COMPONENTS OF INDIAN FINANCIAL SYSTEM

FINANCIAL SYSTEM AND ECONOMIC DEVELOPMENT The growth of output in any economy depends on the increase in the proportion of savings/investment to a nations output of goods and services. The financial system and financial institutions help in the diversion of rising current income into savings/investments. The financial system is possibly the most important institutional and functional vehicle for economic transformation. Finance is a bridge between the present and the future and whether it be the mobilization of savings or their efficient, effective and equitable allocation for investment, it is the success with which the financial system performs its functions that sets the pace for the achievement of broader national objectives. SIGNIFICANCE & DEFINITION The term financial system is a set of inter-related activities/services working together to achieve some predetermined purpose or goal. It includes different markets, the institutions, instruments, services and mechanisms which influence the generation of savings, investment capital formation and growth. Van Horne defined the financial system as the purpose of financial markets to allocate savings efficiently in an economy to ultimate users either for investment in real assets or for consumption. According to Robinson, the primary function of the system is "to provide a link between savings and investment for the creation of new wealth and to permit portfolio adjustment in the composition of the existing wealth.

From the above definitions, it may be said that the primary function of the financial system is the mobilization of savings, their distribution for industrial investment and stimulating capital formation to accelerate the process of economic growth.

1. Financial intermediaries A. Banks: Commercial banks are business enterprises which deal in finances, financial instruments and provide various financial services for a price known as interest, discount, commission, fee etc. According to the Banking Regulation Act, 1949, Banking means, accepting, deposit of money from the public, for the purpose of lending or investment. These deposits may be repayable on demand or otherwise and may be withdrawn by cheque, draft and order or otherwise. Accepting deposits and lending these resources to business houses and individuals are the main function of commercial banks.

FUNCTIONS OF COMMERCIAL BANKS Accepting deposits Loans and advances Agency functions Dealings in foreign exchange Credit creation Popularizing cheque system Transfer of funds Function under innovative banking Insurance business

B. NBFCs Non Banking Financial Companies Non-banking Financial Institutions carry out financing activities but their resources are not directly obtained from the savers as debt. Instead, these Institutions mobilize the public savings for rendering other financial services including investment. All such Institutions are financial intermediaries and when they lend, they are known as Non-Banking Financial Intermediaries (NBFIs) or Investment Institutions. The principal business of NBFCs is to accept deposits under various schemes or arrangements like regulated deposits and exempted deposits and to lend in various ways. NBFCs are regulated by the RBI. NBFCs were allowed to enter into credit card business on their own or in association with another NBFC or a scheduled commercial bank. Following are the functions of NBFCs Loan Companies Investment Companies Hire-purchase Finance Housing finance Lease Finance Mutual Benefit Financial Companies Residuary Non-Banking Companies Merchant Banks Venture Capital Funds Factors

C. Mutual Funds: Mutual Funds are financial intermediaries which collect the savings of investors and invest them in a large and well diversified portfolio of securities such as money market instruments, corporate and Government bonds and equity shares of joint stock companies. A Mutual Fund is a pool of mix funds invested by different investors, who have no contact with each other. Mutual funds help the investors who generally dont have adequate time, knowledge, experience and resources for directly accessing the capital market Mutual Funds are of three types: Open ended Mutual funds Close ended mutual funds Interval funds D. Insurance organizations The Insurance companies are financial intermediaries as they collect and invest large amounts of premiums.Insurance companies are regulated by IRDA Insurance regulatory and development authority They offer protection to the investors, provide means for accumulating savings and channelize funds to the government and other sectors. The insurance industry has both economic and social purpose. It provides social security and promotes individual welfare.The actual premium of insurance companies comprises the pure premium and administrative as well as marketing cost

2. Financial markets A. Money market: It is the market for dealing in monetary assets of short-term nature. Short-term funds up to one year. Money market provides access to providers and users of short term funds to fulfill their borrowings and investment requirements. The Money Market is the major mechanism through which the Reserve Bank influences liquidity and the general level of interest rates. There are a large number of participants in the money market: Commercial Banks, Mutual funds, investment institutions, financial institutions and finally the Reserve Bank of India. Instruments in Money Market Call money market Treasury bills market Markets for commercial paper Certificate of deposits Bills of Exchange

a) Call Money Market Is an integral part of the Indian money market where day-to-day surplus funds (mostly of banks) are traded. The loans are of short-term duration (1 to 14 days). Money lent for one day is called call money; if it exceeds 1 day but is less than 15 days it is called notice money. Money lent for more than 15 days is term money

 The borrowing is exclusively limited to banks, which are temporarily short of funds. Call loans are generally made on a clean basis- i.e. no collateral is required The main function of the call money market is to redistribute the pool of day-to-day surplus funds of banks among other banks in temporary deficit of funds The call market helps banks economize their cash and yet improve their liquidity It is a highly competitive and sensitive market It acts as a good indicator of the liquidity position REPO AND REVERSE REPO RATE Repo rate is the rate at which banks borrow short-term funds from RBI. Reverse repo rate is the rate at which banks park their short-term surplus funds in the RBI

b) Treasury Bills Treasury Bills are short term (up to one year) borrowing instruments of the union government. It is a promise by the Government to pay a stated sum after expiry of the stated period from the date of issue (14/91/182/364 days i.e. less than one year). They are issued at a discount to the face value, and on maturity the face value is paid to the holder. The rate of discount and the corresponding issue price are determined at each auction.

c). Commercial Papers Unsecured Promissory note. Issued by well known companies with strong and high credit rating. Sold directly by the issuers to investors or through agents like merchant banks and security houses. Flexible Maturity Low interest rates with compared to banks. Imparts a degree of financial stability to the system

d) Certificate of deposit Certificates of Deposit (CDs) is a negotiable money market instrument and issued in dematerialised form or as a Usance Promissory Note, for funds deposited at a bank or other eligible financial institution for a specified time period. Guidelines for issue of CDs are presently governed by various directives issued by the Reserve Bank of India, as amended from time to time. CDs can be issued by (i) scheduled commercial banks excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs); and (ii) select all-India Financial Institutions that have been permitted by RBI to raise short-term resources within the umbrella limit fixed by RBI. Banks have the freedom to issue CDs depending on their requirements.

B. CAPITAL MARKET a) New Issue Market/ Primary market New Issues Market comprises all people, institutions, methods, services and practices involved in raising fresh capital for both new and existing companies. This Market is also called Primary Market. PM deals in only new securities which acquire form for the first time, i.e. which were not available previously. b) Secondary market Secondary market or stock market or stock exchange deals in existing securities, i.e. securities which have already been issued by companies and are listed with the stock exchanges. Differences between Primary and Secondary market:
Primary Markets Secondary Markets

When companies need financial resources for its expansion, they borrow money from investors through issue of securities.

The place where such securities are traded by these investors is known as the secondary market.

Securities issued Preference Shares Equity Shares Debentures

Securities like Preference Shares and Debentures cannot be traded in the secondary market.

Equity shares is issued by the under writers and merchant bankers on behalf of the company.

Equity shares are tradable through a private broker or a brokerage house.

People who apply for these securities are: High networth individual Retail investors Employees Financial Institutions Mutual Fund Houses Banks

Securities that are traded are traded by the retail investors.

One time activity by the company.

Helps in mobilising the funds for the investors in the short run.