A financial system refers to a system which enables the transfer of money between

investors and borrowers. A financial system could be defined at an international,

regional or organization level. The term system in Financial System indicates a
group of complex and closely linked institutions, agents, procedures, markets,
transactions, claims and liabilities within a economy.

Five Basic Components of Financial System

Financial Institutions
Financial Markets
Financial Instruments (Assets or Securities)
Financial Services
Money

Financial Institutions
Financial institutions facilitate smooth working of the financial system by making
investors and borrowers meet. They mobilize the savings of investors either directly
or indirectly via financial markets, by making use of different financial instruments as
well as in the process using the services of numerous financial services providers.
They could be categorized into Regulatory, Intermediaries, Non-intermediaries and
Others. They offer services to organizations looking for advises on different problems
including restructuring to diversification strategies. They offer complete array of
services to the organizations who want to raise funds from the markets and take care
of financial assets for example deposits, securities, loans, etc.

Figure 1: Five Basic Components of Financial System

Financial Markets
A financial market is the place where financial assets are created or transferred. It can
be broadly categorized into money markets and capital markets. Money market
handles short-term financial assets (less than a year) whereas capital markets take care

of those financial assets that have maturity period of more than a year. The key
functions are:
1. Assist in creation and allocation of credit and liquidity.
2. Serve as intermediaries for mobilization of savings.
3. Help achieve balanced economic growth.
4. Offer financial convenience.
One more classification is possible: primary markets and secondary markets. Primary
markets handles new issue of securities in contrast secondary markets take care of
securities that are presently available in the stock market.
Financial markets catch the attention of investors and make it possible for companies
to finance their operations and attain growth. Money markets make it possible for
businesses to gain access to funds on a short term basis, while capital markets allow
businesses to gain long-term funding to aid expansion. Without financial markets,
borrowers would have problems finding lenders. Intermediaries like banks assist in
this procedure. Banks take deposits from investors and lend money from this pool of
deposited money to people who need loan. Banks commonly provide money in the
form of loans.
Financial Instruments
This is an important component of financial system. The products which are traded in
a financial market are financial assets, securities or other type of financial
instruments. There is a wide range of securities in the markets since the needs of
investors and credit seekers are different. They indicate a claim on the settlement of
principal down the road or payment of a regular amount by means of interest or
dividend. Equity shares, debentures, bonds, etc are some examples.
Financial Services
Financial services consist of services provided by Asset Management and Liability
Management Companies. They help to get the necessary funds and also make sure
that they are efficiently deployed. They assist to determine the financing combination
and extend their professional services upto the stage of servicing of lenders. They help
with borrowing, selling and purchasing securities, lending and investing, making and
allowing payments and settlements and taking care of risk exposures in financial
markets. These range from the leasing companies, mutual fund houses, merchant
bankers, portfolio managers, bill discounting and acceptance houses. The financial
services sector offers a number of professional services like credit rating, venture
capital financing, mutual funds, merchant banking, depository services, book
building, etc. Financial institutions and financial markets help in the working of the
financial system by means of financial instruments. 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.
Money

Money is understood to be anything that is accepted for payment of products and

services or for the repayment of debt. It is a medium of exchange and acts as a store
of value.

SEBI: The Purpose, Objective and Functions of SEBI

Article shared by Samiksha S
Read this article to learn about the purpose, objective and functions of SEBI!
Securities Exchange Board of India (SEBI) was set up in 1988 to regulate the
functions of securities market. SEBI promotes orderly and healthy development in the
stock market but initially SEBI was not able to exercise complete control over the
stock market transactions.
It was left as a watch dog to observe the activities but was found ineffective in
regulating and controlling them. As a result in May 1992, SEBI was granted legal
status. SEBI is a body corporate having a separate legal existence and perpetual
succession.
Reasons for Establishment of SEBI:
With the growth in the dealings of stock markets, lot of malpractices also started in
stock markets such as price rigging, unofficial premium on new issue, and delay in
delivery of shares, violation of rules and regulations of stock exchange and listing
requirements. Due to these malpractices the customers started losing confidence and
faith in the stock exchange. So government of India decided to set up an agency or
regulatory body known as Securities Exchange Board of India (SEBI).
Purpose and Role of SEBI:
SEBI was set up with the main purpose of keeping a check on malpractices and
protect the interest of investors. It was set up to meet the needs of three groups.
1. Issuers:
For issuers it provides a market place in which they can raise finance fairly and easily.
2. Investors:
For investors it provides protection and supply of accurate and correct information.
3. Intermediaries:
For intermediaries it provides a competitive professional market.
Objectives of SEBI:

The overall objectives of SEBI are to protect the interest of investors and to promote
the development of stock exchange and to regulate the activities of stock market. The
objectives of SEBI are:
1. To regulate the activities of stock exchange.
2. To protect the rights of investors and ensuring safety to their investment.
3. To prevent fraudulent and malpractices by having balance between self regulation
of business and its statutory regulations.
4. To regulate and develop a code of conduct for intermediaries such as brokers,
underwriters, etc.
Functions of SEBI:
The SEBI performs functions to meet its objectives. To meet three objectives SEBI
has three important functions. These are:
i. Protective functions
ii. Developmental functions
iii. Regulatory functions.
1. Protective Functions:
These functions are performed by SEBI to protect the interest of investor and provide
safety of investment.
As protective functions SEBI performs following functions:
(i) It Checks Price Rigging:
Price rigging refers to manipulating the prices of securities with the main objective of
inflating or depressing the market price of securities. SEBI prohibits such practice
because this can defraud and cheat the investors.
(ii) It Prohibits Insider trading:
Insider is any person connected with the company such as directors, promoters etc.
These insiders have sensitive information which affects the prices of the securities.
This information is not available to people at large but the insiders get this privileged
information by working inside the company and if they use this information to make
profit, then it is known as insider trading, e.g., the directors of a company may know
that company will issue Bonus shares to its shareholders at the end of year and they
purchase shares from market to make profit with bonus issue. This is known as insider
trading. SEBI keeps a strict check when insiders are buying securities of the company
and takes strict action on insider trading.

(iii) SEBI prohibits fraudulent and Unfair Trade Practices:

SEBI does not allow the companies to make misleading statements which are likely to
induce the sale or purchase of securities by any other person.
(iv) SEBI undertakes steps to educate investors so that they are able to evaluate the
securities of various companies and select the most profitable securities.
(v) SEBI promotes fair practices and code of conduct in security market by taking
following steps:
(a) SEBI has issued guidelines to protect the interest of debenture-holders wherein
companies cannot change terms in midterm.
(b) SEBI is empowered to investigate cases of insider trading and has provisions for
stiff fine and imprisonment.
(c) SEBI has stopped the practice of making preferential allotment of shares unrelated
to market prices.
2. Developmental Functions:
These functions are performed by the SEBI to promote and develop activities in stock
exchange and increase the business in stock exchange. Under developmental
categories following functions are performed by SEBI:
(i) SEBI promotes training of intermediaries of the securities market.
(ii) SEBI tries to promote activities of stock exchange by adopting flexible and
adoptable approach in following way:
(a) SEBI has permitted internet trading through registered stock brokers.
(b) SEBI has made underwriting optional to reduce the cost of issue.
(c) Even initial public offer of primary market is permitted through stock exchange.
3. Regulatory Functions:
These functions are performed by SEBI to regulate the business in stock exchange. To
regulate the activities of stock exchange following functions are performed:
(i) SEBI has framed rules and regulations and a code of conduct to regulate the
intermediaries such as merchant bankers, brokers, underwriters, etc.
(ii) These intermediaries have been brought under the regulatory purview and private
placement has been made more restrictive.

(iii) SEBI registers and regulates the working of stock brokers, sub-brokers, share
transfer agents, trustees, merchant bankers and all those who are associated with stock
exchange in any manner.
(iv) SEBI registers and regulates the working of mutual funds etc.
(v) SEBI regulates takeover of the companies.
(vi) SEBI conducts inquiries and audit of stock exchanges.
The Organisational Structure of SEBI:
1. SEBI is working as a corporate sector.
2. Its activities are divided into five departments. Each department is headed by an
executive director.
3. The head office of SEBI is in Mumbai and it has branch office in Kolkata, Chennai
and Delhi.
4. SEBI has formed two advisory committees to deal with primary and secondary
markets.
5. These committees consist of market players, investors associations and eminent
persons.
Objectives of the two Committees are:
1. To advise SEBI to regulate intermediaries.
2. To advise SEBI on issue of securities in primary market.
3. To advise SEBI on disclosure requirements of companies.
4. To advise for changes in legal framework and to make stock exchange more
transparent.
5. To advise on matters related to regulation and development of secondary stock
exchange.
These committees can only advise SEBI but they cannot force SEBI to take action on
their advice.

. REFORM OF THE INSURANCE SECTOR

No review of financial sector reforms in India can be complete without reference to
the need for reforms in the insurance sector. India is one of only four countries the

other three being Cuba, North Korea, and Myanmar where insurance is a public
sector monopoly! The rationale' of liberalizing the banking system and encouraging
competition among the three major participants viz. public sector banks, Indian
private sector banks, and foreign banks, applies equally to insurance. There is a
strong case for ending the public sector monopoly in insurance and opening it up : to
private sector participants subject to suitable prudential regulation.
Cross-country evidence suggests that contractual savings institutions are an
extremely important determinant of the aggregate rate of savings and insurance and
pension schemes are the most important form of contractual savings in this context.
Their importance will increase in the years ahead as household savings capacity
increases with rising per capita incomes, life expectancy increases, and as traditional
family support systems, which are a substitute for insurance and pensions, are
eroded. A competitive insurance industry providing a diversified set of insurance
products to meet differing customer needs, can help increase savings in this situation
and allocate them efficiently. The insurance and? pensions industry typically has
long-term liabilities which it seeks to; match by investing in long-term secure assets.
A healthy insurance is therefore an important source of long-term capital in domestic
currency which is especially for infrastructure financing. Reforms in insurance will
therefore strengthen the capital market at the long-term end by adding new players in
this segment of the market, giving it greater depth or liquidity.
It is relevant to ask why these developments are less likely if insurance remains a
public sector monopoly. One reason is that the industry suffers from a relatively high
requirement for mandatory investment in government securities. However this implies
that it is the mandatory requirement ; and not the public sector monopoly which is the
real constraint. The fact is that the insurance industry does not fully utilize even the
flexibility; available at present for investment in corporate securities. This is
principally because lack of competition in the insurance sector means there is no
pressure to improve the return offered to the investor. Competition will increase the
pressure to improve returns and push insurance companies to move out of
government securities to seek higher returns in high quality corporate debt. Needless
to say, the process would be greatly expedited if fiscal deficit is also reduced
resulting in a fall in the interest rate on government securities. Reforms in insurance
are therefore more likely to create a flow of finance for the corporate sector if we can
simultaneously make progress in reducing fiscal deficit.
The Malhotra Committee had recommended opening up the insurance sector to new
private companies as early as 1994. It took five years to build a consensus on this
issue and legislation to open up insurance, allowing foreign equity up to 26 per cent
was finally submitted to. Parliament in 1999. It could not be passed before the
dissolution of Parliament and the earliest it can now be passed is by 2000. If
approved, i t will require legislation to remove the existing government monopoly and
the earliest that this can be done is some time in 1999. This means new licences to
competing insurers can only be issued by the end of 2000 and since the new
entrants will have to build up their business from scratch, i t w i ll take another 5 to 10
years before private insurance companies, even with foreign partners, can reach
significant levels. The sooner w e start the sooner we will derive the benefit of
providing better service for the consumer, and the sooner it will be possible to finance
infrastructure from the capital market.
CONCLUSION
The reforms currently under way in the banking sector and in the capital market,
combined with the agenda for reform identified for the insurance sector, represent a
major structural overhaul of the financial system. It will certainly bring India's financial
system much closer to what is expected of developing countries as they integrate

with the world economy. As in so many other areas, reforms in the financial sector
have been of the gradualist variety, with changes being made only after much
discussion and over a somewhat longer period than attempted in most other
countries. However the direction of change has been steady and in retrospect a great
deal has been accomplished in the past seven years. It is essential to continue these
reforms along the directions already indicated and to accelerate the pace of change
as much as possible.
Finally, it is important to recognize that financial sector reforms by themselves cannot
guarantee good economic performance. That depends upon a number of other
factors, including especially the maintenance of as a favourable rnacro-economic
environment and the pursuit of much needed economic reforms in other parts of the
real economy. The impact of financial sector reforms in accelerating growth will be
maximized if combined with progress in economic reforms in other areas.

ROLE OF DEVELOPMENT BANKING

Traditionally, commercial banks were the main source of finance during the preindependence era. After Independence, the Government of India announced the
Industrial Policy in 1948 with a view to build a sound industrial base and a strong
village and small industry sector. The enactment of the State Financial
Corporation Act in 1951 and the consequent establishment of the different
development banks acted as a positive step to ensure balanced growth of
industry throughout the country. The development banks supply capital,
knowledge and enterprise, the three major ingredients of development, for
business enterprises. These enterprises in turn by augmenting their productivity
can help the nation to develop rapidly. These institutions extend longterm finance
to the small and medium scale units under different schemes and their lending
operations are supplemented with promotional and developmental activities to
facilitate entrepreneurship. The development banks are of two types; namely, the
all India level institutions like IFCI, ICICI, IDBI, SIDBI, NSIC and the State Level
Institutions like the State Financial Corporations (SFCs), State Industrial
Development Corporations (SIDCs) and the State Industrial Investment
Corporations (SIICs).
The all India level financial institutions like IFCI, IDBI, ICICI extend financial
assistance to the medium and large sectors whereas institutions like SIDBI and
the NSIC cater to the need of the Small Scale Industry (SSI) sector. The State
level institutions provide financial support to the small and the medium sectors.
Besides the lending, these corporations act as the implementing agency of the
various government sponsored schemes in order to ensure a fair distribution of
wealth. The total value of the financial assets of SFCs over the years is about Rs.
10,999 crores (upto 1996-97) which is quite encouraging