An Introduction on

INDI AN FI NANCIAL SY STEM

 Meaning and Definition

Financial System is a complex, well-integrated set

of sub-systems of
Financial institution,
Markets,
Instruments, and
Services
which facilitates the transfer and allocation of funds,
efficiently and effectively.
 Formal and Informal Financial system

Formal Financial Sector is characterized by

presence of an organized, institutional and regulated
system which caters the financial needs of the
modern spheres of the economy.
Informal Financial Sector is an unorganized,
non-institutional and non-regularized system
dealing with the traditional and rural spheres of the
economy.
 Financial Dualism

Financial Dualism: It is the combination of

formal and informal financial system.
 Informal financial system

Informal Financial Sector is an unorganized,

non-institutional and non-regularized system
dealing with the traditional and rural spheres of the
economy.
Advantages: 1). Low Transaction, 2). Minimum
default risk, 3). Less of formalities, 4). Less time
consuming, 5). Fulfillment of urgent requirements.

Disadvantages: 1). Unregulated 2). High rates of

interest 3). Less transparency of procedures, 4). Rise
to black money, 5). Exploitation of victims.
 Components of Formal Financial System

1. Financial institutions;
2. Financial markets;
3. Financial instruments;
4. Financial services.
 Components of Formal Financial System

 Term finance institutions: IFCI, IDBI, ICICI,

SIDBI,IIBI.
 Components of Formal Financial System-
Institutions

 Term finance institutions: IFCI (1948), IDBI

(1964), ICICI (1955), SIDBI (1989), IIBI (1997).
 Specialized services institutions: EXIM
(1982), TFCI(1994), ICICI VENTURE;
 Sectoral financial institutions:
NABARD(1982), NHB(1988).
 Investment institutions: UTI(1964),
LIC(1955), GIC(1972) and its subsidiaries;
 state-level financial institutions:
SIDC(1955), SFC(1951).
 Financial Markets

Financial markets are the mechanism enabling

participants to deal in financial claims.
Literally, financial markets also provide a facility in
which their demands and requirements interact to
set a price for such claims. (D=S)
 Types of Financial Markets

1. Money Market: a market for short-term

securities or securities with a maturity of less than
one year;
2. Capital market: A market for long-term
securities or securities with a maturity period of
one or more year.
 Primary market;
 Secondary market.
 Types of the Capital Market

1. Primary market: it refers to the market:

 Where securities are created/issued;
 where the securities are traded for very first time;

2. Secondary market: it refers to the market where

those securities traded which have already been
issued in the primary market:
 Over the counter;
 Trade through stock exchanges;
 Types of the Capital Market

1. Primary market: it refers to the


market: Where securities are

created/issued;
where the securities are traded for very
first time;

2. Secondary market: it refers to the market where those securities traded

which have already been issued in the primary market:
 Over the counter: trade thorough the direct counters of the company or on
the immediate basis;
 Trade through stock exchanges: approach to BSE, NSE or any other stock
exchange through stock brokers or agents of registered broking companies.
 Types of the Capital Market

 Stock brokers or agents of registered broking

companies: these are the individuals, companies
or the institutions registered with SEBI (1992)
and are authorised to sale and purchase of
securities or the financial assets.
 Share khan, Religare and Unicorn etc.
 3. Financial Instruments

Financial asset or the financial instrument is

the claim of money, against a particular person or
institution, at a future date, for a specific amount;
A financial asset may also include the claim of
periodic payment in form of interest or dividend,
Implies Debentures, shares, bonds and notes;
1. Primary securities: Equity, Debentures;
2. Secondary securities: Bank deposits, Insurance
policies and Mutual funds.
 Features of a Security

Marketable;
Traceable;
Tailor-made.
 Financial Services

Financial facilitate the

ease of:
1. Borrowing and funding;
2. Lending and investing;
3. Buying and selling;
Need for Financial Services
4. Making and enabling
payments and settlements;
5. Managing risk and
exposures;
 Categories of Financial Services

1. Fund intermediation:
2. Liquidity facility:
3. Payment mechanism:
4. Risk management:
5. Financial engineering is the application of
mathematical methods to the solution of problems
in finance.  It is also known as financial
mathematics, mathematical finance, and
computational finance.
 Functions of a Financial System

Mobilize and allocate savings;

Monitor corporate performance;
Provide payment and settlement system;
Optimum allocation of risk bearing and reduction;
Disseminate price related information;
Offer portfolio adjustment facility;
Lower the cost of transactions;
Promote the process of financial deepening of
broadening. Financial Deepening: It refers to the increased
provision of financial services with a wider choice of
services geared to all levels of society.
 Financial System and Economy

Increase in rate of saving and investments;

Increase in the productivity and production;
Growth in GDP and GNP of India;
Helps in capital formation;
Utilization of idle funds;
Maintains circular flows in economy;
Increase transparency and reduce risk of several
defaults.
Improvement in living standard;
Keys elements of well functioning financial system

A strong legal and regulatory environment;

Stable money;
Sound public;
Sound finances and public debt management;
A central bank;
Sound banking system;
Information system;
Well functioning securities market;
 Features and characteristics of money market

1. Money market refers to the market for financial assets

that are close substitutes for money;
2. It is the market for overnight to short-term funds and
instruments;
3. Instrument having maturity period of one or less than one
year.
4. It is not a physical location (like stock exchanges),
hence activities are conducted over telephones;
5. Collection of several instruments and their markets;
6. Whole sale market of short term debt instruments;
7. Creditworthiness of the participants is important;
8. Main players are: DHFI, RBI, Banking institutions,
NBFCs, STCI, PSUs and non-residents Indians.
9. Need based market;
10. Price determination through free play of demand and
supply forces;
 Functions of money market

• Money market is generally expected to perform

three broad functions:
1. Provide balancing mechanism to even out the
demand for and supply of short term funds;
2. Provide a focal point for central bank intervention
for influencing liquidity and general level of
interest rates in the economy;
3. Provide reasonable access t suppliers and users of
short term funds to fulfill their borrowings and
investment requirements at an efficient and market
clearing price.
 Benefits of The Efficient Money Market

1. Provides a stable source of funds to banks;

2. Encourage development of non bank entities;
3. Facilitates government, market borrowing;
4. Makes effective monetary policy actions;
5. Helps in pricing different floating interest
products.
Role of Reserve Bank of India in The Money Market

Money market comes under the direct purview of

Reserve Bank of India;
The aims of RBI’s operations in the money market
are:
1. To ensure that liquidity and short term interest
rates are maintained at levels consistent with the
monetary
2. objectives of maintaining price stability;
3. To bring about order in foreign exchange market;
Tools of RBI: CRR, SLR and open market operations etc.
 Organization of money market in India

Formal/organized money market;

Informal/unorganized money market.
 Money Marker Centers In India

There are three money market centers in India,

which are located at:
1. Mumbai
2. Delhi
3. Kolkata.
Note: Mumbai is the only money market center in
India with money flowing in from all parts of the
country getting transacted there.
 Money Market Instruments

1. Treasury bills;
2. Call money;
3. Notice money;
4. Term money;
5. Commercial papers (CP);
6. Certificates of deposits(CD);
7. Commercial bills (CB);
8. Collateralized borrowing and lending obligations
(CBLO).
 Money Market Instruments

1. Treasury bills are short-term instruments used by

the government to raise short-term funds;
• Negotiable securities;
• Highly liquid;
• No default risk;
• Assured yield, low transaction cost, inclusion in SLR
limit;
• Transacted through SGL account and not issued as a
scrip;
• Maturity periods are: 91-days, 181-days and 364-days;
• Min. amount of 25,000Rs. And multiples of the same.
• Categorized as: On-tap, auctioned and Adhoc T-bills.
 Money Market Instruments

2. Call money: commercial banks borrow money

from other banks to maintain minimum cash
balance known as cash reserve ratio (CRR);
 Maturity: over the night;
 Rating:
 Denomination: not specified or equal to NDTL;
 Raised by: commercial banks;
 Related term: notice money and term money.
 Money Market Instruments

3. Notice Money: commercial banks borrow money

from other banks to maintain minimum cash
balance known as cash reserve ratio (CRR);
 Maturity: 1 day to 14 days;
 Rating:
 Denomination: not specified;
 Raised by: commercial banks;
 Related term: call money and term money.
 Money Market Instruments

4. Term money: commercial banks borrow money

from other banks to maintain minimum cash
balance known as cash reserve ratio (CRR);
 Maturity: 15-364 days;
 Rating:
 Denomination: not specified;
 Raised by: commercial banks;
 Related term: notice money and call money.
Link between the call money market and other
financial markets

Call rate interest rate paid on the call loans;

MIBOR (1998): developed by National stock
exchange of India along with MIBID-Mumbai inter-
bank bid rate for overnight money markets; provides
quotations from overnight to 24 months;
LIBOR- London inter-bank offer rate;
Call rate volatility: call rates are subject to change;
 Money market intermediaries in India

DHFI(1988)- discount and finance house of India;

Money market mutual funds of India;
 Link between the money market and monetary
policy of India

Direct instruments :
Reserve requirements;
Limits on refinance;
Administered interest rates;
Qualitative and quantitative restrictions on the
credit;

Indirect instruments:
Open market operations
Repos.
 Money Market Instruments

5. Commercial papers (CP-1990) is an unsecured

short-term promissory note issued at a discount by
creditworthy corporate, primary dealers and all-
Indian financial institution.
 maturity: 7 days – 364 days;
 Rating: P series of CRISIL;
 Denomination: 5 lac and multiples;
 Investment through: demat account.
 Money Market Instruments

6. Certificates of deposits(CD-1989) are short-

term tradable time deposits issued by commercial
banks and financial institutions;
 Maturity:7 days to 1 year for banks but 1-3 years for
FIs ;
 Rating:
 Denomination: 1 lakh and multiples;
 Issued by: financial institutions.
 Related term: it is same as FD but freely
transferable and tradable unlike the FD.
 Money Market Instruments

7. Commercial bills (CB) are negotiable instruments drawn

on the seller by the buyer, in turn, accepted and discounted
by commercial banks;
1. Types of commercial bills:
 Demand bill
 Usance bill:
 Clean bill:
 Documentary bill:
 Inland bill:
 Foreign bill:
 Hundi:
 Derivative usance promissory notes:
 Inchoate:
 Money Market Instruments

7. Commercial bills (CB) are negotiable instruments

drawn on the seller by the buyer, in turn, accepted and
discounted by commercial banks;
1. Features of commercial bills:
 Maturity: 30, 60,90 days usually;
 Rating:
 Denomination: not specified-can be any amount;
 Discounted through: Commercial banks;
 some time also known as trade bills; but known as the
commercial bill when discount by the bank.
 Money Market Instruments

9. Collateralized borrowing and lending

obligations (CBLO): same as the call money
facility availed by the non-bank financial
institutions and entities;
Because non-bank financial institutions are not
eligible for availing the facility of the call money.
 Meaning and Definition

Capital market is a market where securities with

the long tenure are bought and sold such as equity
and debt, funds are raised for long period;
 Types of the Capital Market

1. Primary market: it refers to the market:

 Where securities are created/issued;
 where the securities are traded for very first time;

2. Secondary market: it refers to the market where

those securities traded which have already been
issued in the primary market:
 Over the counter;
 Trade through stock exchanges;
Role of capital markets in the growth of economy

It helps in economic growth of a country by

mobilizing the savings and direct is to the right way
for more productive uses:
Directs cash from deficit sector to the surplus sector:
issue of securities in the primary; domestic,
government, corporate sector.
 direct cash from the surplus sector to the financial
intermediaries: issue of the secondary in the primary
market;
Facilitation of the liquidity: resale and repurchase of
the financial assets through the secondary market.
 Functions of The Capital Market

1. Mobilization of savings;
2. Provides risk capital to entrepreneurs such as equity and quasi
equity;
3. Encourage broader ownership of productive assets through
equity participation;
4. Lower cost of transaction and information;
5. Improve efficiency of capital allocation through competitive
pricing methods;
6. Enable quick valuation of the financial assets i.e. share and
debentures;
7. Provides insurance against market risk;
8. Increases the width of market by enabling wider participation;
9. Provide operational efficiency;
10. Develop integration among different sectors and participants.
 Components of Capital Market

1. Primary market: it refers to the market where

financial securities are created/issued and sold for
very first time; it serves the mobilization function
and capital creation/formation function;
2. Secondary market: it refers to the market where
those financial securities are re-bought and re-sold
which have already been issued and sold in primary
market; it facilitates the liquidity function.
Hence, primary market is for the new issues and
secondary market is for the outstanding or the
existing issues;
 Primary Market

1. Primary market: it refers to the market where

financial securities are created/issued and sold for
very first time; it serves the mobilization function
and capital creation/formation function;
 Issue of The Securities in Primary Market

Name of the Security Domestic issue External issue

1. Equity Corporate (primary Through issue of:
issues) Global Depository
Financial Receipts (GDR);
intermediaries (secondary American Depository
issues) Receipt (ADR)

2. Debt Corporate (primary External commercial

issues) borrowing (ECB)
Government (primary
issues)
 Issue of The Securities in Primary Market

Other external borrowings Method of investment

1. Foreign Direct Investment (FDI) Equity form;

Debt form;

2. Foreign Institutional Investments In the form of portfolio investment;

(FII)

3. Non-resident Indian Deposits (NRI)  short- term and medium term

borrowings;
 Methods of Issuing Equity in Primary Market

1. Public issues through prospectus: IPOs, FPOs;

2. Private placement;
3. Right issues;
4. Preferential issues;
 Secondary Market

Secondary market: it refers to the market where

those financial securities are re-bought and re-sold
which have already been issued and sold in primary
market; it facilitates the liquidity function.
 Functions of The Secondary Market

1. Facilitates liquidity and marketability of securities;

2. Provides valuation of securities;
3. Reduces cost of capital;
4. Enable price discovery;
5. Creates a wealth effect;