The Indian Financial

System (Formal)

Markets, Institutions
and Services
The Indian Financial System
Formal and Informal System

Formal Financial System

Regulatory
Financial System
Financial Market
Financial Institute
Financial Instruments
 Meaning of the Financial
System

 A set of sub systems of financial

institutions, markets, instruments and
services

 Intermediates with the flow of funds

between savers and borrowers.

 Facilitates transfer and allocation of scarce

resources efficiently and effectively
 Functions of financial system
•Provision of liquidity
• Supply of Money (RBI – Monopoly power of issuing coins and currency notes)

•Mobilization of saving
• Appropriate incentive to attract saving

•Size transformation function

• Loan of a sizeable quantity

•Maturity transformation function

•Risk transformation function

 Types of Financial
System
 Formal financial system
• Organized, Institutional and Regulated

 Informal financial system

Advantages
Low transaction costs
Minimum default risk
Transparency of procedures
Disadvantages
Wide range of interest rates
Higher rates of interest
Unregulated
 Financial System Designs

Types
Bank-based

Market-based
 Market-based Financial
System
Advantages
Provide attractive terms to both investors
and borrowers
Facilitate diversification
Allow risk sharing
Allow financing of new technologies

Drawbacks
Prone to instability
Exposure to market risk
Free-rider problem
 Bank-based Financial
System
Advantages
Close relationships with parties
Provide tailor-made contracts
Efficient inter-temporal risk sharing
No free-rider problem

Drawbacks
Retards innovation and growth
Impedes competition
 Key Elements of a Well-
functioning Financial System

A strong legal and regulatory environment

Stable money
Sound public finances and public debt
management
A central bank
Sound banking system
Information system
Well-functioning securities market
Components of the Financial
System

A. Financial Institutions

B. Financial Markets

C. Financial Instruments

D. Financial Services
Financial Institutions
Functions of Financial
Institutions
Provide three transformation services

 Liability, asset and size transformation

 Maturity transformation

 Risk transformation

Next Components
Financial Market
 Money Market:
•1. Call money market (https://www.investopedia.com/terms/c/call-money.asp)
•https://rbi.org.in/scripts/NotificationUser.aspx?Id=1752&Mode=0
 Money Market:
•1. Call money market (https://www.investopedia.com/terms/c/call-money.asp)
• Extremely short period time ( upto fourteen days)
• Highly Liquid
• Associated with stock exchange
• Interest rate is varies from day to day, even hour to hour
• Highly sensitive to changes in demand and supply
• Participants in call/notice money market currently include banks, Primary Dealers (PDs), development
finance institutions, insurance companies and select mutual funds
•2. Commercial Bills Market (commercial bank issue bill of exchange)
•3. Treasury Bills Market
• Is a promissory note or financial bill issued by government
• Highly liquid
• Types of T- Bill
• Ordinary or Regular
• Ad hoc – Popular T- Bill
•4. Short term Loan Market
• Issue for corporate customers for meeting their working capital requirements
• Commercial bank issue it
• Types of short term loan
 Short term loan (cash credit and overdraft)
•Overdraft –
•given to business people
•Purely temporary accommodation , and given to current account
holder
•Cash Credit
•Given to industrialists.
•Cash credit for one year and given to separate accout
 Functions of Financial
Markets

Enabling economic units to exercise their

time preference
Separation, distribution, diversification and
reduction of risk
Efficient payment mechanism
Providing information
Enhancing liquidity
Providing portfolio management services
 Link Between Primary and
Secondary Capital Market

 A float secondary market is indispensable

(extremely important and necessary) for the
presence of a vibrant primary 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.
Next Components
Financial Instruments
 Financial Instruments

Distinct Features

Marketable

Tradable

Tailor-made

Next Components
 Financial Services

Major Categories
o Depositories
oCustodian
oCredit Rating
oFactoring
oForfaiting
oMerchant Banking
oLeasing
oHire Purchase
oGuaranteeing
oPortfolio Management
o Underwriting
Need of financial services

• Borrowing and Funding

• Lending and Investing

• Buying and selling securities

• Making and enabling

• Payment and settlements

• Managing risk
Next Components