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INDIAN FINANCIAL SYSTEM

In finance, the financial system is the system that allows the transfer of money between savers and borrowers. It comprises a set of complex and closely interconnected financial institutions, markets, instruments, services, practices, and transactions. Financial systems are crucial to the allocation of resources in a modern economy. They channel household savings to the corporate sector and allocate investment funds among firms; they allow intertemporal smoothing of consumption by households and expenditures by firms; and they enable households and firms to share risks. These functions are common to the financial systems of most developed economies. Yet the form of these financial systems varies widely.

Financial Controls and Monitoring


Financial controls and monitoring methods have a dual role in supporting internal needs and external requirements. There are ve key aspects to nancial controls and monitoring. These include: Accounting Records (or Accounts Receivable and Payable): Establish a process that records every nancial transaction by maintaining paper les, an electronic database, and copying all records in a virtual library. Your organization needs to be able to demonstrate what funds were received and how funds were spent. Accounting records should be consistent. Choose

a method and regular schedule for tracking income and expenses that works for your organization. This is important in case the organization is audited or if a funder requests information for a specic item or transaction. A system should also be developed to track donations from individuals to keep donors updated of the organizations progress or to solicit annual and repeat contributions. A separate accounting system should be developed for funding from foundations with the original proposal and budget, dates of receipt of funds, notes on allowable expenditures, and reporting requirements so that you can respond to funders requests for nancial records or in case of audits.

Financial Planning:

Financial planning converts your organizations objectives into a budget. The budget serves as a critical planning guide for your staff and governing board. It is a public record for funders of how you intend to spend the funds received. Financial planning allows you to review your organization, examining successes and challenges in the past. Planning also enables you to make projections and set targets, informing strategies for future success.

Financial Monitoring and Reporting:

Drawing from the information in the accounting records, your organization can create internal reports that help monitor progress by comparing budgets to actual expenses. Frequent reviews and monitoring allows the governing board and staff to measure your organizations progress and helps inform decision-making about the organizations or a projects

future. Internal reports, sometimes called management reports allow you to be forward thinking as you assess the nancial status of the organization and what will be needed to realize your goals. Accounting records are also the source for creating external nancial reports that demonstrate to funders and other stakeholders how funds have been spent. Funders may require nancial reports at the completion of the project or periodically during the projects implementation.

Governing Board:

A governing board, whether comprised by a board of directors or leadership from the community, serves as stewards of an organizations resources. Governing boards should participate in approving budgets, nancial monitoring and reviews, and agree upon and ensure that internal controls are implemented. The board treasurer who has skills in accounting should be the lead person in working with the staff in ensuring nancial accountability.

Internal Controls:

Controls are organizational practices that help safeguard your assets and ensure that money is being handled properly. Controls help detect errors in accounting, prevent fraud or theft, and help support the people responsible for handling your organizations nances.

THREE PHASES IN THE EVOLUTION OF INDIAN FINANCIAL SYSTEM


I. PRE 1951 ORGANISATION Before 1951, the industry had minimum access to the savings of the savings-surplus units. It was due to weak financial system which was incapable of sustaining high rate of industrial growth basically for the new & innovating enterprises.

II. 1951 to MID EIGHTIES


Around 1951, Government adopted mixed economics pattern of industrial development. Hence, there was an introduction of planned economic development. Thus, distribution of credit & finance was under Government's control. The main elements of the financial organisation in planned economic development are (1) Public/Government ownership of financial institution (2) Fortification of the institutional structure. (3) Protection to investors (4) Protection of financial institutions in corporate management.

III. POST NINETIES


New economic policy was introduced in 1991.Development process was shifted from mixed economics to free market economics & the consequent globalization of the economy. Major economic policies were changed which had affected structure of the corporate industrial sector in India. Hence the influence of the Government began to decline over the distribution of finance & credit. There was capital market

oriented developments. Hence, the notable developments during this phase (1) Privatisation of financial institutions (2) Reorganisation of institutional structure (3) Investor's Protection

COMPONENTS OF THE FINANCIAL SYSTEM


A] Financial Institutions
Financial institutions are government-regulated or private entities that offer financial services to their customers. These institutions control the flow of cash from an investor to a company and vice versa within and outside a country. Financial institutions cater to clients ranging from individuals to big organizations, depending on their size and the services offered. Broadly speaking, financial institutions deal in the sectors pertaining to mortgage, automobile, homeowner, personal, business and corporate finance. They consist of financial intermediaries and nonintermediaries. Financial intermediary Financial intermediation consists of channeling funds between surplus and deficit agents. A financial intermediary is a financial institution that connects surplus

and deficit agents. The classic example of a financial intermediary is a bank that transforms bank deposits into bank loans. Through the process of financial intermediation, certain assets or liabilities are transformed into different assets or liabilities. As such, financial intermediaries channel funds from people who have extra money to those who do not have enough money to carry out a desired activity. In the U.S., a financial intermediary is typically an institution that facilitates the channeling of funds between lenders and borrowers indirectly. That is, lenders give funds to an intermediary institution (such as a bank), and that institution gives those funds to borrowers. This may be in the form of loans or mortgages. Alternatively, they may lend the money directly via the financial markets, which is known as financial disintermediation. They are classified into bank and non-bank financial intermediaries. Bank A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:

A central bank circulates money on behalf of a government and acts as its monetary authority by implementing monetary policy, which regulates the money supply. A commercial bank accepts deposits and pools those funds to provide credit, either directly by lending, or indirectly by investing through the capital markets. Within

the global financial markets, these institutions connect market participants with capital deficits (borrowers) to market participants with capital surpluses (investors and lenders) by transferring funds from those parties who have surplus funds to invest (financial assets) to those parties who borrow funds to invest in real assets. A savings bank (known as a "building society" in the United Kingdom) is similar to a savings and loan association (S&L). They can either be stockholder owned or mutually owned, in which case they are permitted to only borrow from members of the financial cooperative. The asset structure of savings banks and savings and loan associations is similar, with residential mortgage loans providing the principal assets of the institution's portfolio. UNDER THE NON-BANK INTERMEDIARIES:

All India Development Financial Institutions The following are the various institutions covered under all India DFIs:

Industrial Finance Corporation of India [IFCI] Industrial Development Bank of India [IDBI], which merged with IDBI Bank in 2004 Industrial Credit and Investment Corporation of India [ICICI], which merged with ICICI Bank in 2002 Industrial Investment Bank of India [IIBI]. The former Industrial Reconstruction Corporation of India was converted into Industrial Reconstruction Corp of India [IRCI] and was later converted into IIBI in 1995

Small Industries Development Bank of India [SIDBI], which is a wholly owned subsidiary of IDBI curved out through an act of parliament in 1990. State Level Financial Corporations These are state level bodies that mainly concentrate on industrial development in a state. They are legal bodies created under the State Finance Corporations Act, 1951 and are funded through an issue of shares in which the state governments, banks, financial institutions, and private investors participate. SFCs are also permitted to raise funds through the issue of bonds and debentures. The main focus of SFCs is financing the local industrial units, which are usually small and medium units, situated in backward regions of the state. Insurance Companies Insurance companies concentrate on fulfilling the insurance needs of the community, both for life and non life insurance. With the globalization of the Indian economy, a large number of private players have entered into this field, offering products that allow investors to select the kind of policies to suit their financial planning needs. Many of these organizations are formed as subsidiaries of banks that enable the banks to cross sell insurance products to their existing customers. Banks benefit by way of fee income through referrals and enhanced relationships with insurance companies for their banking needs. Mutual Funds These organizations satisfy the needs of individual investors through pooling resources from a large number with similar

investment goals and risk appetite. The resources collected are invested in the capital market and money market securities and the returns generated are distributed to investors. The fund managers of MFs are specialists in the fields of investment analysis and are able to diversify and even out risks through portfolio mix. MFs offer a wide variety of schemes, such as, growth funds, income funds, balanced funds, money market funds and equity related funds designed to cater to the different needs of investors. Non Banking Finance Corporations NBFCs are commonly known as finance companies and are corporate bodies, which concentrate mainly on lending activities in a well defined area. The Reserve bank of India [RBI] Amendment Act, 1997 defines an NBFC as a financial institution or non banking institution, which has its principal business of receiving deposits under any scheme or arranging and lending in any manner. There are 4 broad categories of NBFCs:

Finance Companies Leasing Companies Loan finance companies Investment finance companies Credit union A credit union is a cooperative financial institution that is owned and controlled by its members and operated for the purpose of promoting thrift, providing credit at competitive rates, and providing other financial services to its members.[1][2][3] Many credit unions exist to

further community development[4] or sustainable international development on a local level.[5] Financial adviser A financial adviser or financial advisor is a professional who renders financial services to individuals, businesses and governments. This can involve investment advice, which may include pension planning, and/or advice on life insurance and other insurances such as income protection insurance, critical illness insurance etc., and/or advice on mortgages. Building society A building society is a financial institution owned by its members as a mutual organization. Building societies offer banking and related financial services, especially mortgage lending. These institutions are found in the United Kingdom (UK) and several other countries.

B] FINANCIAL MARKETS
Broad term describing any marketplace where buyers and sellers participate in the trade of assets such as equities, bonds, currencies and derivatives. Financial markets are typically defined by having transparent pricing, basic regulations on trading, costs and fees and market forces determining the prices of securities that trade. ORGANIZED FINANCIAL MARKET

1) Capital market A capital market is a market for securities (debt or equity), where business enterprises (companies) and governments can raise long-term funds. It is defined as a market in which money is provided for periods longer than a year, as the raising of short-term funds takes place on other markets. The capital market includes the stock market (equity securities) and the bond market (debt). Financial regulators, such as the UK's Financial Services Authority (FSA) or the U.S. Securities and Exchange Commission (SEC), oversee the capital markets in their designated jurisdictions to ensure that investors are protected against fraud, among other duties. Capital markets may be classified as primary markets and secondary markets. In primary markets, new stock or bond issues are sold to investors via a mechanism known as underwriting. In the secondary markets, existing securities are sold and bought among investors or traders, usually on a securities exchange, over-the-counter, or elsewhere. Stock market A stock market or equity market is a public entity for the trading of company stock(shares) and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately. The size of the world stock market was estimated at about $36.6 trillion at the start of October 2008. market price.The stocks are listed and traded on stock exchanges which are entities of a corporation or mutual organization specialized in

the business of bringing buyers and sellers of the organizations to a listing of stocks and securities together. Bond Market A financial marketplace where debt instruments, primarily bonds, are bought and sold is called a bond market. The dealings in a bond market are limited to a small group of participants. Contrary to stock or commodities trading, the bond market (also known as the debt market) lacks a central exchange. 2) Commodity Market A physical or virtual marketplace for buying, selling and trading raw or primary products. For investors' purposes there are currently about 50 major commodity markets worldwide that facilitate investment trade in nearly 100 primary commodities. Commodities are split into two types: hard and soft commodities. Hard commodities are typically natural resources that must be mined or extracted (gold, rubber, oil, etc.), whereas soft commodities are agricultural products or livestock (corn, wheat, coffee, sugar, soybeans, pork, etc.) The most direct way of investing in commodities is by buying into a futures contract. 3) Money Market A segment of the financial market in which financial instruments with high liquidity and very short maturities are traded. The money market is used by participants as a means for borrowing and lending in the short term, from several

days to just under a year. Money market securities consist of negotiable certificates of deposit (CDs), bankers acceptances, U.S. Treasury bills, commercial paper, municipal notes, federal funds and repurchase agreements (repos). 4) Derivatives market The derivatives market is the financial market for derivatives, financial instruments like futures contracts or options, which are derived from other forms of assets. The market can be divided into two, that for exchange-traded derivatives and that for over-the-counter derivatives. The legal nature of these products is very different as well as the way they are traded, though many market participants are active in both. 4) Futures exchange A futures exchange or futures market is a central financial exchange where people can trade standardized futures contracts; that is, a contract to buy specific quantities of a commodity or financial instrument at a specified price with delivery set at a specified time in the future. These types of contracts fall into the category of derivatives. Such instruments are priced according to the movement of the underlying asset (stock, physical commodity, index, etc.). The aforementioned category is named "derivatives" because the value of these instruments is derived from another asset class. 5) Insurance market

Insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the insurance; an insured, or policyholder, is the person or entity buying the insurance policy. The insurance rate is a factor used to determine the amount to be charged for a certain amount of insurance coverage, called the premium. It facilitates the redistribution of various risks. 6) Foreign

Exchange Market

The markets, in which participants are able to buy, sell exchange and speculate on currencies. The foreign exchange market determines the relative values of different currencies. The primary purpose of the foreign exchange is to assist international trade and investment, by allowing businesses to convert one currency to another currency. UNORGANIZED FINANCIAL MARKET Players in this type of market are money lenders, indigenous bankers, and traders etc who lend money to the public. Indigenous banks include private finance companies, chit funds etc. However activities of these players are not controlled by RBI and thus are not standardized. C] FINANCIAL INSTRUMENTS Categorization

Financial instruments can be categorized by form depending on whether they are cash instruments or derivative instruments: Cash instruments are financial instruments whose value is determined directly by markets. They can be divided into securities, which are readily transferable, and other cash instruments such as loans and deposits, where both borrower and lender have to agree on a transfer. Derivative instruments are financial instruments which derive their value from the value and characteristics of one or more underlying entities such as an asset, index, or interest rate. They can be divided into exchange-traded derivatives and over-the-counter (OTC) derivatives. Alternatively, financial instruments can be categorized by "asset class" depending on whether they are equity based or debt based If it is debt, it can be further categorised into short term (less than one year) or long term. Foreign Exchange instruments and transactions are neither debt nor equity based and belong in their own category. The foreign exchange market (forex, FX, or currency market) is a global, worldwide decentralized financial market for trading currencies. The foreign exchange market determines the relative values of different currencies.[1]

A table Combining the above methods for categorization, the main instruments can be organized into a table as follows:

Instrument Type Asset Class Other cash Exchangetraded derivatives OTC derivatives

Securities

Debt (Long Bonds Term) >1 year

Loans

Interest rate swaps Interest rate Bond futures caps and Options on floors bond futures Interest rate options Exotic instruments

Bills, Debt e.g. T(Short Bills Term) Commerci <=1 year al paper

Deposits Short Certificate Forward rate term interest s of agreements rate futures deposit Stock option Stock options s Exotic Equity futur instruments es

Equity Stock

N/A

Foreign Exchan N/A ge

Spot forei Currency gn futures exchange

Foreign exchange opti ons Outright forwards Foreign exchange swaps Currency swaps

Some instruments defy categorization into the above matrix, for example repurchase agreements. ASSET CLASS: BONDS-a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (thecoupon) to use and/or to repay the principal at a later date, termed maturity. A bond is a formal contract to repay borrowed money with interest at fixed intervals.[1] LOAN-A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower.

FUTURES- a futures contract is a standardized contract between two parties to exchange a specified asset of standardized quantity and quality for a price agreed today (the futures price or the strike price) with delivery occurring at a specified future date, the delivery date. The contracts are traded on a futures exchange. OPTIONS- an option is a derivative financial instrument that specifies a contract between two parties for a future transaction on an asset at a reference price.[1] The buyer of the option gains the right, but not the obligation, to engage in that transaction, while the seller incurs the corresponding obligation to fulfill the transaction. The price of an option derives from the difference between the reference price and the value of the underlying asset (commonly a stock, a bond, a currency or a futures contract) plus a premium based on the time remaining until the expiration of the option. Other types of options exist, and options can in principle be created for any type of valuable asset. INTEREST RATE SWAP-An interest rate swap is a derivative in which one party exchanges a stream of interest payments for another party's stream of cash flows. Interest rate swaps can be used by hedgers to manage their fixed or floating assets and liabilities. They can also be used by speculators to replicate unfunded bond exposures to profit from changes in interest rates. Interest rate swaps are very popular and highly liquid instruments. Treasury Bill - T-Bill

A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations of $1,000 up to a maximum purchase of $5 million and commonly have maturities of one month (four weeks), three months (13 weeks) or six months (26 weeks).Tbills are issued through a competitive bidding process at a discount from par, which means that rather than paying fixed interest payments like conventional bonds, the appreciation of the bond provides the return to the holder. Commercial Paper An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities. Maturities on commercial paper rarely range any longer than 270 days. The debt is usually issued at a discount, reflecting prevailing market interest rates. Deposit account A deposit account is a current account, savings account, or other type of bank account, at a banking institution that allows money to be deposited and withdrawn by the account holder. These transactions are recorded on the bank's books, and the resulting balance is recorded as a liability for the bank, and represent the amount owed by the bank to the customer. Some banks charge a fee for this service, while others may pay the customer interest on the funds deposited. Certificate Of Deposit - CD

A savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate and can be issued in any denomination. CDs are generally issued by commercial banks and are insured by the FDIC. The term of a CD generally ranges from one month to five years. Interest rate future An interest rate futures is a financial derivative (a futures contract) with an interest-bearing instrument as the underlying asset. Examples include Treasury-bill futures, Treasury-bond futures and Eurodollar futures. Stock The capital stock (or just stock) of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors. Stock is different from the property and the assets of a business which may fluctuate in quantity and value. Forex swap In finance, a forex swap (or FX swap) is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates (normally spot to forward).

D] Financial services

Financial services refer to services provided by the finance industry. Facilities such as saving accounts, accounts, confirming, leasing, and money transfer, provided generally by banks, credit unions, and finance companies. TYPES OF FINANCIAL SERVICES ARE: 1) Merchant BankingA bank that deals mostly in (but is not limited to) international finance, long-term loans for companies and underwriting. Merchant banks do not provide regular banking services to the general public. Their knowledge in international finances make merchant banks specialists in dealing with multinational corporations. A financial institution that specializes in services such as acceptance of bills of exchange, hire purchase orinstallment buying, international trade financing, long-term loans, and management of investment portfolios. 2) Leasing The use of a lease or of equipment under a lease. Lease is an agreement in which one party gains a long-term rental agreement, and the other party receives a form of secured long-term debt. 3) Factoring Factoring is a financial transaction whereby a business job sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business. Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables (essentially

a financial asset),[1][2] not the firms credit worthiness. Secondly, factoring is not a loan it is the purchase of a financial asset (the receivable). Finally, a bank loan involves two parties whereas factoring involves three. 4) Venture capital Money provided by investors to startup firms and small businesses with perceived long-term growth potential. This is a very important source of funding for startups that do not have access to capital markets. It typically entails high risk for the investor, but it has the potential for above-average returns. 5) Counseling Counseling is a scientific process which is largely accepted by many of us. Whether its vocation guidance or coping with personal trauma counseling surely makes it easy for us to seek professional guidance. There are many subjects that require counseling.With changing times our lifestyle offers us so many advantages that make life easy but at the same time it is important to acknowledge the side effects of a routine fast paced life. 6) Hire purchase A method of buying goods through making installment payments over time. The term hire purchase originated in the U.K., and is similar to what are called "rent-to-own" arrangements in the United States. Under a hire purchase contract, the buyer is leasing the goods and does not obtain ownership until the full amount of the contract is paid. 7) Credit Rating An assessment of the credit worthiness of individuals and corporations. It is based upon the history of borrowing and

repayment, as well as the availability of assets and extent of liabilities. 8) Bank guarantee A guarantee from a lending institution ensuring that the liabilities of a debtor will be met. In other words, if the debtor fails to settle a debt, the bank will cover it. A bank guarantee enables the customer (debtor) to acquire goods, buy equipment, or draw down loans, and thereby expand business activity.