I N T RO D U C T I O N T O

FINANCIAL SYSTEM
Prof. Dhaval Bhatt
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TOPICS
o Financial System – Functions and Constituents

o Types of Financial Markets

o Functions of Financial Markets

o Classification of Financial Institutions

o Types of Financial Instruments

o Different financial services – REITs and InVITs

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FINANCIAL SYSTEM
o A financial system is a network of financial institutions such as:
o Insurance companies,
o Stock Exchanges, and
o investment banks

that work together to exchange and transfer capital from one place to
another.
 FINANCIAL SYSTEM
The economic good traded on both sides in these markets is
usually some form of money: current money (cash), claims on
future money (credit), or claims on the potential for future
income or real asset value (equity).
These include derivative instruments as well.
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CONSTITUENTS OF FINANCIAL SYSTEM
Financial System

Financial Financial Financial Financial

Institutions Markets Instruments Services

Capital Direct
Banks NBFCs
Market Instruments

Mutual Money Indirect Credit

Funds Market Instruments Rating

Insurance
Derivatives ARCs
Co.
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FINANCIAL MARKETS
o Financial Markets include any place or system that provides buyers and sellers the
means to trade financial instruments, i.e.
o Equities,
o Bonds,
o International Currencies, and
o Derivatives.
o Financial Markets are enabling the interaction between:
o Those who need capital and
o Those who have excess of capital.
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FINANCIAL MARKETS
o Financial markets play a vital role in facilitating the smooth
operation of capitalist economies by allocating resources and
creating liquidity for businesses and entrepreneurs.
o Financial markets rely heavily on informational transparency to
ensure that the markets set prices that are efficient and
appropriate.
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Price Determination

Funds Mobilization
FUNCTIONS OF
FINANCIAL
MARKETS
Liquidity

Risk Management

Capital Formation
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TYPES OF FINANCIAL MARKETS

Stock O-T-C Money

Market Market Market

Derivatives Forex
Market Market
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STOCK MARKET
o The stock market trades shares of
ownership of public companies.
o Each share comes with a price, and
investors make money with the stocks
when they perform well in the market.
o Example:
o Bombay Stock Exchange (BSE)
o National Stock Exchange (NSE)
o Metropolitan Stock Exchange (MSE)
o New York Stock Exchange (NYSE)
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An over-the-counter (OTC) market is a decentralized market—meaning it
does not have physical locations, and trading is conducted electronically—in
which market participants trade securities directly (meaning without a broker).

While OTC markets may handle trading in certain stocks (e.g., smaller or
riskier companies that do not meet the listing criteria of exchanges), most
stock trading is done via exchanges.
OVER THE
COUNTER
MARKET Certain derivatives markets, however, are exclusively OTC, making up an
essential segment of the financial markets.

Broadly speaking, OTC markets and the transactions that occur in them are
far less regulated, less liquid, and opaquer.
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MONEY MARKET o They trade in products with highly liquid

short-term maturities (less than one year)
and are characterized by a high degree of
safety and a relatively lower interest return
than other markets.
o At the wholesale level, the money markets
involve large-volume trades between
institutions and traders.
o At the retail level, they include money
market mutual funds bought by individual
investors and money market accounts
opened by bank customers.
o Individuals may also invest in the money
markets by purchasing
o Short-term Certificates of Deposit (CDs),
o Municipal Notes, Or
o Treasury Bills.
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D E R I VAT I V E S M A R K E T

o The derivatives market is a

financial market for contracts
(derivatives) that derive their
value from an underlying asset
or benchmark, such as stocks,
bonds, commodities, currencies,
or indexes.
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FOREX MARKET
This market determines foreign exchange
rates for every currency pair.

It includes all aspects of buying, selling and

exchanging currencies at current or
predetermined prices.

The forex market, also known as the foreign

exchange market or FX market, is the largest
financial market in the world, with a daily
trading volume exceeding $7.5 trillion.
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C L A S S I F I C AT I O N O F F I N A N C I A L
MARKETS

Financial Maturity of Time of Nature of

Issue Based
Claim Claim Delivery Organisation
•Equity Market •Capital Market •Primary •Cash Market •Exchange
•Debt Market •Money Market Market •Derivatives Traded
•Secondary Markets •Over the
Market •Spot Market Counter
•Forward
•Futures
•Options
 RO L E O F F I N A N C I A L M A R K E T S I N
E C O N O M I C G ROW T H
o Mobilize savings for productive investments and facilitate capital
inflows
o Financial Markets play an important role in promoting economic
growth
o Strong Incentive for Investments
o Improved resource use and technological diffusion
o Collecting and Analysing information about investments
o Monitoring management and exerting corporate controls
FINANCIAL INSTITUTIONS
Financial institutions facilitate smooth working of the financial system
by making investors and borrowers meet.
 Commercial Banks
Banking Institutions Co-Operative Banks

New Proposed Banks / Payment Banks

NBFCs
Categories Non-Banking
of Institutions Development Finance Bank

Financial Life Insurance

institutions Insurance General Insurance
Re-Insurance
Health Insurance

Public Sector
Mutual Funds
Private Sector
BANKING INSTITUTIONS
20 C O M M E RC I A L BA N K S

Commercial banks accept deposits and provide

security and convenience to their customers.

Part of the original purpose of banks was to offer

customers safe keeping for their money.

Commercial banks also make loans that individuals

and businesses use to buy goods or expand
business operations, which in turn leads to more
deposited funds that make their way to banks.
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F U N C T I O N S O F C O M M E RC I A L B A N K S
o Primary Functions o Secondary Functions
o Accepting Deposits o Agency Functions
o Granting Loans and Advances o Utility Functions
 C O - O P E R AT I V E B A N K
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o Co-operative banks usually meet the needs of specific types or groups of

members pertaining to a certain trade, profession, community or even
locality.
According to these new norms CBs should have;
o A minimum share capital of INR 4 crore and membership of at least 3,000 if the
population is over 10 lakh;
o A minimum share capital of INR 2 crore and membership of at least 2,000 if the
population is between 5 to 10 lakh;
o A minimum share capital of INR 1 crore and membership of at least 1,500 for
population of 1 to 5 lakh and;
o A minimum share capital of INR 25 lakh and membership of at last 500 for
population less than 1 lakh
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PAY M E N T S B A N K S
o Reaches the customers through their mobile phone accessibility.
o Cannot accept deposit of more than 2 lakh.
o Cannot lend Money.
o Pays interest on bank balance.
o Can issue Debit / ATM cards / Forex Cards.
o Can transfer money directly to other bank accounts.
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SMALL FINANCE BANKS

o Allowed to take deposits and lend money.
o Mainly targets small and medium enterprises.
o Provides banking services to reserved or undeserved sections of
the economy i.e. farmers, micro and small industries, etc.
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NON-BANKING INSTITUTIONS
 NON-BANKING FINANCIAL
C O R P O R AT I O N S ( N B F C S )
o Registered under Companies Act, 2013.
o Undertakes regular banking business except accepting deposits
i.e.:
o Lending Money,
o Leasing,
o Hire Purchase.
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NBFC V/S BANK
Deposits
Cannot Accept Accepts Deposits

Settlement Systems
Not a part of Settlement system Crucial Part of Settlement System

Issuance of Cheque
Cannot issue cheques Issues Cheque for Withdrawal

Insurance on Deposit
No Insurance on Deposits Insurance on Deposits
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TYPES OF NBFCS

Basis of
Classification

Kind of Method of
Activity Financing
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Asset
Finance
Company

Investment
Others
Company

Kind of
Activity
Micro
Loan
Finance
Company
Co.

Infra Fin.
Co.
31 AFCs
• Financing of physical assets supporting productive / economic activity

Investment Company

• Acquisition of securities
Loan Company

• Making loans or advances

Infrastructure Finance Company

• Atleast 75 per cent of its total assets in infrastructure loans

Micro Finance Institution Non-deposit taking NBFC

• Loan disbursed to borrower with income less than Rs. 1,25,000

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Hire Purchase
• Purchasing assets in instalments

Leasing Rental
• Right to Use / Possession
• No ownership rights
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Loan Lease Hire Purchase

Passes immediately to the Transfers to the hirer at end

Ownership of Asset borrower
Remains with the lessor
of HP contract

Interest expenses are tax

deductible. In India, home Complete lease rentals are Only interest component is
Tax Treatment loan principal repayments tax deductible. tax deductible.
are also tax deductible.
Borrower must pay some
Lessor may collect 1 or 2 Owner may collect 1 or 2
Upfront payment amount as lender doesn’t
lease rentals upfront instalments upfront
finance 100%

Higher as it is for the full Lower as it is for the part Higher than lease of loan as
Installment Payment value of the asset value of the asset HP charges are higher

Claimed by the hirer

Claimed by borrower as he Claimed by the lessor as he though not the owner
Tax Benefit is the owner is the owner (ownership passes to him
after expiry of HP)
A S S E T R E C O N S T RU C T IO N
C O M PA N Y ( A R C S )
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A S S E T R E C O N S T R U C T I O N C O M PA N I E S
( A RC S )

Asset Reconstruction Companies (ARCs) are specialized financial institutions

in India that deal with bad debts

Purchase Non-Performing Assets (NPAs) or bad

What they do: loans from banks and financial institutions.

Governed by the Securitisation and Reconstruction of Financial Assets and

Enforcement of Security Interest (SARFAESI) Act, 2002.
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P R I M A RY D E A L E R S

o They have license to Buy and Sell the government securities.

o Act as intermediaries and are registered with RBI
o They create markets for Government Securities.
o Mainly deals in:
o G Sec Bond
o T-Bill
o Commercial mortgages – backed securities (CMBS)
FINANCIAL INSTITUTIONS
Exchanges

Brokers and Sub Brokers

Depositories / Depository Participants

Alternative Investment Funds (AIFs)

Foreign Institutional Investors (FIIs)

Custodial Agencies

Portfolio Management Companies

Investment Bankers

Financial Advisory Firm

Registrars and Transfers Agents (RTAs)

AMFI (Self-Regulated Organisation – SROs)

39 DEVELOPMENT FINANCIAL INSTITUTIONS
o Gives sector specific loans to various sectors like
o Industry
o Agriculture
o Housing
o Infrastructure
o Export Finance
o They have been converted into banks as industry got opportunity to
avail funds from Capital Markets.
o DFIs are financial agencies that provide medium and long-term
financial assistance and engaged in promotion and development of
industry, agriculture and other key sectors.
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DEVELOPMENT FINANCIAL INSTITUTIONS

Industrial Finance Industrial Industrial

Corporations of Development Bank Investment Bank of
India (IFCI) of India (IDBI) India (IIBI)

National Bank for

Small and Industrial
Export Import Bank Agricultural and
Development Bank
of India (EXIM) Rural Development
of India (SIDBI)
(NABARD)
41 FINANCIAL INSTITUTIONS WITH
DEVELOPMENT PERSPECTIVE
o Clearing Corporation of India Limited (CCIL)
o Manage risks in settlements of transactions in debt, money and forex
markets.
o Credit Rating Agencies
o Credit ratings the various Debt Instruments.
o Credit Information Bureau of India Ltd.
o Provides credit related information about the individual borrowers.
o Discount and Finance House of India Ltd. (DFHIL)
o Create liquidity in money market.
o Securities Trading Corporation of India Ltd. (STCI)
o Creates active secondary market in the government securities.
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FINANCIAL INSTITUTIONS WITH
DEVELOPMENT PERSPECTIVE
o EXIM
o To finance, facilitate and promote foreign trade.
o National Bank for Agriculture & Rural Development (NABARD)
o Apex Institution in the field of credit for agriculture.
o Small Industries Development bank of India (SIDBI)
o To provide financial assistance to the Micro, Small and Medium Enterprises
o Deposit Insurance and Credit Guarantee Corporation (DICGC)
o To provide insurance of deposits and guaranteeing credit facilities
o Export Credit Guarantee Corporation (ECGC)
o Provides a range of credit risk insurance covers to exporters against loss in export
of goods and services.
MUTUAL FUNDS
 MUTUAL FUNDS
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o A mutual fund is a pool of money

Professional from numerous investors who wish
to save or make money just like
Management you.
o Investing in a mutual fund can be
Fund a lot easier than buying and selling
individual stocks and bonds on
Ownership your own.

Mutual Funds
are Diversified
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A L T E R N AT I V E I N V E S T M E N T F U N D S :
o An alternative investment is an asset that is not one of the
conventional investment types, such as stocks, bonds and cash.
o Most alternative investment assets are held by institutional
investors or accredited, high-net-worth individuals because of the
complex natures and limited regulations of the investments.
o Alternative investments include strategies like
o Private Equity,
o Hedge Funds,
o Managed Futures,
o Real Estate,
o Commodities and
o Derivatives Contracts.
46 P O RT F O L I O M A N AG E M E N T S E RV I C E S
(PMS)
o Portfolio management Services popularly known as PMS are
specialized investment vehicle for lump sum investments.
o The portfolio manager invests the money in shares and other
securities and manages the portfolio on behalf of the client.
o One can invest fresh money in PMS and the portfolio managers
will construct a portfolio by deploying that money.
o Also, one can transfer his existing share portfolio to the PMS
provider, in this case the portfolio manager will revamp the
portfolio in sync with his investment philosophy and strategy.
INSURANCE
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INSURANCE
o A promise of compensation for specific potential future losses in
exchange for a periodic payment i.e. Premium
o Insurance companies in India are regulated by Insurance
Regulatory and Development Authority (IRDA)
o Designed to protect the financial well-being of an individual,
company or other entity in the case of unexpected loss.
o Can be mandatory or optional.
o Insurance works on the principle of Utmost Good Faith.
 TYPES OF INSURANCE
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Life Insurance

General Insurance

Health Insurance

Re Insurance
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PENSION FUNDS
o National Pension System: Voluntary, defined contribution
retirement savings scheme
o Institutions under the purview of Pension Fund Regulatory and
Development Authority (PFRDA):
o NPS Trust
o Central Record Keeping Agency (CRA)
o Pension Funds
o Trustee Bank
o Custodian
o Aggregators
o Points of presence
o Government Nodal Office
F I N A N C I A L S E RV I C E S
 F I N A N C I A L S E RV I C E S
o Financial services consist of services provided by:
o Asset Management and Liability Management Companies.
o They help to get the necessary funds and make sure that they are
efficiently deployed.
o Financial institutions and financial markets help in the working of
the financial system by means of financial instruments.
o To be able to carry out the jobs given, they need several services
of financial nature. Therefore, Financial services are considered as
the 4th major component of the financial system.
53 S E RV I C E S B Y F I N A N C I A L S E RV I C E S C O M PA N I E S
Housing Financing

Investment Banking

Merchant Banking

Distributors

Credit Rating

Custodial Services

Factoring

Forfaiting

Leasing / Hire Purchase