Indian Financial System:
Banking Awareness Notes
The ‘Indian Financial System’ is an important
topic in the general awareness section of banking exams. In this blog post, we
bring to you everything you need to know about the financial system in India.
What is a financial system?
While performing economic activities some
units (such as shops, companies etc.) will be placed in surplus/deficit/balanced
budgetary situations.
A financial system or financial sector
functions as an intermediary and facilitates the flow of funds from the areas
of surplus to the areas of deficit. A Financial System is a composition
of various institutions, markets, regulations and laws, practices, money
manager, analysts, transactions and claims and liabilities.
In other terms,
A financial system helps in wealth creation by
linking savings with investments. It facilitates the flow of funds from the
households (savers) to business firms (investors) and thus aids the development
of both sides.
The financial system is mostly concerned about
money, credit and finance – these terms are related but differ from each other
as well. The Indian financial system primarily consists of the
following:-
- Financial Services
- Financial Assets/Instruments
- Financial Markets
- Financial Intermediaries
The following sections discuss each of these
in detail.
Financial
Services
These refer to the activities concerning the
design and delivery of financial instruments to individuals and businesses
within the area of banking and related institutions, personal financial
planning, leasing, investment, assets, insurance etc. These include:-
- Operations & services provided by the banks
- Currency exchange, foreign exchange banking or the wire transfer
- Asset management, hedge fund management and the custody services
- Selling insurance policies, brokerages, insurance underwriting or
the reinsurance
Financial
Markets
It is defined as the market in which financial
assets are created or transferred. Financial markets can be categorized as
follows:-
1. Money
Market– It is defined
as the market for short-term money and financial assets that are near
substitutes for money. The term short-term means generally a period upto one
year and near substitutes to money is used to denote any financial asset which
can be quickly converted into money with minimum transaction cost. It can be
sub-categorized as follows:-
- Unorganized
Market: money lenders, chit funds etc.
- Organized
Money Market: Instruments include: treasury bills,
commercial papers, certificate of deposit etc. Organized Markets work as
per the rules and regulations of RBI. RBI controls the Organized Financial
Market in India.
2.
Capital Market – The capital market is designed to finance the
long-term investments. The transactions taking place in this market will
be for periods over a year. It can be classified into three groups:-
- Corporate
Securities Market: Corporate securities are equity and
preference shares, debentures and bonds of companies. The corporate
security market is a very sensitive and active market. It can be divided
into two groups: primary and secondary.
- Government
Securities Market: In this market government
securities are bought and sold. The securities are issued in the form of
bonds and credit notes. The buyers of such securities are Banks, Insurance
Companies, Provident funds, RBI and Individuals.
- Long-Term
Loans Market: Banks and Financial institutions
that provide long-term loans to firms for modernization, expansion and
diversification of business. It is further categorized into: Term Loans
Market, Mortgages Market and Financial Guarantees Market
3. Forex
Market – The
Forex market deals with the multi-currency requirements, which are met by the
exchange of currencies. Depending on the exchange rate that is
applicable, the transfer of funds takes place in this market. This is one
of the most developed and integrated market across the globe.
4.
Credit Market– Credit
market is a place where banks, FIs and NBFCs purvey short, medium and long-term
loans to corporate and individuals.
Financial
Assets / Instruments
Financial Assets or Financial Instruments
represents a claim to the payment of a sum of money sometime in the future and
/or periodic payment in the form of interest or dividend.
A financial transaction involves creation or
transfer of a financial asset (as against a real transaction that involves
exchange of money for real goods or services).
Some important financial assets / instruments
are briefly discussed below :-
1. Call
/Notice-Money Market
- It’s money borrowed or lent on demand for a very short period.
- Thus money borrowed on a day and repaid on the next working day is
called call money.
- When money is borrowed or lent for more than a day and up to 14 days
it is called notice money.
- No collateral is required to cover these transactions.
2.
Inter-Bank Term Money
Deposits with maturity period beyond 14 days
is referred as the term money. The entry restrictions are the same as that of
Call/Notice Money. However, lending beyond 14 days is not allowed.
3.
Treasury Bills
These are short term (up to one year)
borrowing instruments of the union government. It is an IOU by the Government
(i.e. a promise by the Government to pay a sum of money after expiry of the
stated period in less than one year). They are issued at a discount to the face
value, and on maturity the face value is paid to the holder. The rate of
discount and the corresponding issue price are determined at each auction.
4.
Certificate of Deposits
It is a negotiable money market instrument and
is issued in a de-materialized form or as a Promissory Note, for funds
deposited at a bank or other eligible financial institution for a specified
time period.
These can be issued by:-
(i) Scheduled commercial banks excluding
Regional Rural Banks (RRBs) and Local Area Banks (LABs)
(ii) Select pan India financial institutions
that have been permitted by RBI to raise short-term resources within the fixed
limit.
(iii) Banks have the freedom to issue CoDs depending
on their requirements.
5.
Commercial Paper
CP is a note in evidence of the debt
obligation of the issuer. It is thus an unsecured promissory note privately
placed with investors at a discount rate to face value determined by market
forces. A company shall be eligible to issue CP provided-
(i) the tangible net worth of the company is
not less than Rs. 4 crores
(ii) the working capital (fund-based) limit of
the company from the banking system is not less than Rs.4 crore and
(iii) the borrowal account of the company is
classified as a Standard Asset by the financing bank/s.
The minimum maturity period of a commercial
paper is 7 days.
Capital Market Instruments
It consists of the following long term period
(i.e. more than one year period) financial instruments:-
- Equity shares, preference shares, convertible preference shares,
non-convertible preference shares etc
- Zero coupon bonds, deep discount bonds etc.
Financial
Intermediation
The role of the financial intermediary is to
distribute funds from people who have extra inflow of money to those who don’t
have enough money to fulfill the needs.
The best example of an intermediary is a bank
which transforms the bank deposits to bank loans.
Some of the important intermediaries operating
in the financial markets include: investment bankers, underwriters, stock
exchanges, registrars, depositories, custodians, portfolio managers, mutual
funds, financial advertisers financial consultants, primary dealers, satellite
dealers, self-regulatory organizations, etc.
Intermediary
|
Market
|
Role
|
Stock Exchange
|
Capital Market
|
Secondary Market to
securities
|
Investment Bankers
|
Capital Market, Credit Market
|
Corporate advisory
services, Issue of securities
|
Underwriters
|
Capital Market, Money Market
|
Subscribe to unsubscribed
portion of securities
|
Registrars, Depositories,
Custodians
|
Capital Market
|
Issue securities to the
investors on behalf of the company and handle share transfer activity
|
Primary Dealers Satellite
Dealers
|
Money Market
|
Market making in government
securities
|
Forex Dealers
|
Forex Market
|
Ensure exchange ink
currencies
|
