Course code: 18JBS201

Name: Indian Financial System

and Financial Market

Credits:2
Evaluation pattern:

CE: Assignments, Quizzes, Presentations, Class tests

 a)      Recognize the initiatives in strengthening the
financial infrastructure by regulations

b)     Differentiate between banks and financial

Learning institutions

outcomes
c)     Demonstrate knowledge of  Financial Markets
and  services
 
  

Module 1: Over view of the Indian Financial System

Module 2: Financial Markets –I
Module 3: Financial Markets –II  
Course Module 4: Financial Services  

content Text Books:

and  LM Bhole, Jitendra Mahakud, (2015). Financial Institutions and Markets- Structure,
growth and Innovations.  McGraw Hill Education.
Recommend  Balaji Rao D G (2016), 'Financial Markets and Investment Instruments', Skyward
Publishing Co.

ed text Reference  Books:

books  M.Y.Khan, (2015). Financial services. McGraw Hill Education.

 NSE  module  on  Financial Markets-Beginner module

Websites:
 Ministry of Finance,  RBI, SEBI, NSE,BSE
 MONEYCONTROL.COM
  Module 1: Over view of the Indian Financial
System    

At the end of this module, student will be able to

Learning
Outcomes:  1a)  Analyse the role of financial markets in the process
of economic development.

Overview:  1b)  Evaluate the structure and growth of Indian

Indian Financial system

Financial  1c)  Examine the role of Regulatory and Promotional

System Institutions

 1d)  Recognise the initiatives in strengthening the

financial infrastructure by regulations
  Why do we study IFS ?
 Finance is the life blood of business.
 Some terms : Money, Credit, Finance
 Money: refers to medium of exchange or means of
payment.
 Credit: refers to debt/loan to be returned with interest.
 Finance: refers to monetary resource either debt or
Overview: equity.
 Finance as a function, refers to all below and more:
Indian  The management of money and credit and banking and
Financial investments
 To provide or raise the funds or capital for business
System (B/S)
 Public finance – refers to sources of raising revenue for
the activities and functions of a Government

 Managers need to know the context in which business

operates.
  What is the context?
 Financial System
 specifically here, Indian Financial system

 What is Financial system?

 A system that aims at providing regular, smooth, efficient and cost effective
linkage between Savers and Investors is known as a Financial system.
 It is the institutional framework existing in a country to enable financial
transactions
Overview:  Role/Importance/Functions of Financial System:

Indian Robinson, “The primary function is to provide link between savings and
investment for creation of wealth and permit portfolio adjustment in the
Financial composition of existing wealth”.
 Encourages savings by creating different investment opportunities for investors
System  Mobilization of financial surplus (savings) from surplus units and transferred to
deficit spenders, thus helps capital formation.
 Allocation of savings among alternative productive uses (LT/ST) and users, thus
contributing to economic development.
 Monitors corporate performance
 Provides liquidity
 Provides payment system for exchange of goods and services.
 Provides avenues for managing risks (insurance, derivatives)
 Provides information, helps decentralized decision making
 Reduces transaction costs.
Overview:
Indian
Financial
System
  Indian Financial system can be broadly classified into
organized (formal) and unorganized (informal) sector.

 Constituents of Financial system (FS):

Overview:  Financial System of any country comprises of :

Indian  1. Financial Markets

 (Primary and Secondary; Money market and Capital

Financial Market)
 2. Financial intermediaries/institutions

System  (Banking & non-Banking; Intermediaries and Non-

Intermediaries)
 3. Financial services
 (Insurance, Depository, Factoring, Credit rating)
 4. Financial assets/instruments, facilitating transfer of funds
 (shares, debentures, CDs, CPs)
  Key elements of a well-functioning Financial system:
 A strong legal and regulatory environment.(contracts)
 Stable money
 Sound public finances and public debt management (development)
 A central bank (supervises, regulates, MP- pace of growth, PD and
FEx)
 Sound banking system
 Information system
Overview:  Well-functioning securities market (exerts corporate control)

Indian  Financial system designs:

 Bank based (Japan, Germany)

Financial  Market based (US, UK, Singapore)

System  In India, banks have traditionally, been dominant entities of

financial intermediation.

 Stock markets in India have gained importance.

 Relative share of banks & FIs in the aggregate financial assets, which
was 75% in early 1980s has dropped to 64% appx since 1990s.
 Popularity of markets growing.
  Indian Financial System - Constituents
 1. Financial Markets
 Financial markets can be defined as the market in which
financial assets are created and transferred.
 They are a mechanism for exchange/trading of financial
Overview: products under a policy framework.
 Wherever a financial transaction has taken place, it is
deemed to have taken place in the financial market.
 They are all pervasive.
Indian  Participants:-
Financial  Borrowers (issuers of securities),
 lenders (buyers of securities) and
System  financial intermediaries
 Types of markets:
 Money market
 Capital market
 Foreign exchange market
 Credit Market
  A. Money market: It is a market for short-term financial assets and securities
which have a maturity period of up to one year.
 It is a wholesale debt market for low-risk, highly-liquid, short-term
instruments, ranging from a single day to a year.
 Functions:
 Provide a balancing mechanism to even out the demand for and supply of
short-term funds

Overview:
 Provide a focal point for central bank intervention for influencing liquidity and
interest rate level in the economy.
 Provide reasonable access to suppliers and users of short-term funds to fulfil
their requirements at an efficient market clearing price.
 A well-functioning money market helps development of market for longer-term

Indian securities.
 The interest rate of this market serve as benchmark for longer-term instruments.

Financial  Benefits:
 Stable source of funds to banks

System 

Facilitates government borrowing
Makes effective Monetary policy
 Helps in pricing of different floating interest instruments.
 Participants:
 Dominated by Government, banks, FIs
 Segments in Money Market: Primary and Secondary
 Financial instruments in Money market:
 T-bills, Call/ Notice money, CPs, CDs, CBLOs
  B. Capital market: This is a market for financial assets which have long maturity,
generally above one year.
 It is designed to finance long term investments.
 It is a market for both equity and debt and funds raised within and outside the
country.
 Functions:
 Mobilise long-term savings to finance long-term investments.
 Provide risk capital in the form of equity to entrepreneurs.
 Provide liquidity enabling investors to sell financial assets.

Overview:  Improve efficiency of capital allocation through competitive pricing and dissemination of
information to participants.

Indian  Provide insurance against market risk through derivative trading and default risk
through investment protection fund.

Financial  Importance/Benefits:
 Serves as an important source for the productive use of economy’s savings.

System 

Provides incentives to saving and facilitates capital formation.
Provides liquidity and marketability to investors through trading in financial assets
 Enables price discovery.
 Important source of risk capital for new technology businesses.
 Reduces cost of capital.
 Participants:
 Individuals, corporates, banks and other financial intermediaries, government
 Segments: Primary , Secondary, Derivatives.
 Financial instruments:
 Equity shares, Preference shares, Debentures, Bonds, Forwards, Futures, Options, Swaps
  C. Forex Market: The forex market deals with multi-
currency requirements which are met by exchange of
currencies.
 RBI’s designated authorized dealers who operate in
Overview: forex.

Indian  Helps international trade and business.

 Participants – Importers, exporters, Individuals, Banks
Financial and FIs
 Instruments– Cash, Spot, Forwards
System
 D. Credit market: Where Banks, FIs and NBFCs
provide short, medium and long term loans to
corporate and individuals.
Overview:

Indian Pension
fund

Financial
System

PFR
  2. Financial Institutions(Intermediaries): Financial institutions are
organisations that act as mobilisers and depositories of savings
and as purveyors of credit or finance.
 Classification:
 Regulatory Institutions and Others
 Banking, Non-Banking, Insurance, Mutual Funds
 Functions/Importance:
Overview:  They perform the vital role of bringing together economic agents with
surplus funds, who want to lend and those with shortage of funds,
who want to borrow.- Indirect finance
 In doing so, FIs provide 4 transformation services:
Indian  Liability-asset: Issue claims to customer (for deposits) that have
different characteristics from those of their owns assets i..e, loans
Financial extended to borrowers.
 Size transformation :Pooling small deposits to provide large loans
System  Maturity transformation :Accepting deposits that are tailor made for
savers and providing term loans suitable for borrowers, matching the
cash flows
 Risk transformation :Reducing risk involved in direct lending by
acquiring diversified portfolio
 FIs - Important because of the otherwise, huge transaction costs and
asymmetric information.
 Besides providing loans, FIs provide merchant banking, underwriting
and issuing guarantees.
 Classification of Financial Intermediaries(Institutions):
 I) Regulatory: RBI, SEBI, IRDA, RERA; II)Non-regulatory – all
other banks & FIs

 I) Banking Institution: The banking system in India consists of

the RBI, commercial and co-operative banks.

Overview:  Essential characteristics as per Banking regulation Act,1949

 They accept deposits from public
 Repayable on demand or otherwise
 Withdrawable by means of instruments like cheque etc.
Indian  For purpose of lending or investment
 These function under license, under the direct control of RBI
Financial  Creators and providers of credit

System 

They form part of RBI’s clearing system
Ancillary functions (transfer of funds, collection, foreign exchange,
lockers, merchant banking)
 Classification :
 A) Commercial banks: Further classified as Public sector, Private sector,
Foreign banks, RRBs.
 B) Co-operative banks : Further classified into Rural co-operative and
Urban co-operative banks
  Sources and Application of funds -Banks:
 Sources:
 Deposits from customers
 Share capital
Overview: 

Reserves and surplus
Borrowings from other banks, FIs and RBI
 Market borrowing in India and abroad.
 Uses:
Indian  Cash and balances with RBI

Financial 

Money at call
Advances

System 

Overdrafts
Bill discounting
 Investments in securities (Bonds/Debentures, units of MFs,
 II) Non-Banking Institutions:
 A) Financial Institutions: Also called Developmental Financial institutions, most
of them set up in planning era by Government and RBI.
 The concept of development banks in post- independence era, when need for
speedy industrial development was focus.
 India has a network of Developmental Financial Institutions (also specialised
institution) at national and state levels.
 They don’t accept deposits from publics, Not part of Payments and settlement
system of RBI

Overview:
 Functions
 To address specific purpose of bridging gap in supply of long-term funds for fixed
capital formation. Eg: EXIM bank, NABARD, NHB, SIDBI
 They provide wide range of fund-based and non-fund-based assistance to business
sector like foreign currency loans, guaranteeing loans and deferred payments, re-

Indian discounting, venture capital etc.

 Sources and Application of funds of DFIs:

Financial  Sources:
 Share capital
System  Reserves and surplus
 Borrowings from RBI, Other FIs
 Market borrowing in India and abroad.
 Uses:
 Term loan (10-12 years)
 Equipment leasing (5-8 years)
 Re-financing of industrial loans
 Resource support/ sponsors to other FIs
 Re- discounting of bills out of sale of indigenous machinery.
 B) NBFCs : These are companies registered under Companies Act engaged in
the business of accepting deposits and delivering credit.
 loans and advances, acquisition of stocks, or other marketable securities,
leasing, hire-purchase, chit business but does not include any institution,
whose principal business is that of agriculture or industrial activity, purchase
/ sales of any goods, or construction sale of immovable property.
 They cannot accept demand deposits.

Overview:  No SLR, CRR.

 They don’t form part of Payment and settlement system and cannot issue
cheques drawn on itself.
 Deposit insurance facility of Deposit Insurance and Credit Guarantee

Indian corporation (DICGC) is not available to depositors of NBFCs, unlike banks.

 Functions:
Financial  They supplement the banking sector in providing finance to corporate sector
and delivering credit to small borrowers.

System  They are more flexible than banks – assume greater risks, quick decisions
and tailor made services
 Sources of funds:
 Public deposits
 Equity and surpluses
 Borrowings – Debenture.
 Application:
 Hire-purchase
 Equipment leasing
 Loans
  III) Mutual Funds: A mutual fund is a financial intermediary that pools the
savings of investors for collective investment in a diversified portfolio of
securities.
 The sponsor, MF trust and AMC are involved in setting up the fund.
 Registered under SEBI.
 They provide:
 Benefits of professional management
 Portfolio diversification
Overview: 

Reduction in transaction cost
Liquidity
 Tax benefits
 Stability to stock market
Indian  MF schemes can be divided into 1. Open-ended and 2. Closed-ended. Further
equity, debt, balanced, gilt, money market, index funds.
Financial  MFs are not free from risks

System  NAV= Market price of all securities+ Other assets- Liabilities/No. of units
outstanding as on NAV date.
 Sources of funds:
 Sale of units / subscription to Open/ closed ended funds
 Share capital
 Reserves
 Uses:
 Investment in Securities
 Money market instruments
 Privately placed debentures
 Gold or gold related instruments
 IV) Insurance and Housing Finance companies:
 Insurance is described as device to reduce or eliminate
risk of loss to life and property.
 It is a contract between Two parties – Insurer and the
insured
 Insurer undertakes to pay a fixed amount on happening
of a particular even, which may be certain or uncertain.
 The insured, in exchange, pays a sum known as premium
 The instrument/ document is the Policy.
 Types- Life and General insurance
 IRDA is the regulatory body
 Functions :
 Protects entrepreneurs against risk of damage to assets
 Life insurance provides economic safety.
 Premium collected invested in Govt. bonds, corporate
securities, thus helping capital formation.
  3. Financial instruments:
 Based on ownership: Equity and Debt instruments
 Based on time: Short, Medium and Long run
 Based on type of market : Primary securities and
Overview: secondary

 4. Financial services:
Indian  Merchant Banking
 Underwriting
Financial  Portfolio management
System 

Forfaiting
Factoring
 Credit rating
 Leasing and hire purchase
 Depositories and Custodial