Indian Financial System

Financial System Nature, Evolution and Structure

A set of closely held financial institutions, intermediaries,

financial

instruments,

services,

methods

of

operations,

procedures.
A set of rules and regulations, abided by which bonds, stocks &

securities are traded, interest rates are determined.

Financial System of any country mobilizes the resources from

surplus sectors to deficit sectors.

A well developed & efficient financial system indicates a strong

economy.

Prerequisites of an Efficient Financial System

Efficient Monetary System: Efficient medium of exchange for

goods and services.

Facilities for the creation of capital: To meet the demands of

economy and for undertaking production activities.

Efficient Financial Markets: Facilitates the process of transfer of

resources and the conversion of financial claims into money.

Evolution of the Financial System

Need for an efficient financial system: Expectations mismatch of

lenders and borrowers.

Financial

Markets (for proper allocation of funds)

Financial Institutions (enabling the mobilization of finances , resources and credits) Financial Services (to match the transactions taking place in these financial markets) Financial Intermediaries (for specialized guidance to perform financial transactions).

Structure of Financial System

Financial Institutions
Includes organizations like banks, finance companies, insurance

companies, co-operative societies etc. which help inculcate the habit of pooling savings in people.
Different

institutions

have

different

responsibilities

and

activities.
Banking organizations form part of payment mechanism of the

country.
Non-banking organizations can disburse credit only through

resources made available to them by the savers.

Functions of Financial Intermediaries

Exchanging financial assets on behalf of customers, providing

investment advise, creating market opportunities for issuers and stimulating markets.
Assists both sides of the market (lender and borrowers). Sophistication of operations. Forms the link between issuer of financial claims and the party

that assumes the risk.

Extending global expertise to their clients in various countries.

Functions of Financial Intermediaries

Providing security, discretion and high service quality. Having an active presence on all the worlds key financial markets. Offering professional and individually tailored support and advising

their clients on variety of issues like taxation, money matters etc.

Offers a range of comprehensive and integrated products and services. Risk Reduction through Diversification. Reducing costs of transaction and information. Providing payments mechanism.

Types of Financial Intermediaries

Depository Institutions

Commercial Banks Saving and Loans Institutions.

Credit Unions.

Non-Depository Institutions

Finance Companies. Mutual Funds. Security Firms, Investment Banks, Brokers, Dealers. Pension Funds. Insurance Companies.

Role of Depository Institutions

Depositories play a crucial role of channelizing savings into the

economy.
Depository institutions play a key role in transmitting the

monetary policy to the financial markets, borrowers and depositors, and ultimately to the real economy.
Depository institutions provide funds to serve the interests of

the society by safeguarding their money and acting as an important source for the investment community.

Non-Depository Institutions
Finance Companies

Consumer Finance Companies: Handles a range of business, including automobile finance, purchase of business equipments, home appliances, home loans, educational loans etc. Sales Finance: Direct loans to consumers by purchasing installment paper from dealers selling automobiles and other consumer durables. (e.g. Bajaj Capital) Commercial Finance: focus principally on extending credit to business firms. (e.g. GE Capital)

Types of Financial Intermediaries

Mutual Funds Insurance Companies Investment Banks Leasing Companies Mortgage Banks Pension Funds

Financial Instruments
Represent the financial obligations that arise when the borrower

raises funds in the financial market.

This financial claim will be packaged in the form of a certificate,

receipt or any other legal document.

All assets are financed by liabilities. While the assets can be

either financial or real the liabilities will be either in the form of

savings or financial liabilities.

Designing of Financial Products

The ability of an issuer to fulfill the promise of future cash flows

depends mainly on his inherent financial strength.

Considerations of Issuer and Investor in designing financial

instruments:
Issuer

Cash Flow: Issuers may consider the period for which the funds are required and try to spread the borrowings in a way to minimize the costs. Generally, the need for funds will depend on the purpose for which the funds are raised.

Issuers Considerations

Taxation: Issuers may have to assess the tax liability of the company and try to design the instrument in order to grant certain tax incentives to the company and the investors. The attempt would be to minimize the tax liability of the issuer. Leverage: Issuers may assess the debt to equity ratio of the company since excess of debt may burden the company with debt servicing. Further, in a falling interest rate scenario a debt contracted for a long-term will increase the cost of funds for the company. Dilution of Control: Likewise, excess of equity will dilute the control over the company and this will be a disincentive especially if the promoters prefer the company to be closely held.

Issuers Considerations

Transaction Costs. Quantum of Funds. Maturity Plan. Market Conditions. Investor Profile.

Past Performance.
Cost of Funds. Regulatory Aspects.

Investors Considerations
Risk Liquidity Returns/Capital Gains Tax Planning Cash Flow

Simplicity

Financial System & Economic Development