INDIAN FINANCIAL SYSTEM: AN INTRODUCTION  Banking – creators and purveyors of credit

 Non-banking – Only purveyors, ex. DFIs,

Introduction NBFCs,
 Financial system intermediates between  Term Finance
 IDBI, ICICI, IFCI, SIDBI, IIBI
the flow of funds belonging to those who
 Specialized
save a part of their income and those
 EXIM, TFCI, ICICI Venture, IDFC, NABARD,
who invest in productive assets.
NHB
 It mobilizes and usefully allocates scarce
 Sectoral
resources of a country.
 UTI, LIC, GIC
 A financial system is a complex, well
 Investment
integrated set of sub systems of financial
 State-Level
institutions, markets, instruments & services  State Financial Corporations, State
which facilitates the transfer and allocation of Industrial Development Corporations
funds efficiently & effectively.

FORMAL/ORGANIZED INFORMAL/ FINANCIAL MARKET

FINANCIAL SYSTEM UNORGANIZED
FINANCIAL SYSTEM Types
It is characterized by the presence It is an unorganized,
of an organized, institutional and non-institutional MONEY MARKET
regulated system which caters to and non-regulated
the financial needs of the modern system dealing with  Treasury Bills
spheres of economy. traditional and rural  Call Money Market
spheres of the  Notice Money Market
economy
 Commercial Papers
Regulators Components Individual money  Certificate of Deposit
MoF 1. Financial lenders
Institutions Group of persons CAPITAL MARKET
SEBI 2. Financial Markets operating as
RBI 3. Financial funds  Equity Market
Instruments Partnership firms  Debt Market
IRDA 4. Financial Services
Segments

Pros and Cons of Informal Financial System  Primary Market

 Secondary Market
Advantages Disadvantages
 Low transaction cost  Wide range of
interest rates
 Minimum default risk  Higher rates of
interest
 Transparency of  Unregulated
procedures

FINANCIAL INSTITUTIONS

They are the intermediaries that mobilize savings and

facilitate the allocation of funds in efficient manner.

Classification of Financial Institutions

 Banking & Non-banking

 MONEY MARKET
 It is market for short term debt instruments.
 A highly liquid market.
 Ex. Call money market, certificates of
deposits, commercial paper and treasury and
bills
Functions:
 Provide a balancing mechanism to even out
the demand for and supply of short-term
funds
 Provide a focal point for central bank
intervention for influencing liquidity
CAPITAL MARKET
 It is a market for long-term securities like
equity or debt.
Functions:
 Mobilize long term savings to finance long-
term investments
 Enable quick valuation of financial
instruments - both equity and debt
 Disseminate information efficiently for
enabling participants to develop an informed
opinion about investment, disinvestment,
reinvestment or holding a particular financial
asset.
 Provide liquidity with a mechanism enabling
the investors to sell financial assets.
LINK BETWEEN CAPITAL MARKET AND
MONEY MARKET
 Often, financial institutions actively involved
in the capital market are also involved in the
money market
 Funds raised in the money market are used to
provide liquidity for long-term investment and
redemption of funds raised in the capital
market
 In the development proves of financial
markets, the development of the money
market typically precedes the development of
capital market
PRIMARY MARKET AND SECONDARY MARKET
 The primary market creates long-term
instruments for borrowings.
 The secondary market provides liquidity
through the marketability of these
instruments
o It is also known as stock market
LINK BETWEEN PRIMARY MARKET AND
SECONDARY MARKET
 A buoyant secondary market is indispensable
for the presence of a vibrant primary capital
market
 The secondary market provides a basis for the
determination of prices of new issues
 Depth of the secondary market depends on
the primary market
 Bunching of new issues affects prices in the
secondary market.
FINANCIAL INSTRUMENTS
 A financial instrument is a claim against a
person or an institution for payment, at a
future date, of a sum of money, and/or a
periodic payment in the form of interest or
dividend
 Many financial instruments are marketable as
they are denominated in small amounts and
traded in organized markets.
 Distinct features of financial instruments:
o Marketable
o Tradable
o Tailor Made
 FINANCIAL SERVICES
 Categories of financial services:
o Funds intermediation
o Payment mechanism
o Provision of liquidity
o Risk management
o Financial engineering – ex. off-balance sheet
items, development of synthetic securities
 Need for financial services
o Borrowing and Funding
o Lending and Investing
o Buying and selling securities
o Payment and settlements
INTERACTION among FINANCIAL SYSTEM
COMPONENTS
 Interdependent and interact continuously
 Interactive
 Close link
 Competing with each other
FUNCTIONS OF FINANCIAL SYSTEM
 Mobilize and allocate savings
Monitor corporate performance
Provide payment and settlement system
 Optimum allocation of risk - bearing
and reduction
 Disseminate price-related information
 Portfolio adjustment facility
KEY ELEMENTS OF WELL FUNCTIONING
FINANCIAL SYSTEM
 Strong legal and regulatory environment
 Stable money
 A central bank
 A sound banking system
 An information system
 A well-functioning security market
FINANCIAL SYSTEM DESIGN
 BANK BASED
o A few large banks play a dominant role
and the stock market is not important
o E.g. Germany, India
 MARKET BASED
o Financial markets play an important role
whole the banking industry is much less
concentrated
o US, UK
BANK BASED
 Banks play a pivotal role in mobilizing savings,
allocation of capital, overseeing the investment
decisions of corporate managers and providing
risk management facilities
 It is tend to be stronger in countries where
governments have a direct hand in industrial
development.
Advantages
o Close relationship with parties
o Provides tailor-made contracts
o No free-rider problem
Disadvantages
o Retards innovation and growth
o Impedes competition
MARKET BASED
 The securities markets share centre stage with
banks in mobilizing the society’s savings for firms,
exerting corporate control and easing risk
management
Advantages
o Providers’ attractive terms to both investors
and borrowers
o Facilitates diversification
o Allows risk sharing
o Allows financing of new technologies
Disadvantages
o Prone to instability
o Exposure to market risk
o Free-rider problem