FACULTY JUGNU SHRIVASTAVA

FINANCIAL SYSTEM
SET OF COMPLEX AND CLOSELY CONNECTED

SUBSETS OF INSTITUTIONS , MARKETS AND SERVICES/PRODUCTS

FINANCIAL SYSTEM

INSTITUTIONS

MARKETS

SERVICES/ PRODUCTS

FINANCIAL INSTITUTIONS

BANKING NONBANKING

DEVELOPMENT FINANCIAL INSTITUTION

All India institutions eg IDBI

Regional/State

level institutions

Other Institutions like DICGC etc

Organisational Structure of Financial Institution

Asset/ Liability Management of the Financial Institutions

FI buy money by borrowing from depositors or other sources of funds. They sell money when they lend it to businesses or individuals The objective of a depository institution is to earn a positive spread between the assets it invests in (what it has sold the money for) and the costs of its funds (what it has purchased the money for).

Intermediary services
Brokerage function :

as represented by the activities of brokers and market operators. transforms a longer-term asset into a shorter-term one activity is provided by institutions issuing claims against themselves, which differ, from the assets they acquire.

Maturity Transformation:

Liability-Asset transformation:

Risk transformation services Payments Mechanism Reduction of transaction cost

FINANCIAL MARKETS
PRIMARY/SECONDARY

MONEY/CAPITAL

ORGANISED/UNORGANISED

EQUILIBRIUM IN FINANCIAL MARKETS

D S
E
ROI

S
VOLUME OF FUNDS

Money Demand, Money Supply, and the Equilibrium Interest Rate

Equilibrium in financial markets requires

that money supply be equal to money demand, or that Ms = Md.

Money Supply = Money demand This equilibrium relation is called the LM

relation.

FINANCIAL PRODUCTS AND SERVICES

EQUITY
DEBT SMALL SAVINGS ELECTRONIC FINANCIAL PRODUCTS MUTUAL FUNDS INSURANCE ETC

FINANCIAL SYSTEM AND ECONOMIC DEVELOPMENT

Financial system impact on saving and investment processes.

The following theories have analyzed this impact:
The Classical Prior Saving Theory, Credit Creation or Forced Saving or Inflationary

Financing Theory, Financial Repression Theory Financial Liberalization Theory.

PRIOR SAVINGS THEORY

All savings finds investment outlets
Need for appropriate monetary and fiscal policy

to promote savings Control inflation Financial system affects both scale and structure of investment It links Savers (surplus units) to the investors (deficit units)

PRIOR SAVINGS THEORY

ECONOMIC DEVELOPMENT

SAVINGS AND INVESTMENT CREATE CAPITAL FORMATION

SURPLUS SPENDING ECONOMIC UNITS

DEFICIT SPENDING ECONOMIC UNITS

SURPLUS OR SAVINGS

DEFICIT OR SAVINGS FINANCIAL SYSTEM

Credit Creation Theory CREATION OF CREDIT IN ANTICIPATION

OF SAVINGS
INVESTMENT BY GOVT, BY CREDIT

CREATION
EX: INDIA FIVE YEARLY PLANNED

BUDGETS

Theory Of Forced Savings

Creation of inflation leads to forced saving
Inflation enhances investment It creates investment in real capital more

lucrative creating Toblin effect or shift of portfolio effect Inflation changes distribution in favour of profit earners increases savings and capital Income distribution effect Transfers resource to govt., since its a hidden taxInflation Tax Effect

Financial Regulation Theory

Govt. regulation is necessary in market to

prevent market failure Specially applies to underdeveloped and developing nations where imperfect competition exists Govt. regulates via direct credit programmes, interest rate regulation, credit and monetary regulations etc.

Financial Liberalization Theory

Govt. regulation creates market repression and leads

to market failure Specially applies to underdeveloped and developing nations where intervention of govt. exists crating low volume , low quality and asymetric investment Interest rate ceiling distort investment direction Financial deregulation, liberalization and privatization eliminates distortions and creates a growth path It increases the allocative efficiency of investments

Financial Regulation VS Liberalization

Over enthusiasm and over of both can harm
Need for a balance between the two paths IMF_WB guided imposed liberalization and

deregulation has led to significant Volatility, instability, and vulnerability of financial systems accompanied by collapse of banks, national currencies financial crisis . Lessons of liberalization of Asia, Soviet Union have not been encouraging

Causes for failure of Liberalisation

Lack of macro-economic stability Inadequate banking supervision Excessive risk exposure by banks For making liberalization a success we need to implement more prudential banking norms and create macro-economic stability.

Banking objective should be profit maximization. The govt. must not create discriminatory taxes .