Financial Market

What it is:

A financial market is a location where buyers and sellers meet

to exchange goods and services at prices determined by the forces
of supply and demand
How it works:

A financial market may be a physical location or a virtual one

over a network

If market demand is steady, an increase in market supply

results in a decline in market prices and vice versa.

If market supply is steady, a rise in demand results in a rise in

market prices and vice versa.

The "financial markets" is often used to refer just to the

markets that are used to raise finance:

The Money markets; for short term finance,

The Capital markets; for long term finance,

few are below.

Money market

Capital market

Derivatives market

Foreign exchange market

Money Market

Money market became a component of the financial markets

for assets involved in short-term borrowing, lending, buying and
selling with original maturities of one year or less.

The core of the money market consists of interbank lending

banks borrowing and lending to each other using commercial
paper, repurchase agreements and treasury bill.

These instruments are often benchmarked to (i.e., priced by

reference to) the London Interbank Offered Rate (LIBOR) for the
appropriate term and currency.

Trading in money markets is done Over the Counter(trading

is done directly between two parties, without any supervision of an
exchange)
Capital Market - Primary Market

Capital Market are financial markets for the buying and

selling of long-term debt or equity-backed securities

Primary Market [IPO] Initial public offer

Secondary Market [FUO] Follow up offering

Primary Market:
Companies, Government or public sector institutions can
obtain funds through the sale of a New stock or Bond
issue through Primary Market

This is typically done through an Investment Bank or

Finance Syndicate

Governments tend to issue only bonds,

whereas companies often issue either equity or bonds

Company receives the money & issues new security

certifications to the investors
Investment Banking helping customers raise funds in capital
markets & assets for merger & Accusation.

An investment bank is a financial institution that assists

individuals, corporations, and governments in raising financial
capital by underwriting or acting as the client's agent in the
issuance of securities.

An investment bank may also assist companies involved

in mergers and acquisitions and provide services such as[Money
market, trading of derivates, FX currencies, FI & Commodities

Investment banking are called the sell side and the buy
side.

The "sell side" involves trading securities for cash or for

other securities

The "buy side" involves the provision of advice to

institutions concerned with buying investment services

Once issued the securities typically trade on a secondary

market such as a stock exchange, bond market or derivatives
exchange
Capital Market - Secondary Market.

The secondary market, is also called aftermarket

Secondary Market is a market for trading & settlement of

securities that have already been issued.

The investors holding securities sell securities

through registered brokersor sub-brokers of the stock
exchange

It has physical location like stock exchange or a trade floor.

Stock Market: [Dividends]

Which provides financing through the issuance of S

Bond Market: [Interest] Fixed income

Which provides financing through the issuance of

Foreign Exchange Market

The foreign exchange market (Forex) is a global decentralized

market for the trading of currencies.

In terms of volume of trading, it is by far the largest market in

the world.

The main participants in this market are the larger

international banks
A Spot
transaction is a two-day delivery transaction (except US dollar, Canadian
dollar, euro and Russian rubble, which settle the next business day)

This trade represents a direct exchange between two

currencies, has the shortest time frame, involves cash rather than a
contract

Spot trading is one of the most common types of Forex Trading.

A forex broker will charge a small fee to the client

Forward

In this transaction, money does not actually change hands until

some agreed upon future date.

A buyer and seller agree on an exchange rate for any date in

the future, and the transaction occurs on that date, regardless of
what the market rates are then.

The duration of the trade can be one day, a few days, months
or years. Usually the date is decided by both parties.

Then the forward contract is negotiated and agreed upon by

both parties.

Derivative

Derivatives are contract between two parties.

In finance, a derivative is a contract that derives its value from

the performance of an underlying entity.

This underlying entity can be an Stocks, Bonds, interest rate

and Currencies.

Some of the more common derivatives

include forwards, futures, optionsand swaps.

Most derivatives are traded over-the-counter (off-exchange)

Derivatives are one of the three main categories of financial

instruments, the other two being stocks (i.e., equities or shares)
and debt (i.e., bonds and mortgages)
Derivative - Forward Contract

Promises to deliver an asset at pre-defined dat in future at predefined price

High popular on Currency & interest rate

The contracts are traded outside the stock exchange &

customized according the needs of parties.

Counterparty risk is high - That one of the parties to the

contract may not fulfil his (or) her obligation.

An obligation is a course of action that someone is required to

take, whether legal or moral.
Derivative Options

An option is a contract which gives the buyer (the owner) the

right, but not the obligation, to buy or sell an underlying asset or
instrument at a specified strike price on or before a specified date.
Two types of Options

Call: Gives the buyer a right but not an obligation to buy a

given quantity of the underlying asset, at the given price on or
before the a given future date.

Put: Gives the buyer a right but not an obligation to sell a

given quantity of the underlying asset, at the given price on or
before the a given date.
Derivative - Swap
Swap are private agreements between two counterparties exchange cash flows
of one party's financial instrument for those of the other party's financial
instrument.

For example, in the case of a swap involving two bonds, the

benefits in question can be the periodic interest payments
associated with such bonds. Specifically, two counterparties agree
to exchange one stream of cash flows against another stream.
Two Common Swaps are.. Interest rate swap & Currency swap

interest rate swap (IRS) is a popular and highly liquid

financial derivative instrument in which two parties agree to
exchange interest rate cash flows, based on a specified notional
amount from a fixed rate to a floating rate (or vice versa) .

A pays fixed rate to B (A receives floating rate)

B pays floating rate to A (B receives fixed rate)

Currently, A borrows from Market @ LIBOR +1.5%. B borrows

from Market @ 8.5%.

A currency swap is a foreign-exchange agreement between two

institutions to exchange aspects (namely the principal and/or
interest payments) of a loan in one currency for equivalent aspects
of an equal in net present value loan in another currency

in currency swap, both principal and interest of loan is

exchanged from one party to another party for mutual benefits

FINANCIAL MARKETS
INTRODUCTION
You all know that a business needs finance from the time an entrepreneur makes
the decision to start it. It needsfinance both for working capital requirements such
as payments for raw materials and salaries to its employees, and fixed
capital expenditure such as the purchase of machinery or building or to expand
its production capacity. The above example gives a fair picture of how companies
need to raise funds from the capital markets. Idea Cellular decided to enter the
Indian capital market for its needs of expansion.
In this chapter you will study concepts like private placement, Initial public Offer
(IPO) and capital markets which you come across in the example of Idea
Cellular. Business can raise these funds from various sources and in different
ways through financial markets. This chapter provides a brief description of the
mechanism through which finances are mobilised by a business organisation for
both short term and long term requirements. It also explains the institutional
structure and the regulatory measures for different financial markets.
CONCEPT OF FINANCIAL MARKET
A business is a part of an economic system that consists of two main sectors
households which save fundsand business firms which invest these funds. A
financial market helps to link the savers and the investors by mobilizing funds
between them. In doing so it performs what is known as an allocative function. It
allocates ordirects funds available for investment into their most productive
investment opportunity.
When the allocative function is performed well, two consequences follow:
The rate of return offered tohouseholds would be higher
Scarce resources are allocated to those firms which have the
highest productivity for the economy.
There are two major alternative mechanisms through which allocation of funds
can be done: via banks or via financial markets. Households can deposit their
surplus funds with banks, who in turn could lend these funds to business firms.
Alternately, households can buy the shares anddebentures offered by a
business using financial markets. The process by which allocation of funds is
done is called financial intermediation. Banks and financial markets
ar competing intermediaries in the financial system, and give households a
choice of where they want to place their savings.
MONEY MARKET

The money market is a market for short term funds which deals in monetary
assets whose period of maturity is upto one year. These assets are close
substitutes for money. It is a market where low risk, unsecured and short term
debt instruments that are highly liquid are issued and actively traded everyday. It
has no physical location, but is an activityconducted over the telephone
and through the internet. It enables the raising of short-term funds for
meeting the temporary shortages of cash and obligations and the
temporary deployment of excess funds for earning returns. The major
participants in the market are the Reserve Bank of India.

A financial market is a market in which people trade financial securities, commodities, and
other fungible items of value at low transaction costs and at prices that reflect supply and
demand. Securities include stocks and bonds, and commodities include precious metals or
agricultural products.

What is the 'Financial Market'

The financial market is a broad term describing any marketplace where buyers and sellers
participate in the trade of assets such as equities, bonds, currencies and derivatives.
Financial markets are typically defined by having transparent pricing, basic regulations on
trading, costs and fees and market forces determining the prices of securities that trade.
Some financial markets only allow participants that meet certain criteria, which can be
based on factors like the amount of money held, the investor's geographical location,
knowledge of the markets or the profession of the participant.

FINANCIAL SYSTEM

What is a 'Financial System'

A financial system can be defined at the global, regional or firm specific level. The firm's
financial system is the set of implemented procedures that track the financial activities of the
company. On a regional scale, the financial system is the system that enables lenders and
borrowers to exchange funds. The global financial system is basically a broader regional
system that encompasses all financial institutions, borrowers and lenders within the global
economy.

BREAKING DOWN 'Financial System'

There are multiple components making up the financial system of different levels: Within a
firm, the financial system encompasses all aspects of finances. For example, it would
include accounting measures, revenue and expense schedules, wages and balance
sheet verification. Regional financial systems would include banks and other financial
institutions, financial markets, financial services In a global view, financial systems would
include the International Monetary Fund, central banks, World Bank and major banks that
practice overseas lending.

A financial system (within the scope of finance) is a system that allows the exchange of funds
between lenders, investors, and borrowers. Financial systems operate at national, global, and firmspecific levels.[1] They consist of complex, closely related services, markets, and institutions used to
provide an efficient and regular linkage between investors and depositors. [2]
Money, credit, and finance are used as media of exchange in financial systems. They serve as a
medium of known value for which goods andservices can be exchanged as an alternative

to bartering.[3] A modern financial system may include banks (operated by the government or private
sector), financial markets, financial instruments, and financial services. Financial systems allow
funds to be allocated, invested, or moved between economic sectors. They enable individuals and
companies to share the associated risks.[4]

Financial institutions[edit]
Financial institutions provide financial services for members and clients. They are typically regulated
heavily, as they provide market stability and consumer protection. Financial institutions include: [citation
needed]

Public banks

Commercial banks

Central banks

Cooperative banks

State-managed cooperative banks

State-managed land development banks

Non-bank financial institutions[edit]

Non-bank financial institutions facilitate financial services like investment, risk pooling, and market
brokering. They generally do not have full banking licenses or are not supervised by a bank
regulation agency.[5] Non-bank financial institutions include:[6]

Casinos and cardrooms

Finance and loan companies

Insurance companies

Mutual funds

Commodity traders

Financial markets[edit]

Financial markets are markets in which securities, commodities, and fungible items are traded at
costs representing supply and demand. The term "market" typically means the aggregate of possible
buyers and sellers of such items.
Primary markets[edit]
The primary market is used for new issues or financial claims. Financial instruments such
as stocks and bonds are often sold through primary markets.
Secondary markets[edit]
The secondary market is the market in which financial instruments that have been issued previously
are sold.

Financial instruments[edit]
Financial instruments are tradable assets of any kind. They include money, evidence of ownership
interest in an entity, and contracts.[7]
Cash instruments[edit]
A cash instrument's value is determined directly by markets. They may include securities, loans,
and deposits.
Derivative instruments[edit]
The value of derivative instruments is variable and derived from one or more underlying entity
(including an asset, index, or interest rate).[8]

Financial services[edit]
Financial services are offered by a large number of business that encompass the finance industry.
These include credit unions, banks, credit cardcompanies, insurance companies, stock brokerages,
and investment funds.

INDIAN FINANCIAL SYSTEM

Meaning and definition of financial system:
The financial system is possibly the most important institutional and functional vehicle
for economic transformation. Finance is a bridge between the present and the future
and whether the mobilization of savings or their efficient, effective and equitable
allocation for investment, it the access with which the financial system performs its
functions that sets the pace for the achievement of broader national objectives.
According to Christy, the objective of the financial system is to supply funds to
various sectors and activities of the economy in ways that promote the fullest possible
utilization of resources without the destabilizing consequence of price level changes or
unnecessary interference with individual desires.
According to Robinson, the primary function of the system is to provide a link
between savings and investment for the creation of new wealth and to permit portfolio
adjustment in the composition of the existing wealth.
A financial system or financial sector functions as an intermediary and facilitates the
flow of funds from the areas of surplus to the deficit. It is a composition of various
institutions, markets, regulations and laws, practices, money manager analyst,
transactions and claims and liabilities.
Features of financial system
The features of a financial system are as follows
1. Financial system provides an ideal linkage between depositors and investors, thus
encouraging both savings and investments.
2. Financial system facilitates expansion of financial markets over space and time.
3. Financial system promotes efficient allocation of financial resources for socially
desirable and economically productive purposes.
4. Financial system influences both the quality and the pace of economic
development.
CONSTITUENTS OF FINANCIAL SYSTEM

The financial system consists of four segments or components. These are: financial
institutions, financial markets, financial services.
1. Financial institutions: Financial institutions are intermediaries that mobilize savings
& facilitate the allocation of funds in an efficient manner.
Financial institutions can be classified as banking & non-banking financial institutions.
Banking institutions are creators of credit while non-banking financial institutions are
purveyors of credit. While the liabilities of banks are part of the money supply, this may
not be true of non-banking financial institutions. In India, non-banking financial
institutions, namely, the developmental financial institutions (DFIs) & non-banking
financial companies (NBFCs) as well as housing finance companies (HFCs) are the
major institutional purveyors of credit. Financial institutions can also be classified as
term-finance institutions such as the industrial development bank of India (IDBI),
industrial credit & Investment Corporation of India (ICICI), industrial financial corporation
of India (IFCI), small industries development bank of India (SIDBI) & industrial
investment bank of India (IIBI).
2. Financial markets:
Financial markets are a mechanism enabling participants to deal in financial claims.
The markets also provide a facility in which their demands & requirements interact to set
a price for such claims. The main organized financial markets in India are the money
market & capital market. The first is a market for short-term securities. Money market is
a market for dealing with financial assets & securities which have a maturity period of
upto one year. While the second is a market for long term securities, that is, securities
having a maturity period of one year or more. The capital market is a market for
financial assets which have a long or indefinite maturity.
Money market consists of:
Call money market:
Call money market is a market for extremely short period loans say one day to fourteen
days. It is highly liquid.
Commercial bills market:
It is a market for bills of exchange arising out of genuine trade transactions. In the case
of credit sale, the seller may draw a bill of exchange on the buyer. The buyer accepts

such a bill promising to pay at a later date the amount specified in the bill. The seller
need not wait until the due date of the bill. Instead, he can get immediate payment by
discounting the bill.
Treasury bills market:
It is a market for treasury bills which have short-term maturity. A treasury bill is a
promissory note or a finance bill issued by the government. It is highly liquid because its
repayment is guaranteed by the government.
Short-term loan market:
It is a market where short- term loans are given to corporate customers for meeting their
working capital requirements. Commercial banks play a significant role in this market.
Capital market consists of:
Industrial securities market:
It is a market for industrial securities namely equity shares or ordinary shares,
preference shares & debentures or bonds. It is a market where industrial concerns raise
their capital or debt by issuing appropriate instruments. It can be further subdivided into
primary & secondary market.
Government securities market:
It is otherwise called gilt-edged securities market. It is a market where government
securities are traded. In India there are many kinds of govt securities- short-term & longterm. Long-term securities are traded in this market while short term securities are
traded in the money market.
Long-term loans market:
Development banks & commercial banks play a significant role in this market by
supplying long term loans to corporate customers. Long-term loans market may further
be classified into:
Term loans market
Mortgages market
Financial guarantees market

3. Financial Instruments:
Financial instruments refers to those document which represents financial claims on
assets. As discussed earlier, financial assets refers to a claim to the repayment of
certain sum of money at the end of specified period together with interest or dividend.
Examples : bills of exchange, promissory notes, treasury bills, government bonds,
deposit receipts, shares debentures etc.
Financial instruments can also be called financial securities. Financial securities can
be classified into:
i. Primary or direct securities
ii. Secondary or indirect securities.
Primary securities
These are securities directly issued by the ultimate investors to the ultimate savers.
Examples, shares and debentures issued directly to the public.
Secondary securities
These are securities issued by some intermediaries called financial intermediaries to
the ultimate savers. E.g. unit trust of India and Mutual funds issue securities in the
form of units to the public and money pooled is invested in companies.
Again these securities may be classified on the basis of duration as follows:
i. Short-term securities
ii. Medium-term securities
iii. Long-term securities.
Short-term securities are those which mature within a period of one year. E.g. Bills of
exchange, treasury bills, etc. medium term securities are those which have a maturity
period ranging between one and five years.
e.g. Debentures maturing within a period of 5 years. Long-term securities are those
which have a maturity period of more than five years. E.g. government Bonds
maturing after 10 years.

Characteristic Features of Financial Instruments

Generally speaking, financial instruments possess the following characteristic
features:
i. Most of the instruments can be easily transferred from one hand to another without
many cumbersome formalities.
ii. They have a ready market, i.e., they can be bought and sold frequently and thus,
trading in these securities is made possible.
iii. They possess liquidity, i.e., some instruments can be converted into cash readily. For
instance, a bill of exchange can be converted into cash readily by means of
discounting and rediscounting.
iv. Most of the securities posses security value, i.e., they can be given as security for the
purpose of raising loans.
v. Some securities enjoy tax status, i.e., investment in these securities are exempted
from income tax, wealth tax, etc., subject to certain limits. E.g. public sector
tax free bonds, magnum tax saving certificates.
vi. They carry risk in the sense that there is uncertainty with regard to the payment of
principle or interest or dividend as the case may be.
vii. These instruments facilitates future trading so as to cover risks due to price
fluctuations, interest rates, etc.
viii. These instruments involve less handling costs since expenses involved in buying
and selling these securities are generally much less.
ix. The return on these instruments is directly in proportion to the risk undertaken.
x. These instruments may be short-term or medium term or long term depending upon
the maturity period of these instruments.
4. Financial Services:
Financial intermediaries provide key financial services such as merchant banking,
leasing hire purchases, credit-rating, and so on. Financial services rendered by the
financial intermediaries bridge the gap between lack of knowledge on the part of

investors and increasing sophistication of financial instruments and markets. These

financial services are vital for creation of firms, industrial expansion, and economic
growth.
Before investors lend money, they need to be reassured that it is safe to exchange
securities for funds. This reassurance is provided by the financial regulator, who
regulates the conduct of the market, and intermediaries to protect the investors
interests. The Reserve Bank of India regulates the money market and Securities
Exchange Board of India (SEBI) regulates capital market.
FUNCTIONS OF FINANCIAL SYSTEM
Good financial system search in the following ways :
1. Promotion of liquidity:
The major function of financial system is the provision of money and monetary
assets for the production of goods and services. There should not be any shortage
of money for productive ventures. In financial language, the money and monetary
assets are referred to as liquidity. The term liquidity refers to cash or money and
other assets which can be converted into cash readily without loss of value and time.
2. Link between savers and investors:
One of the important functions of financial system is to link the savers and
investors and thereby help in mobilizing and allocating the savings effectively and
efficiently. By acting as an efficient medium for allocation of resources, it permits
continuous up gradation of technologies for promoting growth on a sustained basis.
3. Information available:
It makes available price- related information which is a valuable assistance to
those who need economic and financial decision.
4. Helps in projects selection:
A financial system not only helps in selecting projects to be funded but also inspires
the operators to monitor the performance of the investment. It provides a payment
mechanism for the exchange of goods and services, and transfers economic
resources through time and across geographic regions and industries.

5. Allocation of risk:
One of most important function of the financial system is to achieve optimum
allocation of risk bearing. It limits, pools, and trades the risks involved in mobilizing
savings and allocating credit. An effective financial system aims at containing risk
within acceptable limit and reducing cost of gathering and analyzing information to
assist operators in taking decisions carefully.
6. Minimizes situations of Asymmetric information:
A financial system minimizes situations where the information is Asymmetric and
likely to affect motivations among operators or when one party has the information
and the other party does not. It provides financial services such as insurance and
pension and offers portfolio adjustments facilities.
7. Reduce cost of transaction and borrowing:
A financial system helps in creation of financial structure that lowers the cost of
transactions. This has a beneficial influence on the rate of return to the savers. It
also reduces the cost of borrowings. Thus , the system generates an impulse
among the people to save more.
8. Financial deepening and broadening:
A well functioning financial system helps in promoting the process of financial
deepening and broadening. Financial deepening refers to an increase of financial
assets as a percentage of the gross domestic product. Financial broadening refers
to building an increasing number and a variety of participants and instruments.

financial system
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Definition
The collection of accounting processes and procedures that allow
a business to keep accurate financial records, monitor accounts,
prevent fraud and mistakes, and catch any discrepancies. A financial
system allows a company to maintain accountability for expenditures and revenues, and to
control their finances to minimize waste and loss.

Introduction:
Economic growth and development of any country depends upon a well-knit financial system. Financial system
comprises, a set of sub-systems of financial institutions financial markets, financial instruments and services which
help in the formation of capital. Thus a financial system provides a mechanism by which savings are transformed into
investments and it can be said that financial system play an significant role in economic growth of the country by
mobilizing surplus funds and utilizing them effectively for productive purpose.
The financial system is characterized by the presence of integrated, organized and regulated financial markets, and
institutions that meet the short term and long term financial needs of both the household and corporate sector. Both
financial markets and financial institutions play an important role in the financial system by rendering various financial
services to the community. They operate in close combination with each other.
Financial System;

The word "system", in the term "financial system", implies a set of complex and closely connected or interlined
institutions, agents, practices, markets, transactions, claims, and liabilities in the economy. The financial system is
concerned about money, credit and finance-the three terms are intimately related yet are somewhat different from
each other. Indian financial system consists of financial market, financial instruments and financial intermediation
Role/ Functions of Financial System:
A financial system performs the following functions:
* It serves as a link between savers and investors. It helps in utilizing the mobilized savings of scattered savers in
more efficient and effective manner. It channelises flow of saving into productive investment.
* It assists in the selection of the projects to be financed and also reviews the performance of such projects
periodically.
* It provides payment mechanism for exchange of goods and services.
* It provides a mechanism for the transfer of resources across geographic boundaries.
* It provides a mechanism for managing and controlling the risk involved in mobilizing savings and allocating credit.
* It promotes the process of capital formation by bringing together the supply of saving and the demand for investible
funds.
* It helps in lowering the cost of transaction and increase returns. Reduce cost motives people to save more.

* It provides you detailed information to the operators/ players in the market such as individuals, business houses,
Governments etc.
Components/ Constituents of Indian Financial system:
The following are the four main components of Indian Financial system
1. Financial institutions
2. Financial Markets
3. Financial Instruments/Assets/Securities
4. Financial Services.
Financial institutions:
Financial institutions are the intermediaries who facilitates smooth functioning of the financial system by making
investors and borrowers meet. They mobilize savings of the surplus units and allocate them in productive activities
promising a better rate of return. Financial institutions also provide services to entities seeking advises on various
issues ranging from restructuring to diversification plans. They provide whole range of services to the entities who
want to raise funds from the markets elsewhere. Financial institutions act as financial intermediaries because they act
as middlemen between savers and borrowers. Were these financial institutions may be of Banking or Non-Banking
institutions.
Financial Markets:
Finance is a prerequisite for modern business and financial institutions play a vital role in economic system. It's
through financial markets the financial system of an economy works. The main functions of financial markets are:
1. to facilitate creation and allocation of credit and liquidity;
2. to serve as intermediaries for mobilization of savings;
3. to assist process of balanced economic growth;
4. to provide financial convenience
Financial Instruments
Another important constituent of financial system is financial instruments. They represent a claim against the future
income and wealth of others. It will be a claim against a person or an institutions, for the payment of the some of the
money at a specified future date.
Financial Services:

Efficiency of emerging financial system largely depends upon the quality and variety of financial services provided by
financial intermediaries. The term financial services can be defined as "activites, benefits and satisfaction connected
with sale of money, that offers to users and customers, financial related value".

Pre-reforms Phase
Until the early 1990s, the role of the financial system in India was primarily restricted to the function of channeling
resources from the surplus to deficit sectors. Whereas the financial system performed this role reasonably well, its
operations came to be marked by some serious deficiencies over the years. The banking sector suffered from lack of
competition, low capital base, low Productivity and high intermediation cost. After the nationalization of large banks in
1969 and 1980, the Government-owned banks dominated the banking sector. The role of technology was minimal
and the quality of service was not given adequate importance. Banks also did not follow proper risk management
systems and the prudential standards were weak. All these resulted in poor asset quality and low profitability. Among
non-banking financial intermediaries, development finance institutions (DFIs) operated in an over-protected
environment with most of the funding coming from assured sources at concessional terms. In the insurance sector,
there was little competition. The mutual fund industry also suffered from lack of competition and was dominated for
long by one institution, viz., the Unit Trust of India. Non-banking financial companies (NBFCs) grew rapidly, but there
was no regulation of their asset side. Financial markets were characterized by control over pricing of financial assets,
barriers to entry, high transaction costs and restrictions on movement of funds/participants between the market
segments. This apart from inhibiting the development of the markets also affected their efficiency.
Financial Sector Reforms in India
It was in this backdrop that wide-ranging financial sector reforms in India were introduced as an integral part of the
economic reforms initiated in the early 1990s with a view to improving the macroeconomic performance of the
economy. The reforms in the financial sector focused on creating efficient and stable financial institutions and
markets. The approach to financial sector reforms in India was one of gradual and non-disruptive progress through a
consultative process. The Reserve Bank has been consistently working towards setting an enabling regulatory
framework with prompt and effective supervision, development of technological and institutional infrastructure, as well
as changing the interface with the market participants through a consultative process. Persistent efforts have been
made towards adoption of international benchmarks as appropriate to Indian conditions. While certain changes in the
legal infrastructure are yet to be effected, the developments so far have brought the Indian financial system closer to
global standards.
The reform of the interest regime constitutes an integral part of the financial sector reform. With the onset of financial
sector reforms, the interest rate regime has been largely deregulated with a view towards better price discovery and
efficient resource allocation. Initially, steps were taken to develop the domestic money market and freeing of the
money market rates. The interest rates offered on Government securities were progressively raised so that the
Government borrowing could be carried out at market-related rates. In respect of banks, a major effort was

undertaken to simplify the administered structure of interest rates. Banks now have sufficient flexibility to decide their
deposit and lending rate structures and manage their assets and liabilities accordingly. At present, apart from savings
account and NRE deposit on the deposit side and export credit and small loans on the lending side, all other interest
rates are deregulated. Indian banking system operated for a long time with high reserve requirements both in the
form of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). This was a consequence of the high fiscal
deficit and a high degree of monetisation of fiscal deficit. The efforts in the recent period have been to lower both the
CRR and SLR. The statutory minimum of 25 per cent for SLR has already been reached, and while the Reserve Bank
continues to pursue its medium-term objective of reducing the CRR to the statutory minimum level of 3.0 per cent, the
CRR of SCBs is currently placed at 5.0 per cent of NDTL.
As part of the reforms programme, due attention has been given to diversification of ownership leading to greater
market accountability and improved efficiency. Initially, there was infusion of capital by the Government in public
sector banks, which was followed by expanding the capital base with equity participation by the private investors. This
was followed by a reduction in the Government shareholding in public sector banks to 51 per cent. Consequently, the
share of the public sector banks in the aggregate assets of the banking sector has come down from 90 per cent in
1991 to around 75 per cent in2004. With a view to enhancing efficiency and productivity through competition,
guidelines were laid down for establishment of new banks in the private sector and the foreign banks have been
allowed more liberal entry. Since 1993, twelve new private sector banks have been set up. As a major step towards
enhancing competition in the banking sector, foreign direct investment in the private sector banks is now allowed up
to 74 per cent, subject to conformity with the guidelines issued from time to time.
Conclusion: The Indian financial system has undergone structural transformation over the past decade. The financial
sector has acquired strength, efficiency and stability by the combined effect of competition, regulatory measures, and
policy environment. While competition, consolidation and convergence have been recognized as the key drivers of
the banking sector in the coming years.

Structure and Function of of Indian Financial System!

Financial System is a set of institutional arrangements through which financial
surpluses in the economy are mobilised from surplus units and transferred to
deficit spenders.
The institutional arrangements include all conditions and mechanisms
governing the production, distribution, exchange and holding of financial

assets or instruments of all kinds and the organisations as well as the manner
of operations of financial markets and institutions of all descriptions.
Thus, there are three main constituents of financial system:
(a) Financial Assets
(b) Financial Markets, and
(c) Financial Institutions.
Financial assets are subdivided under two heads:
Primary securities and secondary securities. The former are financial claims
against real-sector units, for example, bills, bonds, equities etc. They are
created by real-sector units as ultimate borrowers for raising funds to finance
their deficit spending. The secondary securities are financial claims issued by
financial institutions or intermediaries against themselves to raise funds from
public. For examples, bank deposits, life insurance policies, UTI units, IDBI
bonds etc.

Functions of Financial System:

The financial system helps production, capital accumulation, and growth by (i)
encouraging savings, (ii) mobilising them, and (iii) allocating them among
alternative uses and users. Each of these functions is important and the
efficiency of a given financial system depends on how well it performs each of
these functions.

(i) Encourage Savings:

Financial system promotes savings by providing a wide array of financial
assets as stores of value aided by the services of financial markets and
intermediaries of various kinds. For wealth holders, all this offers ample choice
of portfolios with attractive combinations of income, safety and yield.
With financial progress and innovations in financial technology, the scope of
portfolio choice has also improved. Therefore, it is widely held that the
savings-income ratio is directly related to both financial assets and financial
institutions. That is, financial progress generally insures larger savings out of
the same level of real income.
As stores of value, financial assets command certain advantages over
tangible assets (physical capital, inventories of goods, etc.) they are
convenient to hold, or easily storable, more liquid, that is more easily
encashable, more easily divisible, and less risky.
A very important property of financial assets is that they do not require regular
management of the kind most tangible assets do. The financial assets have
made possible the separation of ultimate ownership and management of
tangible assets. The separation of savings from management has encouraged
savings greatly.
Savings are done by households, businesses, and government. Following the
official classification adopted by the Central Statistical Organization (CSO),
Government of India, we reclassify savers into household sector, domestic
private corporate sector, and the public sector.

The household sector is defined to comprise individuals, non-Government,

non-corporate entities in agriculture, trade and industry, and non-profit making
organisations like trusts and charitable and religious institutions.
The public sector comprises Central and state governments, departmental
and non departmental undertakings, the RBI, etc. The domestic private
corporate sector comprises non-government public and private limited
companies (whether financial or non-financial) and corrective institutions.
Of these three sectors, the dominant saver is the household sector, followed
by the domestic private corporate sector. The contribution of the public sector
to total net domestic savings is relatively small.

(ii) Mobilisation of Savings:

Financial system is a highly efficient mechanism for mobilising savings. In a
fully-monetised economy this is done automatically when, in the first instance,
the public holds its savings in the form of money. However, this is not the only
way of instantaneous mobilisation of savings.
Other financial methods used are deductions at source of the contributions to
provident fund and other savings schemes. More generally, mobilisation of
savings taken place when savers move into financial assets, whether
currency, bank deposits, post office savings deposits, life insurance policies,
bill, bonds, equity shares, etc.

(iii) Allocation of Funds:

Another important function of a financial system is to arrange smooth,
efficient, and socially equitable allocation of credit. With modem financial

development and new financial assets, institutions and markets have come to
be organised, which are replaying an increasingly important role in the
provision of credit.
In the allocative functions of financial institutions lies their main source of
power. By granting easy and cheap credit to particular firms, they can shift
outward the resource constraint of these firms and make them grow faster.
On the other hand, by denying adequate credit on reasonable terms to other
firms, financial institutions can restrict the growth or even normal working of
these other firms substantially. Thus, the power of credit can be used highly
discriminately to favour some and to hinder others.

Structure of Indian Financial System:

Financial system operates through financial markets and institutions.
The Indian Financial system (financial markets) is broadly divided under
two heads:
(i) Indian Money Market
(ii) Indian Capital Market
The Indian money market is the market in which short-term funds are
borrowed and lent. The money market does not deal in cash, or money but in
bills of exchange, grade bills and treasury bills and other instruments. The
capital market in India on the other hand is the market for the medium term
and long term funds.