Indian financial system a brief outline and introduction

Indian Financial System
Prepared by
Prinsha K

Indian Financial System
• Meaning:-
Indian Financial System is a combination of
financial institutions, financial markets,
financial instruments and financial services to
facilitate the transfer of funds. Financial
system provides a payment mechanism for the
exchange of goods and services. It is a link
between saver and investor.

Features
• It plays a vital role in the economic development of the
country as it encourages both savings and investment
• It helps in mobilising and allocating one’s savings
• It facilitates the expansion of financial institutions and
markets
• Plays a key role in capital formation
• It helps form a link between the investor and the one
saving
• It is also concerned with the Provision of funds

Components
• Financial Institutions
• Financial Assets
• Financial Services
• Financial Markets

Financial Institutions
The Financial Institutions act as a mediator between the
investor and the borrower. The investor’s savings are mobilised
either directly or indirectly via the Financial Markets.
The main functions of the Financial Institutions are as follows:
• A short term liability can be converted into a long term
investment
• It helps in conversion of a risky investment into a risk-free
investment
• Also acts as a medium of convenience denomination, which
means, it can match a small deposit with large loans and a
large deposit with small loans

Classifications
• Banking Institutions or Depository Institutions – This includes banks and
other credit unions which collect money from the public against interest
provided on the deposits made and lend that money to the ones in need
• Non-Banking Institutions or Non-Depository Institutions – Insurance,
mutual funds and brokerage companies fall under this category. They
cannot ask for monetary deposits but sell financial products to their
customers.
• Regulatory – Institutes that regulate the financial markets like RBI, IRDA,
SEBI, etc.
• Intermediates – Commercial banks which provide loans and other
financial assistance such as SBI, BOB, PNB, etc.
• Non Intermediates – Institutions that provide financial aid to corporate
customers. It includes NABARD, SIBDI, etc

Financial Assets/Instruments
The products which are traded in the Financial Markets are called Financial
Assets. Based on the different requirements and needs of the credit seeker, the
securities in the market also differ from each other. Eg:-
• Call Money – When a loan is granted for one day and is repaid on the second
day, it is called call money. No collateral securities are required for this kind of
transaction.
• Notice Money – When a loan is granted for more than a day and for less than
14 days, it is called notice money. No collateral securities are required for this
kind of transaction.
• Term Money – When the maturity period of a deposit is beyond 14 days, it is
called term money.
• Treasury Bills – Also known as T-Bills, these are Government bonds or debt
securities with maturity of less than a year. Buying a T-Bill means lending money
to the Government.
• Certificate of Deposits – It is a dematerialised form (Electronically generated)
for funds deposited in the bank for a specific period of time.
• Commercial Paper – It is an unsecured short-term debt instrument issued by
corporations.

Financial Services
Services provided by Asset Management and Liability
Management Companies. They help to get the required funds
and also make sure that they are efficiently invested.
The financial services in India include:
• Banking Services – Any small or big service provided by banks
like granting a loan, depositing money, issuing debit/credit
cards, opening accounts, etc.
• Insurance Services – Services like issuing of insurance, selling
policies, insurance undertaking and brokerages, etc. are all a
part of the Insurance services
• Investment Services – It mostly includes asset management
• Foreign Exchange Services – Exchange of currency, foreign
exchange, etc. are a part of the Foreign exchange services

Financial Markets
The marketplace where buyers and sellers interact with each other and
participate in the trading of money, bonds, shares and other assets is called
a financial market
The financial market can be further divided into four types:
Capital Market – Designed to finance the long term investment, the Capital
market deals with transactions which are taking place in the market for over
a year. The capital market can further be divided into three types:
(a)Corporate Securities Market
(b)Government Securities Market
(c)Long Term Loan Market
Money Market – Mostly dominated by Government, Banks and other Large
Institutions, the type of market is authorised for small-term investments
only. It is a wholesale debt market which works on low-risk and highly liquid
instruments. The money market can further be divided into two types:

(a) Organised Money Market
(b) Unorganised Money Market
• Foreign exchange Market – One of the most
developed markets across the world, the Foreign
exchange market, deals with the requirements
related to multi-currency. The transfer of funds in
this market takes place based on the foreign
currency rate.
• Credit Market – A market where short-term and
long-term loans are granted to individuals or
Organisations by various banks and Financial and
Non-Financial Institutions is called Credit Market

FINANCIAL SERVICES
Features :-
• Intangibility
• Inseparability
• Perish ability
• Variability
• Dominance of human element
• Information based

Types of financial services
1. Fund based
2. Fee Based (Non Fund Based)
A.Fund Based:-
1. Equipment leasing/Lease financing:
A lease is an agreement under which a firm acquires a right
to make use of a capital asset like machinery etc. on
payment of an agreed fee calledlease rentals. The person
(or the company) which acquires the right is known as
lessee. He does not get the ownership of the asset. He
acquires only the right to use the asset. The person (or the
company) who gives the right is known as lessor.

• Hire purchase and consumer credit:
Hire purchase is an alternative to leasing. Hire
purchase is a transaction where goods are
purchased and sold on the condition that
payment is made in installments. The buyer
gets only possession of goods. He does not get
ownership. He gets ownership only after the
payment of the last installment. If the buyer
fails to pay any installment, the seller can
repossess the goods. Each installment includes
interest also.

•Bill discounting:
Discounting of bill is an attractive fund based financial service
provided by the finance companies. In the case of time bill
(payable after a specified period), the holder need not wait till
maturity or due date. If he is in need of money, he can discount the
bill with his banker. After deducting a certain amount (discount),
the banker credits the net amount in the customer’s account. Thus,
the bank purchases the bill and credits the customer’s account with
the amount of the bill less discount. On the due date, the drawee
makes payment to the banker. If he fails to make payment, the
banker will recover the amount from the customer who has
discounted the bill. In short, discounting of bill means giving
loans on the basis of the security of a bill of exchange.

• Venture capital:
Venture capital simply refers to capital which
is available for financing the new business
ventures. It involves lending finance to the
growing companies. It is theinvestment in a
highly risky project with the objective of
earning a high rate of return. In short,
venture capital means long term risk capital in
the form of equity finance.

• Housing finance:
Housing finance simply refers to providing
finance for house building. It emerged as a fund
based financial service in India with the
establishment of National Housing Bank (NHB)
by the RBI in 1988. It is an apex housing finance
institution in the country. Till now, a number of
specialised financial institutions/companies
have entered in the filed of housing finance.
Some of the institutions are HDFC, LIC Housing
Finance, Citi Home, Ind Bank Housing etc.

• Insurance services:
• Insurance is a contract between two parties. One party is
the insured and the other party is the insurer. Insured is the
person whose life or property is insured with the insurer.
That is, the person whose risk is insured is called insured.
Insurer is the insurance company to whom risk is
transferred by the insured. That is, the person who insures
the risk of insured is called insurer. Thus insurance is a
contract between insurer and insured. It is a contract in
which the insurance company undertakes to indemnify the
insured on the happening of certain event for a payment of
consideration. It is a contract between the insurer and
insured under which the insurer undertakes to compensate
the insured for the loss arising from the risk insured against

• Factoring:
– Factoring is an arrangement under which the
factor purchases the account receivables (arising
out of credit sale of goods/services) and makes
immediate cash payment to the supplier or
creditor. Thus, it is an arrangement in which the
account receivables of a firm (client) are
purchased by a financial institution or banker.
Thus, the factor provides finance to the client
(supplier) in respect of account receivables. The
factor undertakes the responsibility of collecting
the account receivables.

• Forfaiting:
– Forfaiting is a form of financing of receivables relating to
international trade. It is a non-recourse purchase by a
banker or any other financial institution of receivables
arising from export of goods and services. The exporter
surrenders his right to the forfaiter to receive future
payment from the buyer to whom goods have been
supplied. Forfaiting is a technique that helps the exporter
sells his goods on credit and yet receives the cash well
before the due date. In short, Forfaiting is a technique by
which a forfaiter (financing agency) discounts an export
bill and pay ready cash to the exporter. The exporter need
not bother about collection of export bill. He can just
concentrate on export trade

• Mutual fund:
– Mutual funds are financial intermediaries which
mobilise savings from the people and invest them
in a mix of corporate and government securities.
The mutual fund operators actively manage this
portfolio of securities and earn income through
dividend, interest and capital gains. The incomes
are eventually passed on to mutual fund
shareholders

Non Fund Based
Merchant Banking
• SEBI (Merchant Bankers) Rule, 1992 has
defined a merchant banker as, “any person
who is engaged in the business of issue
management either by making arrangements
regarding selling, buying or subscribing to
securities or acting as manager, consultant,
advisor, or rendering corporate advisory
services

Credit Rating
• Credit rating means giving an expert opinion by a
rating agency on the relative willingness and ability
of the issuer of a debt instrument to meet the
financial obligations in time and in full. It measures
the relative risk of an issuer’s ability and willingness
to repay both interest and principal over the period
of the rated instrument. It is a judgement about a
firm’s financial and business prospects. In short,
credit rating means assessing the creditworthiness
of a company by an independent organisation.

Stock Brocking
• Now stock broking has emerged as a
professional advisory service. Stock broker is a
member of a recognized stock exchange. He
buys, sells, or deals in shares/securities. It is
compulsory for each stock broker to get
himself/herself registeredwith SEBI in order to
act as a broker. As a member of a stock
exchange, he will have to abide by its rules,
regulations and by-laws.

Custodial services
• In simple words, the services provided by a custodian are
known as custodial services (custodian services).
Custodian is an institution or a person who is handed
over securities by the security owners for safe custody.
Custodian is a caretaker of a public property or securities.
Custodians are intermediaries between companies and
clients (i.e. security holders) and institutions (financial
institutions and mutual funds). There is an arrangement
and agreement between custodian and real owners of
securities or properties to act as custodians of those who
hand over it

Loan Syndication
• Loan syndication is an arrangement where a
group of banks participate to provide funds for
a single loan. In a loan syndication, a group of
banks comprising 10 to 30 banks participate to
provide funds wherein one of the banks is the
lead manager. This lead bank is decided by the
corporate enterprises, depending on
confidence in the lead manager.

. Securitisation (of debt)
• Loans given to customers are assets for the bank. They are called
loan assets. Unlike investment assets, loan assets are not tradable
and transferable. Thus loan assets are not liquid. The problem is how
to make the loan of a bank liquid. This problem can be solved by
transforming the loans into marketable securities. Now loans
become liquid. They get the characteristic of marketability. This is
done through the process of securitization. Securitization is a
financial innovation. It is conversion of existing or future cash flows
into marketable securities that can be sold to investors. It is the
process by which financial assets such as loan receivables, credit
card balances, hire purchase debtors, lease receivables, trade
debtors etc. are transformed into securities. Thus, any asset with
predictable cash flows can be securitised.

FINANCIAL MARKETS
Mentioned below are the important functions of the financial
market.
• It mobilises savings by trading it in the most productive methods.
• It assists in deciding the securities price by interaction with the
investors and depending on the demand and supply in the
market.
• It gives liquidity to bartered assets.
• Less time-consuming and cost-effective as parties don’t have to
spend extra time and money to find potential clients to deal with
securities. It also decreases cost by giving valuable information
about the securities traded in the financial market.

Types
• 1. By Nature of Claim
Debt Market – It is a market where fixed bonds and
debentures or bonds are exchanged between investors.
Equity Market – It is a place for investors to deal with equity.
• 2. By Maturity of Claim
Money Market – It deals with monetary assets and short-
term funds such as a certificate of deposits, treasury bills,
and commercial paper, etc. which mature within twelve
months.
Capital Market – It trades medium and long term financial
assets.

• 3. By Timing of Delivery
• Cash Market – It is a market place where trade is
completed in real-time.
• Futures Market – Here, the delivery or
compensation of products are taken in the future
specified date.
• 4. By Organizational Structure
• Exchange-Traded Market – It has a centralised
system with a patterned procedure.
• Over-the-Counter Market – It has a decentralised
organisation with customised procedures

Financial market slang
• Poison pill, when a company issues more shares to prevent being bought out by
another company, thereby increasing the number of outstanding shares to be bought
by the hostile company making the bid to establish majority.
• Bips, meaning "bps" or basis points. A basis point is a financial unit of measurement
used to describe the magnitude of percent change in a variable. One basis point is the
equivalent of one hundredth of a percent. For example, if a stock price were to rise
100bit/s, it means it would increase 1%.
• Quant, a quantitative analyst with advanced training in mathematics and statistical
methods.
• Rocket scientist, a financial consultant at the zenith of mathematical and computer
programming skill. They are able to invent derivatives of high complexity and
construct sophisticated pricing models. They generally handle the most advanced
computing techniques adopted by the financial markets since the early 1980s.
Typically, they are physicists and engineers by training.
• IPO, stands for initial public offering, which is the process a new private company goes
through to "go public" or become a publicly traded company on some index.

• White Knight, a friendly party in a takeover bid. Used to describe a party
that buys the shares of one organization to help prevent against a hostile
takeover of that organization by another party.
• Smurfing, a deliberate structuring of payments or transactions to
conceal it from regulators or other parties, a type of money laundering
that is often illegal.
• Bid–ask spread, the difference between the highest bid and the lowest
offer.
• Pip, smallest price move that a given exchange rate makes based on
market convention.[7]
• Pegging, when a country wants to obtain price stability, it can use
pegging to fix their exchange rate relative to another currency.[8]
• Bearish, this phrase is used to refer to the fact that the market has a
downward trend.
• Bullish, this term is used to refer to the fact that the market has an
upward trend.

FINANCIAL INSTITUTIONS
• Commercial Banks
• Merchant Banks
• Mutual funds
• Investment banks
Such banks are engaged in banking activities associated with securities
underwriting, making a market in securities, and arranging mergers,
acqui
sitions and restructuring regulated by the Securities and Exchange
Board of India (SEBI).
• Credit Unions
These are non-profit making cooperative soci
eties formed by individuals
bound together by same common tie, such as a common employer or
labour union. Typically credit union members hold mem
bers’ savings
accounts and enjoy access to pooled savings of all members.

• Savings and Loan Associations:
These are financial institutions, mostly mutual
organisations having no capital stock, sometimes re
ferred to as savings associations, building and loan
associations, normally found in western countries.
Such associations pool the savings of a
neighbourhood in order to provide funds for home
purchases.
• Mutual Savings Banks:
These were originally set up to serve very small
savers. These banks can use their deposits for a
wide variety of purposes, including investment in
bonds and blue chip-stocks.

FUNCTIONS OF FINANCIAL INSTITUTIONS
• Regulation of monetary supply
• Banking services
• Insurance services
• Capital formation
• Information advice
• Brokerage services
• Pension fund services
• Trust fund services
• Financing the Small and Medium Scale Enterprises
• Act as A Government Agent for Economic Growth

Indian financial system a brief outline and introduction

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