Chapter 1

FINANCIAL SERVICES: AN OVERVIEW

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Basic Concepts
 Capital formation
 Definition of savings
 Types of savings
 Savings rate and pattern
 Financial deepening and widening

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Capital Formation
 One of the major determinants of a country’s
ability to produce goods and services
 Refers to the transfer of savings from the savers
to the users of capital
 Defined as the net addition to the capital stock or
to the value of the amount of increase of the
capital stock that is required for producing goods
and services
 Three major sub-processes: Saving, Financing &
Investment
 GDP: Country’s aggregate production of final
goods and services during a specified period-also
called aggregate real income
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Savings
 Savings is an activity by which claims to
resources that might be put to current
consumption are set aside and so become
available for other purposes

 Any income not spent on current

consumption
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 Types of Savings
 Public savings are the savings of the
government through normal budgetary
channels and the savings of public sector
enterprises
 Private savings refers to all other savings
(savings by households and business
enterprises)
 Corporate savings are the retained earnings
(earnings after tax − payment of dividend and
interest)
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Savings Rate and Pattern
 Savings as percentage of GDP-around 24%
 Household savings in financial assets(lower)
 Household savings in physical assets(higher)
 Proportion of bank deposits(55% of total FA)
 Proportion of mutual funds(5%)
 Proportion of shares and debentures(12%)
 Proportion of insurance funds- increasing
over years
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Financial Deepening and
Widening
 The nature, composition and growth of
financial assets along with the number of
participants in the financial system reflects
the sophistication, development and growth
of the financial system in an economy
 The concepts of financial deepening and
financial widening are important in this
context

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 Financial Deepening and
Widening (contd)
 Financial deepening is measured by the size of
financial assets in relation to the size of the
economy, or the GDP. The higher this ratio, the
deeper is the financial system
 Financial widening refers to the number and
variety of participants and financial instruments
in a financial system. Financial widening
indicates how diverse the financial system is.
More the banks, insurance companies, savers,
investors, borrowers, listed stocks and financial
instruments, wider is the economy
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 Investments
 Financial Investment: FA such as shares, bank
deposits, debentures and bonds, store of
purchasing power
 Real Investments: Real Assets which can be
used for producing goods and services meant for
ultimate consumption-responsible for
development of economy
 Those having surplus money-invest;
 Those having deficit of funds- borrow
 Transfer of investible funds between two
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Financial System
 Definition
 Constituents of a financial system
 Financial institutions
 Financial markets
 Financial instruments
 Regulatory authority

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Financial System (contd)
 A system is a set of elements that are
interrelated and interactive. The elements
operate together to accomplish a stated
purpose. It is the common purpose that
makes the elements belong together.
 Need for financial system to mobilise and
channelise savings for capital formation
 A financial system consists broadly of financial
institutions, financial markets and financial
instruments or securities.
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The Financial System in India

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Structure of Indian Financial System

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Functions of Financial System
 Establish a bridge between savers and
investors to transform entrepreneurial
ideas into reality
 Increase the saving and investment rate
 Makes allocation and utilisation of
savings optimal and efficient
 Influences the volume of funds to be
made available for productive purposes
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Financial Institutions
 Also called Financial Intermediaries,
intermediating between savers and real
investors creating and using productive assets-
known as asset transformers
 Use different kinds of claims called securities
( savers) and loans( investors)
 Different in liquidity, maturity, interest rates,
size
 New approach: Corporates directly accessing
the savers, bypassing banking channels and
raising resources by issuing securities

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Types of Financial Institutions
 Different types of Financial Institutions provide
different type of specialised services.
 Commercial Banks: Public, Private, Rural,
Cooperative Banks, Payment Banks, EXIM, SIDBI,
NABARD etc
 NBFCs, DFIs, State Financial Institutions & State
Industrial Development Corporations
 Micro Finance Companies
 Mutual Funds
 Insurance Companies
 Merchant Banks, Hedge Funds, Private Equity,
Venture Capital and Angel Funds, Infra Funds
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Financial Markets
 Significant Component of Indian Financial
System, facilitating transfer of funds from
savers to investors through issue or sale of
financial instruments.
 Financial Markets provide liquidity
 Helps separate, distribute, diversify and reduce
the risk
 Perfect Financial Market when large number of
players, free flow of information and rational
decision making by participants.
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 Financial Markets Classification
 The centers or arrangements that provide facilities
for demand and supply side of financial claims and
services.

 Classification of Financial Markets

• Money & Capital Markets

• Organised & Unorganised Markets
• Primary & Secondary Markets
• Formal & Informal Markets
• Official & Parallel Markets
• Domestic & Foreign Markets
• Broad & Deep Financial Markets
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Types of Financial Markets
 Government Securities Market and Corporate
Securities Market
 Primary vs. Secondary Market
 Capital market – long term corporate securities-
funds through equity shares, preference
shares, debentures and bonds
 Money Market- short term securities ( one year)
 Debt and Stock Markets
 Stock( NSE and BSE) and Commodity Markets

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Financial Securities
 Financial securities are financial assets
representing claims to payment of money
in future- principal and/or interest or
dividend
 Direct (primary-say shares, debentures)
securities directly issued by users or
indirect ( secondary- financial claim
created by financial intermediaries like
bank deposits, insurance policies)
securities issued by suppliers
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Financial Securities contd..
 Corporate vs. Govt. Securities- treasury
bills, dated incl. promissory notes and
bonds
 Corporate: Equity vs Debt Instruments-
different risk and return characteristics
 Derivatives
 Short term corporate securities like
commercial paper, certificate of deposit
 ADRs/GDRs, Euro bonds, flexi bonds,
indexed bonds, participatory notes, masala
bonds etc
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Financial Instruments & Services
 Financial Assets
 Financial securities (Primary & Secondary)
 Investment characteristics of Financial assets
• Liquidity • Maturity period
• Marketability • Tax status
• Reversibility • Buy-back options
• Transferability • Volatility of prices
• Transaction costs • Rate of return
• Risk of default

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Financial Regulators
 Independent Regualators in India in the
sectors of banking, insurance and
capital markets
 Ensure that participants conduct their
activities in accordance with guidelines
and directives of Government
 RBI, SEBI, IRDA( Insurance Regulatory
and Development Authority)
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 Globalisation of Financial
Services
 Financial services are services provided by the
financial system. These encompass all the services
provided by financial institutions and financial
markets
 Globalization of financial services refers to the
integration of providers of financial services all over
the globe
 Options of raising finance in domestic/ foreign
markets at cheaper rates or easier terms, hedging of
risk
 Facilitation of cross border transactions through
participation of financial institutions spread globally
competing on prices, delivery, speed etc.
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THANK YOU

PROF. ANIL KALRA

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