Module 1 - Overview of

Indian Financial System

Module 1 - Overview of Indian Financial System

• Introduction to Financial System – Features,

• Constituents of Financial System;
• Financial Institutions; Financial Services;
• Financial Markets and Financial Instruments,
• Financial Regulators (a brief profile of RBI, SEBI,
IRDAI).
The term "finance" in our simple understanding, is
perceived as equivalent to 'Money'. But finance exactly is
not money; it is the source of providing fund for a particular
activity.

Finance is a facility that built the Gap between deficit

sectors to surplus sector by shifting funds. Finance as a
function is defined by the dictionary as under-

1:"To provide or raise the fund or capital”

2: "To supply fund ".

3: "To furnish credit ".

Introduction

• Financial managers and investors don’t operate in a

vacuum; they make decisions within a large and complex
financial environment.

• This environment includes financial markets and

institutions, tax and regulatory policies, and the state of
the economy.

• The environment both determines the available financial

alternatives and affects the outcomes of various decisions.
Thus, it is crucial that investors and financial managers
have a good understanding of the environment in which
they operate.
• History shows that a strong financial system is a necessary
ingredient for a growing and prosperous economy.

• Companies raising capital to finance capital expenditures as

well as investors saving to accumulate funds for future use
require well functioning financial markets and institutions.

• A financial system (within the scope of finance) is a system

that allows the exchange of funds between lenders, investors,
and borrowers.

• Financial systems operate at national, global, and firm-

specific levels.

• They consist of complex, closely related services, markets,

and institutions intended to provide an efficient and regular
linkage between investors and depositors.
Money, credit, and finance are used as media of exchange in
financial systems. They serve as a medium of known value for
which goods and services can be exchanged as an alternative
to bartering.

A modern financial system may include banks (operated by

the government or private sector), financial markets, financial
instruments, and financial services.

Financial systems allow funds to be allocated, invested, or

moved between economic sectors. They enable individuals
and companies to share the associated risks.
The formal financial system consists of four components:

1.Financial institutions,
2.Financial markets,
3.Financial instruments and
4.Financial services.

The financial system acts as a connecting link between savers of

money and users of money and thereby promotes faster economic
and industrial growth.

Thus financial system may be defined as “a set of markets and

institutions to facilitate the exchange of assets and risks.”

Efficient functioning of the financial system enables proper flow of

funds from investors to productive activities which in turn
facilitates investment.
Definition of Financial System

• “It is a set of institutions , instruments and markets which

fosters saving and channels them to their most efficient
use”.-(H.R. Machiraju)

• In the worlds of Van Horne, “financial system allocates

savings efficiently in an economy to ultimate users either
for investment in real assets or for consumption”.

• According to Prasanna Chandra, “financial system

consists of a variety of institutions, markets and instruments
related in a systematic manner and provides the principal
means by which savings are transformed into investments”
Functions/important and role of financial system

1. It links the savers and investors. It helps in mobilizing and

allocating the savings efficiently and effectively. It plays a
crucial role in economic development through saving-
investment process. This savings – investment process is
called capital formation.

2. It helps to monitor corporate performance.

3. It provides a mechanism for managing uncertainty and

controlling risk.

4. It provides a mechanism for the transfer of resources across

geographical boundaries
5. It offers portfolio adjustment facilities (provided by financial
markets and financial intermediaries).

6. It helps in lowering the transaction costs and increase

returns. This will motivate people to save more.

7. It promotes the process of capital formation.

8. It helps in promoting the process of financial deepening and

broadening.

• Financial deepening means increasing financial assets as a

percentage of GDP and financial broadening means building
an increasing number and variety of participants and
instruments.

• In short, a financial system contributes to the acceleration of

economic development. It contributes to growth through
Growth and Development of Indian Financial System

• At the time of independence in 1947, there was no strong

financial institutional mechanism in the country.

• The industrial sector had no access to the savings of the

community.

• The capital market was primitive and shy. The private and
unorganised sector played an important role in the
provision of liquidity.

• On the whole, there were chaos and confusions in the

financial system. After independence, the government
adopted mixed economic system.
• The government started creating new financial institutions to
supply finance both for agricultural and industrial
development.

• It also progressively started nationalizing some important

financial institutions so that the flow of finance might be in
the right direction.

The following developments took place in the Indian financial

system:
1. Nationalisation of financial institutions:
2. Establishment of Development Banks:
3. Establishment of institution for housing finance:
4. Establishment of Stock Holding Corporation of India (SHCIL):
5. Establishment of mutual funds and venture capital
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.
1)Financial Market: -

It is a system through which funds are transferred from

surplus sector to the deficit sector.

On the basis of the duration of financial Assets and nature

of product money market can be classified into 3 types:

a) Money Market: - It is the institutional arrangement of

borrowing and lending into 2 sectors i.e. organised
sector headed by RBI and unorganized sector no way
related with RBI.

Further depending upon the type of instrument used

money is divided into various sub market
b) Capital Market: - It deals with long term lending’s and
borrowings. It is a market for long term instruments such as
shares, debentures and bonds. It also deals with term loans. This
market is also dividend into 2 types:-

A)Primary or New Issue Market

B)Secondary Market of Stock exchange.

c) Foreign Exchange market: -It deals with foreign exchange.

It is a market where the exchanging of currencies will takes
places. It is the market where currencies of different country are
purchased and sold. Depending on the exchange rate that is
applicable, the transfer of funds takes place in this market. This
is one of the most developed and integrated market across the
globe.
ii) Financial Institution: -

It is classified into categories:-

a.Banking Institution:- It includes commercial banks, private

bank and foreign banks are operating in India. There are 27
Commercial Banks of Public Sector further, we have
Development Banks (ICICI, IDBI), Agriculture Bank (RRB,
Cooperative Banks, NABARD).

b.Non-Banking Institution: - These are established to mobilise

saving in different modes. These institutions do not offer
banking services such as accepting deposit and Lending Loans.
For example LIC, UTI, GIC. Financial institutions are financial
intermediaries. They intermediate between savers and investors.
They lend money. They also mobilise savings. The various financial
intermediaries, their performing areas and respective roles are
given in following table:
iii) Financial Instruments: -

It includes through these instruments financial Institution

mobilise saving.

These are of 2 type’s i.e.

a)Long Term : - Shares, Debenture, Mutual Funds, Term

Loans.

b) Short Term: - Call Loan (money market), Promissory

Notes, Bills of exchange etc.
iv) Financial Services: -

a) Banking service provided by Commercial banks and

Development banks. Accepting Deposits and lending loans.

b) Non-Banking Services: - These services are provided by Non-

Banking Companies such as LIC and GIC. They accept saving in
different modes and mobiles to various channels of
investments.

c) Other Services: - In modern days banks are providing various

new services such as ATM, Credit Cards, Debit Cards, Electronic
Transfer of Funds(ETF),Internet Banking, E- Banking, off shore
Banking.
TYPES OF FINANCIAL SERVICES:
• Financial Services is a term used to refer to the services
provided by the finance market. Financial Services is also the
term used to describe organizations that deal with the
management of money.

• Examples are the Banks, investment banks, insurance

companies, credit card companies and stock brokerages. Some
basic types of financial services are as following.

• Banking
• Insurance
• Securities brokerage or financial advisory services
• Investment banking
• Securities trading
• Investment management or money management
• Securities analysis
• Financial planning
THREE TYPES OF FINANCIAL SERVICES
• Stocks: Which are sold by Stock Exchanges

• Insurance: This is sold by Insurance Companies

• Money: This is lent by the commercial banks and other financial

institutions

NEED FOR REGULATORS:

• The institutions selling financial services may indulge in fraudulent
practices adversely affecting the general public.

• Financial regulation is a form of regulation or supervision, which subjects

financial institutions to certain requirements, restrictions and guidelines,
aiming to maintain the integrity of the financial system.

• This may be handled by either a government or non-government

organization.

• Financial regulation has also influenced the structure of banking sectors

AIMS OF REGULATION

The objectives of financial regulators are usually,

• market confidence – to maintain confidence in the financial

system
• financial stability – contributing to the protection and
enhancement of stability of the financial system
• Consumer protection – securing the appropriate degree of
protection for consumers.
THREE MAIN REGULATORS:
RBI is the main regulator in case of Money Market.

The central bank of the country is the Reserve Bank of India (RBI). It was
established in April 1935 with a share capital of Rs. 5 crores on the basis of
the recommendations of the Hilton Young Commission.

The share capital was divided into shares of Rs. 100 each fully paid which
was entirely owned by private shareholders in the beginning.

The Bank was constituted for the need of following:

• To regulate the issue of banknotes.

• To maintain reserves with a view to securing monetary stability and,
• To operate the credit and currency system of the country to its
advantage IRDA (Insurance Regulatory Development Authority) is the main
regulator in case of Insurance sector where as SEBI is the main regulator in
case of stock exchanges.
NEED FOR RBI AS A REGULATOR
• The Reserve Bank regulates and supervises the nation’s financial system.

• Different departments of the Reserve Bank oversee the various entities that
comprise India’s financial infrastructure.

• They direct Commercial banks and all-India development financial

institutions, Urban cooperative banks, Regional Rural banks (RRB), Non-
Banking Financial Companies (NBFC) etc.

• Financial Institutions accept deposits from the general public and lend it to
the corporates.

• The Banks may lend money to wrong people and this may result into loss of
public money.

• So there was a need for some regulator which can monitor and control the
decisions of the banks. RBI is such a regulator.

• The ‘Board for Financial Supervision’ oversees the RBIs role as a regulator.
STEPS TAKEN BY RBI AS A REGULATOR:
The preamble of the Reserve Bank of India describes it main functions as:

..to regulate the issue of Bank Notes and keeping of reserves with a view to
securing monetary stability in India and generally to operate the currency and
credit system of the country to its advantage.

Accordingly, RBI takes several steps as a regulator of money market. The steps
are as following.

1. On Site Inspection
2. Off Site Surveillance by making reporting compulsory
3. Periodic meetings with management of the financial institutes Licensing
4. Prescribing Minimum capital and cash requirements
5. Monitoring the Governance of the Banks
6. Prescribing lending requirements to the priority sector
7. Prescribing conditions for lending
 STOCK EXCHANGE BOARD OF INDIA:
Functions and Objectives

Under the SEBI Act, 1992, the SEBI has been authorized to conduct inspection
of stock exchanges.

The SEBI has been scrutinizing the stock exchanges once every year since
1995-96. During these inspections, a review of the market operations,
organizational structure and managerial control of the exchange is made to
ascertain whether:

1. the exchange provides a fair, equitable and growing market to investors

2. the exchange’s organization, systems and practices are in accordance with
the Securities Contracts (Regulation) Act (SC(R) Act), 1956 and rules framed
there under
3. the exchange has implemented the directions, guidelines and instructions
issued by the SEBI from time to time
4. the exchange has complied with the conditions, if any, imposed on it at the
time of renewal/ grant of its recognition under section 4 of the SC(R) Act,
1956.
The main objectives of SEBI are:

(1) Regulation of Stock Exchanges: The first objective of SEBI is to regulate

stock exchanges so that efficient services may be provided to all the parties
operating there.
(2) Protection to the Investors
(3) Checking the Insider Trading
(4) Control over Brokers

Steps taken by SEBI as Regulator of Stock Market Since the establishment of

SEB in 1992, the Indian securities market has developed enormously in terms
of volumes, new products and financial services. SEBI takes the following
steps for controlling the stock-exchanges of the country.

1. Educate the Investors

2. SEBI is authorized to call for information, Investigation, Audit Registration of
intermediaries like brokers, underwriters, merchant bankers etc.
3. Cancelling their licenses if they violate the rules
4. Regulating acquisition of substantial shares by a company
5. Issuing guidelines for issuing shares
 INSURANCE REGULATION DEVELOPMENT ACT:
NEED FOR IRDA

The Insurance Regulatory and Development Authority of India (IRDAI) is an

autonomous, statutory body tasked with regulating and promoting the
insurance and re-insurance industries in India.
It was constituted by the Insurance Regulatory and Development Authority Act,
1999, an Act of Parliament passed by the Government of India. The agency's
headquarters are in Hyderabad, Telangana, where it moved from Delhi in 2001.

It was constituted by Parliament of India Act called IRDA after the formal
declaration of Insurance Laws (Amendment) Ordinance 2014, by the President
of India Pranab Mukherjee on December 26, 2014.
Its main objectives are as under :
1. To promote the interest and rights of policy holders.
2. To promote and ensure the growth of Insurance Industry.
3. To ensure speedy settlement of genuine claims and to prevent
frauds and malpractices
4. To bring transparency and orderly conduct of in financial markets
dealing with insurance.
FUNCTIONS OF IRDAI
The functions of the IRDAI are defined in Section 14 of the IRDAI Act, 1999, and
include:

• Issuing, renewing, modifying, withdrawing, suspending or cancelling

registrations
• Protecting policyholder interests
• Specifying qualifications, the code of conduct and training for intermediaries
and agents
• Specifying the code of conduct for surveyors and loss assessors
• Promoting efficiency
• Promoting and regulating professional organizations connected with the
insurance and re-insurance industry
• Levying fees and other charges
• Inspecting and investigating insurers, intermediaries and other relevant
organizations
• Regulating rates, advantages, terms and conditions which may be offered by
insurers not covered by the Tariff Advisory Committee under section 64U of
• Specifying how books should be kept
• Regulating company investment of funds
• Regulating a margin of solvency
• Adjudicating disputes between insurers and intermediaries or insurance
intermediaries
• Supervising the Tariff Advisory Committee
• Specifying the percentage of premium income to finance schemes for
promoting and regulating professional organisations
• Specifying the percentage of life- and general-insurance business
undertaken in the rural or social sector
• Specifying the form and the manner in which books of accounts shall be
maintained, and statement of accounts shall be rendered by insurers
and other insurer intermediaries
Steps taken by IRDA

IRDA has put forth many measures to protect the policyholders’ interests. Insurers
have been told to strengthen their grievance redress procedures, consumer complaint
resolving procedures where they are found weak. It takes following steps for
regulating the insurance sector.

1. Registration of Insurance Companies (Giving them Licenses)

2. Cancelling the licenses in case they act against the IRDA Act
3. Imposing penalty on those insurance companies which violate the provisions of the
Act.
4. Prescribing Minimum Qualification & Training etc for becoming an intermediary
5. Registration of Insurance Agents etc. and Cancelling their license
6. Inspection and Audit of Insurance companies
7. Prescribe the manner in which the insurance company should maintain the
books (Financial Reporting)

8. The way in which the funds should be invested

9. Targets for covering insurance in rural areas

10. Allowing Private and Foreign Insurance companies in India (to boost
competition)

11. Regulation and supervision of premium rates and terms

12. Maintenance of Solvency Margin

CONCLUSION:

• The financial system in India is regulated by independent regulators in

the field of banking, insurance, capital market, commodities market, and
pension funds.

• However, Government of India plays a significant role in controlling the

financial system in India and influences the roles of such regulators at
least to some extent.

• However there is a dire need of stringent laws and harsh punishments in

cases of scams to curb the frauds and violations.

• "The most urgent and most debated area of regulation has to do with
that which affects the operation of the economic machine itself. Adverse
conduct here can be deeply damaging, but even when it is visibly
destructive, action to correct it can be strongly resisted," wrote John
Kenneth Galbraith.