Financial System comprises , a set of sub-systems of
financial institutions, financial markets, financial
instruments and services which help in formation of
capital. It provides a mechanism by which savings are
transformed into investment.
The financial system is characterized by the presence of
an integrated, organized and regulated financial
markets and institutions that meet the short term and
long term financial needs of both the household and
“ A FINANCIAL SYSTEM MAY BE DEFINED AS A
SET OF INSTITUTIONS, INSTRUMENTS AND
MARKET WHICH FOSTER SAVINGS AND
CHANNELS THEM TO MOST EFFICIENT USE.
THE SYSTEM CONSISTS OF INDIVIDUALS
( SAVERS), INTERMEDIARIES, MARKET AND
USERS OF SAVINGS”
_ H.R MACHIRAJU
⇒ The word “system” means an ordered
organisation & assemblage of facts ,
principles or components relating to
particular field or for specified purpose.
⇒ A Financial System is an integral part of
Link between savers and investors.
Selection of the projects to be financed and review the
performance of such projects.
Payment mechanism for exchange of goods & services
Mechanism for the transfer of resources across
provide mechanism for Managing and control risk
Promotes capital formation by bringing together the
supply of savings & demand for investable funds.
Lowering the cost of transactions and
increase returns.Reduced cost motivate
people to save more.
Provides information to the operators/
players in the market(indivisuals,
Components of Indian Financial System
Financial Institutions Financial Markets Financial Instruments Financial Services
- State Level
- Equipment Leasing
Money Market Capital Market
-Call Money Market
- Merchant Banking
I. Financial Institutions
Financial institutions are the intermediaries who
facilitate smooth functioning of the financial system by
making investors and buyers meet.
Financial institutions mobilize saving of the surplus
units & allocate them in productive activities promising
a better rate of return.
Indian banking industry is subject to the control of the
Central Bank (RBI).Indian banking system can be
classified in two categories.
1. Organized Sector
2. Unorganized Sector
a) Commercial Banks
b) Co-operative Banks
c) Regional Rural Banks (RRBs)
d) Foreign Banks
Commercial Banks :
Commercial banking system in India consisted of 297
scheduled banks (including foreign banks) and one
non-scheduled bank at the end of Dec. 2000.
Scheduled commercial Banks constitute those banks
which have been included in the Second Schedule of
Reserve Bank of India(RBI) Act, 1934. RBI in turn
includes only those banks in this schedule which
satisfy the criteria laid down vide section 42 (60 of the
"Non-scheduled bank in India" means a banking
company as defined in clause (c) of section 5 of the
Banking Regulation Act, 1949 (10 of 1949), which is
not a scheduled bank".
Co-operative Banks :
This segment is represented by a group of
societies registered under the Acts of the States
relating to co-operative societies. These are
classified into two broad categories:-
a) Rural credit societies which are primarily
b) Urban credit societies which are primarily non-
Regional Rural Banks (RRBs) :
RRBs were set by the state government and the sponsoring
commercial banks with the objective of developing the rural
economy. IDBI, NABARD (National bank for agriculture &
rural development)and SIDBI are also required to provide
managerial and financial assistance to RRBs under Regional
Rural Bank Act.
Foreign Banks :
1 Barclays Bank
2 Bank of Ceylon
3 Bank Indonesia International
4 Development Bank of Singapore
5 Fuji Bank
a) Indigenous Bankers
b) Money Lenders
(Seths and Sahukars)
Indigenous Bankers :
Indigenous bankers are the forefathers of modern
commercial banks. As the term indigenous indicates, they
are the local bankers.
Indigenous bankers provide finance for productive purposes
directly to trade , industries,& indirectly through money lenders
& traders to agriculture.
Money Lenders :
Money lenders depend entirely on their own funds for
the working capital. Money lenders may be rural or
urban, professional or non-professional. They enjoy
monopoly in their areas of operation.
Money lenders are not bankers,their business is money
Characteristics of Money Lenders
1. Own funds.
2. Weaker sections of the society.
3. High rates of interest.
4. Unregulated Operations
5. Prompt and flexible.
The non-banking institutions may be broadly
categorised broadly into two groups:-
a) Organised Financial Institutions
b) Unorganised Financial Institutions
Organised Financial Institutions
1. Development Finance Institutions:-
a) The institutions like IDBI, ICICI, IFCI(Industrial finance
cooperation of India), IIBI(industrial investment bank of india)
at all India level.
b) State Finance Corporations (SFCs), State Industrial
Development Corporations (SIDCs) at state level.
c) Agriculture Development Finance Institutions as NABARD etc.
. Investment Institutions :- It includes those
financial institutions which mobilize savings of
the public at large through various schemes and
invest these funds in corporate and government
securities. These include LIC, GIC,
UTI, and mutual funds.
Unorganised Financial Institutions
The unorganised non-banking financial institutions include
number of non-banking financial companies (NBFCs)
providing whole range of financial services.
Hire-purchase and consumer finance companies, leasing
companies, housing finance companies, factoring
companies, credit rating agencies, merchant banking
II. Financial Markets
Financial markets refer to the institutional arrangements
for dealing in financial assets and credit instruments of
different types such as currency, cheques, bank deposits,
bills, bonds etc.
a) Negotiated loan market-is a market in which lender & the
borrower personally negotiate the terms of loan agreement.
b) Open Markets-in which standardized securities are traded
in large volumes.-stock market
Functions of financial markets
1. Creation and allocation of credit and liquidity.
2. Intermediaries for mobilization of savings.
3. Balanced economic growth.
4. Financial convenience.
5. Cater Credit needs of corporate houses.
Types of Financial Market
1) Money Market
2) Capital Market
Money Market refers to the institutional arrangements
facilitating borrowing and lending of short-term funds.
The RBI describes money market as, “the centre for
dealings, mainly of a short-term character, in monetary
assets, it meets the short-term requirements of
borrowers and provides liquidity or cash to the lenders.”
In the global money market, Commercial Paper is
an unsecured promissory note with a fixed maturity of
1 to 270 days. Commercial Paper is a money-market
security issued (sold) by large banks and corporations
to get money to meet short term debt obligations .
Just like commercial bills which represent commercial
debt, treasury bills represent short-term borrowings
of the Government. Treasury bill market refers to the
market where treasury bills are brought and sold.
Treasury bills are very popular and enjoy higher
degree of liquidity since they are issued by the
Call money market
Market in which brokers and dealers borrow money
to satisfy their credit needs, either to finance their
own inventory of securities .
promissory note (issued by financial institutions or
large firms) with very-short to short maturity period
(usually, 2 to 30 days, and not more than 270 days),
and secured only by the reputation of the issuer.
Rated, bought, sold, and traded like other negotiable
instruments, commercial paper is a popular means of
Certificate of Deposit
A savings certificate entitling the bearer to receive
interest. A CD bears a maturity date, a specified fixed
interest rate and can be issued in any denomination.
CDs are generally issued by commercial banks . The
term of a CD generally ranges from one month to five
Functions of the Money Market
1. Adjustment of liquidity position of commercial
2. Provides short-term funds
3. Short-term funds to the government institutions.
4. Helpful to businessmen
5. Proper flow of funds.
6. Provide outlets to various borrowers such as
businessman, traders, Industrialists.
7. Mechanism for credit control.
The term ‘capital market’ refers to the institutional
arrangements for facilitating the borrowing and lending
of long-term funds.
Repo is a collateralized lending i.e. the banks which
borrow money from Reserve Bank to meet short term
needs have to sell securities
Capital Market Instruments :
Importance of Capital Market
a) Coordination and balance between savings and
b) Optimum utilisation of financial resources.
c) Concentration of national savings
d) To maintain the Expected rate of economic growth
III. Financial Instruments
A financial instrument/asset/security is a claim,
against a person or an institution, for the payment
of a sum of money or a periodic payment in the
form of interest or dividend, at a specified future
Types of Financial Securities
1. PRIMARY SECURITIES –direct securites,issued directly
by borrower of funds.
2. SECONDARY SECURITIES –indirect securities eg –
Insurance & mutual funds.
Some new innovative financial
i. Equity Warrants
ii. Secured Premium notes
iii. Regular Income Bonds
iv. Retirement Bonds
v. Inflation Adjusted Bonds
vi. Easy Exit Bond
vii. Growth Bonds
IV. FINANCIAL SERVICES
Financial services are the activities, benefits and
satisfactions, connected with the sale of money,
that offer to users and customers, financial related
Suppliers of Financial Services
i) Banks and Financial Institutions
ii) House Building Societies
iii) Insurance Companies
iv) Credit Card Issuer Companies
v) Investment Trusts and Mutual Funds
vi) Stock Exchanges
vii) Leasing Companies/Equipment
Finance/Consumer Finance Companies
viii) Unit Trusts
Characteristics of Financial Services
2. Direct Sale
4. Fluctuation in demand
5. Protect Consumer’s interest
6. Labour Intensive
7. Geographical dispersion
8. Lack of special identity
9. Information based
10. Require quality labour
Kinds of Financial Services
A. Asset based/fund based services.
B. Fee based/advisory services
Asset/Fund Based Services
1. Equipment Leasing/Lease Financing
2. Hire Purchase and Consumer Credit
3. Bill Discounting
4. Venture Capital
5. Housing Finance
6. Insurance Services
Leasing is an arrangement that provides a firm with
the use & control over assets without buying them.it
is the form of renting assests.
Hire purchase means transaction where goods are
purchased & sold on the terms that
payment will be made in instalments.
the possession of the goods given to buyer.
The ownership right remains with the vendor till the
last instalment is paid.
The seller can repossess the goods in case of default
in payment of any instalment.
According to negotiable instrument act 1881
The bill of exchange is an instrument in writing
containing an unconditional order,signed by
maker ,directing a certain person to pay a certain sum
of money only to,or to order of,a certain person,or to
the bearer of that instrument.
The term venture capital represents financial
investment in a highly risky project with the objective
of earning high rate of return.
Housing finance emerged as a fund based financial
service in the country with the setting up of national
housing bank by RBI IN 1998.
With setting up of the IRDA Act 1999,the monopoly
of LIC & GIC has been dismantled & new players
entered in the field.
A factor is a financial institution which offers services
related to management & financing of Debts.
B. Fee Based Advisory Services
1. Merchant Banking
2. Credit Rating
3. Stock Broking
Indian Financial System-
After Independence till 1990
Stage I : Before Independence
Few industrial securities in securities market
No separate issuing institution
Outside savings were restricted.
Stage II : After Independence
1) Transfer of Ownership from Private to Public Sector:
a) Nationalization of RBI
b) Setting up of State Bank of India
c) Nationalization of Life Insurance Business
d) Nationalization of Commercial Banks
e) Nationalization of General Insurance Business.
2. Setting up of Financial Institutions
a) Development of Finance Institutions :
IFCI, SFC’s, NIDC, ICICI, LIC, IDBI etc.
b) Investing Institutions : UTI established in 1964, LIC in
1956, GIC in 1973.
c) Other Institutions : RCI in 1971, EXIM Bank in 1982,
NABARD in 1982.
STAGE III : After 1990’s
a) Privatization in banking and insurance sector.
b) Development of Finance Institutions
c) Emergence of Non-Banking Financial Companies
d) Growth of Mutual Funds.
e) Establishment of SEBI Act in 1992.