•Introduction to Financial System

•Financial System as
• Indicators of Financial Development
• A financial system is a Monetary System
• that allows
• exchange of funds between
• lenders,
• Investors, and
• Borrowers.
• Financial system operates at
• firm-specific
• National, and
• Global level.
• Financial system consist of
• Financial services, Financial markets, and
Financial institutions.
• All the above ingredients of Financial System
intend to provide an
• efficient and regular linkage between
• Investors and (users of funds)
• Depositors(source of fund)
• Money, Credit, and Finance are used as
• media of exchange in financial systems.
• The above factors serve as a medium of specific value
• for which
• goods and services can be exchanged as an alternative
to bartering.
• A modern financial system consists of
• Banking industry, financial markets, financial
instruments, and financial services as it’s essential arms.
• Financial systems allow funds to be
• allocated, invested, or moved between economic
sectors.
• A financial system consists of four major components:
• 1. Financial institutions,
• 2. Financial markets,
• 3. Financial instruments and
• 4. Financial services.
.
•Efficient functioning of the financial system
enables
•proper flow of funds from
•investors to
• productive activities
• which in turn facilitates
•Investment.
 Relationship between financial system and economic development

• The development of any country depends on

• it’s economic growth.
• This can be achieved over a period of time.
• Economic growth deals about
• investment and production and also
• the extent of Gross Domestic Product in a country.
• Only when this grows, the people will experience
• growth in the form of improved standard of living,
• namely economic development.
• The following are the roles of financial
system in the economic development of a country.
• Savings and investment relationship
• To attain economic development,
• a country needs more investment and production.
• This can happen only when there are avenues for
savings.
• Savings are channelized to productive resources
• in the form of investment.
•Here, the role of financial institutions is
important,
•since they induce the public to save
•by offering attractive returns.
•These savings are channelized by lending to
•various business concerns.
• Business activities give rise to
• production and distribution.
•Financial systems and growth of capital market
• Any business requires two types of capital
• fixed capital and working capital.
• Fixed capital is long term and is used for
• investment in fixed assets, like plant and machinery,
land and building.
• While working capital is used for
• the day-to-day running of business.
• It is used for purchase of raw materials and
• converting them into finished products
• Financial system is like a conduit pipe to
Infrastructure and Growth
• Economic development of any country depends on
the infrastructure facility available in the country.
• The key industries like coal, power ,roads and
transportation help development of other
industries.
• It is here that the financial services offered by a
strong financial system play a crucial role by
• providing funds for the growth of infrastructure
industries.
• In the initial period of post independent era
• infrastructure industries were started only by the
government of India and it led to good economic
growth of our country.
• But now, with the policy of economic liberalization,
• private sector industries have come forward to start
infrastructure industry.
• The Development Banks and the Commercial Banks
have helped these industries to raise capital for such
infrastructural activities
• Thus leading to economic growth.
•Financial system helps in development of Trade
•The financial system helps in the promotion of both
domestic and foreign trade.
•The financial institutions finance the trades and
• the financial market helps in
•discounting financial instruments such as
• bills, per-shipment and post-shipment finance
• offered by commercial banks to part finance the traders.
• Thus, the precious foreign exchange is earned by the
country
•because of the presence of financial system.
• The best part of the financial system is that
• the seller or the buyer do not meet each other,
• and the documents are negotiated through the bank
and the trade transaction is settled.
• In this manner, the financial system not only helps
the traders but also various financial institutions.
• Some of the capital goods are sold through hire
purchase and L/C system, both in the domestic and
foreign trade.
• As a result of all these, the growth of the country is
speeded up.
•Role of financial system in Employment Growth .
•The presence of financial system generates more
employment opportunities in the country.
•The money market which is a part of financial system
• provides working capital to the businessmen and
•manufacturers due to which production increases,
•resulting in generating more employment opportunities.
•With competition picking up in various sectors,
• the service sector such as
•sales, marketing, advertisement, etc., also pick up,
•leading to more employment opportunities.
• Various financial services such as
• leasing,
• factoring,
• merchant banking/investment banking etc.,
• also generates more employment.
• The growth of trade in the country also induces
employment opportunities.
• FDI and FII provides additional opportunities for
techno-based industries and employment.
•Financial system ensures Balanced growth
•Economic development requires a balanced growth which means
growth in all the sectors simultaneously.
•Primary sector, secondary sector and territorial sector require
adequate funds for their growth.
•The financial system in the country will be geared up by the
•authorities in such a way that
•the available funds will be distributed to
• all the sectors in such a manner, that
•there will be a balanced growth in industries, agriculture and
service sectors.
•Financial system helps in fiscal discipline and control of
economy
•It is through the financial system, that
• the government can create a congenial business
atmosphere
•Through the money control using the different monetary
methods the financial system is kept healthy and stable.
• The industries should be given suitable protection
through the financial system so that
•their credit requirements will be met even
•during the difficult period.
•The government on its part,
•can raise adequate resources to meet its
•financial commitments so that
•economic development is not hampered.
• The government can also regulate the financial system
•through suitable legislation so that
• unwanted or speculative transactions could be avoided.
•The growth of black money could also be minimized.
•Financial system’s role in Economic Integration
•Financial systems of different countries are capable
of promoting economic integration.
•What Is Economic Integration?
•Economic integration is an arrangement among
nations
• that typically includes the reduction or elimination of
•trade barriers and the coordination of monetary and
fiscal policies.
•Economic integration aims to reduce costs for both
• consumers and producers and to
•increase trade between the countries involved in the
agreement
Example The European Union (EU) is a group of
countries that acts as one economic unit in the world
economy.
 Its official currency is the euro..
•Role of financial system in attracting foreign
capital
•Financial system promotes capital market.
•A dynamic capital market is capable of
attracting funds both from domestic and abroad.
•With more capital,
•investment will expand and
• this will speed up the economic development of
a country.
•Role of financial system in Political stability
•The political conditions in all the countries with a developed
financial system will be stable.
• Unstable political environment will not only affect their
financial system but also their economic development.
•Financial system helps in Uniform interest rates
•The financial system is capable of bringing an uniform interest
rate throughout the country by which
•there will be balanced movement of funds between centres
• which will ensure availability of capital for all kinds of
industries.
•Last but not the least
•Financial system has a role to play in Electronic development:
•Due to the development of technology and the introduction
of computers in the financial system
•the transactions have increased manifold bringing in
changes for the
•all round development of the world
•leading to Globalisation..
•The promotion of World Trade Organization (WTO) has
further improved international trade and the financial
system in all its member countries.
 Indicators of Financial Development
• financial development is broadly defined as
• an increase in the volume of financial services of banks
• and other financial intermediaries as well as of
• financial transaction of capital market
• with the development of sophisticated financial system
• in every nation across the globe,
• modern economists conclude that
• the development of the financial sector of an economy
• can be an important aid towards the economic growth.
• A growing body of evidence suggests that
• the financial institutions (such as banks and insurance
companies) and financial markets (including stock
markets, bond markets, and derivative markets)
• exert a powerful influence on economic development,
• poverty alleviation, and economic stability.
• Since the financial sector of a country comprises a
variety of financial institutions, markets and products,
• these measures only serve as a rough estimate and
• do not fully capture all aspects of financial development .
 Financial development in Indian context
• Indian economy had experienced major policy changes in early 1990s.
• The new economic reform, the popularly known as, Liberalization,
Privatization and Globalization
• aimed India a fast growing and globally competitive economy.
• With the onset of reforms to liberalize the Indian economy in July of
1991,
• a new chapter has dawned for India and her billion plus population.
• This period of economic transition had a tremendous impact on
• the overall economic substantiate with numbers.
• Besides, it also marks the advent of the real integration of the
• Indian economy into the global economy
 Benefit of financial globalization in India
•In India, even the limited entry of foreign banks
has given domestic banks
•a much-needed kick in the rear side
•and forced them to improve their efficiency
• in order to compete and stay viable.
•Liberalizing outflows has the salutary effect
• of giving domestic investors
•an opportunity to diversify their portfolios
internationally.
•This means greater competition for
•domestic financial institutions
•And also an opportunity for them to
•cultivate the financial savvy to offer
products
•that would help their customers invest
abroad.
• Indirect benefits associated with foreign capital
• include transfers of expertise technological
• and managerial from more advanced economies.
• When supported by liberal trade policies,
• foreign investment can help boost export growth.
• Foreign invested firms also tend to have spillover
effects
• in generating efficiency gains among domestic
firms.
 Financial development indicator-Methods

• Ratio of Liquid liabilities of the financial sector to GDP:

• LL, is traditional measure of financial sector
development.
• LL is the liquid liabilities of the financial system
• and is
• currency plus demand and interest-bearing liabilities
of financial intermediaries and
• non-bank financial intermediaries
• as a percentage of GDP
• This is the broadest available indicator of
• financial intermediation, since it includes
• all three financial sectors (central bank,
commercial bank and other financial institutions).
• It is a typical measure of financial “depth” and
• thus of the overall size of the financial sector
• without distinguishing between the
• financial sectors or between the use of liabilities.
• M2 (ratio to monetary GDP):
• It is used as one of the proxy measure of
• financial depth in developing countries.
• The money supply (M2) that includes M1, plus
• savings and small-time deposits,
• overnight repos at commercial banks,
• and non-institutional money market accounts.
• It is a key economic indicator used to forecast
inflation.
•Financial system deposits to GDP (FSD):
•This is another indicator for financial
depth of the country.
•It includes Demand, time and saving
deposits
• in banks and other financial institutions
•as a share of GDP.
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