OVERVIEW OF INDIAN FINANCIAL SYTEM

Finance
The term "finance" in our simple understanding it is perceived as equivalent to 'Money'. But finance exactly is not money, it is the source of providing funds for a particular activity.

Definition of Finance.
The American Heritage Dictionary of the English Language, Fourth Edition defines the term Finance as under "The science of the management of money and assets. other

"The management of money, banking, investments, and credit. "The supplying of funds or capital."

 A financial system plays of vital role in the economic growth of a country. It intermediates between the flow of funds belonging to those who save a part of their income and those who invest in productive assets. A set of sub systems of financial institutions, markets, instruments and services Intermediates with the flow of funds between savers and borrowers. Facilitates transfer and allocation of scarce resources efficiently and effectively

INTRODUCTION

 A financial system is a complex, well-integrated set of sub-systems of financial institutions, markets, instruments, and services which facilitates the transfer and allocation of funds, efficiently and effectively. The main function of financial systems is the collection of savings and their distribution for industrial investment, thereby stimulating the capital formation and, to that extent, accelerating the process of economic growth.

The Indian Financial System

 Indian Financial System we can classified under two way: Formal or Organized Financial System; Informal or Unorganized Financial System. Formal Financial System: is presence of an organized, institutional and regulated system which caters to the financial needs of the modern spheres of economy. The formal financial system comes under the preview of the Ministry of Finance [MoF], RBI, SEBI, IRDA and other regulatory authorities.

Indian Financial System

 Informal Financial System: is an unorganized, no institutional and nonregulated system dealing with the traditional and rural spheres of the economy. It consist of individual moneylenders such as neighbors, relatives, landlords, traders and storeowners. Group of persons operating as funds or association. Characteristics : flexibility of operations and interface relationship between the creditor and the debtor.

 Advantages:

Informal Financial System

Low transaction costs Minimal default risk Transparency of procedures

Due to above advantages, a wide range and higher rates of interest prevail in the informal sector. A higher priority should be given in the development of an efficient formal financial system as it can offer lower intermediation costs and services to wide base of savers and entrepreneurs.

COMPONENTS OF THE FORMAL FINANCIAL SYSTEM

Financial Institutions. Financial Markets. Financial Instruments. Financial Services.

FINANCIAL INSTITUTIONS
These are intermediaries that mobilizes savings and facilitate the allocation of funds in an efficient manner. Classification of Financial Institutions: 1. Banking and Non Banking: Banking inst. are creators and purveyor of credit while non banking financial inst. are purveyors of credit. (DFIs, NBFCs HFCs) 2. Term Finance (IDBI, ICICI, SIDBI) 3. Investment Inst. (EXIM, NABARD, NHB, UTI, LIC, GIC) 4. State level Financial Inst.(SFCs, SIDCs)

 Financial markets are mechanism enabling participants to deal in financial claims. Financial markets are not sources of finance but they are a link between the savers and investors (individual and institutional) Types Money Market (short term securities) Capital Market (long term securities) Segments Primary Markets (deals with new issues) Secondary Markets (trading in existing securities)

Financial Markets

 A financial instrument is a claim against a person or an institution for payment, at a future date, of a sum of money and/or a periodic payments in the form of interest or dividend . Types: Primary (Direct Securities) Secondary (Indirect Securities) Different types of instruments can be designed to suit the risk and return preferences of different classes of investors.

Financial Instruments

Financial Instruments
Primary Securities: Secondary Securities:
Equity Bank Deposits Preference MF Units Debt Insurance Policies Various combinations. Features: Marketable Tradable Tailor made Financial instruments differ in terms of marketability, liquidity, reversibility, return, risk and transaction costs. Financial markets channelizing funds from

Financial services
These are those that help with borrowing and funding, lending and investing, buying and selling securities, making and enabling payments and settlements and managing risk exposures in financial markets.

Financial services
Need of financial services for: Borrowing and funding Lending and investing Buying and selling securities Making and enabling Payments and settlements Managing risk Financial services are: Funds intermediation Payments mechanism Provision of liquidity Risk management

Financial Services
Depositories Custodial Credit rating Factoring Forfeiting Merchant Banking Leasing Hire Purchase Guaranteeing Portfolio Management Underwriting

Functions of a Financial System

Mobilize and allocate savings Monitor corporate performance Provide payment and settlement systems Optimum allocation of risk bearing and reduction Circulate price related information Offer portfolio adjustment facility Lower the cost of transactions Promote the process of financial deepening and broadening

Key/ Basic Elements of a well functioning financial system

A strong legal and regulatory environment Stable money Sound public finance and public debt management A central bank Sound banking system Information system Well functioning securities market

Financial System Designs

Bank Based. Market Based.

Bank based
Here a few large banks play a dominant role and the stock market is not important. Banks play a pivotal role in mobilizing savings, allocating capital, overseeing the investment decision of corporate managers and provide risk management facilities. This system tends to be stronger in countries where govt. have a direct hand in industrial development.

Market based
Here financial markets play an important role while the banking industry is much less concentrated. The securities markets share centre stage with banks in mobilizing the society's savings for firms, exerting corporate control, and lessening risk management. This systems are, on an average, more developed in rich countries. There is a tendency for a financial system to become more market oriented as the country becomes richer.

Classification of Financial Structure and Level of Development of Selected Economies

Extent of Bank Based Development Developed Japan, Germany, France, Italy Market Based US, UK, Singapore, Malaysia, Korea Brazil, Mexico, Philippines, Turkey

Under Developed

Argentina, Pakistan, Sri Lanka, Bangladesh

Advantages of Bank Based Financial System

Close relationship with parties. Provide tailor made contracts. Efficient inter-temporal risk sharing. No free-rider problem.

Advantages of Market Based Financial System

Provide attractive terms to both investors and borrowers. Facilitate diversification. Allow risk sharing Allow financing of new technologies.

Drawbacks of Bank Based Financial System

Retards innovation and growth. Impends competition.

Drawbacks of Market Based Financial System

Prone to instability. Exposure to market risk. Free rider problem.

Nature and Role of Financial Institutions

Financial Institutions provides three transformation services:
Liability, asset and size transformation. Maturity transformation. Risk transformation.

Functions of Financial Markets

Enabling economic units to exercise their time preference. Separation, distribution, diversification and reduction of risk. Efficient payment mechanism. Providing information about companies. Transformation of financial claims to suit the preferences of both savers and borrowers.