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The Financial System An Introduction

The Indian financial system serves as an intermediary between savers and investors, facilitating the allocation of resources through a structured network of institutions, markets, and services. It comprises both formal and informal systems, with various financial institutions and markets that cater to different economic needs. The document outlines the functions, advantages, and disadvantages of these systems, as well as the roles of financial instruments and services in the overall financial landscape.

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8 views25 pages

The Financial System An Introduction

The Indian financial system serves as an intermediary between savers and investors, facilitating the allocation of resources through a structured network of institutions, markets, and services. It comprises both formal and informal systems, with various financial institutions and markets that cater to different economic needs. The document outlines the functions, advantages, and disadvantages of these systems, as well as the roles of financial instruments and services in the overall financial landscape.

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Unknown01
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© © All Rights Reserved
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THE INDIAN FINANCIAL

SYSTEM: AN
INTRODUCTION
Introduction
 Financial system intermideates between the
flow of funds belonging to those who save a
part of their income and those who invest in
productive assets.
 It mobilizes and usefully allocates scarce
resources of a country.
 A financial system is a complex , well
integrated set of sub systems of financial
institutions, markets, instruments & services
which facilitates the transfer and allocation of
funds efficiently & effectively.
Indian Financial System

Indian Financial System


Formal / Informal /
It is
Organized Unorganized
characterized It is an
Financial
by the Financial
unorganized,
System
presence of an System
non-
organized, institutional
institutional and non-
and regulated regulated
system which system dealing
caters to the with traditional
financial needs and rural
of the modern spheres of the
spheres of economy.
economy.
Compon
Indian Financial System
ents
1.
Financia
Formal l Informal
Financial
Instituti Financial
Systemons System
2.
Regulat
Financia
ors
l
MoF Individual money lenders
Markets Group of persons operating
SEBI as funds or association
3. Partnership firms
RBI
Financia
IRDA
l
Instrum
ents
4.
Financia
l
Service
Pros and Cons of Informal Financial
System

 Advantages :
 Low transaction cost
 Minimum default risk
 Transparency of procedures
 Disadvantages :
 Wide range of interest rates
 Higher rates of interest
 unregulated
Financial Institutions
 They are the intermediaries that mobilize
savings and facilitates the allocation of
funds in efficient manner.
 Classification of Financial Institutions :
 Banking – Non-Banking
 Term Finance
 Specialized
 Sectoral
 Investment
 State - Level
 Banking & Non-banking
 Banking : Creators and purveyor of credit
 Non-banking : Only purveyors. E.g.. DFIs, NBFCs
 Term Finance
 IDBI, ICICI, IFCI, SIDBI, IIBI
 Specialized
 EXIM, TFCI, ICICI Venture, IDFC,
 Sectoral
 NABARD, NHB
 Investment
 UTI, LIC, GIC
 State – Level
 State Financial Corporations, State Industrial
Financial Market
 Types
 Money Market
 Treasury Bills
 Call Money Market
 Notice Money Market
 Commercial Papers
 Certificate of Deposit

 Capital Market
 Equity Market
 Debt Market

 Segments
 Primary Market
Types

Capital Market Money Market


S D Treasury Bills
e e Call Money
P Market
c ri
ri Equity Debt
Commercial
o v
mMarket Market
Bills
n a
a Certificates of
d ti
r Deposits
a v
y
r e
M
y s
a
M M
r
a a
k
r r
e
k k
t
e e
Money Market
 It is market for short term debt instruments.
 A highly liquid market.
 E.g. Call money market, certificates of
deposits, commercial paper and treasury bills
 Functions :
 Provide a balancing mechanism to even out the
demand for and supply of short-term funds
 Provide a focal point for central bank
intervention for influencing liquidity and general
level of interest rates in the economy
Capital Market
 It is a market for long-term securities like equity or
debt.
 Functions :
 Mobilize long term savings to finance long-term
investments
 Enable quick valuation of financial instruments – both
equity and debt
 Disseminate information efficiently for enabling
participants to develop an informed opinion about
investment, disinvestment, reinvestment or holding a
particular financial asset.
 Provide liquidity with a mechanism enabling the
investors to sell financial assets
Link Between Capital Market and
Money Market

 Often, financial institutions actively involved


in the capital market are also involved in the
money market
 Funds raised in the money market are used
to provide liquidity for long-term investment
and redemption of funds raised in the capital
market
 In the development process of financial
markets, the development of the money
market typically precedes the development
of capital market
Primary Market and Secondary
Market

 The primary market creates long-term


instruments for borrowings.
 The secondary market provides liquidity
through the marketability of these
instruments.
 It is also known as stock market.
Link between Primary Market and
Secondary Market

 A buoyant secondary market is


indispensable for the presence of a
vibrant primary capital market
 The secondary market provides a basis for
the determination of prices of new issues.
 Depth of the secondary market depends
on the primary market
 Bunching of new issues affects prices in
the secondary market.
Financial Instruments
 A financial instrument is a claim against a
person or an institution for payment, at a future
date, of a sum of money and/or a periodic
payment in the form of interest or dividend.
 Many financial instruments are marketable as
they are denominated in small amounts and
traded in organized markets.
 Distinct Features of financial instruments:
 Marketable
 Tradable
 Tailor made
Financial Instruments

Term :
Short
Type
Medium
Long
Second
Primary
ary /
/ Direct
Indirect
Securiti
Securiti
es
es

Equity Time Deposits


Preference MF Units
Debts and
Various Insurance
Combinations Policies
Financial Services
 Categories of financial services:
 Funds intermediation
 Payment mechanism
 Provision of liquidity
 Risk management
 Financial engineering – E.g. off-balance sheet items,
development of synthetic securities
 Need for financial services:
 Borrowing and Funding
 Lending and investing
 Buying and selling securities
 Payments and settlements
Interaction among Financial System
Components

 Interdependent and interact


continuously
 Interactive
 Close link
 Competing with each other
Functions of Financial System

 Mobilize and allocate savings


 Monitor corporate performance
 Provide payment and settlement system,
 Optimum allocation of risk – bearing and
reduction
 Disseminate price-related information
 Portfolio adjustment facility
Key Elements of well functioning
Financial System

 Strong legal and regulatory environment


 Stable money
 A central bank
 A sound banking system
 An information system
 A well functioning security market
Financial System Design
 Bank Based
 A few large banks play a dominant role and
the stock market is not important
 E.g. Germany, India
 Market Based
 Financial markets play an important role
whole the banking industry is much less
concentrated
 US, UK
Bank Based :
 Banks play a pivotal role in mobilizing
savings, allocation of capital, overseeing
the investment decisions of corporate
managers and providing risk management
facilities
 It is tend to be stronger in countries where
governments have a direct hand in
industrial development.
 Advantages:
 Close relationship with parties
 Provides tailor-made contracts
 No free-rider problem
 Disadvantages :
 Retards innovation and growth
Market Based
 The securities markets share centre stage with banks in
mobilizing the society’s savings for firms, exerting
corporate control and easing risk management
 Advantages :
 Provides attractive terms to both investors and borrowers
 Facilitates diversification
 Allows risk sharing
 Allows financing of new technologies
 Disadvantages :
 Prone to instability
 Exposure to market risk
 Free-rider problem
: Review Questions :
1. Explain Financial System. “A financial
system is a well integrated system whose
components / parts interact with each
other” Explain.
2. Explain the functions and key elements of
well functioning financial system.
3. Explain the types of various financial
markets and their inter-relationship.
4. “A market-based financial system is
preferable over a bank-based system”.
Explain and Comment Critically.
THANK YOU

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