4. The Financial System in India
The economic development of any country depends upon
the existence of a well organized financial system.
It is the financial system which supplies the necessary
financial inputs for the production of goods and services
which in turn promote the well-being and standard of
living of the people of a country.
Thus, the ‘financial system’ is a broader term which brings
under its fold the financial markets and the financial
institutions which support the system.
5. The responsibility of the financial system is to
mobilize the savings in the form of money and
monetary assets and invest them to productive
ventures.
An efficient functioning of the financial system
facilitates the free flow of funds to more
productive activities and thus promotes
investment.
Thus, the financial system provides the
intermediation between savers and investors
and promotes faster economic development.
9. Provision of Liquidity
The major function of the financial system is the provision of
money and monetary assets for the production of goods and
services.
There should not be any shortage of money for productive
ventures. In financial language, the money and monetary assets
are referred to as liquidity.
The term liquidity refers to cash or money and other assets
which can be converted into cash readily without loss of value
and time.
10. Mobilisation of Savings
Another important activity of the financial system is to mobilize
savings and channelize them into productive activities.
The financial system should offer appropriate incentives to attract
savings and make them available for more productive ventures.
Thus, the financial system facilitates the transformation of savings
into investment and consumption.
The financial intermediaries have to play a dominant role in this
activity.
11. Size Transformation
Generally, the savings of millions of small investors are in
the nature of a small unit of capital which cannot find any
fruitful avenue for investment unless it is transformed into
a perceptible size of credit unit.
Banks and other financial intermediaries perform this size
transformation function by collecting deposits from a vast
majority of small customers and giving them as loan of a
sizeable quantity.
Thus, this size transformation function is considered to be
one of the very important functions of the financial system.
12. Maturity Transformation
The financial intermediaries accept deposits
from public in different maturities
according to their liquidity preference and
lend them to the borrowers in different
maturities according to their need and
promote the economic activities of a
country.
13. Risk Transformation
Most of the small investors are risk-averse with their small
holding of savings.
So, they hesitate to invest directly in stock market.
On the other hand, the financial intermediaries collect the
savings from individual savers and distribute them over different
investment units with their high knowledge and expertise.
Thus, the risks of individual investors get distributed.
This risk transformation function promotes industrial
development.
Moreover, various risk mitigating tools are available in the
financial system like hedging, insurance, use of derivatives, etc.
15. Generally speaking, there is no specific place
or location to indicate a financial market.
However, financial markets can be referred
to as those centers and arrangements which
facilitate buying and selling of financial
assets, claims and services.
Sometimes, we do find the existence of a
specific place or location for a financial
market as in the case of stock exchange.
16.
17. FINANCIAL INSTRUMENTS
Financial instruments refer to those documents which
represent financial claims on assets.
Financial asset refers to a claim to the repayment of
a certain sum of money at the end of a specified
period together with interest or dividend.
Examples: Bill of Exchange, Promissory Note,
Treasury Bill, Government Bond, Deposit Receipt,
Share, Debenture, etc.
18. Financial instruments can also be called financial securities.
Financial securities can be classified into:
(i) Primary or direct securities.
These are securities directly issued by the ultimate investors to the
ultimate savers,
e.g., shares and debentures issued directly to the public.
(i) Secondary or indirect securities.
These are securities issued by some intermediaries called financial
intermediaries to the ultimate savers, e.g., Unit Trust of India and
Mutual Funds issue securities in the form of units to the public
and the money pooled is invested in companies.
19. Again these securities may be classified on the basis of duration as
follows:
(i) Short-term securities.
Short-term securities are those which mature within a period of one
year, e.g., Bill of Exchange, Treasury Bill, etc.
(i) Medium-term securities.
Medium-term securities are those which have a maturity period
ranging between one to five years, e.g., Debentures maturing within a
period of five years.
(i) Long-term securities.
Long-term securities are those which have a maturity period of more
than five years, e.g., Government Bonds maturing after ten years.
20. Characteristic features of financial instruments
1. Most of the instruments can be easily transferred from one
hand to another without many cumbersome formalities.
2. They have a ready market, i.e., they can be bought and sold
frequently and thus, trading in these securities is made
possible.
3. They possess liquidity, i.e., some instruments can be
converted into cash readily. For instance, a bill of exchange
can be converted into cash readily by means of discounting
and rediscounting.
4. Most of the securities possess security value, i.e., they can be
given as security for the purpose of raising loans.
21. 5. Some securities enjoy tax status, i.e., investments in these securities
are exempted from Income Tax, Wealth Tax, etc., subject to certain
limits, e.g., Public Sector Tax Free Bonds, Magnum Tax Saving
Certificates.
6. They carry risk in the sense that there is uncertainty with regard to
payment of principal or interest or dividend as the case may be.
7. These instruments facilitate futures trading so as to cover risks due
to price fluctuations, interest rate fluctuations, etc.
8. These instruments involve less handling costs since expenses
involved in buying and selling these securities are generally much
less.
9. The return on these instruments is directly in proportion to the risk
undertaken.
10. These instruments may be short-term or medium-term or long-term
depending upon the maturity period of these instruments.
23. Reserve Bank of India
The origins of the Reserve Bank of India can be traced to 1926,
when the Royal Commission on Indian Currency and Finance – also
known as the Hilton-Young Commission – recommended the
creation of a central bank for India to separate the control of
currency and credit from the Government and to augment banking
facilities throughout the country.
The Reserve Bank of India Act of 1934 established the Reserve Bank
and set in motion a series of actions culminating in the start of
operations in 1935.
Since then, the Reserve Bank’s role and functions have undergone
numerous changes, as the nature of the Indian economy and
financial sector changed.
24. Functions of the Reserve Bank
The functions of the Reserve Bank today can be categorised
as follows:
1) Monetary policy.
2) Regulation and supervision of the banking and non-
banking financial institutions, including credit
information companies.
3) Regulation of money, forex and government securities
markets as also certain financial derivatives
4) Debt and cash management for Central and State
Governments
25. 5) Management of foreign exchange reserves.
6) Foreign exchange management—current and
capital account management
7) Banker to banks.
8) Banker to the Central and State Governments.
9) Oversight of the payment and settlement systems.
10) Currency management.
11) Developmental role.
12) Research and statistics
27. Securities and Exchange Board of India (SEBI)
was established by the Government of India
through an executive resolution in the year 1988.
And was subsequently upgraded as a fully
autonomous body (a statutory Board) on 12th of
April in 1992.
In the same year 1992 the Securities and
Exchange Board of India Act (SEBI Act) was
passed on 30th January 1992.
28. The Preamble of the Securities and
Exchange Board of India describes the
basic functions as
“…..to protect the interests of
investors in securities and to promote
the development of, and to regulate
the securities market and for matters
connected therewith or incidental
thereto”
29. Why was SEBI formed?
At the end of the 1970s and during 1980s, capital markets were
emerging as the new sensation among the individuals of India.
Many malpractices started taking place such as unofficial self-
styled merchant bankers, unofficial private placements, rigging of
prices, non-adherence of provisions of the Companies Act,
violation of rules and regulations of stock exchanges, delay in
delivery of shares, price rigging, etc.
Due to these malpractices, people started losing confidence in the
stock market. The government felt a sudden need to set up an
authority to regulate the working and reduce these malpractices.
As a result, the Government came up with the establishment of
SEBI.
30. Functions of SEBI
SEBI primarily has three functions
1. Protective Function
2. Regulatory Function
3. Development Function
31. Protective Functions
As the name suggests, these functions are performed by
SEBI to protect the interest of investors and other financial
participants.
It includes:
1. Checking price rigging
2. Prevent insider trading
3. Promote fair practices
4. Create awareness among investors
5. Prohibit fraudulent and unfair trade practices
32. Regulatory Functions
These functions are basically performed to keep a check on the
functioning of the business in the financial markets.
These functions include:
1. Designing guidelines and code of conduct for the proper functioning
of financial intermediaries and corporate.
2. Regulation of takeover of companies
3. Conducting inquiries and audit of exchanges
4. Registration of brokers, sub-brokers, merchant bankers etc.
5. Levying of fees
6. Performing and exercising powers
7. Register and regulate credit rating agency
33. Development Functions
SEBI performs certain development functions also
that include but they are not limited to
1. Imparting training to intermediaries
2. Promotion of fair trading and reduction of
malpractices
3. Carry out research work
4. Encouraging self-regulating organizations
5. Buy-sell mutual funds directly from AMC through
a broker
35. Global Financial Markets plying the significant
role in the development of Countries and
Corporate Houses.
It helps to raise money from global market at a
competitive rate and provide the investment
opportunities for developed countries.
It also provides the opportunity to operate
Globally to expand the business operations.
36. Following are some of the important
international financial markets:
Foreign exchange market
Eurocurrency market
Eurocredit market
Eurobond market
International stock markets.
38. Investors invest in foreign markets
•To take advantage of favorable economic
conditions.
•When they expect foreign currencies to appreciate
against their own
•To reap the benefits of international diversification.
39. Creditors provide credit in foreign markets
•To capitalize on higher foreign interest rates
•When they expect foreign currencies to
appreciate against their own
•To reap the benefits of international
diversification.
40. Borrowers borrow in foreign markets
•To capitalize on lower foreign interest
rates.
•When they expect foreign currencies
to depreciate against their own.
41. Topics Covered
•The Financial System in India
•Indian Financial Structure
•FUNCTIONS OF THE FINANCIAL SYSTEM
•FINANCIAL MARKETS
•FINANCIAL INSTRUMENTS
•Regulatory Institutions and Their Functions
RBI & SEBI
• Global Financial Markets
42. Important Questions
Long Answer Type Questions
1. Explain structure of financial market service in India.
2. What is financial service? Classification of financial
services.
3. Explain the structure and functions of Indian financial
system.
4. Briefly explain about global financial markets.
5. Explain Indian Financial System
43. Short Answer Type Questions
1.Financial Market
2.SEBI
3.Capital Market
4.Types of Financial Markets
5.RBI
