FINANCIAL MARKETS AND SERVICES

UNIT-1 INTRODUCTION OF INDIAN FINANCIAL SYSTEM

Meaning of Indian financial system

The financial system enables lenders and borrowers to exchange funds. India
has a financial system that is controlled by independent regulators in the
sectors of insurance, banking, capital markets and various services sectors.

Thus, a financial system can be said to play a significant role in the economic
growth of a country by mobilizing the surplus funds and utilizing them
effectively for productive purposes.

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.

FUNCTIONS OF INDIAN FINANCIAL SYSTEM:

1. The Savings Function: As already stated, public savings find their way
into the hands of those in production through the financial system. Financial
claims are issued in the money and capital markets, which promise future
income flows. The funds are in the hands of the producers, resulting in better
goods and services and an increase in society's living standards. When savings
flow declines, however, the growth of investment and living standards begins
to fall.

2. Liquidity Function: Money in the form of deposits offers the least risk of all
financial instruments. But its value is mainly eroded by inflation. That is why
one always prefers to store funds in financial instruments like stocks, bonds,
debentures, etc. However, in such investments, (i) a greater level of risk is

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involved, (ii) and the degree of liquidity (i.e., conversion of the claims into
money) is; moreover, The financial markets provide the investor with the
opportunity to liquidate their investments.

3. Payment Function: The financial systems offer a very convenient mode of

payment for goods and services. The check system, credit card systems, et
al. are the easiest methods of charge in the economy; they also drastically
reduce the cost and time of transactions.

4. Risk Function: The financial markets provide protection against life, health,
and income risks. These are accomplished through the sale of life, health, and
property insurance policies. Overall, they provide immense opportunities for
the investor to hedge himself/herself against or reduce the possible risk
involved in various instruments.

5. Policy Function: Most governments intervene in the financial system to

influence macroeconomic variables like interest rates or inflation. So, for
example, the federal or central bank indulges in several cuts in CRR and tries to
decrease the interest rates and increase the availability of credit at cheaper
rates to the corporates.

6. Provides Financial Services: A financial system minimizes situations where

the information is an asymmetric and likely to affect motivations among
operators or when one party has the information and the other party does not.
It provides financial services such as insurance, pension etc.

7. Lowers the Cost of Transactions: A financial system helps in the creation of

a financial structure that lowers the cost of transactions. This has a beneficial
influence on the rate of returns to saver. It also reduces the cost of borrowings.
Thus, the system generates an impulse among the people to save more.

8. Financial Deepening and Broadening: A well-functioning financial system

helps in promoting the process of financial deepening and broadening.
Financial deepening refers to an increase of financial assets as a percentage of
the Gross Domestic Product (GDP). Financial broadening refers to building an
increasing number variety of different participants and instruments.

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Conclusion: Modern-day economies require vast sums of money to invest in
capital assets (land, equipment, factory, etc.), which are then used to provide
goods and services. The funds required are so huge that a single
government/firm can't meet the requirement. However, by selling financial
claims like stocks, bonds, etc., various investors can quickly raise the required
funds. The business firm/government issuing such a monetary claim hopes to
return the borrowed funds from expected future inflows. Indeed, we see that
the financial markets within the financial system have made possible the
exchange of current income for future income and the transformation of
savings into investments so that production and revenue keep growing

COMPONENTS/ CONSTITUENTS OF INDIAN FINANCIAL SYSTEM

The following are the four major components that comprise the Indian
Financial System:

1. Financial Institutions

2. Financial Markets

3. Financial Instruments/ Assets/ Securities

4. Financial Services.
COMPONENT IS DISCUSSED BELOW:

 FINANCIAL INSTITUTIONS

Financial institutions are the intermediaries who facilitate smooth functioning

of the financial system by making investors and borrowers meet. They
mobilize savings of the surplus units and allocate them in productive activities
promising a better rate of return. Financial institutions also provide services
to entities (individual, business, government) seeking advice on various issue
ranging from restructuring to diversification plans. They provide whole range
of services to the entities who want to raise funds from the markets or
elsewhere.

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Financial institutions are also termed as financial intermediaries because they
act as middle between savers by accumulating Funds them and borrowers by
lending these fund.

It is also act as intermediaries because they accept deposits from a set of

customers (savers lend these funds to another set of customers (borrowers).
Like - wise investing institutions such ICCIC, mutual funds also accumulate
savings and lend these to borrowers, thus perform the role of financial
intermediaries.

Benefits of Financial Institutions

1. Economy of Scale: When financial institutions are carrying out their

investment or other activities in large scale out of pooled funds, they can
achieve economy of scale.

2. Lower Transaction Cost: Because of Economy of scale the cost of each

transaction is much lower than what it would have been, if that transaction
is carried on by individual investor on his own.

3. Diversification: As financial institutions are dealing in huge amounts of

pooled funds, they diversify their investments in such a way that the risk
involved would reduce considerably.
 FINANCIAL MARKET
It is through financial markets and institutions that the financial system of an
economic works. Financial markets refer to the institutional arrangements for
dealing in financial assets and credit instruments of different types such as
currency, cheques, bank deposits, bills, bonds etc.

Functions of financial markets are:

(i) To facilitate creation and allocation of credit and liquidity
(ii) To serve as intermediaries for mobilisaton of savings.
(iii) To assist the process of balanced economic growth.
(iv) To provide financial convenience.
(v) To cater to the various credit needs of the business houses.

These organised markets can be further classified into two they are

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(i) Capital Market
(ii) Money Market

 FINANCIAL SERVICES

Efficiency of emerging financial system largely depends upon the quality and
variety of financial services provided by financial intermediaries. The term
financial services can be defined as “activities, benefits, and satisfactions,
connected with the sale of money, that offer to users and financial related
value. Within the financial services industry the main sectors are banks,
financial institutions, and non-banking financial companies.
KINDS OF FINANCIAL SERVICES

Financial services provided by various financial institutions, commercial

banks and merchant bankers can be broadly classified into two categories.

1. Asset based/fund based services.

2. Fee based/advisory services.

 FINANCIAL INTERMEDIARIES: A financial intermediary refers to a third-

party, forming environment for conducting financial transactions between
different parties. For example, the banks accepting deposits from customers
and lending them to the customers who need money exemplifies the basic
financial intermediation process.

FEATURES OF FINANCIAL INTERMEDIARIES:

 Financial intermediary refers to the financial entities acting as
intermediaries to conduct their clients’ financial transactions. It connects
entities with surplus funds and deficit funds.
 Intermediaries protect customers’ deposits, stimulate money flow in the
economy and subsequent economic development.
 They can be banking or non-banking institutes owned by the government or
private entities. Furthermore, they are also discerned as primary and
secondary intermediaries.
 Examples include commercial banks, NBFCs or non-banking financial
companies, mutual fund companies, insurance companies, factoring
companies, financial advisors, credit unions, and stock exchanges.

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Financial Intermediary Examples

Let’s briefly describe some financial intermediary examples like banks,

insurance companies, stock exchanges, mutual fund companies, and credit
unions.

 Banks: Banks primarily utilize the deposits made by clients to support other
eligible clients in need. The interest earned for providing loans serves as
income for the banks. Banks also offer several other services like forex
services, insurance for deposits, and credit cards.
 Insurance companies: Insurance companies provide various insurance
policies like life insurance, home insurance, and liability insurance designed
to give financial protection to the customers. They deal with different
entities like brokers and agents for completing the transactions. It pools
policy holders’ premiums and invests them in various investment vehicles
like bonds and other money market instruments. Moreover, this way, they
make a huge profit and pay claims and other liabilities without incurring
massive losses even if the payouts are large. The income from their
investments ensures that the insurance company is cushioned against this.
 Stock exchanges: The stock exchange reflects a marketplace where buyers
and sellers engage in trading financial instruments like stocks and
derivatives. It connects companies that need funding and investors who
have excess funds to invest as an intermediary. Even with a small amount of
money, one can have an ownership interest in a blue-chip company which
may have otherwise been impossible.
 Mutual fund companies: Generally, fund managers in mutual fund
companies invest the money collected from retail investors in different
financial assets and distribute the return to the retail investors proportional
to their investment. Based on the client preferences and investment fund
managers focusing on growing the investors’ wealth, select appropriate
securities and compile them to form the portfolio. Mutual fund companies
help clients with investment management.

 Credit unions: Credit unions are usually non-profit entities owned by their
members. It functions similar to banks; however, they offer better savings
rates and reduced borrowing costs, that is, loans at competitive rates

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Regulators

Financial Institutions

Organised
Sector Financial Markets

Financial Services

Classification
Money Lenders
of Indian
Financial
System Local Bankers

Traders
UnOrganised
Sector Landlords

Pawn Brokers

Chit Funds

A. ORGANISED SECTOR

 Regulators:

 1. Securities and Exchange Board of India (SEBI)

 2. Reserve Bank of India (RBI)
 3. Insurance Regulatory and Development Authority of India (IRDAI)
 4. Pension Funds Regulatory and Development Authority (PFRDA)
 5. Association of Mutual Funds in India (AMFI)
 6. Ministry of Corporate Affairs (MCA)

1. The Securities and Exchange Board of India (SEBI) is a statutory body established
under the SEBI Act of 1992, as a response to prevent malpractices in the capital markets
that were negatively impacting people’s confidence in the market. Its primary objective is
to protect the interest of the investors, prevent malpractices, and ensure the proper and
fair functioning of the markets.

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2. The Reserve Bank of India (RBI) is India’s central bank and was established under the
Reserve Bank of India Act in 1935. The primary purpose of RBI is to conduct the
monetary policy and regulate and supervise the financial sector, most importantly the
commercial banks and non-banking financial companies. It is responsible to maintain
price stability and the flow of credit to different sectors of the economy.
3. The Insurance Regulatory and Development Authority of India (IRDAI) is an
independent statutory body that was set up under the IRDA Act, of 1999. Its purpose is to
protect the interests of the insurance policyholders and to develop and regulates the
insurance industry. It issues advisories regularly to insurance companies regarding the
changes in rules and regulations.
4. The Pension Fund Regulatory and Development Authority (PFRDA) is a statutory
body, which was established under the PFRDA Act, 2013. It is the sole regulator of the
pension industry in India. Initially, PFRDA covered only employees in the government
sector but later, its services were extended to all citizens of India including NRI’s. Its
major objectives are – to provide income security to the old aged by regulating and
developing pension funds and to protect the interest of subscribers to pension schemes
5. The Ministry of Corporate Affairs (MCA) is a ministry within the government of India.
It regulates the corporate sector and is primarily concerned with the administration of
the Companies Act, of 1956, 2013, and other legislations. It frames the rules and
regulations to ensure the functioning of the corporate sector according to the law.

 Financial Institutions

1. Credit Rating Information Services of India Limited (CRISIL)

2. Investment Information and Credit Rating Agency of India (ICRA)
3. Insurance Regulatory and Development Authority of India (IRDAI)
4. Board for Industrial and Financial Reconstruction (BIFR)
5. Export Import Bank of India (EXIM)
6. National Bank for Agriculture and Rural Development (NABARD)
7. Small Industries Development Bank of India ( SIDBI)
8. National Housing Bank (NHB)

 Financial Markets: A financial Market is a market in which people and

entities can trade financial securities, commodities and other financial
stock at low transactions costs and at prices that reflect supply and
demand.

 Financial Services: Financial services are the economic services

provided by the finance industry, which encompasses a broad range of
organizations that manage money, including credit unions, banks, credit
card companies, insurance companies, consumer finance companies,
stock brokerages, investment funds and some government sponsored

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enterprises.

B. Unorganized Financial System

1. Money Lenders: A moneylender is a person or group who typically offers

small personal loans at high rates of interest. The high interest rate charged
by them is justified in many cases by the risk involved.

2. Local Bankers: Local banker is a person, who conducts the business of

banking; one who individually, or as a member of a company, keeps an
establishment for the deposit or loan of money, or for traffic in money, bills
of exchange, etc.

3. Traders: A trader is person or entity, in finance, who buys and sells

financial instruments such as stocks, bonds, commodities and derivatives, in
the capacity of agent, hedger, arbitrageur and speculator.

4. Landlords: A landlord is the owner of a house, apartment, land and real

estate which is rented or leased to an individual or business, who is called a
tenant. When a juristic person is in this position, the term landlord is used.
Other terms include lessor and owner.

5. Pawn Brokers: A pawnbroker is an individual or business that offers

secured loans to people with items of personal property used as collateral.

6. Chit Funds: A chit fund of savings scheme practiced in india. A chit fund
company means a company managing, conducting or supervising, as
foremen, agent or in any other capacity, chits as defined in section 2 of the
Chit Funds Act, 1982.

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