Indian Financial System

Introduction:
Economic growth and development of any country depends upon a well-knit financial system.
Financial system comprises, a set of sub-systems of financial institutions financial markets,
financial instruments and services which help in the formation of capital. Thus a financial system
provides a mechanism by which savings are transformed into investments and it can be said that
financial system play an significant role in economic growth of the country by mobilizing
surplus funds and utilizing them effectively for productive purpose.
The financial system is characterized by the presence of integrated, organized and regulated
financial markets, and institutions that meet the short term and long term financial needs of both
the household and corporate sector. Both financial markets and financial institutions play an
important role in the financial system by rendering various financial services to the community.
They operate in close combination with each other.
Financial System;
The word system, in the term financial system, implies a set of comple! and closely
connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities
in the economy. The financial system is concerned about money, credit and finance-the three
terms are intimately related yet are somewhat different from each other. "ndian financial system
consists of financial market, financial instruments and financial intermediation
#ole$ Functions of Financial %ystem&
' financial system performs the following functions&
( "t serves as a link between savers and investors. "t helps in utilizing the mobilized savings of
scattered savers in more efficient and effective manner. "t channelises flow of saving into
productive investment.
( "t assists in the selection of the pro)ects to be financed and also reviews the performance of
such pro)ects periodically.
( "t provides payment mechanism for e!change of goods and services.
( "t provides a mechanism for the transfer of resources across geographic boundaries.
( "t provides a mechanism for managing and controlling the risk involved in mobilizing savings
and allocating credit.
( "t promotes the process of capital formation by bringing together the supply of saving and the
demand for investible funds.
( "t helps in lowering the cost of transaction and increase returns. #educe cost motives people to
save more.
( "t provides you detailed information to the operators$ players in the market such as individuals,
business houses, *overnments etc.
Components/ Constituents of Indian Financial system&
The following are the four main components of "ndian Financial system
+. Financial institutions
,. Financial -arkets
.. Financial "nstruments$'ssets$%ecurities
/. Financial %ervices.
Financial institutions:
Financial institutions are the intermediaries who facilitates 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 seeking advises on various issues
ranging from restructuring to diversification plans. They provide whole range of services to
the entities who want to raise funds from the markets elsewhere. Financial institutions act as
financial intermediaries because they act as middlemen between savers and borrowers. 0ere
these financial institutions may be of Banking or 1on-Banking institutions.
Financial Markets:
Finance is a prere2uisite for modern business and financial institutions play a vital role in
economic system. "t3s through financial markets the financial system of an economy works.
The main functions of financial markets are&
+. to facilitate creation and allocation of credit and li2uidity4
,. to serve as intermediaries for mobilization of savings4
.. to assist process of balanced economic growth4
/. to provide financial convenience
Financial Instruments
'nother important constituent of financial system is financial instruments. They represent a
claim against the future income and wealth of others. "t will be a claim against a person or an
institutions, for the payment of the some of the money at a specified future date.
Financial Services:
Efficiency of emerging financial system largely depends upon the 2uality and variety of
financial services provided by financial intermediaries. The term financial services can be
defined as activites, benefits and satisfaction connected with sale of money, that offers to
users and customers, financial related value.
Pre-reforms Phase
5ntil the early +667s, the role of the financial system in "ndia was primarily restricted to the
function of channeling resources from the surplus to deficit sectors. 0hereas the financial system
performed this role reasonably well, its operations came to be marked by some serious
deficiencies over the years. The banking sector suffered from lack of competition, low capital
base, low 8roductivity and high intermediation cost. 'fter the nationalization of large banks in
+696 and +6:7, the *overnment-owned banks dominated the banking sector. The role of
technology was minimal and the 2uality of service was not given ade2uate importance. Banks
also did not follow proper risk management systems and the prudential standards were weak. 'll
these resulted in poor asset 2uality and low profitability. 'mong non-banking financial
intermediaries, development finance institutions ;<F"s= operated in an over-protected
environment with most of the funding coming from assured sources at concessional terms. "n the
insurance sector, there was little competition. The mutual fund industry also suffered from lack
of competition and was dominated for long by one institution, viz., the 5nit Trust of "ndia. 1on-
banking financial companies ;1BF>s= grew rapidly, but there was no regulation of their asset
side. Financial markets were characterized by control over pricing of financial assets, barriers to
entry, high transaction costs and restrictions on movement of funds$participants between the
market segments. This apart from inhibiting the development of the markets also affected their
efficiency.Financial Market Euili!rium
euili!rium conditions- where money supply e2uals money demand
money supply generally given as a constant ;vertical line=
o doesn3t change w$ interest rate
-
s
? -
d
-
d
$ @A ? B;i=
o -
d
$ @A - ratio of money demand to nominal income ;fraction of total income that
ppl hold as money=
"M relation - e2uilibrium at intersection of money supply and money demand
;downward sloping curve dependent on interest rate i from B;i==
o interest at level that that cause ppl to hold -
d
e2ual to -
s
o if -
d
?-
s
then B
d
?B
s
since ;wealth ? BC< and wealth stays constant=
changes in @A DD shift of -
d
curve
changes in interest rate DD mov3t along curve

money supply ;not dependent on interest rate at all=
money demand
e2uilibrium

higher @A DD higher interest rate
lower @A DD lower interest rate
money demand always e2uals money supply at e2uilibrium, so interest rate ad)usts
need higher interest rate w$ higher income to compel consumers to invest and have the
same money demand as before, etc
Financial %tructure and <evelopment
"ndicators of financial structure include
%ystem-wide indicators of size,
Breadth and composition of the financial system4
"ndicators of key attributes such as competition, concentration, efficiency, and access4 and
measures of the scope, coverage, and outreach of financial services
%ystem-wide "ndicators
Financial structure is defined in terms of the aggregate size of the financial sector, its sectoral
composition, and a range of attributes of individual sectors that determine their effectiveness in
meeting usersE re2uirements. The evaluation of financial structure should cover the roles of the
key institutional players, including the central bank, commercial and merchant banks, savings
institutions, development finance institutions, insurance companies, mortgage entities, pension
funds, and financial market institution
Breadth of the Financial %ystem
<ata on the financial breadth or penetration often serve as pro!ies for access of the population to
different segments of the financial sector. 0ell-functioning financial systems should offer a wide
range of financial services and products from a diversified set of financial intermediaries and
markets. "deally, there should be a variety of financial instruments that provide alternative rates
of return, risk, and maturities to savers, as well as different sources of finance at varying interest
rates and maturities
Table ,.+. %ectoral "ndicators of Financial <evelopment
%ub-sector "ndicator
Banking F Total number of banks
F 1umber of branches and outlets
F 1umber of branches$thousand population
F Bank deposits$*<8 ;G=
F Bank assets$total financial assets ;G=
F Bank assets$*<8 ;G=
"nsurance F *ross premiums$*<8 ;G=
F *ross life premiums$*<8 ;G=
F *ross non-life premiums$*<8 ;G=
1umber of insurance companies
8ensions F Types of pension plans
F 8ercentage of labor force covered by
pensions
F 8ension fund assets$*<8 ;G=
F 8ension fund assets$total financial assets ;G=
-ortgage F -ortgage assets$total financial assets
F -ortgage debt stock$*<8
Beasing F Beased assets$total domestic
investment
-oney markets F Types and value of money market instruments
F 1ew issues and growth in outstanding value
F 1umber and value of daily ;weekly=
transactions in the instruments
Foreign e!change markets F Holume and value of daily foreign e!change
transactions
F 'de2uacy of foreign e!change ;reserves in
months of imports, as ratio to short-term
e!ternal debt or to broad money=
>apital markets F 1umber of listed securities ;bonds and
e2uities=
F %hare of households, corporations, banks, and
1BF"s in the holdings of securities
F 1umber and value of new issues ;bonds and
e2uities=
F -arket capitalization$*<8 ;G=
F Halue traded$market capitalization ;G=
F %ize of derivative markets
>olllective investment funds F Types and number of schemes ;uni2ue and
mi!ed funds=
F Total assets and growth rates ;nominal and as
percentage of *<8=
F Total number of investors and average
balance per investor
F %hare of households, corporations, banks, and
1BF"s, in total mutual funds assets
Competition# Concentration# and Efficiency
>ompetition in the financial system can be defined as the e!tent to which financial markets are
contestable and the e!tent to which consumers can choose a wide range of financial services
from a variety of providers. >ompetition is often a desirable feature because it normally leads to
increased institutional efficiency, lower costs for clients, and improvements in the 2uality and
range of financial services provided. There are numerous measures of competition, including the
total number of financial institutions, changes in market share, ease of entry, price of services,
and so forth. "n addition, the degree of diversity of the financial system could be an indicator of
competition or the lack thereof because the emergence of vibrant non-bank intermediaries and
capital markets often have been a source of effective competition for banking systems in many
countries. 'll things remaining e2ual, an increase in the number of financial institutions or an
e!pansion in available financial market instruments will increase competition by e!panding the
available sources of financial services that consumers can access. Ease of entry into the system
could be )udged by looking at the regulatory and policy re2uirements for licensing, for e!ample,
the re2uired minimum paid-up capital.
Indicators of Financial System Performance
%ub-sector "ndicator
>ompetition and concentration
F Total number of institutions
F "nterest rate spreads and prices of financial
services
F "ntermediary concentration ratios ;market
share of . or I of the largest institutions=
F Financial market concentration ratios ;market
share of the largest financial instruments,
as a percentage of total financial assets=
F Jerfindahl inde!
Efficiency F "nterest rate spreads
F "ntermediation costs ;as percentage of total
assets=
Bi2uidity F #atio of value traded to market capitalization
F 'verage bidKask spread
Scope and Covera$e of Financial Services
The financial system provides five key services& ;a= savings facilities, ;b= credit allocation
and monitoring of borrowers, ;c= payments, ;d= risk mitigation, and ;e= li2uidity services.
%avings mobilization can be assessed by e!amining the effectiveness with which the
financial system provides saving facilities and mobilizes financial resources from households
and firms. The e!tent of financial savings could be ascertained by e!amining the level and trends
in the ratio of broad money to *<8.
"i!erali%ation# Privati%ation and &lo!ali%ation in India '
The economy of "ndia had undergone significant policy shifts in the beginning of the +667s. This
new model of economic reforms is commonly known as the B8* or Biberalisation, 8rivatisation
and *lobalisation model. The primary ob)ective of this model was to make the economy of "ndia
the fastest developing economy in the globe with capabilities that help it match up with the
biggest economies of the world.
The chain of reforms that took place with regards to business, manufacturing, and financial
services industries targeted at lifting the economy of the country to a more proficient level. These
economic reforms had influenced the overall economic growth of the country in a significant
manner.
"i!eralisation
Biberalisation refers to the slackening of government regulations. The economic liberalisation in
"ndia denotes the continuing financial reforms which began since Luly ,/, +66+.
Privatisation and &lo!alisation
8rivatisation refers to the participation of private entities in businesses and services and transfer
of ownership from the public sector ;or government= to the private sector as well. *lobalisation
stands for the consolidation of the various economies of the world.
"P& and the Economic (eform Policy of India
Following its freedom on 'ugust +I, +6/M, the #epublic of "ndia stuck to socialistic economic
strategies. "n the +6:7s, #a)iv *andhi, the then 8rime -inister of "ndia, started a number of
economic restructuring measures. "n +66+, the country e!perienced a balance of payments
dilemma following the *ulf 0ar and the downfall of the erstwhile %oviet 5nion. The country
had to make a deposit of /M tons of gold to the Bank of England and ,7 tons to the 5nion Bank
of %witzerland. This was necessary under a recovery pact with the "-F or "nternational
-onetary Fund. Furthermore, the "nternational -onetary Fund necessitated "ndia to assume a
se2uence of systematic economic reorganisations. >onse2uently, the then 8rime -inister of the
country, 8 H 1arasimha #ao initiated groundbreaking economic reforms. Jowever, the
>ommittee formed by 1arasimha #ao did not put into operation a number of reforms which the
"nternational -onetary Fund looked for.
<r -anmohan %ingh, the present 8rime -inister of "ndia, was then the Finance -inister of the
*overnment of "ndia. Je assisted. 1arasimha #ao and played a key role in implementing these
reform policies.
)arasimha (ao Committee*s (ecommendations
The recommendations of the 1arasimha #ao >ommittee were as follows&
Bringing in the %ecurity #egulations ;-odified= and the %EB" 'ct of +66, which
rendered the legitimate power to the %ecurities E!change Board of "ndia to record and
control all the mediators in the capital market.
<oing away with the >ontroller of >apital matters in +66, that determined the rates and
number of stocks that companies were supposed to issue in the market.
Baunching of the 1ational %tock E!change in +66/ in the form of a computerised share
buying and selling system which acted as a tool to influence the restructuring of the other
stock e!changes in the country. By the year +669, the 1ational %tock E!change surfaced
as the biggest stock e!change in "ndia.
"n +66,, the e2uity markets of the country were made available for investment through
overseas corporate investors. The companies were allowed to raise funds from overseas
markets through issuance of *<#s or *lobal <epository #eceipts.
8romoting F<" ;Foreign <irect "nvestment= by means of raising the highest cap on the
contribution of international capital in business ventures or partnerships to I+ per cent
from /7 per cent. "n high priority industries, +77 per cent international e2uity was
allowed.
>utting down duties from a mean level of :I per cent to ,I per cent, and withdrawing
2uantitative regulations. The rupee or the official "ndian currency was turned into an
e!changeable currency on trading account.
#eorganisation of the methods for sanction of F<" in .I sectors. The boundaries for
international investment and involvement were demarcated.
The outcome of these reorganisations can be estimated by the fact that the overall amount of
overseas investment ;comprising portfolio investment, F<", and investment collected from
overseas e2uity capital markets = rose to @I.. billion in +66I-+669 in the country= from a
microscopic 5% @+., million in +66+-+66,. 1arasimha #ao started industrial guideline changes
with the production zones. Je did away with the Bicense #a), leaving )ust +: sectors which
re2uired licensing. >ontrol on industries was moderated.
+i$hli$hts of the "P& Policy
*iven below are the salient highlights of the Biberalisation, 8rivatisation and *lobalisation
8olicy in "ndia&
Foreign Technology 'greements
Foreign "nvestment
-#T8 'ct, +696 ;'mended=
"ndustrial Bicensing
<eregulation
Beginning of privatisation
Npportunities for overseas trade
%teps to regulate inflation
Ta! reforms
'bolition of Bicense -8ermit #a)
Financial (e$ulatory ,odies
Financial sector in "ndia has e!perienced a better environment to grow with the presence of
higher competition. The financial system in "ndia is regulated by independent regulators in the
field of banking, insurance, mortgage and capital market. *overnment of "ndia plays a
significant role in controlling the financial market in "ndia.
-inistry of Finance, *overnment of "ndia controls the financial sector in "ndia. Every year the
finance ministry presents the annual budget on ,:th February. The #eserve Bank of "ndia is an
ape! institution in controlling banking system in the country. "t3s monetary policy acts as a ma)or
weapon in "ndia3s financial market.
%ecurities and E!change Board of "ndia ;%EB"= is one of the regulatory authorities for "ndia3s
capital market.
%ecurities and E!change Board of "ndia ;%EB"=
1ational %tock E!change
Bombay %tock E!change ;B%E=
#eserve Bank of "ndia
-a)or Financial "nstitutions in "ndia
Foreign "nvestment 8romotion Board
Securities and E-chan$e ,oard of India.SE,I/
%ecurities and E!change Board of "ndia ;%EB"= was first established in the year +6:: as a non-
statutory body for regulating the securities market. "t became an autonomous body in +66, and
more powers were given through an ordinance. %ince then it regulates the market through its
independent powers.
0!1ectives of SE,I
2s an important entity in the market it 3orks 3ith follo3in$ o!1ectives:
"t tries to develop the securities market.
8romotes "nvestors "nterest.
-akes rules and regulations for the securities market.
Functions 0f SE,I
#egulates >apital -arket
>hecks Trading of securities.
>hecks the malpractices in securities market.
"t enhances investor3s knowledge on market by providing education.
"t regulates the stockbrokers and sub-brokers.
To promote #esearch and "nvestigation
SE,I In India*s Capital Market
%EB" from time to time have adopted many rules and regulations for enhancing the "ndian
capital market. The recent initiatives undertaken are as follows&
Sole Control on ,rokers:5nder this rule every brokers and sub brokers have to get
registration with %EB" and any stock e!change in "ndia.
For 4nder3riters:For working as an underwriter an asset limit of ,7 lakhs has been
fi!ed.
For Share Prices:'ccording to this law all "ndian companies are free to determine their
respective share prices and premiums on the share prices.
For Mutual Funds:%EB"3s introduction of %EB" ;-utual Funds= #egulation in +66. is to
have direct control on all mutual funds of both public and private sector.
)ational Stock E-chan$e
"n the year +66+ 8herwani >ommittee recommended to establish 1ational %tock E!change
;1%E= in "ndia. "n +66, the *overnment of "ndia authorized "<B" for establishing this e!change.
"n 1ational %tock E!change there is trading of e2uity shares, bonds and government securities.
"ndia3s %tock E!changes particularly 1ational %tock E!change has achieved world standards in
the recent years. The 1%E "ndia ranked its .rd position since last four years in terms of total
number of trading per calendar year.
8resently there are ,/ stock e!changes in "ndia, out of which ,7 have e!changes 1ational %tock
E!change ;1%E=, over the >ounter E!change of "ndia Btd, ;NT>E"= and "nter-connected %tock
E!change of "ndia limited ;"%E= have nationwide trading facilities.
)e3 )SE (eference (ates
Both -"BN# ;-umbai "nter Bank Nffer #ate= and -"B"< ;-umbai "nter Bank Bid #ate= are
the two new references rates of the 1ational %tock E!changes. These two new reference rates
were launched on Lune +I, +66: for the loans of inter bank call money market.
Both -"BN# and -"B"< work simultaneously. The -"BN# indicates lending rate for loans
while -"B"< is the rate for receipts.
,om!ay Stock E-chan$e .,SE/
Bombay %tock E!change is one of the oldest stock e!changes in 'sia was established in the year
+:MI in the name of The 1ative %hare O %tock Brokers 'ssociation.
Bombay %tock E!change is located at <alal %treet, -umbai, "ndia. "t got recognition in +6I9
from the *overnment of "ndia under %ecurities >ontracts ;#egulation= 'ct, +6I9. 8resently B%E
%E1%EP is recognized over the world. Trading volumes growth in the year ,77/-7I have drawn
the attention over the globe.
's to the statistics, the total turnover from B%E transcation as in Lune ,779 is calculated at
M,7+...9 crores.
,SE Indices:The well-known B%E %E1%EP is a value weighted of .7 scrips.Nther stock
indices of B%E are B%E I77, B%E8%5, B%E-"<>'8, B%E%-B>'8, and
B%EB'1QEP.
,SE 566 Inde-:The e2uity share of +77 companies from the list of I ma)or stock
e!changes such as -umbai, >alcutta, <elhi, 'hmedabad and -adras are selected for the
purpose of compiling the B%E 1ational "nde!. The year +6:.-:/ is taken as the base year
for this inde!. The method of compilation here is same as that of the B%E %E1%EP.
,SE 766 Inde-:The B%E ,77 "nde! was lunched on ,Mth -ay +66/. The companies
under B%E ,77 have been selected on the basis of their market capitalisation, volumes of
turnover and other findamental factors. The financial year +6:6-67 has been selected as
the base year.
,SE 866 Inde-:B%E I77 "nde! consisting of I77 scrips is functioning since +666.
8resently B%E I77 "nde! represents more than 67G of the total market capitalisation on
Bombay %tock E!change Bimited.
,SE PS4 Inde-:B%E 8%5 "nde! has been working since /th Lune ,77+. This inde!
includes ma)or 8ublic %ector 5ndertakings listed in the E!change. The B%E 8%5 "nde!
tracks the performance of listed 8%5 stocks in the e!change.
Companies In ,SE:
>ompanies listed on the Bombay %tock is rising very fast. 's to statistics, companies listed to the
end of -arch +66/ reached at .,,77 compared to 66, in +6:7.
(eserve ,ank of India
#eserve Bank of "ndia is the ape! monetary "nstitution of "ndia. "t is also called as the central
bank of the country. The bank was established on 'pril+, +6.I according to the #eserve Bank of
"ndia act +6./. "t acts as the ape! monetary authority of the country.The >entral Nffice of the
#eserve Bank has been in -umbai since inception. The >entral Nffice is where the *overnor
sits and is where policies are formulated. Though originally privately owned, since
nationalization in +6/6, the #eserve Bank is fully owned by the *overnment of "ndia.
9he pream!le of the reserve !ank of India is as follo3s:
...to regulate the issue of Bank 1otes and keeping of reserves with a view to securing monetary
stability in "ndia and generally to operate the currency and credit system of the country to its
advantage.

Central ,oard
The #eserve Bank3s affairs are governed by a central board of directors. The board is appointed
by the *overnment of "ndia in keeping with the #eserve Bank of "ndia 'ct.
'ppointed$nominated for a period of four years.
>onstitution
Nfficial <irectors
Full-time& *overnor and not more than four <eputy *overnors
1on-Nfficial <irectors
1ominated by *overnment& ten <irectors from various fields and one government
Nfficial
Nthers& four <irectors - one each from four local boards
Functions& *eneral superintendence and direction of the Bank3s affairs
"ocal ,oards
Nne each for the four regions of the country in -umbai, >alcutta, >hennai and 1ew
<elhi
-embership
>onsist of five members each
'ppointed by the >entral *overnment
For a term of four years
Functions
To advise the >entral Board on local matters and to represent territorial and economic interests of
local cooperative and indigenous banks, to perform such other functions as delegated by >entral
Board from time to time.
Forei$n Investment Promotion ,oard
The Foreign "nvestment 8romotion Board is a special agency in "ndia dealing with the matters
relating to Foreign <irect "nvestment. This special board was set up with a view to raise the
volume of investment to the country. The sole aim of the board is to create a base in the country
by which a larger volume of investment can be drawn to the country.
0n 5: Fe!ruary 766;# the !oard 3as transferred to the <epartment of Economic 2ffairs
.<E2/ Ministry of Finance=
Important functions of the ,oard are as follo3s:
Formulating proposals for the promotion of investment.
%teps to implement the proposals.
%etting friendly guidelines for facilitating more investors.
"nviting more companies to make investment.
To recommend the *overnment to have necessary actions for attracting more investment.
>ith re$ards to the structure of the Forei$n Investment Promotion ,oard# the !oard
comprises the follo3in$ $roup of secretaries to the &overnment:
%ecretary to *overnment <epartment of Economic 'ffairs, -inistry of Finance-
>hairman.
%ecretary to *overnment <epartment of "ndustrial 8olicy and 8romotion, -inistry of
commerce and "ndustry.
%ecretary to *overnment, <epartment of >ommerce, -inistry of >ommerce and
"ndustry.
%ecretary to *overnment, Economic #elations, -inistry of E!ternal 'ffairs.
%ecretary to *overnment, -inistry of Nverseas "ndian 'ffairs.
"n the recent years, particularly after the implementation of the new economic policy, the
*overnment has undertaken many steps to attract more investors for investing in the country.
The new proposals for the foreign investment are allowed under the automatic route keeping in
view the sectoral practices
Ma1or Financial Institutions in India
9his is a list on the ma1or financial institutions in India and their respective date of startin$
operations=
Financial Institution <ate of Startin$
"mperial Bank of "ndia +6,+
#eserve Bank of "ndia 'pril +, +6.I
"ndustrial Finance corporation of "ndia +6/:
%tate Bank of "ndia Luly +, +6II
5nit Trust of "ndia Feb. +,+69/
"<B" Luly +69/
1'B'#< Luly +,,+6:,
%"<B" +667
EP"- Bank Lanuary +, +6:,
1ational Jousing Bank Luly +6::
Bife "nsurance >orporation ;B">= %eptember +6I9
*eneral "nsurance >orporation ;*">= 1ovember +6M,
#egional #ural Banks Nct. ,, +6MI
#isk >apital and Technology Finance >orporation Btd. -arch +6MI
Technology <evelopment O "nformation >o. of "ndia Btd. +6:6
"nfrastructure Beasing O Financial %ervices Btd. +6::
Jousing <evelopment Finance >orporation Btd. ;J<F>= +6MM