouraging people to save and invest not only helps them
accumulate wealth but also provides a source of funds for economic development.
5. Digital Financial Inclusion: With the advent of digital technology, financial inclusion
efforts increasingly focus on leveraging digital tools and platforms to reach underserved
populations. Mobile banking, digital wallets, and other fintech innovations play a crucial
role in expanding financial access.
6. Education and Literacy: Financial education and literacy programs are essential
components of financial inclusion. Empowering individuals with the knowledge and skills
to make informed financial decisions enhances their ability to navigate the financial
system effectively.
Financial inclusion is viewed as a powerful tool for reducing income inequality, fostering
economic growth, and promoting social development. Governments, financial institutions,
and international organizations often collaborate to design and implement policies and
initiatives that address barriers to financial access, whether they be geographical,
economic, or social in nature. The ultimate aim is to create a more inclusive financial
system that benefits all members of society, including those in marginalized or
underserved communities.

Regulatory and Promotional Institutions of India

India has several regulatory and promotional institutions that play crucial roles in shaping
and overseeing various aspects of the country's economy, industries, and society. Here
are some key regulatory and promotional institutions in India:
1. Reserve Bank of India (RBI): The RBI is the central banking institution in India
responsible for issuing and regulating the Indian Rupee. It formulates and implements
monetary policy, regulates and supervises the banking sector, and manages foreign
exchange.
2. Securities and Exchange Board of India (SEBI): SEBI is the regulatory authority for the
securities market in India. It oversees and regulates capital markets, protecting the
interests of investors and promoting the development and regulation of the securities
market.
3. Insurance Regulatory and Development Authority of India (IRDAI): IRDAI is the
regulatory body for the insurance sector in India. It oversees and regulates insurance
companies to ensure fair practices, protect policyholders' interests, and promote the
growth of the insurance industry.
4. Telecom Regulatory Authority of India (TRAI): TRAI is responsible for regulating the
telecommunications sector in India. It formulates and implements policies to ensure the
growth and development of the telecommunications industry while protecting the interests
of consumers.
5. Central Electricity Regulatory Commission (CERC): CERC regulates the power sector
in India, with a focus on ensuring the development of a competitive and efficient power
market. It sets tariff regulations and promotes transparency in the electricity sector.
6. Competition Commission of India (CCI): CCI is responsible for promoting fair
competition in the market and preventing anti-competitive practices. It regulates mergers
and acquisitions to ensure they do not adversely affect competition in various sectors.
7. National Stock Exchange (NSE) and Bombay Stock Exchange (BSE): These are the
two major stock exchanges in India where equity and other financial instruments are
traded. They play a crucial role in the capital market.
8. National Institution for Transforming India (NITI Aayog): NITI Aayog is a policy think
tank that provides strategic and developmental guidelines to the government. It replaces
the Planning Commission and focuses on fostering cooperative federalism and
sustainable development.
9. Export-Import Bank of India (EXIM Bank): EXIM Bank facilitates India's international
trade by providing financial assistance, information, and advisory services to exporters
and importers.

10. Small Industries Development Bank of India (SIDBI): SIDBI focuses on the
development and promotion of small-scale industries in India by providing financial and
non-financial support.
These institutions collectively contribute to the regulatory framework and economic
development of India by overseeing various sectors and ensuring compliance with
relevant laws and regulations.
.

Functions and Role of RBI

Introduction to RBI:

- Establishment: The Reserve Bank of India (RBI) was established on April

1, 1935, in accordance with the provisions of the Reserve Bank of India Act,
1934.

- Constitutional Status: The RBI operates as the central bank of India and
derives its authority from the Reserve Bank of India Act, which outlines its
powers and functions.
The Reserve Bank of India (RBI), established in 1935, stands as the
cornerstone of India's financial system. Endowed with a multifaceted role,
the RBI is the country's central bank, overseeing monetary policy, financial
regulation, and economic development. Its significance is paramount, and its
functions are diverse, contributing to the stability and growth of the Indian
economy.

One of the primary roles of the RBI is the formulation and implementation of
monetary policy. Through tools like the repo rate, the RBI endeavors to strike
a balance between controlling inflation and fostering economic growth. By
adjusting interest rates, the RBI influences the availability of credit in the
economy, thus shaping the overall economic trajectory.

As the sole issuer of currency notes and coins, the RBI manages the supply
and circulation of currency. This responsibility extends to meeting the
dynamic demands of the economy, such as during festivals when there is a
surge in cash transactions. The meticulous management of currency
ensures the smooth functioning of financial transactions across the nation.

Acting as the banker to the government, the RBI handles financial

transactions, manages public debt, and provides critical advice. Government
securities auctions, conducted by the RBI, serve as a mechanism for the
government to raise funds by selling bonds to investors. This interaction
exemplifies the symbiotic relationship between the government and the
central bank, essential for financial stability.

The RBI also plays a crucial role in ensuring the stability of the banking
system. Serving as the banker's bank, it maintains accounts for commercial
banks and acts as a lender of last resort during financial crises. The RBI's
interventions and liquidity support have been pivotal in safeguarding the
integrity of the banking sector, notably during times of global economic
turmoil.

In its capacity as a regulator and supervisor, the RBI sets prudential norms
for banks and conducts regular inspections to ensure compliance. Capital
adequacy standards and other regulatory measures are enforced to fortify
the financial health of banks and financial institutions, contributing to the
overall robustness of the financial system.
The RBI's developmental roles extend to fostering financial inclusion,
promoting the growth of priority sectors, and advancing the infrastructure of
financial markets. Initiatives like the Pradhan Mantri Jan Dhan Yojana
underscore the commitment to bringing banking services to the unbanked
and underbanked populations, while targeted lending encourages the growth
of sectors critical to India's economic development.

In overseeing payment and settlement systems, the RBI ensures the

efficiency and security of electronic payment mechanisms. The management
of the Real-Time Gross Settlement (RTGS) system exemplifies its
commitment to facilitating seamless and secure high-value transactions.

In conclusion, the Reserve Bank of India stands as a sentinel, steering the

economic course of the nation. Its multifaceted functions, encompassing
monetary policy, financial regulation, and developmental initiatives,
contribute to the resilience and dynamism of the Indian economy. The RBI's
adaptability and strategic interventions remain pivotal in navigating the
evolving economic landscape and fostering sustainable growth.

Functions and role of RBI:

1. Monetary Policy Formulation:

- *Objective:* Maintaining price stability and supporting economic growth.
- *Tools:* Repo rate, reverse repo rate, cash reserve ratio (CRR), statutory
liquidity ratio (SLR), and open market operations (OMO).
- *Example:* If inflation is rising, the RBI may increase the repo rate to
control the money supply and curb inflationary pressures.

2. Currency Issuance and Management:

- *Role:* The sole issuer of currency notes and coins in India.
- *Management:* Ensures an adequate supply of currency and manages
its circulation.
- *Example:* Adjusts the circulation during peak demand periods, such as
festivals, to meet the needs of the public.

3. Banker to the Government:

 - *Functions:* Acts as the banker, agent, and advisor to the central and
state governments.
- *Management:* Handles government accounts, manages public debt,
and facilitates financial transactions.
- *Example:* Conducts auctions of government securities to raise funds for
the government.

4. Banker's Bank and Lender of Last Resort:

- *Role:* Serves as the banker for commercial banks.
- *Support:* Provides liquidity support and acts as the lender of last resort
during financial crises.
- *Example:* Infused liquidity during the 2008 global financial crisis to
maintain the stability of the banking sector.

5. Regulator and Supervisor of the Financial System:

- *Responsibility:* Regulates and supervises banks and financial
institutions.
- *Norms:* Sets prudential norms and conducts inspections to ensure
compliance.
- *Example:* Sets capital adequacy standards to ensure the financial
health of banks.

6. Foreign Exchange Management:

- *Role:* Manages the country's foreign exchange reserves.
- *Objective:* Stabilizes the exchange rate and ensures external sector
stability.
- *Example:* Intervenes in the foreign exchange market to control the
volatility of the Indian rupee.

7. Developmental Roles:
- *Initiatives:* Promotes the development of financial institutions, markets,
and infrastructure.
- *Financial Inclusion:* Implements policies to promote financial inclusion.
- *Example:* Launches initiatives like the Pradhan Mantri Jan Dhan Yojana
to provide banking services to the unbanked.

8. Payment and Settlement Systems:

- *Oversight:* Regulates and oversees payment and settlement systems.
- *Efficiency:* Ensures the efficiency and security of electronic payment
systems.
 - *Example:* Manages the Real-Time Gross Settlement (RTGS) system
for high-value transactions.

9. Data and Research:

- *Function:* Conducts economic research and collects data.
- *Insights:* Provides insights into economic trends.
- *Example:* Publishes reports on key economic indicators like the
Consumer Price Index (CPI).

10. Consumer Protection:

- *Policy:* Implements policies to protect consumer interests in the
financial sector.
- *Guidelines:* Issues guidelines for fair and transparent practices by
financial institutions.
- *Example:* Ensures banks provide clear information on the terms and
conditions of financial products.

11. Financial Stability:

- *Monitoring:* Monitors and assesses overall financial stability.
- *Measures:* Takes measures to address systemic risks and disruptions.
- *Example:* Conducts stress tests on banks to evaluate their resilience
to economic shocks.

12. Promotion of Priority Sectors:

- *Encouragement:* Encourages lending to priority sectors like agriculture
and SMEs.
- *Targets:* Sets targets for banks to allocate a percentage of lending to
priority sectors.
- *Example:* Supports the growth and development of priority sectors
through targeted lending.

The Securities and Exchange Board of India (SEBI) is the regulatory

authority in India that oversees and regulates the securities and capital
markets. Established on April 12, 1992, SEBI was given statutory powers
through the SEBI Act of 1992. The primary objective of SEBI is to protect the
interests of investors and ensure the smooth functioning and development
of the securities markets in India. Here are the key functions and roles of
SEBI:

1. Regulatory Oversight:
 - Market Regulation: SEBI regulates the securities markets, including stock
exchanges, brokers, and other market intermediaries.
- Issuers and Market Participants: SEBI formulates regulations and
guidelines for issuers of securities, market intermediaries, and other entities
involved in the securities market.

2. Investor Protection:
- Disclosure Requirements: SEBI ensures that companies disclose
accurate and timely information to the public. This includes financial
statements, corporate governance practices, and material events.
- Investor Education: SEBI undertakes initiatives to educate investors,
improve financial literacy, and enhance awareness about investment
opportunities and risks.

3. Legal Framework Development:

- Regulatory Framework: SEBI develops and enforces a comprehensive
legal and regulatory framework for the securities markets in India.
- Amendments: SEBI periodically reviews and updates regulations to align
them with market dynamics and international best practices.

4. Supervision and Surveillance:

- Monitoring Market Activities: SEBI conducts surveillance and monitors
trading activities to detect market abuses, insider trading, and other
malpractices.
- Enforcement Actions: SEBI takes enforcement actions against entities
and individuals found in violation of securities laws.

5. Registration and Regulation of Intermediaries:

- Brokers and Sub-Brokers: SEBI regulates and registers stockbrokers,
sub-brokers, and other market intermediaries.
- Merchant Bankers and Underwriters: SEBI oversees the activities of
merchant bankers and underwriters involved in the issuance of securities.

6. Development of Securities Market:

- Innovative Financial Instruments: SEBI encourages the introduction of
new and innovative financial instruments to diversify investment options.
- Market Infrastructure: SEBI works towards enhancing the efficiency and
transparency of market infrastructure, including stock exchanges and
clearing corporations.
7. Corporate Governance:
- Code of Conduct: SEBI prescribes a code of conduct for listed
companies, ensuring good corporate governance practices.
- Board Structure: SEBI promotes transparency in corporate governance
by setting guidelines for the composition and functioning of company boards.

8. Mutual Funds and Collective Investment Schemes:

- Regulation and Oversight: SEBI regulates and oversees the activities of
mutual funds and collective investment schemes to protect the interests of
investors.
- Asset Management Companies: SEBI monitors the functioning of asset
management companies managing mutual funds.

9. Credit Rating Agencies:

- Registration and Oversight: SEBI regulates and registers credit rating
agencies, ensuring they adhere to standards of transparency and objectivity
in rating securities.

10. Takeovers and Mergers:

- Regulation: SEBI regulates takeovers and mergers in listed companies,
protecting the interests of minority shareholders.
- Disclosure Requirements: SEBI mandates disclosure requirements for
entities involved in takeovers and mergers.

11. International Cooperation:

- Collaboration: SEBI collaborates with international regulatory bodies and
exchanges to enhance regulatory standards and facilitate cross-border
cooperation.
- Information Exchange: SEBI exchanges information with foreign
regulators to address global market challenges.

SEBI's role is instrumental in creating a fair, transparent, and efficient

securities market in India. By ensuring investor protection, maintaining
market integrity, and fostering market development, SEBI contributes to the
overall stability and growth of the Indian financial system.