INDIAN FINANCIAL SYSTEM

By: Dr. Silony Gupta

Assistant Professor, Department of MBA,
Quantum School of Management,
Roorkee, Uttarakhand

FINANCIAL SYSTEM

Financial system", implies a set of complex and

closely connected or interlined institutions, agents,
practices, markets, transactions, claims, and
liabilities in the economy.
is the system that allows the transfer of money
between savers (and investors) and borrowers.
is the set of Financial Intermediaries, Financial
Markets and Financial Assets.
helps in the formation of capital.
meets the short term and long term capital needs of
households, corporate houses, Govt. and foreigners.
its responsibility is to mobilize the savings in the form
of money and invest them in the productive manner.

FLOW OF FUNDS IN THE FINANCIAL

SYSTEM

FUNCTIONS OF THE FINANCIAL

SYSTEM

To link the savers & investors.

To inspire the operators to monitor the
performance of the investment.
To achieve optimum allocation of risk
bearing.
It makes available price - related
information.
It helps in promoting the process of financial
deepening and broadening

ORGANIZATION / STRUCTURE OF
FINANCIAL SYSTEM

FINANCIAL INTERMEDIARIES

Come in between the ultimate borrowers

and ultimate lenders
provide key financial services such as
merchant banking, leasing, credit rating,
factoring etc.
Services provided by them are:
Convenience( maturity and divisibility),
Lower Risk(diversification), Expert
Management and Economies of Scale.

TYPES OF FINANCIAL
INTERMEDIARIES

Financial
Intermediarie
s

Banks

NBFCs

Mutual Funds

Insurance
Organizations

TYPES OF FINANCIAL INTERMEDIARIES

1. COMMERCIAL BANKS

Collect savings primarily in the form of

deposits and traditionally finance working
capital requirement of corporates
With the emerging needs of economic and
financial system banks have entered in to:
Term lending business particularly in the
infrastructure sector,
Capital market directly and indirectly,
Retail finance such as housing finance,
consumer finance
Enlarged geographical and functional coverage

2. NON-BANKING FINANCE COMPANIES

(NBFC)

A Non-Banking Financial Company (NBFC) is a

company registered under the Companies Act,
1956 engaged in the business of loans and
advances, acquisition of shares/stocks/
bonds/debentures/securities issued by
Government or local authority or other
marketable securities of a like nature, leasing,
hire-purchase, insurance business, etc.
Provide variety of fund/asset-based and nonfund based/advisory services.
Their funds are raised in the form of public
deposits ranging between 1 to 7 years maturity.

Depending upon the nature and type of service

provided, they are categorised into:
Asset finance companies
Housing finance companies
Venture capital funds
Merchant banking organisations
Credit rating agencies
Factoring and forfaiting organisations
Housing finance companies
Stock brokering firms
Depositories

3. MUTUAL FUNDS

A mutual fund is a company that pools money from

many investors and invests in well diversified
portfolio of sound investment.
issues securities (units) to the investors (unit
holders) in accordance with the quantum of money
invested by them.
profit shared by the investors in proportion to their
investments.
set up in the form of trust and has a sponsor,
trustee, asset management company and custodian
advantages in terms of convenience, lower risk,
expert management and reduced transaction cost.

MUTUAL FUND OPERATION

FLOW CHART

4. INSURANCE ORGANIZATIONS

They invest the savings of their policy

holders in exchange promise them a
specified sum at a later stage or upon the
happening of a certain event.
Provide the combination of savings and
protection
Through the contractual payment of
premium creates the desire in people to
save.

FINANCIAL MARKET

It is a place where funds from surplus units

are transferred to deficit units.
It is a market for creation and exchange of
financial assets
They are not the source of finance but link
between savers and investors.
Corporations, financial institutions,
individuals and governments trade in
financial products on this market either
directly or indirectly.

COMPONENTS OF FINANCIAL
MARKET
Financial
Market

Money
Market

Capital/
Securities
Market

Primary
Market
Secondary/
Stock Market

MONEY MARKET
A market for dealing in monetary assets of short
term nature, less than one year.
enables raising up of short term funds for meeting
temporary shortage of fund and obligations and
temporary deployment of excess fund.
Major participant are: RBI and Commercial Banks
Major objectives:
equilibrium mechanism for evening out short term
surpluses and deficits
focal point for influencing liquidity in economy
access to users of short term funds at reasonable
cost

COMPONENTS OF MONEY
MARKET

Money
Market

Call
Market

T-bills
Market

Bills
Market

CP
Market

CD
Market

Repo
Market

CAPITAL MARKET

A market for long term funds

focus on financing of fixed investments
main participants are mutual funds, insurance
organizations, foreign institutional investors,
corporate and individuals.
two segments: Primary market and secondary
market

PRIMARY/NEW ISSUE MARKET

A market for new issues i.e. a market for

fresh capital.
provides the channel for sale of new
securities, not previously available.
provides opportunity to issuers of securities;
government as well as corporates.
to raise resources to meet their requirements
of investment and/or discharge some
obligation.
does not have any organizational setup
performs triple-service function: origination,
underwriting and distribution.

SECONDARY MARKET/
STOCK MARKET
A market for old/existing securities.
a place where buyers and sellers of securities can
enter into transactions to purchase and sell shares,
bonds, debentures etc.
enables corporates, entrepreneurs to raise
resources for their companies and business
ventures through public issues.
has physical existence
vital functions are:
nexus between savings and investments
liquidity to investors
continuous price formation

FINANCIAL INSTRUMENTS :
TRADED
IN
FINANCIAL
ASSETS/SECURITIES
OR INSTRUMENTS

THE COMMODITIES THAT ARE

MARKET
ARE
FINANCIAL

Financial
Instruments

Primary Securities

Indirect Securities

Derivatives

PRIMARY SECURITIES
Securities issued by the non-financial
economic units

Equity Shares: An equity share are the

ownership securities. They bear the risk and enjoy
the rewards of ownership.
Preference Shares: Holders enjoy preferential
right as to: (a) payment of dividend at a fixed rate
during the life time of the Company; and (b) the
return of capital on winding up of the Company
Debentures: An creditorship security. Holders
are entitled to predetermined interest and claim
on the assets of the company.

Innovative Debt instruments: A variety

of debt innovative instruments emerges
with the growth of financial system to make
them more attractive.
Participative Debentures: participate in
the excess profits of the company after the
payment of dividend.
Convertible debentures with options:
Third party convertible debentures:
entitle the holder to subscribe to the equity
of another firm at a preferential price.
Convertible debenture redeemable at
premium: issued at face value with option
to sell at premium.
Debt equity swap: offers to swap
debentures for equity.

 Warrants:

entitles the holder to purchase specified

number of shares at a stated price before a stated
date. Issued with shares or debentures.
Secured premium notes with detachable
warrants:
redeemable after lock-in period
warrants entitle the holder to receive shares after
the SPN is fully paid
no interest during lock-in period
option to sell back SPN to company at par after lockin.
no interest/ premium on redemption if option
exercised
right to receive principal+interest in instalments, in
case of redemption after expiry of the term
detachables required to be converted in to shares
within specified period.

 Non

-Convertible debenture with

detachable equity warrants: option to buy a
specified no. of share at a specified price and
time.
Zero interest Fully Convertible debentures:
carries no interest and convertible in to shares after
lock-in period.
Secured zero interest partly convertible
debentures with detachable and separately
tradable warrants:
Having two parts
Part A convertible at a fixed amount on the date of
allotment
Part B redeemable at par after specified period from
date of allotment.
Carries warrants of equity shares at a price to be
determined by company

Fully convertible debentures with

interest(optional):
No interest for short period
After that option to apply for equities at
premium without paying for premium.
Interest is made from first conversion
date to the second/final conversion date

INDIRECT SECURITIES/
FINANCIAL ASSETS:
Issued

by financial intermediaries.
such as units of mutual funds, policies of
insurance companies, deposits of banks,
etc.
Better suited to small investors
Benefits of pooling of funds by
intermediaries
Convenience, lower risk and expert
management.

DERIVATIVES
Derivative

is a product whose value is derived from

the value of one or more basic variables called base,
in a contractual manner
The underlying asset can be equity/forex or any
other assets.
The Securities Contracts (Regulation) Act, 1956
(SCIA) defined derivative to include1. A security derived from a debt instrument, share,
loan whether secured or unsecured, risk instrument
or contract for differences or any other form of
security.
2. A contract which derives its value from the prices,
or index of prices, of underlying securities.

Derivative
s
Forward
Contract

Indirect
Securities

Options

FORWARD CONTRACT

is a customized contract between two

entities, where settlement takes place on a
specific date in the future at today's preagreed price.

At the end offsetting is done by paying the

difference in the price.

FUTURE CONTRACT

is an agreement between two parties to buy

or sell an asset at a certain time in the
future at a certain price.

They are special types of forward contracts

which are standardized exchange-traded
contracts.

OPTIONS

Contracts that give the buyer the right to buy

or sell securities at a predetermined price
within/at the end of a specified period.
Two types - calls and puts.
Calls give the buyer the right but not the
obligation to buy a given quantity of the
underlying asset, at a given price on or before a
given future date.
Puts give the buyer the right, but not the
obligation to sell a given quantity of the
underlying asset at a given price on or before a
given date.