Structure Of Indian Financial System

Financial System
1] Meaning.
Financial System is a set of complex and closely inter-mixed wi
th financial institutions, market, instruments, services, practices and procedur
e. A well developed financial system facilitates the normal production process a
nd exchange of goods and to enlarge market over space and time. Currency and exc
hange form an essential part of any financial system. The financial of any count
ry consist of specialized and non-specialized financial institution. The financi
al institutions are divided into banking and non-banking institution.
The Financial System is an organization which provides people wi
th adequate supply of finance or money. In other word finance is the back bone o
f any economy. No economy can take place without money. In any economy in a give
n period of time there are some people whose current expenditure is less than th
eir current income. There are some people whose current expenditure is not more
than current income. The first category is called Ultimate Savers and the second
category of people is called as Ultimate Investors.
The function of a financial system is to establish a bridge betw
een the savers and investors and there by helps the mobilization of saving. The
money can be borrowed from the financial system when there is a shortage of mone
y in the banks and other financial inter mediatory. Commercial banks, mutual fun
ds, Insurance companies, provident fund and non-banking financial companies are
the important financial inter mediatory.

2] Classification of Financial Institution.

1.Banking and Non-Banking institutions:
=> According to one classification, financial institution are divid
ed into the banking and non-Banking ones. The banking institution have quite a f
ew things in common with the non-banking ones, but their distinguishing characte
r lies in the fact that, unlike other institutions; a] they participate the econ
omy’s payments mechanism, i.e., they provide transactions services, b] their depos
it liabilities constitute a major part of the national money supply, and c] they
can, as a whole, create deposits or credit, which is money. banks, subjects to
legal reserve requirements, can advance credit by creating claims against themse
lves, while other institutions can lend only out of resources put at characteriz
ing the former as “creators” of credit, and the latter as mere “purveyors” of Sayers whi
le the banking system in India comprises the commercial banks and co-operative b
anks, the examples of non-banking financial institutions are Life Insurance Corp
oration(LIC).Unit Trust Of India(UTI),and Industrial Development Banks Of India
(IDBI).
2. Intermediaries and non- Intermediaries:
=> The financial institution are also classified as intermediaries an
d non- Intermediaries. As the term indicates, Intermediaries intermediate betwee
n savers and investors; they lend money as well as mobilize savings; their liabi
lities are towards the ultimate savers, while their assets are from the investor
s or borrowers. Non- Intermediary institutions are intermediaries. Many non-bank
ing institutions also act as Intermediaries and when they do so they are known a
s non-banking financial institutions like (NBFI).The UTI, LIC and GIC are some o
f the NBFIs in India. The non- Intermediary institutions like IDBI,IFC, and NABA
RD poses, sectors, and regions; their creation as a matter of policy has been mo
tivated by the philosophy that the credit needs of certain borrowers might not b
e otherwise adequately met by the usual private institutions. Since they have be
en set up the government, we would call them non-late, taken place in the nature
 of NBSFOs.
3. Financial Markets:
=> Financial markets are the centres or arrangements they provide fac
ilitates for buying and selling of financial claims and services. The corporatio
ns, financial institutions, individuals, and governments trade in financial prod
ucts on these markets either directly or through broker and dealers on organized
exchanges or off-exchanges. The participants on the demand and supply sides of
these markets are financial institutions, agents, brokers, borrowers, lenders, s
avers and others who are inter-linked by the laws, contracts, convenants, and co
mmunication networks.
4. Classification of Financial Markets:
=> (A) Primary and Secondary Markets: Financial markets are sometimes
classified as primary (direct) and secondary (indirect) markets. The primary ma
rkets deal in the new financial claims or new securities and, therefore they are
also known as the new issue markets. On the other hand, secondary markets deal
in securities already issued or existing or outstanding. The primary markets mob
ilise savings and they supply fresh or additional capital to business units. Alt
hough secondary markets do not contribute directly to the supply of additional c
apital, they do so indirectly by rendering securities issued on the primary mark
ets liquid. Stock markets have both the primary and secondary market segments.
(B) Money and Capital Markets: Very often the financial markets
are classified as money markets and capital markets, although there is no essent
ial difference between the two because both perform the same function of transfe
rring resources to the producers. This conventional distinction is based on the
differences in the period of maturity of financial assets issued in these market
s. While the money markets deal in the short-term claims (with a period of matur
ity of one year or loss), the capital markets does so in the long-term (maturity
period above 1 year) claims. Contrary to the popular usage, the capital market
is co-extensive not only with the stock markets; it is much wider than the stock
market. Similarly, it is not always possible to include a given participant onl
y in either of the two (money and capital) markets. Commercial banks, for exampl
e, belong to both. While treasury bills market, call money market, and commercia
l bills market are example of the money markets, stock markets and government bo
nds market are the example of the capital market. Equity market, debt market, an
d derivatives market can be said to be the parts of capital markets.
Keeping in view different purposes, financial have also been cla
ssified into the following categories: (a) organized and unorganized, (b) formal
and informal, (c) official and parallel, and (d) domestic and foreign. There is
no precise connotation with which the words unorganized and informal are used i
n this context. They are quite often used interchangeably. The financial transac
tions take place outside the well-established exchanges or without systematic an
d orderly structure or arrangements constitute unorganized markets. They general
ly refer to the markets in villages or rural areas, but they exist in urban area
s also. Interbank money markets and most foreign exchange markets do not have or
ganized exchanges. But they are not unorganized markets in the same way the rura
l markets are. The informal markets are said to usually involve families and sma
ll groups of individuals lending and borrowing from each other. This description
cannot be strictly applied to the foreign exchange markets, but they are also m
ostly informal markets.

5. Financial Instruments and Services:

=> As mentioned earlier, financial system deals in financial services
and claims or financial assets or securities or financial instruments. These ser
vices and claims are many and varied in character. This is to financial system c
an often be judged from the diversity of financial instruments that exist in the
system. It is not possible here to discuss individually the nature of various f
inancial claims that exist in the Indian Financial System. We will tackle that t
ask later, and meanwhile we will just touch upon the general characteristics of
these claims.
6. Financial Asset:
=> The financial asset represents a claim to the payment of a sum of m
oney sometimes in future (repayment of principal) and/or a periodic (regular or
not so regular) payment in the form of interest or dividend. With regard to bank
deposit or government bond or industrial debenture, the holder receives both th
e regular periodic payments are received (which are regular in the case of perpe
tual bond but may be irregular in the case of ordinary share).
7. Financial Securities:
=> Financial securities are classified as primary (direct) and secondary
(indirect) securities. The primary securities are issued by the secondary secur
ities are issued by the financial intermediaries to the ultimate savers as, bank
deposits, units, insurance policies, and so on. For the purpose of certain type’s
analysis, it is also useful to talk about ownership securities (viz. shares) an
d debt securities (viz. debentures, deposits).
Financial instruments differ from each other in respect of their
investment characteristics which, of course, are interdependent and interrelate
d. Among the investment characteristics of financial assets or financial product
s, the followings are important: (i) liquidity, (ii) marketability, (iii) revers
ibility, (v) transaction costs, (vi) risks of default or the degree of capital a
nd income uncertainity, and a wide array of other risks, (vii) maturity period,
(viii) tax status, (ix) options such as, call-back option. (x) voluntility of pr
ices, and (xi) the rate of return—nominal, effective, and real.

Bank
1] Meaning & Definition of bank.
A bank is an institution which deals in money. It means that
a bank receives money in the form of deposits from the public and lends money fo
r the development of trade and commerce. Several economists have defined the ter
m ‘banking’ in various ways. Crowther in his book ‘an outline of money ‘says that the pr
esent day banker has three ancestors: merchant, money lender and goldsmith. A mo
dern bank is something of each of these. It is round that it can circulate. The
progeny of the money lender are concerned with flat money savings. The progeny o
f the goldsmith are concerned with round money, circulating money-cash. This def
inition shows the origin of modern banking.
Prof.Hart says that banker is one who in the ordinary course of
his business receives money which he repays by honouring the cheques of persons
from whom or on whose account he receives it.
Prof.Kinley defines a bank as an establishment which makes to ind
ividuals such advances of money as may be required and safely made and to which
individuals entrust money which it is not required by them for use.
The Indian companies Act defines the term bank as “The accepting fo
r the purpose of lending or investment of deposits of money from the public, rep
ayable on demand or otherwise and withdraw able by cheque, draft, order or other
wise.”
If we closely examine the above definitions, we come to the conc
lusion that a bank performs two important functions. One is accepting the deposi
ts; the other is lending the deposits to the needy people. The purpose of accept
ing the deposits is lend. If an institution performs these two functions only, t
hen it cannot be called a bank. For example, the ‘sahukars’ in India perform these t
wo functions, yet they are not called bankers. They are simply called money lend
ers. As such, as suitable definition of a bank should include one more very impo
rtant function, namely, creation of credit. Accordingly, Bank is defined as an i
nstitution which deals with money and credit. Thus, a bank borrows money, lends
money and credit. In other words, the bank buys credit from its customers and se
lls its own credit to them.
The bank creates credit when it lends to its customers. These loa
ns later result in the creation of deposits and these deposits create the credit
of the depositors. When a depositor draws a cheque on a bank, then the credit o
f the customers is converted into the credit of the bank. Thus, the credit is tr
ansferred through the medium of loans. In these days, credit business is one of
the specialties of the bank. The acceptance of deposits and lending money to the
customers are performed by sahukars as well. But there is a difference between
sahukar and the bank. Thus , every bank performs the function of a sahukar , but
every sahukar cannot perform all the functions of the bank .Therefore , what pr
ofessor sayers says is very appropriate that banks are not merely traders in mo
ney but also important generators of money.

2] Classification of banks.
Banks are classified into several types based on the function th
ey perform. General, the banks are classified into: (i) Commercial banks, (ii) I
nvestment or industrial banks, (iii) Exchange banks, (iv)Co-operative banks, (v)
Land development banks, (vi) Saving banks and (vii) Central banks.
(i) Commercial Banks: Commercial banks perform all the business transaction of a
typical bank. Commercial banks accept there types of deposits-the savings bank
deposits, fixed deposits and current deposit or on short notice. As such, they l
end or invest only for short durations. They provide funds only for short-term n
eeds of trade and commerce. The commercial banks render an important service by
providing to its customers a simple means of exchange called cheques. The cheque
is considered as the most developed type of credit instrument.
(ii) Investment or industrial banks: Investment banks are those banks which prov
ide funds on long –term for industries, the investment banks are also called indus
trial banks. These banks have specialized in providing long term loans to indust
ries with a view to buy plant and machinery. The investment banks obtain funds t
hrough share capital, debentures and long-term deposits from the public. The ind
ustrial or investment banks float bonds for the sake of mobilizing funds to prov
ide funds for big industrial corporations. This type of specialized banking inst
itutions are found in some developing countries and in more developed countries
like Japan.
(iii) Exchange banks: Exchange banks are known as foreign banks or foreign excha
nge banks which provide foreign exchange for import trade. Their main function i
s to make international payment through the purchase and sale of exchange bills.
They convert home currency into foreign currency and vice versa. They discount
foreign exchange bills which are used in foreign trade. The foreign exchange ban
ks function like commercial banks, accepting deposits and lending funds for inve
stment.
(iv) Co-operative banks: Co-operative banks are promoted to meet the banking req
uirements of consumers not only in urban areas but also in the rural areas. The
co-operative banks function like commercial banks receiving deposits and lending
money. In the rural areas, these banks supply finance to agriculture, while in
the urban areas they provide finance to buy consumer goods. They provide short a
nd medium-term loans. They are formed on the co-operative principles and as such
they are more service-oriented than profit-oriented. The cooperative banks prov
ide credit at lower rates of interest to people of small means, like small culti
vators and articians, peety shopkeepers, etc.They provide crop loans to agricul
turists, in order to purchase seeds, fertilizers, etc.They also arrange for ware
housing, grading and marketing.
(v) Land development banks: In the case of co-operative banks, loans are provide
d for small duration only. Whenever agriculturists require investment loans, the
y have to approach land development banks, where the loans are given on long-ter
m basis. Land development banks provide long-term loans on the security of the l
and to initiate permanent improvements on the land and to buy agriculture machin
eries.
The Central Land Mortgage Banks raise resource by means of sellin
g debentures in the money market. Generally, these debentures are bought by big
Commercial Banks and the central Bank. The government may also stand as security
the debentures. In India the land development banks function on co-operative pr
inciples. In western countries, they function as co-operative as well as investm
ent banks.
(vi) Saving banks: Saving banks are specialized financial institutions establish
ed to mobilize savings from the people. Generally they pool the savings of the s
mall incomes of the community. The ordinary object of the commercial banks is o
promote thrift among the low and middle income groups. The banks also offer inte
rest on these deposits. The depositors are allowed to withdraw from their accoun
ts as and when necessary. The savings banks accounts have been provided by all c
ommercial and co-operative banks. The post offices also run savings banks all ov
er the country. On accounts of various facilities like frequent withdrawals, att
ractive rates of interest, the use of cheques etc., business has become more pro
minent than other forms of accounts.
(vii) Central banks: Central banks are an apex bank in the country, which brings
the entire banking system unified, controlled and regulated. In fact the centra
l bank is the main source of an efficient banking system in the country. These b
anks are responsible for monetary stability in the country. Central banking is a
t specialist monitory system under which all other banking institutions have to
function. It regulates the note issue. The expansion and contraction of note iss
ue are managed by the central Bank. Every country has a central bank. It is call
ed Reserve Bank of India, while it is Bank of England in Great Britain. It contr
ols credit creation by the commercial banks. It functions as a Banker to the gov
ernment and commercial banks. The banking system in the country cannot function
without the guidance of the central bank. Thus the bank holds importance in the
economic system of a country.

3] Function Of Bank.
Professor Sayers in his book ‘Modern Banking’ has described the funct
ions of a modern bank in the following words: “Ordinary banking business consists
of changing cash from bank deposits and bank deposits for cash, transferring ban
k deposits from one person to another and giving bank deposits in exchange of bi
lls of exchange, government bonds, the secured promises of businessmen to repay
and so forth.” These functions are dealt in details below:
A] Accepting deposits from the public:
=> Accepting various types of deposits is an important function of t
he commercial banks. Those who have cash balances want to keep them in a safe pl
ace, i.e., deposit the same with a bank. Commercial banks not only protect the c
ash of the customers, but also provide a convenient method of transferring funds
through the use of cheques. When the bank accepts deposits from people, it is o
bligated to repay the money either in part or in full in legal tender money. The
 bank accepts three types of deposits from all types of income earners. They are
:
(i) Fixed Deposits (ii) Saving Deposits (iii) Current Deposits.
(i) Fixed Deposits:- A fixed deposits is one where a customer keeps a certain am
ount of money in a bank for a specified period. It may be six months, one year,
two years, three years or five years. The fixed deposits carry higher rates of i
nterest than that allowed to savings deposits. The fixed deposits are not accept
ed to be withdrawn before the expiry of the period. The rate of interest varies
with the period-the longer the period the higher is the rate of interest is and
vice versa. In India, it varies from 8% to 10%.Fixed deposits are liked by both
depositors and customers. The depositors are given full security for his amount
by the bank.
(ii) Savings Deposits:- Savings deposits are those on which the bank pays a cert
ain rate of interest to the depositor’s subject on to certain conditions. A person
can open the amount with a small amount and go on depositing any amount. The cu
stomers are expected to maintain a minimum balance in the account. There are cer
tain restrictions with regard to withdrawals. The banks fix the maximum number o
f withdrawals in a year. Withdrawals can be made either withdrawals slip or cheq
ues. The banks attract deposits from huge deposits from savings bank account and
provide funds for the development of trade and commerce. These banks render ver
y useful service to the nation by mobilizing resources through savings bank acco
unts.
(iii) Current Deposits:- Current Deposits are those deposits which can be withdr
awn at any time by means of cheques. The pay into not pay interest on current ac
count deposits. A customer who opens a current account has to maintain a minimum
credit balance of Rs.500.At the same time, current account holders have to pay
service charges for operating the account. Any amount may be deposited in this a
ccount. There are no restrictions for withdrawals. Generally traders and busines
smen keep their money with the bank under current accounts. The current deposits
are also called demand deposits.
B] Making Loans and Advances.
=> Banks receive deposits with a view to lend. Providing loans and adva
nces out of the money which the bank receives by way of deposits is the second m
ajor function of commercial banks. They provide different types of loans. The di
fferent types of loans given by the banks are direct loans, cash credits, bills
discounted and overdrafts etc.An overdraft is an arrangement where the customer
is allowed to overdraw from his account. It is done through discounting bills of
exchange. The business community in India prefers cash credit loans to discount
ing the bills of exchange. Thus, banks working as the middleman mobilize the sav
ings from the public and provide them to the traders and industrialists for deve
lopment of the nations.
C] Agency Service.
=> Apart from these major functions, commercial banks perform other us
eful functions to society. They are the following:
The commercial banks have developed and popularized the cheque sy
stem through which transfer of money is made passible.The cheque system has redu
ced the use of money is made possible. The cheque system is a highly developed s
ystem of credit instrument through which money can be transferred from one count
ry to another. The banks perform miscellaneous functions such as undertaking the
payment subscriptions, insurance premium, rent, etc.On behalf of the customers
and collecting cheques, bills salaries, pensions, dividends, interests, etc., be
longing to customers are credited to the respective accounts of the customers. T
he banker acts as a trustee, executor, administrator and an attorney. As a trust
ee, the bank looks after the funds of the customers. All these services are call
ed agency functions.
D] General Utility Services.
=> The commercial banks render a good number of useful services known
as general utility services. The general utility services include the safe-keep
ing of valuables and documents, the issue of credit instruments for easy transfe
r of funds, collection of credit information regarding the customers, transactio
n in foreign exchange and provision of specialized advisory services to the cust
omers. The banks provide safe deposit lockers to the customers to keep their sec
urities, jewellery, documents of title to goods, etc.The customers are required
to pay an annual rent for this purpose. The banks also help the importers by acc
epting the bills drawn by foreign exporters.
A very useful service rendered to the customers by the bank is t
hat of remitting the funds from one place to another in the form of drafts, lett
ers of draft, credit notes and travellors cheques, etc.

Banking
1]Meaning & Definition of Banking.
A banking company is defined as a company which transacts the
business of banking in India. The Banking Regulation Act defines the business o
f banking by stating the essential function s of a banker. It also states the va
rious other businesses to be performed by it.
The term ‘Banking’ is defined as “accepting for the purpose of lending
or investment of deposits of money from the public, repay- order or otherwise”
A banking company must perform both of the essential function, v
iz., (a) accepting of deposits, and (b) lending or investing the same. If the pu
rpose of accepting of deposits is not to lend or invest, the business will not b
e called banking business. The word ‘public’ implies that a banker accepts deposits
from anyone who offers his/her money for such purpose.
The definition also specifies the time and mode of withdrawal of t
he deposits. The depositor’s money should be repayable to the depositors on demand
made by the latter or according to the agreement reached between the two partie
s. The essential feature of banking business is that the two bankers does not re
fund the money on his own accord, even if the period for which it was deposited
expires. The depositors must make a demand for the same.