Indian Financial System

Financial System
• Financial system facilitates the flow of funds.
• Financial System is a composition of various
– Institutions,
– Markets,
– Regulations and laws,
– Practices,
– Money manager,
– Analysts,
– Transactions claims and liabilities.
 Financial System-

Part One- Financial Markets

 What is a developed Financial
Market?
• Deep-A market in which a large number options

• Liquid

• Wide Participation

• High Transparency / Information Flow

• Technology

5
 Role of Financial Markets

• Intermediate between savers and investors

• Generate resources for investment and growth
• Allocate resources efficiently
 Role of Financial Markets
• Deep and liquid financial markets play a key role
• In allocating resources in an efficient manner among the
competing uses in an economy, thereby contributing to
sustained economic growth.
• Efficient price discovery in the various segments of the financial
market.
• Developed financial markets are also critical for effective
transmission of monetary policy impulses to the rest of
the economy.
Financial Markets Constitutes

a. Money Market
 Money Market
• Money Market- The money market is a wholesale debt market for
low-risk, highly liquid, short-term instrument. 
• Funds are available in this market for periods ranging from a single
day up to a year. 
• This market is dominated mostly by government, banks and financial
institutions.
 Money Market Participants
• Commercial Banks & NBFCs -Borrowers, issuers
• Financial institutions - Borrowers, issuers
• Mutual funds-Intermediaries
• Provident funds; Pension funds (EPF; PPF)
• Insurance companies-Issuers, intermediaries.
• Corporate (PSUs & private companies)-Issuers.
• State Municipal Corporations-Borrowers, Issuers
• Market makers (Primary dealers)
• Discount houses & Acceptance Houses-market
makers

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 Instruments dealt in Indian Money Market
1. Debentures LONG-TERM DEBT
INSTRUMENTS
2. Bonds
Issued in capital market but traded
in Money & Capital market both
3. Commercial papers SHORT-TERM
4. Govt. Securities DEBT
INSTRUMENTS
5. Treasury bill (91 & 364 days)
6. Repos Issued by banks
7. Certificates of deposits & financial
institutions &
8. Inter-bank call money
Traded
short term loans in Money market

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Financial Markets Constitutes

b. Capital Market
 Indian Capital Market
• Capital Market - The capital market is designed to
finance the long-term investments. 
• The capital market is a system or framework, which
facilitates savings and investment.
• The securities markets provide channels for the
allocation of savings to investments. Through the
capital market:
– Companies can raise resources from the people
(investors); and
– Households can invest their savings in industrial or
commercial activities to earn a return
 Indian Capital Market
• India has a long tradition of functioning securities
markets.
• The Bombay stock exchange is over a hundred years
old and the volume of activity has increased in the
recent years.
• The process of reform of capital markets started in
1992 and aimed at removing direct government
control and replacing it by a regulatory framework
based on transparency and disclosure.
 Indian Capital Market
• The capital market framework consists of the
following participants:
• 1. Securities Market (Primary and Secondary)
• 2. Market intermediaries, such as stock-
brokers
• 3. Investors
• 4. Regulatory institutions (e.g. SEBI) 
 Indian Capital Market
• Primary vs. Secondary Market: The securities market
has two interdependent and inseparable segments,
namely the primary market and the secondary
market.
• The primary market is the channel for creation of
new securities through financial instruments by
public limited companies as well as government
agencies
• Whereas secondary market deals in securities already
issued.
Market Design for Primary Market
• The market design for primary market is provided in
the provision of the Companies Act, 1956 which
deals with issues, listing and allotment of securities.

• In addition, DIP(Disclosure and Investor Protection)

guidelines issued under securities law by SEBI
prescribe a series of disclosure norms to be
complied about by the issuer, promoter,
management, project, risk factors and eligibility
norms for accessing the market.
Market Design for Primary Market
• Book Building: Book Building is a process of offering
securities in which bids at various prices from
investors through syndicate members and based on
bids, demand for the security is assessed and its
price discovered.
 Market Design for Secondary
Market
• Membership: The trading platform of an exchange is
accessible only to brokers.
• The broker enters into trades in exchanges either on
his own account or on behalf of clients.
• Over time, a number of brokers-proprietor firms and
partnership firms have converted themselves into
corporate.
 Market Design for Secondary
Market
• Listing of Securities: Listing means a formal
admission of a security to the trading platform
of a stock exchange
• A government circular requires that the
companies wishing to list their securities must
get listing on the regional stock exchange
nearest to the registered office.
• If they so wish, they can seek listing on other
exchanges also.
 Market Design for Secondary
Market
• Trading Rules: SEBI has framed regulations to
prevent insider trading as well as unfair trade
practices.
• The acquisitions and takeovers are permitted
in a well-defined and orderly manner.
• The companies are permitted to buy back.
 Market Design for Secondary
Market
• Price Bands: Stock market volatility is generally a
cause of concern for both policy makers as well as
investors.
• To curb excessive volatility, SEBI has prescribed a
system of price bands.
• An index-based market-wide circuit breaker system at
three stages of the index movement either way at
10%, 15% and 20% has been prescribed.
• As an additional measure of safety, individual scrip-
wise price bands have also been fixed.
 Depositary
• Depository: Dematerialization of securities occurs
when securities issued in physical form is destroyed,
and an equivalent number of securities are credited
into the owner’s account.
• It is effectively, a process by which shares are
converted from physical form (share certificates) into
electronic form (credit in the owner’s account).
 Important Stock Exchanges in India

• National Stock Exchange (NSE)

• Bombay Stock Exchange (BSE)

• Kindly Browse the Websites of Both Stock Exchanges to

gather information on the functioning of both.
 National Stock Exchange
• Trading at NSE takes place through a Fully automated
screen-based trading mechanism, an order-driven
market.
• The prices at which the buyer and seller are willing to
transact will appear on the screen.
• When the prices match the transaction will be
completed and a confirmation slip will be printed at
the office of the trading member.
• The NSE trading system called 'National Exchange for
Automated Trading' (NEAT).
 National Stock Exchange
• Trading System - Order Matching Rules
– The best buy order is matched with the best sell
order.
– An order may match partially with another order
resulting in multiple trades.
– For order matching, the best buy order is the one
with the highest price and the best sell order is
the one with the lowest price.
 National Stock Exchange
• NSCCL carries out clearing and settlement functions as per the
settlement cycles of different sub-segments in the Equities segment.
• The clearing function of the clearing corporation is designed to work
out
– a) what counter parties owe and
– b) what counter parties are due to receive on the settlement date.
– Settlement is a two way process which involves legal transfer of title
to funds and securities or other assets on the settlement date.
– NSCCL has also devised mechanism to handle various exceptional
situations like security shortages, bad delivery, company objections,
auction settlement etc.
 National Stock Exchange
• At the end of each trading day, concluded or
locked-in trades are received from NSE by
NSCCL.
• NSCCL determines the cumulative obligations
of each member and electronically transfers
the data to Clearing Members (CMs).
• All trades concluded during a particular
trading period are settled together.
 Bombay Stock Exchange
• Sensex: Due to is wide acceptance amongst
the Indian investors; SENSEX is regarded to be
the pulse of the Indian stock market.
• As the oldest index in the country, it provides
the time series data over a fairly long period
of time (From 1979 onwards).
 Bombay Stock Exchange
• SENSEX is calculated using the "Free-float
Market Capitalization" methodology.
• Free-float Methodology refers to an index
construction methodology that takes into
consideration only the free-float market
capitalization of a company for the purpose of
index calculation and assigning weight to stocks
in Index.
 Bombay Stock Exchange
• Free-float market capitalization is defined as that
proportion of total shares issued by the company that
are readily available for trading in the market.
• It generally excludes promoters' holding, government
holding, strategic holding and other locked-in shares
that will not come to the market for trading in the
normal course.
 Bombay Stock Exchange
• The market capitalization of a company is determined by
multiplying the price of its stock by the number of shares
issued by the company.
• This market capitalization is further multiplied by the
free-float factor to determine the free-float market
capitalization.
• MCAP Currently for the Market is appx. USD1.6 Trillion
(100 Lac Crore) and GDP is appx. USD 2 Trillion. So .8 is to
1.
• TCS is the largest company in terms of MCAP. Appx. USD
100 Billion (5 Lac Crore).
 Bombay Stock Exchange
• The closing SENSEX on any trading day is computed
taking the weighted average of all the trades on
SENSEX constituents in the last 30 minutes of trading
session.
• If a SENSEX constituent has not traded in the last 30
minutes, the last traded price is taken for
computation of the Index closure.
• If a SENSEX constituent has not traded at all in a day,
then its last day's closing price is taken for
computation of Index closure.
 Financial System-

Part Two- Financial Institutions

 Financial Institutions-Depository
Institutions
• Depository Institutions include Commercial
Banks
• Commercial banks in India comprise of State
bank of India and its associates (8),
• Nationalized banks (19),
• Foreign banks (45),
• Private sector banks (32),
• Co-operative banks and
• Regional rural banks.
 Financial Institutions-Non Depository
Institutions
a. Finance Companies
• There are three types of finance companies.
– The consumer finance companies
– Sales finance companies make direct loans to
consumers by purchasing installment paper from
dealers selling automobiles and other consumer
durables.
– Commercial finance companies focus principally on
extending credit to business firms. They Also provide
accounts receivable financing and factoring services to
small-or medium-sized manufacturers and wholesalers.
 Financial Institutions-Non Depository
Institutions
b. Mutual funds: Mutual funds can be
described as a single portfolio of stocks,
bonds, and/or cash managed by an
investment company on behalf of many
investors. The investment company (AMC) is
responsible for the management of the fund,
and it sells shares in the fund to individual
investors.
 Financial Institutions-Non Depository
Institutions
c. Insurance Companies: Insurance companies
basically make payment for a price (premium)
if a certain event occurs to the policyholders
or to their dependents.
• Risk Cover + Investment
 Financial Institutions-Non Depository
Institutions
d. Investment Baking: Investment bankers are
financial institutions and individuals who assist
companies in raising capital, often through a
private placement or public offering of company
stock.
 Financial Institutions-Non Depository
Institutions
e. Leasing Companies: Leasing represents a specialized
financial institution that provides the access to
productive assets such as airplanes, automobiles,
machinery, etc.
The party that gives assets on lease called as a lessor
will get a regular stream of inflows in the form of lease
rentals from the lessee and also tax benefits by
depreciating the asset.
The company or household which has taken the asset
on lease benefits as a lessee by getting the asset at a
lower cost than borrowing or owing it.
 Financial System-

Part Three- Regulators

 Regulatory Framework
• The four main legislations governing the securities
market are:
• The SEBI Act, 1992 which establishes SEBI to protect investors and
develop and regulate securities market;
• The Companies Act, 1956, which sets out the code of conduct for the
corporate sector in relation to issue, allotment and transfer of
securities, and disclosures to be made in public issues;
• The Securities Contracts (Regulation) Act, 1956, which provides for
regulation of transactions in securities through control over stock
exchanges; and
• The Depositories Act, 1996, which provides for electronic
maintenance and transfer of ownership of demat securities.
 SEBI
• SEBI Act, 1992: The SEBI Act, 1992 establishes
SEBI with statutory powers for
– Protecting the interests of investors in securities,
– Promoting the development of the securities
market, and
– Regulating the securities market.
 SEBI’s Guidelines
SEBI also provides guidelines for the following:
1. Issue of regulation for proper functioning of MF industry
2. Regulations for the activities of FII’s and venture capitalists.
3. Issue of suitable guidelines on preferential allotments, stock
options and share purchase schemes initiated by listed Co’s,
as well as for buy-back of shares.
4. Framework of derivative trading. etc
 SCRA
• Securities Contracts (Regulation) Act, 1956: It
provides for direct and indirect control of virtually all
aspects of securities trading and the running of stock
exchanges and aims to prevent undesirable
transactions in securities. It gives central
government/SEBI regulatory jurisdiction over
– stock exchanges through a process of recognition and
continued supervision,
– Contracts in securities, and
– Listing of securities on stock exchanges.
 Depositories Act
• Depositories Act, 1996: The Depositories Act, 1996
provides for the establishment of depositories in
securities with the objective of ensuring free
transferability of securities with speed, accuracy and
security by
– Making securities of public limited companies freely
transferable subject to certain exceptions;
– Dematerializing the securities in the depository mode; and
– Providing for maintenance of ownership records in a book
entry form.
 Companies Act
• Companies Act, 1956: It deals with issue, allotment and
transfer of securities and various aspects relating to company
management.
• It provides for standard of disclosure in public issues of capital,
particularly in the fields of company management and projects,
information about other listed companies under the same
management, and management perception of risk factors.
• It also regulates underwriting, the use of premium and
discounts on issues, rights and bonus issues, payment of
interest and dividends, supply of annual report and other
information.
 The RBI
1. RBI regulates the activities of banks, financial
institutions and financial intermediaries in regulating
the exposure to capital market instruments more
particularly instrument and corporate debt.
2. The RBI has fixed a norm of 5% of total advances as
the maximum limit up to which banks can have
exposure to capital markets.
3. The RBI determines the treasury operations of banks
& other financial intermediaries by stipulating fund
management and valuation norms for their
investments in securities market.