The financial system of a country includes various institutions, instruments, and services that facilitate the mobilization of savings for investment in productive assets. It encompasses both capital and money markets, which involve long-term and short-term lending and borrowing respectively, and includes entities such as banks, financial institutions, and markets for securities and currencies. Additionally, financial services like mutual funds, venture capital, and merchant banking play a key role in supporting economic activities and investment opportunities.

1. Financial System

2. The term Financial Environment refers to the financial sector or
financial system of a country. It comprises various financial
institutions, instruments, policies and services concerning the
financial sector.
Meaning of Financial System
 The financial system of a country means a set of financial
arrangements by which the savings in the economy are
mobilized for investment in productive assets.
 The financial system deals with all types of finance, agricultural,
industrial, developmental and governmental finance.
 The suppliers and users of funds are a part of the financial
system.
 Thus, the financial system is concerned with borrowing and
lending of funds or the demand and supply of funds of all
individuals, institutions, companies and the Government.

3. Constituents of the Financial System
1. Financial Markets: Provide facilities for raising long term and short term funds.
2. Financial Institutions: Serve as intermediaries between borrowers and lenders
of funds.
3. Financial Instruments: Are used to raise funds in the financial markets
4. Financial Services: Services offered by various financial institutions.
Financial Markets:
 Financial Markets refer to the market for borrowing and lending of funds. They
provide facilities for buying and selling of financial claims.
Capital Market: A capital market may be defined as the market for borrowing and
lending of long term funds. It is concerned with the raising of capital for the
purpose of investment. Capital market is a market where securities issued by
firms (ie shares, bonds and debentures) can be bought and sold freely.
The demand for capital comes from business firms, agriculture and
Government while the supply of capital is provided by individual savers,
corporate savings, specialized financial institutions.

4. Capital Markets (contd)
The capital market is classified into:
 Primary Market: The primary market or the new issues market refers to the
raising of new capital by the issue of new shares, debentures and bonds.
 By prospectus: It is an invitation to the general public for subscribing to the
capital.
 By offer for sale: This method is almost similar to the prospectus method except
with a difference that shares are taken up by a third party in bulk. Later a
statement like prospectus is issued for sale to the public. Thus the company has
already received the money and any premium from the public goes to the third
party.
 By private placing: Shares are sold to individuals or institutions directly by making
a private appeal to them.
 By offering rights issue: Under a rights issue, the shareholders have the right to a
certain number of shares in proportion to the shares held by them.
 Secondary Market: The secondary market or the stock exchange is the
market for old or already issued securities. It comprises of the stock market
in which industrial securities are bought and sold.
The capital market serves a very useful purpose by pooling the capital
resources of the country and making them available to the enterprising
investors.
 Well developed capital markets augment resources by attracting and
lending funds on a global scale.

5. Money Markets
 Money market refers to the market for lending and borrowing of
short term funds. It is the market in which the short term
surplus investible funds of banks and other financial
institutions are demanded by borrowers. A well organized money
market is the basis of an effective monetary policy.
 The money market consists of the Organised and Unorganised
Sector. The rates of interest differ between the two markets.
Organised Sector: Comprises the Reserve Bank of India,
public and private sector banks, foreign banks, finance
corporations, mutual funds etc. This consists of the submarket
such as the commercial bill market and the interbank call money
market. The RBI is the Apex organization in the Indian money
market
 The Unorganised Sector consist of indigenous bankers and
money lenders who pursue the banking business on traditional
lines and non banking financial companies such as chit funds,
nidhis and finance companies. The unorganized sector is by and
large outside the control of the Central Bank and is characterized
by lack of uniformity and formality in their business dealings.

6. Functions of Money Market
 By providing various kinds of credit instruments suitable and
attractive for different sections, a money market augments the
supply of funds
 Efficient working of a money market helps to minimize the
stringencies in the money market due to the seasonal variations
in the flow of and demand for funds.
 A money market by augmenting the supply of funds and making
them readily available to the legitimate borrowers, helps in making
funds available at cheaper rates.
 A well organised money market, through quick transfer of funds,
helps to avoid regional imbalances in availability of funds and
enhances the liquidity available.
 A money market by providing profitable investment opportunities for
short term surplus funds, helps to enhance the profit of FIs

7. Constituents of the Indian Money Market
 Call money Market: The call money market consists of overnight
and money at short notice for period upto 14 days. It is meant to
balance the short term needs of banks, most important of these
being to meet the CRR requirements. This is the most sensitive part
of the financial system and any change in flow of funds is clearly
reflected in it. There is currently no ceiling on the call money rate.
 Treasury Bill market : This market deals in treasury bills and in
India are short term liability of the Central Government. These bills
are issued to meet deficits which a Government faces due to its
excess of expenditure over revenue. Treasury bills are
promissory notes issued by the Central Government to raise
short term funds to bridge short term mismatches between
receipts and expenditures. The treasury bill market in India is
quite underdeveloped and RBI is the major holder of these bills as it
is under an obligation to purchase all treasury bills being offered by
the Government. RBI is also required to rediscount treasury bills
that are presented to it by banks and others.

8.  Repo Market: Repo market helps in collateralised short term
borrowing and lending through sale / purchase operations in debt
instruments. Under a repo transaction, securities are sold by their
holder to an investor with an agreement to repurchase at a
predetermined rate and date. Under reverse repo transaction,
securities are purchased with a simultaneous commitment to resell
at a predetermined interest and rate. Repos help to maintain
liquidity conditions in the short term.
 Certificate of Deposit market: A certificate of deposit is a
certificate issued by a bank to depositors of funds that remain on
deposit at the bank for a specified time period between fifteen days
to one year. They are similar to traditional term deposits but are
negotiable and tradeable in the short term money market. CDs are
issued at discount to face value and the discount rate is market
determined. They are freely transferable by endorsement and
delivery, however as banks pay a high interest rate on CDs, holders
of CDs prefer to hold them till maturity.
Constituents of the Indian Money Market

9. Constituents of the Indian Money Market
 Commercial Bill market: In this market trade bills or commercial
bills are handled. Commercial bill is a bill drawn by one merchant
firm on the other. Legitimate purpose of a commercial bill is to
reimburse the seller while the buyer delays the payment. These bills
can be rediscounted.
 Commercial Paper: Commercial paper is a short term instrument of
raising funds by corporates and Institutional investors. It is essentially a
sort of unsecured promissory note sold by the investor. The maturity of
the instrument is flexible and borrowers and lenders adopt a maturity to
a CP as per their needs. Highly rated corporates which can obtain funds
at a cost lower than the cost of borrowing from banks are generally
keen on issuing CPs. CP can be issued for maturities between a
minimum of 15 days and a maximum up to one year from the date of
issue. CP will be issued at a discount to face value as may be
determined by the issuer
 Money market mutual funds: Banks, public and private financial
institutions can set up MMMFs and can issue untis to corporate
enterprises and others. Resources mobilised by MMMFs can be
invested in call money market, CDs, CPs, commercial bill etc.The
MMFS have been brought under the purview of SEBI.

10. Money Market Reforms
 RBI deregulated money market interest rates in 1989 to
make interest rates flexible and lend transparency to
transaction. Earlier the call money was subject to interest
rate ceiling of 10%, rediscounting of commercial bills
12.54% etc.
 Over the past fifteen years four major money market
instruments have been introduced – 182 days treasury
bills, 364 days treasury bills, CDs and CPs.
 Introducing money market mutual funds in 1991 which
provide an additional short term avenue to investors and
bring money market instruments within the reach of
individuals

11.  Developing call money market: Earlier only UTI and LIC were
allowed to operate as lenders in the call money market. As of
now, broadly speaking banks are operating as lenders and
borrowers while a number of non bank financial institutions and
mutual funds are operating only as lenders.
 Setting the Discount and Finance House of India (DFHI): The
DFHI was set up in 1988 and its major function is to bring into
the fold of the Indian money market the financial system
comprising of scheduled commercial banks, foreign and co-
operative banks so that their short term surpluses and deficits
are equilibrated at market related prices.
 Sector specific refinance facilities: Refinance is used by central
banks to meet liquidity shortage in the system, to control
monetary and credit conditions and direct credit to selective
sectors. Currently there are two refinance schemes – export
credit refinance and general refinance. With the emergence of
the bank rate as the signaling rate of monetary policy stance, the
RBIs policy has been to keep the refinance rate linked to the
bank rate.
Money Market Reforms (contd…)

12.  Foreign Exchange Market: In this market foreign
currency is made available. It comprises of the RBI,
authorized dealers in foreign currency, money changers,
foreign banks, exporters and importers. The Indian forex
market has grown in depth in the 1990s.
 Government Securities Market: Government requires
considerable amount of funds to invest in economic and
social projects. The market in which Government
securities are purchased and sold is known as the
Government securities market.
 Treasury bills are issued for raising short term funds
while bonds are issued for long term funds. Market for
Government and semi government securities is known
as the Gilt edged market.
 Gilt edged market is relatively risk free and returns are
guaranteed, RBI plays a dominant role and its position is
that of a monopolist. Government securities are the most
liquid debt instruments.

13. Financial Market
Capital Market
Money
Market
Foreign
Exchange
Market
Government
Securities
Market
Primary Market
Secondary Market
Organised Market
Unorganised Market
RBI
Authorised Dealers
Importers and Exporters
Foreign Banks
Money Changers
Bonds
Treasury Bills

14. Financial Instruments:
Primary or Direct Securities: These are financial claims
against real sector units. They are created by real sector units as
ultimate borrowers for raising funds. Eg: Equities, bills of
exchange, bonds etc.
Secondary or Indirect Securities: These are financial
claims issued by financial institutions for raising funds from the
public. Eg: Currency, bank deposits, insurance policies,
government securities etc. Bank drafts, cheques, dividend
warrants, treasury bills, railway receipts, promissory notes, credit
and debit cards, letters of credit, travelers cheques etc. are also
examples of financial instruments. Some of these instruments
are described below
 Promissory Note: An instrument in writing containing an
unconditional promise signed by the maker to pay a certain sum
of money to the bearer of the instrument.

15.  Bill of exchange: An instrument in writing
containing an unconditional order signed by the
maker, directing the certain person to pay certain
some of money to the bearer of the instrument
 Commercial Paper
 Credit Card
 Cheque
 Travellers Cheque: A cheque issued to the
traveling public by a bank for a fixed amount without
requiring any letter of identification.

16. Financial Services:
Some of the prominent types of financial services are:
Mutual Funds
 A mutual fund is a fund established in the form of a trust by a sponsor to raise
money by the trustees through the sale of units to the public under one or more
schemes for investing in securities in accordance with the regulations.
 A mutual fund raises funds from the investors by offering various types of unit
schemes and invests the mobilized funds in eligible instruments and securities.
In a mutual fund the legal relationship between the investor and the mutual fund
is that of a trustee and beneficiary while in the case of a bank it is of a creditor
and debtor.
 Mutual Funds offer both open ended and close ended schemes.
Mutual funds offer the follow. benefits:
 Diversification of risks
 Liquidity
 Professional management
 Convenience
 Tax Benefits: Tax benefits are available under the Income Tax Act, Wealth Tax
Act etc.

17. Financial Services:
Venture Capital Funds:
 Venture capital funds provide commercial support to new ideas and for
the introduction and adoption of new technologies.
 Banks and financial institutions require a sizable equity contribution
from the promoter of a project.
 However technocrats and scientists who want to become entrepreneurs
cannot afford to provide such capital. It is the venture capital funds
which provide them the equity capital for such projects.
 However one must bear in mind that there is a high degree of risk
involved. In India, the VC funds are regulated under the SEBI
Regulations, 1996.
Merchant Banking:
 A financial institution that specializes in providing various financial
services such as accepting bills arising out of trade, underwriting new
issues and providing advice on mergers, acquisitions etc. Law now
requires that all public issues are managed by merchant bankers who
function as Lead Managers. They help the company in carrying out
functions relating to new issues such as determination of securities to
be issued, drafting of prospectus, application forms, allotment letter,
appointment of registrars etc.

18. Financial Services:
Factoring:
 Factoring is a continual financial arrangement under which a
financial institution undertakes the credit and collection functions for
its client, purchases his receivables as they arise, maintains the
sales ledger, and attends to other functions such as accounts
receivables. Factoring is of recent origin in India. Eg: Canbank
Factors Ltd. Etc.
 A financial institution (factor) buys the accounts receivable of a
company (Client) and pays up to 80%(rarely up to 90%) of the
amount immediately on agreement. Factoring company pays the
remaining amount (Balance 20%-finance cost-operating cost) to the
client when the customer pays the debt
Leasing:
 Leasing means an agreement between the leasing company (called
lessor) and the user (called lessee), under which the former
undertakes to buy the capital equipment for use by the latter. The
lessor remains the owner of the asset during the specified period .
The lessee has to pay the rentals to the lessor.

19. Financial Services:
Credit Rating:
 Credit rating by a competent and authorized agency provides a
bird’s view of the financial strength of the company and its securities
 Such an agency makes a systematic analysis of the strengths and
weaknesses of a company and its securities before assigning a
rating to it.
 This means a codified rating assigned to an issue of securities by an
authorized credit rating agency.
 Financial Institutions like IDBI, ICICI, UTI and commercial banks
have established credit rating agencies.
 Credit Rating and Information Services of India Ltd (CRISIL),
Investment Information and Credit Rating Agency of India Ltd
(ICRA) and Credit Analysis and Research Ltd. (CARE) are
prominent credit rating agencies in India.

20. Financial Institutions
The financial institutions maybe classified as:
Banking Institutions:
 A bank is an institution which deals in money and credit. It accepts deposits from
the public and lends to the borrowers. The Banking Regulation Act. 1949
defines banking as “the accepting, for the purpose of lending or investment, of
deposits of money from the public, repayable on demand or otherwise and
withdrawable by cheque, draft, order or otherwise”.
 Central Bank The Reserve Bank of India is the central bank of the country. It
supervises and regulates the entire banking system.
 Commercial Banks: They perform the usual banking functions of mobilizing
deposits and providing credit.
 Cooperative Banks: They are organized on the principles of cooperation to
encourage thrift and savings amongst members. They are usually formed by low
and middle income groups in urban and rural areas.
 Agricultural Banks: They provide financial assistance to farmers. Generally,
loans are provided against mortgage of agricultural land. Regional Rural Banks
were set up to provide credit and deposit facilities to farmers, agricultural labor
and small entrepreneurs in rural areas.
 Merchant Banks: These banks manage and underwrite new issues of
securities. They undertake credit syndication, advise companies on fund raising
and other financial matters etc.
 Indigenous Banks: In rural and semi urban areas, moneylenders carry on
banking business in a traditional manner and usually charge a high interest rate.

21. Non Banking Institutions/ Non
Banking Finance Companies:
 The NBFC raise deposits from the public by offering
attractive interest rates and other incentives and
thereafter advance loans to small scale industries,
traders and semi employed persons. NBFCs
generally provide unsecured loans and thereby
charge high interest rates. Besides giving loans,
they run chit funds, purchase and discount hundies
and undertake other financial activities like hire-
purchase and leasing.
 NBFCs are financial intermediaries engaged
primarily in the business of accepting public
deposits and making loans and advances. They
cannot accept demand deposits.

22. Non Banking Institutions/ Non
Banking Finance Companies
Merits:
 Relatively lower degree of regulation
 Simplified and speedy sanction and disbursement procedures.
 Orientation towards customers
 Attractive interest rates on deposits
 Flexibility and timeliness in meeting the credit needs of customers.
 Wide rage of financial services.
Demerits:
Risks are faced due to:
 Bulk of their loans are unsecured and are given to risky enterprises.
 The loans though given for short periods are often renewed.
 The same firm may borrow from more than one finance company
 The deposits made by the public with the NBFC are not protected by the
Deposit Insurance Corporation.

23. Types of NBFC
 Loan Companies: Lend money to companies and individuals. Eg:
Housing finance companies
 Investment Companies: These companies mobilize savings and invest
them in industrial securities. They provide the benefits of diversification
of risk and a steady return to investors. Eg: UTI, LIC
 Leasing Companies: They provide loans to small firms and individuals
who want to buy new machines and equipment.
 Chit Funds: Under this scheme the promoter collects subscriptions at
specified time periods from enrolled members and the amount so
collected if handed over to a member on rotation.
 Housing Finance Companies: HUDCO is a national level institution
which gives loans to individuals and societies for building houses and
flats

24. Objectives of Financial Institutions
1. To promote and develop new industries so as to fill gaps in the
industrial structure of the country.
2. To meet the growing needs of industries for long term finance
3. To help promotion of new enterprises by identifying and
formulating new projects, training and developing entrepreneurs,
streamlining the management of assisted industrial units.
4. To provide merchant banking facilities.
5. To mobilize public savings and accelerate the rate of capital
formation
6. To ensure balanced regional development
7. To develop a strong and healthy capital market
8. To assist in the modernization, expansion and diversification of
existing industries.
9. To encourage the growth of small scale industries and new and
technical entrepreneurs.
10. To optimize the use of scarce resources.

25. Industrial Finance Corporation of
India
The IFCI was established on July 1, 1948. It was jointly owned by the GOI,
the RBI and the financial institutions. In 1993, IFCI was converted into a
Public Limited Company to enable it reshape its business strategies
with greater authority, tap the capital market for funds, expand its equity
base and provide better customer services.
Objective:
 Making medium and long term credit available to industrial concerns.
 Assisting industrial concerns which have planned schemes for
manufacture of or modernization and expansion of a plant.
 Provide project finance, merchant banking, equipment leasing etc. and
promotional services.
 To give priority to development of backward areas, new entrepreneurs
and technocrats, indigenous technology, ancillary industries etc.
 Provide financial assistance to public companies and cooperative
sectors engaged in manufacturing, mining, shipping, hotel business etc.

26. Industrial Finance Corporation of
India
Functions, Scope:
 Granting loans and advance to or subscribing to debentures of industrial
concerns.
 Guaranteeing loans raised by industrial concerns from the capital
market.
 Providing guarantees for deferred payments for import of capital foods
manufactured in India.
 Guaranteeing with the approval of the GOI, loans raised from or credit
arrangements made by industrial concerns with any bank or financial
institution outside India.
 Underwriting the issue of shares and debentures by industrial concerns.
 Subscribing directly to the shares and debentures of industrial
concerns.
 Providing financial assistance on concessional terms for setting up
industrial projects in backward areas.
 Providing guidance in project planning and implementation through
specialized agencies like Technical Consultancy Organisation.
 The financial assistance is available for setting up new projects and for
the expansion, diversification and modernization of existing units.

27. Industrial Finance Corporation of
India
Before sanctioning assistance, IFCI evaluates the proposal in terms of:
 Importance of the industry in the national economy
 Feasibility and cost of the project
 Competence of the management
 Nature of the security offered
 Adequacy of supply of technical personnel and raw materials
 The country’s requirements of the product manufactured and its quantity.
IFCI has been criticized for the following reasons:
 Assistance sanctioned for new projects has been only about 20% of the
total assistance
 Equity finance has been very little as compared to debt finance
 Adequate focus has not been laid on backward regions and small scale
sector.
 Percentage share of infrastructure projects in the total loans outstanding
is about 13%
 There has been a sharp fall in the assistance provided in foreign
currency.
 Income of IFCI has fallen sharply
 Non performing assets of IFCI are very high of the total net assets. Its
capital adequacy ratio has fallen to less than one percent.

28. Industrial Credit and Investment
Corporation of India (ICICI Bank)
Was established in 1955 as a public limited company in the private sector.
ICICI set up the ICICI Bank in 2002. The ICICI Ltd was later merged
with its subsidiary the ICICI Bank ltd. ICICI Bank is now the second
largest commercial bank in India and the largest bank in the private
sector. It has assumed the role of a universal bank.
Objectives:
 Main aim was to promote industrial development in the private sector by
providing financial, technical, administrative and other services
 To assist in the promotion, expansion and modernization of industrial
enterprises in the private sector
 To encourage and promote the participation of private capital, both
Indian and foreign
 To stimulate the growth of private ownership of industrial investments
and expansion of investment markets.

29. Industrial Credit and Investment
Corporation of India (ICICI Bank)
Functions: ICICI provides assistance in the following ways
 Granting medium and long term rupee loans to industrial concerns
 Advancing loans in foreign countries towards the cost of imported capital
equipment.
 Providing guarantees to the loans raised by companies in the open market
 Sponsoring and underwriting new issues of industrial securities.
 Subscribing directly to shares and debentures of companies
 Making funds available for reinvestment by revolving investments as rapidly as
prudent
 Providing technical and managerial know how to industries.
 Encouraging the participation of private capital in industrial concerns
 Assisting industrial concerns in obtaining technical and administrative services
from internal and external sources
ICICI has played a vital role in the development of industries in the private sector
and in strengthening the capital market in the country. It has become the largest
supplier of foreign currency to private sector industries. It has also played a
leading role in the areas of venture capital. ICICI Bank Ltd. is listed on the New
York Stock Exchange. It launched infinity the first internet banking service in
India.

30. Industrial Development Bank
of India
 It started operations in 1964. IDBI represents an attempt to combine in
a single institution the requirements of an expanding economy and need
for a coordinated approach to industrial financing. In 1994 the Bank was
permitted to issue equity shares in the capital market. Majority of its
shares are still owned by the Government.
Objectives:
 To co-ordinate, regulate and supervise the activities of all financial
institutions providing long term finance to industry.
 To enlarge the usefulness of these institutions by supplementing their
resources and by widening the scope of their assistance
 Provide direct finance to industry to bridge the gap between demand
and supply of long term and medium term finance to industrial concerns
in both the public and private sectors
 Locate and fill up gaps in the industrial structure of the country
 Adopt and enforce a system of priorities so as to diversify and speed up
the process of industrial growth

31. Industrial Development Bank
of India
Functions:
 Subscribe to the shares and bonds of financial institutions
 Refinancing term loans and export credits extended by other financial
institutions
 Granting loans and advances directly to industrial concerns
 Guaranteeing deferred payments due from and loans raised by
industrial concerns
 Subscribing to and underwriting shares and debentures of industrial
concerns
 Accepting, discounting and rediscounting commercial bills or promissory
notes of industrial concerns
 Financing turnkey projects by Indians outside India
 Planning, promoting and developing industries to fill gaps in the
industrial structure of the country.
 Providing technical and managerial assistance for promotion and
expansion of industrial undertakings
 Coordinating and regulating the activities of other financial institutions.
On 30.12.2003, IDBI was converted into a banking company and IDBI
Bank Ltd and IDBI were merged together.

32. Small Industries Development
Bank of India (SIDBI)
Set up in 1990as a wholly owned subsidiary of IDBI. SIDBI took over the
outstanding portfolio of IDBI related to the small scale sector worth Rs.
4000 crores.
Objective:
 It was envisaged as the principal financial institution for the promotion,
financing and development of the industry in the small scale sector and
to coordinate the functions of other institutions engaged in similar
activities.
Functions:
 Refinancing loans and advances extended by primary lending
institutions to small scale industrial units
 Discounting and rediscounting bills in the small scale sector
 Extending need capital /soft loan assistance under the National Equity
Fund, Mahila Vikas Nidhi etc.
 Granting direct assistance and refinance for financing exports of
products manufactured in the small scale sector
 Providing financial support to NSIC (National Small Industries
Corporation) for providing leasing, and marketing support
 Providing services like leasing, factoring to industrial concerns in the
small scale sector.