Introduction to Financial System

Finance is also referred to as Funds or Capital.

We distinguish between 'personal finance" and "corporate finance" i.e.
resources needed personally by an individual for his family and individual
needs and resources needed by a business organization to carry on its
functions intended for the achievement of its corporate goals.
Financial System
A financial system or financial sector functions as an intermediary and
facilitates the flow of funds from the areas of surplus to the deficit. It is a
composition of various institutions, markets, regulations and laws, money
manager analyst, transactions and claims and liabilities.
Components of Financial System
The financial system consists of four segments or components. These are:
Financial Institutions, Financial Markets and Financial Instruments.
1. Financial institutions: Financial institutions are intermediaries that
mobilize savings & facilitate the allocation of funds in an efficient manner.
Financial institutions can be classified as banking & non-banking
financial institutions.
A Bank is an organization that accepts customer cash deposits and then
provides financial services like bank accounts, loans, share trading
account, mutual funds, etc.
A NBFC (Non Banking Financial Company) is an organization that does
not accept customer cash deposits but provides all financial services
except bank accounts.
NBFC were created by the government of India as it felt the need to provide
banking facilities to the poor and underprivileged who could not get access to
banks. NBFC is required to be registered under the Companies Act 1956 to be
able to perform functions similar to a bank. Normally, a NBFC is engaged in
the business of loans and advances, acquisition of shares, debentures, stocks,
bonds and securities issued by the government. It also indulges in insurance
and chit business.
In India, non-banking financial institutions, namely, the Industrial
Development Bank of India (IDBI), HDFC, Small Industries Development Bank

of India (SIDBI) & Industrial Investment Bank of India (IIBI) & Micro Finance
Institutions like REPCO, Shri Ram Capital Ltd., Murugappa Holdings Ltd, etc.
2. Financial markets:
A Financial Market is a market for creation and exchange of financial assets. If
you buy or sell financial assets, you will participate in financial markets in
some way or the other.
The main organized financial markets in India are the Money market &
Capital market.
Money Market is a market for dealing with financial assets & securities which
have a maturity period of up to one year.
Capital Market is a market for long term securities, that is, securities having a
maturity period of one year or more. The capital market is a market for
financial assets which have a long or indefinite maturity.
Money market consists of Call Money, Commercial Bills and
Treasury Bills etc.
Capital market consists of Equity, Debentures and Bonds. It is a
market where industrial concerns raise their capital or debt by
issuing appropriate instruments.
Debenture: A debenture is an unsecured bond. Most bonds issued by
corporations are debentures, which are backed by their reputation rather than
by any collateral, such as the company's buildings or its inventory.
Although debentures sound riskier than secured bonds, they are not issued by
well-established companies with good credit ratings.
Bonds: Bonds, however, in India are typically issued by financial institutions,
government undertakings and large companies. The interest rate is assured
and is paid at a fixed interval, i.e. on an annual or semi-annual basis. On
maturity, the principal is repaid.
Bond is a form of loan. The holder of the bond is the lender and the issuer of
the bond is the borrower. In todays scenario, you see many government
undertakings and companies issuing bonds. These are done to fund their longterm capital expenditure needs. The Government raising the same that helps in
funding its current expenditure.
Capital Market can be further subdivided into Primary & Secondary Market.

Securities issued by a company for the first time are offered to the public in the primary
market. Once the IPO is done and the stock is listed, they are traded in the secondary market.
The main difference between the two is that in the primary market, an investor gets securities
directly from the company through IPOs, while in the secondary market, one purchases
securities from other investors willing to sell the same.
The selling process of new issues in primary market is called as Underwriting and this process is
done by a group of people called underwriters or security dealers.
Once issued the securities typically trade on a secondary market such as a stock exchange.
Financial Instruments:
Characteristic Features of Financial Instruments
i. Most of the instruments can be easily transferred from one hand to
another without many burdensome formalities.
ii. They have a ready market, i.e., they can be bought and sold frequently
and thus, trading in stocks possess liquidity, i.e., ease of converted
into cash readily.
iii. Some securities enjoy tax status, i.e., investment in these securities
are exempted from income tax, subject to certain limits. E.g. Public
Sector Tax Free Bonds, Insurance Bonds, Magnum Tax Saving
Certificates.
iv. They carry risk in the sense that there is uncertainty with regard to
the payment of interest or dividend as the case may be.
v. Financial instruments involve less handling costs since expenses
involved in buying and selling these securities are generally much less.
vi. The return on the financial instruments is directly in proportion to the
risk undertaken.
Call Money (STCI Finance Limited)
Call money market is a market for extremely short period loans say 1 day to 14
days. It is highly liquid.
The Call/Notice/Term money market is a market for trading very short term
liquid financial assets that are readily convertible into cash at low cost.

The money market primarily facilitates lending and borrowing of funds between
banks and entities like Primary Dealers. An institution which has surplus
funds may lend them on an uncollateralized basis to an institution which is
short of funds.
The period of lending may be for a period of 1 day which is known as call
money and between 2 days and 14 days which is known as notice money.
Term money refers to borrowing/lending of funds for a period exceeding 14
days. The interest rates on such funds depend on the surplus funds available
with lenders and the demand for the same which remains volatile.
This market is governed by the Reserve Bank of India which issues guidelines
for the various participants in the call/notice money market. The entities
permitted to participate both as lender and borrower in the call/notice money
market are Scheduled Commercial Banks (excluding RRBs), Co-operative
Banks other than Land Development Banks and Primary Dealers.
Commercial Bill
Commercial Paper (CP) is an unsecured money market instrument issued in the form of a
promissory note. It was introduced in India in 1990 with a view to enabling highly rated
corporate borrowers/ to diversify their sources of short-term borrowings and to provide an
additional instrument to investors.
Commercial Paper can be issued for a maturity for a minimum of 15 days and a maximum upto
one year from the date of issue.
A promissory note is a legal instrument (more particularly, a financial instrument), in which one
party (the maker or issuer) promises in writing to pay a determinate sum of money to the other
(the payee), either at a fixed or determinable future time or on demand of the payee, under
specific terms.
Treasury Bill
It is a market for treasury bills which have short-term maturity. A treasury bill
is a finance bill issued by the Government. 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 rate to the face value, and on maturity the face
value is paid to the holder.
It is highly liquid because its repayment is guaranteed by the Government.

Corporate Securities
It is a market for industrial securities namely equity shares & debentures or
bonds. It is a market where industrial concerns raise their capital or debt by
issuing appropriate instruments.
Gilt-Edged securities
It is otherwise called Gilt-Edged securities market. It is a market where
government securities are traded. In India there are many kinds of govt
securities- short-term & long-term. Long-term securities are traded in this
market while short term securities are traded in the money market.
Certificate of Deposit
Certificate of Deposit is a money market instrument issued in dematerialized
form by scheduled commercial banks excluding Regional Rural Banks (RRBs)
and local Area Banks (LABs) and has been permitted by RBI to raise short-term
resources.
CDs can range from 7 days to 1 year, however most CDs are issued by banks
for 3, 6 and 12 months.
CDs can be issued to individuals (other than minors), corporations, companies,
trusts, funds, associations, etc.
The minimum amount of a CD should be Rs. 1 lakh i.e., the minimum deposit
that can be accepted from a single subscriber should not be less than Rs 1
lakh and in multiples of Rs 1 lakh thereafter.