INDIAN FINANCIAL SYSTEM

The economic development of any country depends upon the existence of a well organized financial system. It is the financial system which supplies the necessary financial inputs for the production of goods and services which in turn promote the well being and standard of living of the people of a country.

Financial System The financial system is a broader term which brings under its fold the financial markets and the financial institution which support the system. The major assets traded in the financial system are money and monetary assets.

Definition

A set of institutions, instruments and markets which promote savings and channel them to their most efficient use.

Funds

Financial Institutions
Commercial Banks Insurance Companies

Funds

Deposits/Shares

Loans agreement

Mutual Funds Provident Funds Non Banking Financial Companies

Suppliers of Funds
Individuals

Funds

Demanders of Funds

Businesses
Governments

Private Placement

Individuals Securities

Businesses
Governments

Financial Markets
Funds Securities Money Market/ Capital Markets Funds Securities

REGULATORY INFRASTRUCTURE

As the maker and enforcer of laws in a society, the government has the responsibility for regulating the financial system. The two major regulatory arms of the Government of India are the Reserve Bank of India and the Securities Exchange Board of India.

Central Bank(RBI )
Central monetary authority of the country , serving as the governments bank as well as the bankers bank is known as a central bank of the country.

The Reserve Bank of India RBI, is the central banking institution of India and controls the monetary policy. The institution was established on 1 April 1935 during the British Raj in accordance with the provisions of the Reserve Bank of India Act, 1934[2] and plays an important part in the development strategy of the government. It is a member bank of the Asian Clearing Union.

The main functions of central bank of a country are function of note issue, bankers to government, bankers bank etc.

The RBI as the central bank of the country is the centre of the Indian financial and monetary system. It has been guiding, monitoring, regulating, controlling, and promoting destiny of the IFS.

Functions

As the central banking authority of India, the reserve Bank of India performs the following traditional functions of the central bank: It provides currency and operates the clearing system for the government and banks. It formulates and implements monetary and credit policies. It functions as the governments and bankers bank It supervises the operations of financial institutions. It regulates foreign exchange transactions. It moderates the fluctuations in the exchange value of the rupee.

In addition to the traditional functions of the central banking authority, the Reserve bank of India performs several functions aimed at developing the Indian financial system: It encourages the extension of the commercial banking system in the rural areas. It influences the allocation of credit. It promotes the development of new institutions.

Securities Exchange Board of India

The SEBI was constituted as a regulatory authority of the various constituents of the capital market in the year 1988. But it was made operational and effective from 1992, when it was empower to secure autonomous position. The Board consists of the following members. Chairman, Two members from the officials in the ministries of central Government dealing with finance and law. One-member form officials from RBI. Two or three members appointed by the central Government

FUNCTION

The Securities Exchange Board of India has been entrusted with the responsibility of dealing with various matters relating to the capital market. SEBIs principal tasks are to: Regulate the business in the securities markets. Register and regulate the capital market intermediaries (brokers, merchant bankers, portfolio mangers etc.). Register and regulate the working of mutual funds.

Promote and regulate share trading firms. Prohibit fraudulent and unfair trade practices in securities markets. Promote investors education and training. Prohibit insider trading in securities. Regulate substantial acquisition of shares and takeovers of companies.

Money Market

Money market is a market for shortterm loans or financial assets. It is a market for lending and borrowing of short term funds. It meets the short-term requirements of borrowers and provides liquidity or cash to lenders.

Definition
According to Geottery Crowther, The money market is the collective name given to the various firms and institutions that deal in the various grades of near money

Features of Money Market

It is a market purely for short term funds or financial assets called near money. It deals with financial assets having a maturity period up to one year only. It deals with only those assets which can be converted into cash readily.

Generally transactions takes place through phone and relevant documents and written communication can be exchanged subsequently. Transactions have to be conducted without the help of brokers.

Important of money market

Development of trade and industries Development of Capital Market Smooth functioning of Commercial banks Effective central bank control Formation of suitable monetary policy

Types of Money Market

Call Money Market

The call money market refers to the market for extremely short period loans, say one day to fourteen days. These loans are repayable on demand at the option of either the lender or the borrower.
.

The day to day surplus funds of commercial banks are traded in the market. The loans made in call market are of short-term nature . The demand for call money is the highest in the month of March of every year. Because it is the time to meet year end and tax payments and withdrawals of funds by financial institutions to meet their statutory obligations.

Commercial Bill Market or Discount Market

A commercial bill is one which arises out of a credit transaction. As soon as goods are sold on credit, the seller draws a bill on the buyer for amount due. The buyer accepts it immediately agreeing to pay the amount mentioned therein after a certain specified date. It is drawn always for a short period ranging between 3 months and 6 months.

Treasury Bill Market

Money Market Instruments

Commercial Papers

Commercial paper is a new instrument introduced in India on 27th March, 1989 and used for financing working capital requirements of corporate enterprises. A commercial paper is an unsecured promissory note issued with a fixed maturity by a company approved by RBI.

Certificate of Deposit (CD)

The banks in the USA in 1960s introduced CDs In June 1989 RBI permitted commercial banks to issue CDs. Meaning: Certificate of Deposits are short term deposit instruments issued by banks and financial institutions to raise large sums of money.

Repo Instrument

It is a transaction in which two parties agree to sell and repurchase the same security. The seller sells specified securities, with an agreement to repurchase the same at a mutually decided future date and price. Like wise, the buyer purchases the securities, with an agreement to resell the same to the seller on an agreed date and at a predetermined price.

Repo Instrument

The difference between the price at which the securities are bought and sold is the lenders profit/interest earned for lending money. Repos are usually entered into with a maturity of 1-14 days. Generally, repo transactions take place in market lots of Rs. 5 crores. There are two types of repos namely, i) inter-bank repos, ii) RBI repos.

Capital Market

Capital market may be defined as a market for borrowing and lending long-term capital funds required by business enterprises. Capital market is the market for financial assets that have long or indefinite maturity. Capital market offers an ideal source of external finance.

It refers to all the facilities and the institutional arrangements for borrowing and lending medium-term and long-term funds. Like any market, the capital market is also composed of those who demands funds (borrowers) and those who supply funds (lenders).

Primary Market

Primary market also known as New issues Market (NIM) is a market for raising fresh capital in the form of shares & debentures. A company, while raising its capital through issues in the capital market must comply with the guide the guidelines & clarifications issued by SEBI and the provisions of the companies Act. 1956.

Types of Issue:
A company can raise its capital through issue of shares & debentures by means of

Public Issue Rights Issue Private placement Bought-out deal Euro Issue

PUBLIC ISSUE: Companies issue securities to the public in the primary market . The public issue can be through a fixed price route or through bookbuilding route. RIGHTS ISSUE: When a company issues additional equity capital , the existing shareholders have a pre-emptive right on such capital issue on a prorate basis . The rights offer is to be kept open for a period of 60 days.

PRIVATE PLACEMENT: It involves direct selling of securities to a limited number of institutional or high net worth investors. BOUGHT-OUT DEALS (BOD): It is a process where by an investor or a group of investors buy-out a significant portion of the equity of an unlisted company with a view to sell the equity to public within an agreed time frame. It is very useful for small projects, which may find it very costly to go for a public issue. EURO-ISSUES: Indian companies have been permitted to float their stocks in foreign capital markets. The instruments, which a company can issue are Global Depositary Receipts (GDRs), American Depository Receipts (ADRs), Euro-Convertible Bonds (ECBs), Foreign Currency Convertible Bonds (FCCBs).

Secondary Market:

It is a market for secondary sale of securities. In other words, securities which have already passed through the new issue market are traded in this market. This market consists of all stock exchange recognized by government of India. The stock exchanges in India are regulated under the securities controls (Regulation) Act, 1956.

A market, which deals in securities that have been already issued by companies, is known as the secondary market. It is also called the stock exchange or the Share Market. For the efficient growth of the market, a Sound secondary market is an essential requirement.

Stock Exchange

Currently 23 stock exchanges are in India of which 4 are national &19 are regional exchanges. The 4 national level exchanges are BSE, NSE, OTCEI (Over the Counter Exchange of India) & ISE (Inter Connected Stock Exchange of India). All these exchanges operate with due recognition from the govt. under the securities & contracts (Regulations) Act. 1956, and SEBI (Securities & exchanges Board of India) by an act of parliament in 1992.

Functions/services of stock exchanges

The stock market occupies an important position in the financial system .It performs several economic functions and renders valuable services to the investors , companies, and to the economic as a whole .

(1)Liquidity and marketability of securities:

Stock exchanges provide liquidity to securities. Securities can be converted into cash at any time according to the interest of the investor.

(2)Safety of Funds:

Stock exchanges give safety to the funds because they have to function under strict rules & regulations of government & SEBI (securities exchange board of India). Speculation is prevented through carefully designed set of rules. This would enhance the investors confidence and promote larger investment.

(3) Supply of long term Funds:

The securities traded in the stock market are negotiable and transferable in character. They can be transferred with minimum formalities from one person to another . so when a security is transacted one investor is substituted by another, but the company is assured of long term availability of funds .

(4) Flow of Capital to profitable ventures:

The profitability and popularity of companies are reflected in their stock prices. The market price of the share shows the relative profitability and performance of Companies . Funds are generally attracted towards securities of profitability companies and this facilitates the flow of capital into profitable channels.

(5) Motivation for improved performance:

The performance of a company is reflected on the prices quoted in the stock market .These prices are more visible in the eyes of the public . This public exposure makes a company conscious of its status in the market and it acts as a motivation to improve its performance further.

(6) Promotion of investment:

Stock exchanges mobilize the savings of the public and promote investment through capital formation .Investors are motivated to invest in the stock market.

(7) Marketing of new issues:

When the new issues are listed, they are , readily acceptable to the public . Costs of underwriting such issues would be less . public response to such new issues are also relatively high. So, a stock market helps in the marketing of new issues also.