INDIAN FINANCIAL SYSTEM

BUSINESS ENVIRONMENT: MODULE 4

FINANCIAL SYSTEM

Financial System: An institutional framework existing in a country to

enable financial transactions.
Three main parts:
1. Financial assets (loans, deposits, bonds, equities, etc.)
2. Financial institutions (banks, mutual funds, insurance companies, etc.)
3. Financial markets (money market, capital market, forex market, etc.)
Regulation is another aspect of the financial system (RBI, SEBI, IRDA,
FMC)
Payment and Settlement System Plays a crucial role in it.
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FINANCIAL SYSTEM CONTINUED

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
A Financial System is a composition of various institutions, markets,
regulations and laws, practices, money manager, analysts,
transactions and claims and liabilities

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SEEKERS OF
FUNDS
(MAINLY
BUSINESS FIRMS
AND
GOVERNMENT)

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FLOW OF FINANCIAL
RESOURCES

INCOME AND FINANCIAL

CLAIMS

SUPPLIERS OF
FUNDS (MAINLY
HOUSEHOLDS)

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FINANCIAL ASSETS/INSTRUMENTS

Financial Assets/Instruments

Enable channelizing funds from surplus units to deficit units

There are instruments for savers such as deposits, equities, mutual fund units, etc.

There are instruments for borrowers such as loans, overdrafts, etc.

Like businesses, governments too raise funds through issuing of bonds, Treasury bills, etc.

Instruments like PPF, KVP, etc. are available to savers who wish to lend money to the government

Major Financial Instruments

Money

Savings account

Credit market Instruments-bonds, mortgages

Common Stocks

Money market funds and mutual funds

Pension funds

Financial Derivatives
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FINANCIAL INSTITUTIONS
A financial institution is an institution that provides financial services for its clients or
members
Includes institutions and mechanisms which
Affect generation of savings by the community
Mobilization of savings
Effective distribution of savings

Institutions are banks, insurance companies, mutual funds- promote savings

Individual investors, industrial and trading companies- borrowers

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FINANCIAL MARKETS

Money Market- for short-term funds (less than a year)

Organized (Banks)
Unorganized (money lenders, chit funds, etc.)

Capital Market- for long-term funds

Primary Issues Market
Stock Market
Bond Market

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INTRODUCTION TO INDIAN
FINANCIAL SYSTEM
The financial system plays an important role in promoting economic
growth not only by channelling savings into investments but also by
improving allocative efficiency of resources.

The recent empirical evidence, in fact, suggests that financial

system contributes to economic growth more by improving the
allocative efficiency of resources than by channelling of resources
from savers to investors. An efficient financial system is now
regarded as a necessary pre-condition for growth.

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CONTINUED.
This shift in the emphasis along with opening up of domestic
economies to international competition has encouraged emerging
market economies (EMEs) to introduce financial sector reforms.
In the wake of the financial crises of the 1990s however, the role of
the financial system in growth has been subjected to a critical
reassessment.
Increased financial integration has exposed the countries to the risk
of contagion. It is now widely recognised that stability of the
financial system is critical for a sustainable growth.

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EVOLUTION OF INDIAN FINANCIAL

SYSTEM (IFS)
The environment in which the IFS has functioned in the post independent
era can be divided into 3 distinct periods.
1. First period: 1949 and 1969
2. Second period: 1969 till 1991

3. Third period starts from 1991

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FIRST PERIOD (1949-1969)

Soon after independence, banking sector was recognized as the major
sector of IFS.
The RBI was nationalized in January 1949.
All banks were required by the RBI Act to maintain 5% demand liabilities
and 2% of their time liabilities on a daily basis and SLR 20% of demand and
time liabilities.
In 1962: CRR was raised to 3-15% and SLR 25% above CRR.
Prior to 1964 the interest payable on deposits were decided by important
banks but since 1964 RBI directly regulated the interest rates.

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CONTINUED
RBI was envisaged to play a promotional role in promoting credit to
agricultural sectors.
The allocation of credit from commercial banks was largely to industry.
Increase in share of credit to industry from 37.5% in 1951 to 67.5% in 1968.

The share of credit from banks to agricultural sector was little over 2%.

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SECOND PERIOD (1969-1991)

Nationalization of 14 largest Indian Scheduled Commercial Banks. This
inhibited the competition in the banking sector.
Other financial institutions like LIC, UTI, IDBI, IFCI and ICICI was nationalized
in this period with special objectives.

UTI to promote stock market.

IDBI to provide direct and long-term loans to industrial sector.

IFCI and ICICI to provide term loans

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CONTINUED.
Financial repression set in due to governments increasing need to use
banking sectors for financing its own deficits.
Financial repression led to segmented and underdeveloped financial
markets.
The need for financial reforms came with the submission of 2 committee
reports- Chakravarthy Committee Report 1985 and Vaghul Committee
Report in 1987.

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Chakravarthy Committee Report:

To develop treasury bills as monetary instrument.

Revise upwards yield of government securities so as to create a demand

for public debt.

Adopt monetary targeting as an important monetary tool with price

stability.

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Vaghul Committee Report: phased decontrol and development of money

markets and gradual integration of these markets with other short term
markets such as treasury bill markets.
The actual reform started in mid eighties with RBI implementing some of the
recommendations of these 2 committees.
The major steps taken by RBI are:
1. Introduction of 182-day treasury bills in 1986.
2. Introduction of commercial papers and certificate of deposits in 1989.

3. Introduction of institution of DFHI in 1988.

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THIRD PERIOD (FROM 1991 TILL NOW)

The financial sector got a major boost with the implementation of

recommendations given by Narasimhan Committee.
1. Reducing SLR to 25% and using CRR as an instrument for monetary policy.
2. Phasing out directed credit programmes and to bring the interest rate on
government borrowing in line with other market determined interest rates.

3. Banks and financial institutions achieve a minimum 4% capital adequacy ratio

in relation to risk weighted assets by March 1993.
4. Banks and financial institutions adopt uniform accounting policies.
5. Liberalizing policies towards foreign banks with regard to opening of offices as
branches or subsidiaries.
6. Freedom should be given to issuers of capital to decide on the nature of the
instruments, its terms and pricing in the capital market.
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Most of these recommendations were implemented by 1955-56 which has

led to significant deregulation and development of money market.

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REFERENCES

http://business.mapsofindia.com/banks-in-india/nationalised-banks-inindia.html
http://en.wikipedia.org/wiki/Financial_institution

http://en.wikipedia.org/wiki/Financial_instrument
http://en.wikipedia.org/wiki/Financial_market

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