FINANCIAL SYSTEM

The financial system refers to a

system of borrowing and lending of

funds or the demand for and supply

of funds of all in

dividuals,

institutions, companies and of th

e

Government.

Role of financial system

Serves as a link between savers and investors

Mechanism for exchange of goods and services

Mechanism of transfer of resources

Promotes process of capital formation

Structure of financial system

Financial system

Financial Assets

Financial Markets

Financial Intermediaries

Financial assets Perform significant role in transferring funds from

lenders to borrowers Each asset differs from each other A financial asset is one which is used for production

or consumption or for future creation of assets. Represent claim against future income and wealth of

others. To suit different requirements, different securities

are issued.

Financial assets/ securities

Primary assets/ securities

Direct securities

Secondary assets/ securities

Indirect securities

Primary securities• Issued directly by ultimate borrowers of the

funds to the ultimate savers or investors.

• Example: Equity shares, preference shares and debentures.

Secondary securities• Not issued directly by ultimate borrowers

• Issued by financial intermediaries to ultimate savers

• Example: Insurance policy, Mutual funds

Financial Markets• Market normally refers to a group of traders carrying on

business at a definite place, building or locality.• A financial market is a market for the creation and

exchange of financial assets.• Once engaged in buying or selling the financial assets,

indicates that you are participating in financial markets in one way or the other.

• Institutional arrangement for dealing in financial assets of different types

Functions of financial market

o To facilitate creation and allocation of credit

o To serve as intermediary for mobilization of savings

o To assist the process of balanced economic growth

o To provide financial convenience

o To cater to various credit needs of the business houses

Financial Markets

Money Market

Capital Market

MONEY MARKET“The centre for dealings, mainly for short term character, in monetary assets, it meets the short term requirements of the borrowers and provide liquidity or cash to the borrowers.”

Money Market• All transactions in near money• Deal with short term funds in the economy• Institutional arrangements for facilitating borrowing

and lending of short term funds• Funds borrowed for a short period (less than a year)• Sub markets are:

oCall money marketoTreasury bill marketoCommercial paper marketoCertificate of deposits market

Capital Market• Institutional arrangements for facilitating the borrowing

and lending of long term funds

• Medium through which investor hand over money today in exchange for promise of money far in the future.

Financial Intermediaries• Facilitate smooth functioning of the financial system by

making investors and borrowers meet

• Mobilize savings of surplus units and allocate them in productive activities promising a better return

• Act as a middlemen between savers and borrowers

Types of financial

intermediaries

Banking Institutions

Organized sector

- Commercial banks

- Co-operative banks

-Regional rural banks

-Foreign banks

Unorganized sector

- Indigenous bankers

- Money lenders

Non banking financial

institutions

Organized financial

institutions

- Development finance

institutions(IDBI,ICICI,IFCI,NABARD,SFC)

- Investment Institutions(LIC,GIC,M

UTUAL FUND,UTI)

Unorganized financial institutions

NBFCs(hire purchase

company,lease company,factory

company)

REGULATORY FRAMEWORK• Plays a critical role in ensuring the health, soundness,

reliability and stability of the financial system

• lays down the specific rules for behavior of participants in the financial system

• necessary to generate, maintain and promote this trust of the participants.

Regulatory Bodies

RBI

SEBI

IDBI

NABARD

RBI• RBI seeks to regulate the volume and direction of

the flow of bank credit

• Apex institution as the monetary authority of the country

• Acts as a guide, regulator, controller and promoter of the financial system.

Functions of RBI

1• Formulates and implements monetary and credit

policies

2• Functions as banker’s bank

3• Supervises the operations of credit institutions

4• Controls the money supply and credit

5• Considered as lender of last resort

RBI also performs several functions aimed at developing Indian financial system:

Integrate the unorganized financial sector with organized financial sector

Encourages extension of commercial banking system in the rural areas

Influences allocation of creditPromotes development of new institutions

Techniques of monetary control

1. Open Market Operations:o Through the open market sale and purchase of government securities

takes place.o RBI can affect the reserves position of banks, yields on government

securities and the volume and cost of bank credit.

2. Bank Rate and Discretionary Control of Refinance: o Bank rate is the standard rate at which the RBI is prepared to buy or

rediscount the B/E or other eligible commercial papers.o Used to regulate the cost and availability of refinance and to change the

volume of lendable resources of banks and other financial institutions.

3. Cash Reserve Ratio(CRR): It refers to the cash which banks have to maintain with the RBI as a certain percentage of their demand and time liabilities.

4. Statutory Liquidity Ratio(SLR): It is the ratio of cash in hand balances in current account with SBI, its subsidiaries other nationalized banks and the RBI; gold and unencumbered approved securities to total demand and time liabilities of the banks.

5. Direct Credit Allocation and Credit Rationing: Through this the RBI has regulated the allocation/distribution

of credit among different sectors, borrowers and users and it has facilitated in narrowing down the regional/geographical imbalances.

6. Moral Suasion: This is another most actively and consistently used technique

of monetary control. It takes the form of writing letters and holding discussions

between the RBI and the banks about trends in the economy in general and in money, credit and finance in particular, and about the measures which ought to be taken from time to time in the light of national objectives.

SEBI• SEBI has emerged as an important constituent of the

system that now is actively engaged in regulating, controlling and monitoring the Indian Financial System.

• Through SEBI, the regulation model which is sought to be put in place in the country, is one in which every aspect of securities market regulation is entrusted to a single highly visible and independent organization, which is backed by a statute, and which is accountable to the Parliament and in which investors can have trust and confidence.

Functions of SEBIRegulates business in stock

exchanges

Register and regulate working of mutual funds

Prohibit insider trading in securities

Register and regulate capital market intermediaries

IDBI IDBI was set up to accelerate the development of the

country

Was a wholly subsidiary of RBI

Was expected to coordinate the activities of the institutions engaged in financing, promoting or developing industry.

Functions of IDBI• Act as an apex institution

• Provide refinance for term loans granted by banks and financial institutions

• Coordinate the activities of institutions providing term finance to industry

• Provide technical and administrative assistance for promotion, management and growth of industry

• Grant direct loans and advances to industrial concerns

NABARD• Apex institution for financing agricultural and

rural sectors• Main objectives are:

oTo provide credit for development of agriculture, small scale industries and rural areas

oTo provide short term refinance assistanceoTo Sanction refinance assistance for

government sponsored programs such as rozgar yojna etc.