Financial SystemFinancial System

Compiled By:- Compiled By:-

Almas Tasneem Almas Tasneem

What is Finance?

• The term "finance" in our simple The term "finance" in our simple understanding it is perceived as understanding it is perceived as equivalent to 'Money'. But finance equivalent to 'Money'. But finance exactly is not money, it is the source of exactly is not money, it is the source of providing funds for a particular activity. providing funds for a particular activity. Thus finance does not mean the Thus finance does not mean the money with the Government, but it money with the Government, but it refers to sources of raising revenue refers to sources of raising revenue for the activities and functions of a for the activities and functions of a Government. Government.

INDIAN FINANCIAL INDIAN FINANCIAL SYSTEMSYSTEM

• The economic development of a nation is reflected The economic development of a nation is reflected by the progress of the various economic units, by the progress of the various economic units, broadly classified into corporate sector, government broadly classified into corporate sector, government and household sector.  While performing their and household sector.  While performing their activities these units will be placed in a activities these units will be placed in a surplus/deficit/balanced budgetary situations. surplus/deficit/balanced budgetary situations.

• There are areas or people with surplus funds and There are areas or people with surplus funds and there are those with a deficit.  A financial system or there are those with a deficit.  A financial system or financial sector functions as an intermediary and financial sector functions as an intermediary and facilitates the flow of funds from the areas of surplus facilitates the flow of funds from the areas of surplus to the areas of deficit.  A Financial System is a to the areas of deficit.  A Financial System is a composition of various institutions, markets, composition of various institutions, markets, regulations and laws, practices, money manager, regulations and laws, practices, money manager, analysts, transactions and claims and liabilities.analysts, transactions and claims and liabilities.

Financial SystemFinancial System

                                                                                                            

                         

Financial SystemFinancial System

• The word "system", in the term "financial The word "system", in the term "financial system", implies a set of complex and closely system", implies a set of complex and closely connected or interlined institutions, agents, connected or interlined institutions, agents, practices, markets, transactions, claims, and practices, markets, transactions, claims, and liabilities in the economy.  The financial liabilities in the economy.  The financial system is concerned about money, credit and system is concerned about money, credit and finance-the three terms are intimately finance-the three terms are intimately related yet are somewhat different from each related yet are somewhat different from each other. Indian financial system consists of other. Indian financial system consists of financial market, financial instruments and financial market, financial instruments and financial intermediation. financial intermediation.

Structure of Financial System

Structure of a Financial Structure of a Financial SystemSystem

FINANCIAL MARKETSFINANCIAL MARKETS

• A Financial Market can be defined as the A Financial Market can be defined as the market in which financial assets are market in which financial assets are created or transferred. As against a real created or transferred. As against a real transaction that involves exchange of transaction that involves exchange of money for real goods or services, a money for real goods or services, a financial transaction involves creation or financial transaction involves creation or transfer of a financial asset. Financial transfer of a financial asset. Financial Assets or Financial Instruments represents Assets or Financial Instruments represents a claim to the payment of a sum of money a claim to the payment of a sum of money sometime in the future and /or periodic sometime in the future and /or periodic payment in the form of interest or payment in the form of interest or dividend. dividend.

• Money MarketMoney Market- The money market ifs a wholesale debt - The money market ifs a wholesale debt market for low-risk, highly-liquid, short-term instrument.  market for low-risk, highly-liquid, short-term instrument.  Funds are available in this market for periods ranging Funds are available in this market for periods ranging from a single day up to a year.  This market is dominated from a single day up to a year.  This market is dominated mostly by government, banks and financial institutions. mostly by government, banks and financial institutions.

• Capital MarketCapital Market -  The capital market is designed to -  The capital market is designed to finance the long-term investments.  The transactions finance the long-term investments.  The transactions taking place in this market will be for periods over a year. taking place in this market will be for periods over a year.

• Forex MarketForex Market - The Forex market deals with the - The Forex market deals with the multicurrency requirements, which are met by the multicurrency requirements, which are met by the exchange of currencies.  Depending on the exchange rate exchange of currencies.  Depending on the exchange rate that is applicable, the transfer of funds takes place in this that is applicable, the transfer of funds takes place in this market.  This is one of the most developed and integrated market.  This is one of the most developed and integrated market across the globe. market across the globe.

• Credit MarketCredit Market- Credit market is a place where banks, FIs - Credit market is a place where banks, FIs and NBFCs purvey short, medium and long-term loans to and NBFCs purvey short, medium and long-term loans to corporate and individuals.corporate and individuals.

FINANCIAL FINANCIAL INTERMEDIATION INTERMEDIATION

• Having designed the instrument, the issuer Having designed the instrument, the issuer should then ensure that these financial assets should then ensure that these financial assets reach the ultimate investor in order to garner the reach the ultimate investor in order to garner the requisite amount.  When the borrower of funds requisite amount.  When the borrower of funds approaches the financial market to raise funds, approaches the financial market to raise funds, mere issue of securities will not suffice.  mere issue of securities will not suffice.  Adequate information of the issue, issuer and the Adequate information of the issue, issuer and the security should be passed on to take place.  security should be passed on to take place.  There should be a proper channel within the There should be a proper channel within the financial system to ensure such transfer. To financial system to ensure such transfer. To serve this purpose, serve this purpose, Financial intermediaries Financial intermediaries came into existence. came into existence.

FINANCIAL FINANCIAL INTERMEDIATIONINTERMEDIATION

• This service was offered by banks, FIs, This service was offered by banks, FIs, brokers, and dealers.  However, as the brokers, and dealers.  However, as the financial system widened along with the financial system widened along with the developments taking place in the financial developments taking place in the financial markets, the scope of its operations also markets, the scope of its operations also widened. Some of the important widened. Some of the important intermediaries operating ink the financial intermediaries operating ink the financial markets include; investment bankers, markets include; investment bankers, underwriters, stock exchanges, registrars, underwriters, stock exchanges, registrars, depositories, custodians, portfolio managers, depositories, custodians, portfolio managers, mutual funds, financial advertisers financial mutual funds, financial advertisers financial consultants, primary dealers, satellite dealers, consultants, primary dealers, satellite dealers, self regulatory organizations, etc. self regulatory organizations, etc.

IntermediaryIntermediary

MarketMarket RoleRole

Stock Exchange Stock Exchange Capital MarketCapital Market Secondary Market to Secondary Market to securitiessecurities

Investment BankersInvestment Bankers Capital Market, Credit Capital Market, Credit Market Market 

Corporate advisory Corporate advisory services, Issue of services, Issue of securitiessecurities

UnderwritersUnderwriters Capital Market, Money Capital Market, Money MarketMarket

Subscribe to Subscribe to unsubscribed portion of unsubscribed portion of securitiessecurities

Registrars, Depositories, Registrars, Depositories, CustodiansCustodians

Capital MarketCapital Market Issue securities to the Issue securities to the investors on behalf of investors on behalf of the company and handle the company and handle share transfer activityshare transfer activity

Primary Dealers Primary Dealers Satellite DealersSatellite Dealers

Money MarketMoney Market Market making in Market making in government securities government securities

Forex DealersForex Dealers Forex MarketForex Market Ensure exchange ink Ensure exchange ink currenciescurrencies

FINANCIAL FINANCIAL INSTRUMENTSINSTRUMENTS

• Money Market Instruments Money Market Instruments • The money market can be defined as a market for The money market can be defined as a market for

short-term money and financial assets that are near short-term money and financial assets that are near substitutes for money. The term short-term means substitutes for money. The term short-term means generally a period up to one year and near generally a period up to one year and near substitutes to money is used to denote any financial substitutes to money is used to denote any financial asset which can be quickly converted into money with asset which can be quickly converted into money with minimum transaction cost.minimum transaction cost.

Some of the important money market instruments Some of the important money market instruments are :are :

1. Call/Notice Money 1. Call/Notice Money 2. Treasury Bills2. Treasury Bills3. Term Money3. Term Money4. Certificate of Deposit4. Certificate of Deposit5. Commercial Papers5. Commercial Papers

Capital Market InstrumentsCapital Market Instruments

• Capital Market InstrumentsCapital Market Instruments • The capital market generally consists of the The capital market generally consists of the

following long term period i.e., more than one year following long term period i.e., more than one year period, financial instruments; In the equity segment period, financial instruments; In the equity segment Equity shares, preference shares, convertible Equity shares, preference shares, convertible preference shares, non-convertible preference preference shares, non-convertible preference shares etc and in the debt segment debentures, shares etc and in the debt segment debentures, zero coupon bonds, deep discount bonds etc. zero coupon bonds, deep discount bonds etc.

• Hybrid InstrumentsHybrid Instruments • Hybrid instruments have both the features of equity Hybrid instruments have both the features of equity

and debenture. This kind of instruments is called as and debenture. This kind of instruments is called as hybrid instruments. Examples are convertible hybrid instruments. Examples are convertible debentures, warrants etc.debentures, warrants etc.

Financial System &

Economic Development

Role of Financial System in Economic Development

• The financial system of a country is of immense use in its economic development.

• The volume and growth of the capital in the country very much depends upon the efficiency and intensity of the operations and activities in the financial markets.

• An immature financial system hinders the growth of the economy.

• Financial intermediaries enhance the investment in the economy through direct and indirect investments.

• The process of transferring the monetary resources of the public into the financial resources by the financial intermediaries involves Maturity intermediation, Risk reduction through diversification, Reducing costs of transaction & information and Providing a payments mechanism.

The Indian Financial System

The Indian Financial System : 

• The Indian Financial System The Indian Financial System before independence closely resembled the model given by RL Benne in his theory of financial organization in a traditional economy. According to him in a traditional economy the per capita output is low and constant.

• Some principal features of the Indian Financial system before independence were: closed-circle character of industrial entrepreneurship; a narrow industrial securities market, absence of issuing institutions and no intermediaries in the long-term financing of the industry

• Outside savings could not be invested in industry. That is, the savings of the financial system could not be channeled to investment opportunities in industrial sector.

• Indian Financial System to supply finance and credit was greatly strengthened in the post-1950

• Significant diversification and innovations in the structure of the financial institutions, have accompanied the growth of Indian Financial System

• In the past 50 years the Indian financial system has shown tremendous growth in terms of quantity, diversity, sophistication, innovations and complexity of operation. Indicators like money supply, deposits and credit of banks, primary and secondary issues, and so on, have increased rapidly.

• India has witnessed all types of financial innovations like diversification, disintermediation, securitization, liberalization, and globalization etc. As a result, today the financial institutions and a large number of new financial instruments lead a fairly diversified portfolio of financial claims.

Summary• The word system in the term ‘financial system’ represents

a set of closely held financial institutions, financial services and financial instruments or claims

• These varied requirements of the lenders and the borrowers led to a mismatch in periods. These factors created a need to develop the financial system in such a way that it matched the requirements of the borrowers and lenders

• The financial system can be segmented into two parts namely, the organized and the unorganized sector

• Financial assets / instruments represents the financial obligation that arises when the borrower raises funds in the financial market.

• The financial system of a country is of immense use in its economic development, adequate capital formation is indispensable to economic development and financial markets are of crucial importance for capital formation

• An immature financial system hinders the growth of the economy

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