1. The Indian Financial
System: An Introduction

2. 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.

3. Indian Financial System
Indian Financial System
Formal / Organized
Financial System
Informal / Unorganized
Financial System
It is characterized by the
presence
of
an
organized, institutional and
regulated system which
caters to the financial needs
of the modern spheres of
economy.
It is an unorganized, noninstitutional
and
nonregulated system dealing
with traditional and rural
spheres of the economy.

4. Indian Financial System
Formal Financial
System
Regulators
MoF
SEBI
RBI
IRDA
Components
1. Financial
Institutions
2. Financial Markets
3. Financial
Instruments
4. Financial Services
Informal Financial
System
Individual money
lenders
Group of persons
operating as funds
Partnership firms

5. 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

6. 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

7. 
Banking & Non-banking
◦ Banking : Creators and purveyors of credit
◦ Non-banking : Only purveyors. E.g.. DFIs,
NBFCs

Term Finance
◦ IDBI, ICICI, IFCI, SIDBI, IIBI

Specialized
◦ EXIM, TFCI, ICICI Venture, IDFC, NABARD,
NHB

Sectoral
◦ UTI, LIC, GIC


Investment
State – Level
◦ State Financial Corporations, State Industrial
Development Corporations

8. 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
◦ Secondary Market

9. Types
Capital Market
Equity
Market
Primary
Market
Money Market
Debt
Market
Secondary
Market
Derivatives
Market
Treasury
Bills
Call Money
Market
Commercial
Bills
Certificates
of Deposits

10. 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

11. Capital Market
It is a market for long-term securities like
equity or debt.
 Functions :

◦ Mobilize long term savings to finance longterm 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

12. 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

13. 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.

14. 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.


15. 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

16. Financial Instruments
Term :
Short
Medium
Long
Type
Primary / Direct
Securities
Equity
Preference
Debts and Various
Combinations
Secondary /
Indirect Securities
Time Deposits
MF Units
Insurance Policies

17. 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

18. Interaction among Financial
System Components
Interdependent and interact
continuously
 Interactive
 Close link
 Competing with each other


19. 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


20. 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


21. 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

22. 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
◦ Impedes competition

23. 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

24. : Review Questions :
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.
1.