INDIAN FINANCIAL SYSTEM

Unit -1
Introduction to Indian Financial Systems

Prof Viraja R Kanawally

Visiting Faculty of Law.
 INDIAN FINANCIAL SYSTEM
Chapter Overview

 Introduction to Financial system - meaning, definition Financial system.

 Role and functions of a financial system,.
 Organized and unorganized financial system.
 Components: a)Financial Assets,b) Financial Intermediaries c)Financial Markets
(money and capital markets in India) .
 Relevance of various interest/return rates,.
 Regulatory framework.
 Financial Instruments.
 INDIAN FINANCIAL SYSTEM
Session 1

Learning Objective

 Understand the key terms, definitions, and concepts of FINANCIAL MANAGEMENT.

 INDIAN FINANCIAL SYSTEM
Introduction

SYSTEM: A system is a set of interrelated parts working together to acheive

soe purpose.
Financial System is a mechanism that works for investors and people who
want finance.

Introduction of Financial system:

Financial system is a mechanism that works for investors and people who
want finance.

It is an interaction of various intermediaries, market instruments, policy

makers, and various regulations to aid the flow of savings from savers to
investors and managing the proper functioning of the system.
Importance of financial system
The financial system of a country is an important tool for economic development
of the country, as it helps in creation of wealth by linking savings with
investments. It facilitates the flow of funds form the households (savers) to
business firms (investors) to aid in wealth creation and development of both the
parties.

The financial system of a country is concerned with:

Allocation and Mobilization of savings
Provision of funds
Facilitating the Financial Transactions
Developing financial markets
Provision of legal financial framework
Provision of financial and advisory services
Definition of Financial system:

According to Robinson, the primary function of a financial

system is “to provide a link between savings and investment
for creation of wealth and to permit portfolio adjustment in
the composition of existing wealth”
Features of financial system:
A Financial System consists of various financial Institutions, Financial
Markets, Financial Transactions, rules and regulations, liabilities and
claims etc.

Features of Financial System:

It plays a vital role in economic development of a country

It encourages both savings and investment
It links savers and investors
It helps in capital formation
It helps in allocation of risk
It facilitates expansion of financial markets
It aids in Financial Deepening and Broadening
Structure of Indian Financial
System/Components of Indian Financial
System:
 (1) Financial Institutions
Financial institutions are intermediaries of financial markets which facilitate financial
transactions between individuals and financial customers.

There can be two types of financial institutions:

• Banking Institutions or Depository institutions

• Non- Banking Institutions or Non-Depository institutions

Financial Institutions may be classified into three categories:

1. • Regulatory
2. • Intermediaries
3. • Non – Intermediaries
 (2) Financial Markets

It refers to any marketplace where buyers and sellers participate

in trading of assets such as shares, bonds, currencies and other
financial instruments.
(3) Financial Assets/Instruments

Financial assets include cash deposits, checks, loans, accounts

receivable, letter of credit, bank notes and all other financial
instruments that provide a claim against a person/financial
institution to pay either a specific amount on a certain future
date or to pay the principal amount along with interest.
(4) Financial Services

Financial Services are concerned with the design and

delivery of financial instruments and advisory services
to individuals and businesses within the area of
banking and related institutions, personal financial
planning, leasing, investment, assets, insurance etc.
 Functions of Indian Financial
System
•  It bridges the gap between savings and investment through efficient
mobilization and allocation of surplus funds
•  It helps a business in capital formation
•  It helps in minimising risk and allocating risk efficiently
•  It helps a business to liquidate tied up funds
•  It facilitates financial transactions through provision of various financial
instruments
•  It facilitate trading of financial assets/instruments by developing and
regulating financial
• markets
 Importance of Indian Financial System
Importance of Indian Financial System:

• It accelerates the rate and volume of savings through provision of various financial instruments and efficient
mobilization of savings
•  It aids in increasing the national output of the country by providing funds to corporate
• customers to expand their respective business
•  It protects the interests of investors and ensures smooth financial transactions throughregulatory bodies
such as RBI, SEBI etc.  It helps economic development and raising the standard of living of people
•  It helps to promote the development of weaker section of the society through rural development banks
and co-operative societies
•  It helps corporate customers to make better financial decisions by providing effective financial as well as
advisory services
•  It aids in Financial Deepening and Broadening:
• Financial Deepening – It refers to the increase in financial assets as a percentage of GDP
• Financial Broadening – It refers to increasing number of participants in the financial system.
Financial
Intermediaries/Intermediaries
 Commercial Banks
 Cooperative Banks
 Regional Rural Banks
 Development Banks
 Non-banking Financial Companies
 Mutual Fund companies
 Insurance Companies
Interest Rate
Definition: The interest rate is the cost of borrowing money or
the reward for saving money, expressed as a percentage of the
principal amount. It’s typically set by financial institutions (like
banks) or central banks.

Types: 

Nominal Interest Rate: The stated rate without adjustment for inflation. 

Real Interest Rate: The nominal rate adjusted for inflation, reflecting the true
cost of borrowing or the true return on savings.

Fixed Interest Rate: Remains constant over the life of the loan or investment. 

Variable Interest Rate: Can fluctuate based on market conditions or benchmarks.

 Importance of Interest rate in
IFS
1. Cost of Borrowing: Determines how expensive or cheap it is to borrow money.
Lower
rates encourage borrowing and spending, while higher rates can discourage them.
2. Savings and Investment: Influences the return on savings accounts and fixed-
income investments. Higher rates lead to better returns for savers and investors in
bonds. 3. Monetary Policy: Central banks use interest rates to control inflation and
stabilize the economy. Lowering rates can stimulate economic growth, while
raising rates can help control inflation.
4. Economic Activity: Affects consumer and business behavior. Lower rates can
spur investment and consumer spending, while higher rates can slow down these
activities.
Return Rate
Definition: The return rate is the gain or loss on an investment over a specific
period, expressed as a percentage of the initial investment. It encompasses
both income (like dividends or interest) and capital gains or losses.

Types:
1)Absolute Return: The total return, including interest, dividends, and capital
gains, without reference to the investment's original value.
2)Relative Return: The return compared to a benchmark or index. 
3)Annualized Return: The average return per year over a specified period,
adjusted to reflect the compounding effect.
Importance in Financial Markets:

1. Investment Performance: Measures how well an investment is

performing. High return rates attract investors, while low return rates may
deter investment.

2. Risk Assessment: Higher potential returns are often associated with

higher risk. Investors assess return rates to balance their risk tolerance with
potential gains.

3. Investment Decisions: Guides investors in choosing among different

assets (stocks, bonds, real estate) based on their return expectations.

4. Portfolio Management: Helps in evaluating the effectiveness of

investment strategies and in making adjustments to optimize overall
Regulatory framework
Financial Regulators In India:
The market regulator in the Indian capital market is the Securities and Exchange
Board of India (SEBI).
The Insurance Regulatory and Development Authority (IRDA) does the same for
the insurance sector.
Reserve Bank of India (RBI) conducts the country’s monetary policy.
Pension Funds Regulatory and Development Authority (PFRDA) regulates
pensions.
Ministry of Corporate Affairs (MCA) regulates the corporate sector.
We will look at the role of these financial regulators in detail and some bodies
that ar
RBI- Reserve Bank of India:

The RBI’s primary responsibility is to ensure price stability in the economy and control
credit flow in the various sectors of the economy.

Commercial banks and the non-banking financial sector are most affected by the RBI’s
pronouncements since they are at the forefront of lending credit. The RBI is the money
market and the banking regulator in India.

Its functions include:

Printing and circulating currency throughout the country

Maintaining banking sector reserves by setting reserve ratios
Inspecting bank financial statements to keep an eye on any stresses in the financial
sector
Regulating payments and settlements as well as their infrastructure
Instrumental in deciding interest rates and maintaining inflation rates in the country
Managing the country’s foreign exchange (FX) reserves
Regulating and controlling interest rates, which affects money market liquidity
SEBI
Established in 1992, SEBI was a response to increasing malpractices in the capital markets that
eroded investors’ confidence in the market back then. As a statutory body, its functions include
protective as well as regulatory ones.

Protection: To protect investors and other participants by preventing insider trading, price rigging,
and other malfeasances

Regulation: To implement codes of conduct and guidelines for the various market participants;
auditing various exchanges, registering brokers, and investment bankers; deciding on the various
fees and fines

SEBI has the power to supervise the stock exchanges’ functioning:

It regulates the business of exchanges.
It has complete access to the exchanges’ financial records and the companies listed on the
exchange.
It oversees the listing and delisting process of companies from any exchange in the country.
It can take disciplinary action, including fines and penalties against malpractices.
It also promotes investor education.
It undertakes inspections, and conducts audits and inquiries when it spots any wrongdoing.
and protects the interests of insurance policyholders.
Since the insurance sector is a constantly changing
scene, IRDA advisories are critical for insurance
companies to keep up with changes in rules and
regulations.

The IRDA has strict control over insurance rates, beyond

which no insurer can go.

The IRDA specifies the qualifications and training

required for insurance agents and other intermediaries,
which then have to be followed by the insurer.

It can levy fees and modify them as well, as per the IRDA
Act. It regulates and controls premium rates and terms
and conditions that insurers are allowed to provide. Any
benefit provided by an insurer has to be ratified by the
IRDA.

This regulator also provides the critical function of

grievance redressal in an industry where claims can be
PFRDA
The PFRDA was set up in 2013 as the sole regulator of India’s pension sector. Its
services extend to all citizens, including non-resident Indians (NRIs).

Its main objective is to ensure income security for senior citizens. To this end, it
regulates pension funds and protects pension scheme subscribers.

PFRDA regulates the pension schemes: NPS and Atal Pension Yojana. PFRDA Act is
applicable to these schemes.

The PFRDA scope includes:

Setting up guidelines for investing in pension funds

Settling disputes between intermediaries and pension fund subscribers
Increasing awareness about retirement and pension schemes
Investigating intermediaries and other participants for malpractice
Ministry of Corporate Affairs (MCA)
The MCA concerns itself with administering the Companies Act and its
various iterations. It sets up the rules and regulations for the lawful
functioning of the corporate sector.

Apart from the Companies Act, MCA also administered the Limited Liability
Partnership Act 2008. It oversees all Acts and rules that regulate the
functioning of the corporate sector in India.

Its objective is to help the growth of companies. The MCA’s Registrar of

Companies authorizes company registrations as well as their functioning as
per law.
Financial Instrument - Meaning, Types and
Importance

A financial instrument is an agreement between two parties with monetary

value. In other words, any asset that holds capital and which can be traded is a
financial instrument. It is noteworthy that financial instruments can be
palpable or virtual documents representing a legal agreement of any monetary
value.

Some examples of financial instruments include life insurance policies, shares,

bonds, stocks, SIPs, etc. Now, let us understand more about the different types
of financial instruments that are popular in India.
Examples of financial Insturments
1. Life Insurance Policies
2. Small Savings Schemes
3. Fixed Deposits (FDs)
4. Certificate of Deposits (CDs)
5. Equity Stocks
6. Bonds
1. Life Insurance Policies
These are financial instruments offering you protection against different types of financial risks,
such as – sudden death and old age. As the untimely demise of a breadwinner places the family
members in economic instability, life insurance plans become critical.

Secondly, they are also helpful during retirement, as the income-generating ability of individuals
recede. Few popular life insurance plans include:

a) Term Life Insurance: Acts as long-term financial protection for family

b) Savings Plans: Safe long-term investments with guaranteed returns.
c) Pension Plans or Annuities: Helps you turn your retirement corpus into a reliable and lifetime
income.
d) ULIPs (Unit-linked Investment Plans): ULIPs are insurance instruments with investment benefits.
In other words, ULIPs allow you to build wealth over time and protect your loved ones and
yourself.
2. Small Savings Schemes

Small Savings Schemes aim to encourage citizens to save regularly as they are generally
government-backed. They are popular as they come with a sovereign guarantee of returns and
tax benefits. Few saving schemes that you can consider are listed below:

a) Post office recurring deposits

b) Public Provident Fund (PPF)
c) Kisan Vikas Patra
d) National Savings Certificate (NSC)
They entail cash investments in banks or
post-office and are highly popular. FDs come
with a zero risk factor, and you are
guaranteed returns. However, the annual
returns on FDs can range from 6 to 9 per
cent.

4. Certificate of Deposits (CDs)

A certificate of deposits is a negotiable
money market instrument issued in
dematerialized form and used as a
promissory note for funds deposited at a
bank for a stipulated period.

a) Financial institutions to raise large sums

of money issue CDs.
b) They are available in denominations of INR
Financial instruments
• 5. Equity Stocks

• It is a type of security that represents the ownership of a company and is traded in stock markets.
a) It represents the money you can return to shareholders of a company if all the assets are liquidated
and the entire company debt is paid off.
• b) Equity is one of the most typical financial indicators investors use to determine a company's
health.

6. Bonds
• They are fixed-income instruments you can issue to raise working capital.
• Private entities and government ventures, including the central and state governments, issue bonds
to raise funds
• Bonds that the government issues have a lower risk rate but ensure returns; on the other hand,
bonds raised by private entities have high risks.
THANK YOU

VIRAJA KANAWALLY
Faculty of Law