OVER VIEW OF BANKING Indian Financial

System

OBJECTIVES

To understand the:-

Nature Evolution and Structure Functions of Financial Intermediaries Financial Instruments Role of Financial System in Economic

Development.

Financial System The word system in the term ‘financial system’

represents a set of closely held financial institutions, financial services and financial instruments or Claims. The financial system of a country can be defined as a set of organizations, instruments, markets, services and methods of operations, procedures that are closely interrelated with each other.

The word ‘System’ means an ordered, organized and comprehensive assemblage of facts, principles or components relating to a particular field and working for a specified purpose. A financial system is an Integral Part of a Modern Economy.

Nature and Evolution of the Financial System : Efficient Monetary System- indicates an efficiency

medium of exchange for goods and services.

Facilities for the creation of the capital- to meet the demands of the economy.

The capital will be necessary to undertake the production activities.

The financial system helps to meet such demands by mobilizing the savings of the surplus units to the demanding units.

Efficient financial markets- and methodologies, which facilitate the process to transfer the resources and the conversion of financial claims into money.

Nature and Evolution of the Financial System Complexities in the functions of the financial system, especially when the requirements of the savers and those of the borrowers did not match, created a need to enhance the financial system.

Segments of the Financial System : 

The Financial System is Segmented into two Parts namely, the Organized and the Un Organized.

The Organized system represents the Structure or nationalized banking, Co-operative banks and development banks set by the government through various enactments and regulations. This includes the private sector also. The Government/RBI controls this sector.

The Unorganized sector comprises of individual money lenders, bankers, pawn brokers and traders, etc.

Components of Financial SystemFinancial System

Financial Institutio

n

Banking

Non Banking

Financial Market

Primary

Market

Secondary

Market

Financial Instrumen

ts

Money Market

Capital

Market

Financial

Services

Borrowing and

Funding

Lending and Investi

ng

Buying and

Selling Securiti

es

INDIAN FINANCIAL SYSTEM The economic development of a nation is reflected

by the progress of the various economic units, broadly classified into corporate sector, government and household sector.  While performing their activities these units will be placed in a surplus/deficit/balanced budgetary situations.

There are areas or people with surplus funds and there are those with a deficit.  A financial system or financial sector functions as an intermediary and facilitates the flow of funds from the areas of surplus to the areas of deficit. 

The Indian Financial System before independence closely resembled the model given by RL Benne in his theory of financial organization in a traditional economy . According to him in a traditional economy the per capita output is low and constant.

Some principal features of the Indian Financial

system before independence were: closed-circle character of industrial entrepreneurship; a narrow industrial securities market, absence of issuing institutions and no intermediaries in the long-term financing of the industry.

Outside savings could not be invested in industry. That is, the savings of the financial system could not be channelled to investment opportunities in industrial sector.

Financial System

FINANCIAL MARKETS A Financial Market can be defined as the market in which financial

assets are created or transferred

Types of financial Market:-

Money Market- A wholesale debt market for low-risk, highly-liquid, short-term instrument.

Capital Market -  The long-term investments, will be for periods over a year.

Forex Market - multicurrency requirements, exchange of currencies.  Depending on the exchange rate that is applicable, the transfer of funds

Credit Market- Banks, FIs and NBFCs purvey short, medium and long-term loans to corporate and individuals.

Constituents of a Financial System

Types of Financial Intermediaries :Financial Intermediaries are Classified into two

types namely, Depository and Non-Depository Institutions.

Depository Institutions include:- Commercial banks, Savings & loans institutions, Credit unions

Depository institutions directly lend these funds to consumers and businesses for a full range of purposes. They also lend them indirectly by investing in securities.

Depository Financial Institutions that is legally allowed to accept monetary deposits from consumers such as a savings bank. A deposit account is a current account, savings account, or other type of bank account, at a banking institution that allows money to be deposited and withdrawn by the account holder.

Non-depository Institutions:-Non-depository institutions include:-

1. Finance Companies, 2. Mutual Funds, 3. Security firms Investment bankers, 4. Brokers and Dealers, 5. Pension funds and Insurance

companies.

In a way they are called as department stores of consumer and business credit. Finance companies handle a range of business, which include, automobile finance, purchase of business equipment, home appliances, etc.

Functions of Financial Intermediaries : Saving function: Public saving find their way into the hands

of those in production through the financial system.Liquidity function: The financial markets provide the

investor with the opportunity to liquidate investments like stocks bonds debentures whenever they need the fund.

Payment function: The financial system offers a very convenient mode for payment of goods and services. Cheque system, credit card system etc

Risk function: The financial markets provide protection against life, health and income risks..

Policy function: Monetary Policy like Inflation Rate, Interest Rate,

INTERMEDIARY MARKET ROLE

Stock Exchange Capital Market Secondary Market to securities

Investment Bankers Capital Market, Credit Market

Corporate advisory services, Issue of securities

Underwriters Capital Market, Money Market

Subscribe to unsubscribed portion of securities

Registrars, Depositories, Custodians

Capital Market Issue securities to the investors on behalf of the company and handle share transfer activity

Primary Dealers Satellite

Money Market Market making in government securities

Forex Dealers Forex Market Ensure exchange ink currencies

FINANCIAL INSTRUMENTS

MONEY MARKET INSTRUMENT

Call/Notice- Money Market

Treasury Bills

Commercial Papers

Certificate of

Deposits

Inter Bank Term

Money

CAPITAL MARKET INSTRUMENTS

HYBRID INSTRUMENT

Issuer’s Considerations : Indian Financial System ISSUER’S CONSIDERATIONS

Past performance Cost of funds Regulatory aspects Issuer’s Considerations Cash Flows: Issuers may consider

the period for which the funds are required and try to spread the borrowings in a way to minimize the costs.

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.

Investor’s Considerations : Investor’s Considerations Indian Financial System

TAX PLANNING CASH FLOWS INVESTOR’S CONSIDERATIONS RETURN

Risk: The primary consideration for the investor will be the safety of the funds lent. Every investment option will have an element of risk.

Liquidity: The Investor will also give due consideration to the liquidity of the instrument, which depends mainly on the secondary market.

Returns: The investor generally expects to earn a return that compensates for the risk exposure taken by investing in the security.

Maturity Pl

an: Depending upon the future requirement of funds and their availability to repay the lenders, the repayment schedule of the instrument has to be designed.

Market conditions: One of the important considerations for the issuer will be the environment, both economic and political. Not with standing the credibility of an issuer, it is important that the market is conducive to facilitate raising of funds.

Investor Profile: Instrument design should necessarily suit the target investors for the issuer.

Past Performance: The performance of the previous issues of the same company or performance of the previous issues of companies in the same industry will have to be considered before designing the instrument.

Cost of funds: Raising funds is a costly affair, so based in the above factors the company should ensure to choose an option which minimizes its cost of funds.

Regulatory Aspects: Finally, the instrument needs to be created after considering all the possible factors in the light of the regulatory aspects.  

Tax Planning: Investors can invest in those securities that offer tax incentives, as the post-tax returns are significant to them.

Cash flows: The investment decision of the investor will also depend on the period for which the surplus funds are available for investment.

Simplicity: The salient features of the instrument should be easily understood by the investor in order to take the investment decision.

Development : Role of Financial System in Economic

Role of Financial System in Economic Development The financial system of a country is of immense use in its economic development. The volume and growth of the capital in the country very much depends upon the efficiency and intensity of the operations and activities in the financial markets. An immature financial system hinders the growth of the economy.

Financial intermediaries enhance the investment in the economy through direct and indirect investments.

The process of transferring the monetary resources of the public into the financial resources by the financial intermediaries involves Maturity intermediation, Risk reduction through diversification, Reducing costs of transaction & information and Providing a payments mechanism.

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