Chapter: 2

Financial System

Sections
Functions of financial system
Financial assets
Financial market
Market returns
Financial intermediaries
Regulatory framework

funds
deposi
ts

Financial
intermediaries
Banks
Insurance
MF
NBFC

securities

funds

Demanders of
funds
Individuals
Businesses
Government

Supplier of
funds
Individuals
Businesses
Government
funds

loans

Financial
markets
Money mkt
Capital mkt

funds
securities

2.1 Functions of financial system

Pooling of funds
Transfer of resources
Risk management (hedge,
insurance, diversification)
Price information
Deal with incentive problems

2.2 Financial Assets

(1)Tangible Assets
Eg Real Assets
(2) Intangible Assets
Eg
()Bonds
()Debenture
()Loan
()Equity shares
()Call or put options

2.3 Financial Markets

Functions
Facilitate price discovery
Provide liquidity
Reduce cost of transaction

Classification of financial markets

(1)Nature of claim : Debt and Equity
(2)Maturity of claim: Money and
Capital
(3)Seasoning of claim: Primary and
Secondary
(4)Timing of Delivery: Cash/ spot and
Forward/future
(5)Organisation Structure: Exchange
traded and OTC market

2.4 Financial Market returns:

Interest rates
ROR on risky assets
Nominal and real rate
Factors affecting Returns:
Degree of uncertainty
Productivity of capital
Time preferences
Risk Capacity

2.5 Financial Intermediaries

Rationale or Advantages:
Diversification
Lower transaction cost
Economies of scale
Confidentiality
Signaling

Key Financial Intermediaries

(1)Commercial banks
()Public banks
()Private banks
()Foreign banks
(2) Financial Institutions
()IFCI, IDBI, ICICI
()SIDBI, NABARD, EXIM, SCICI, NHB, IDFC
(3) Insurance:
()Life and general insurance companies
()Public and private

(4) Mutual Funds

Asset Management Companies

(5) Non-banking Financial Companies
Sundaram finance
Dewan housing
Religare Finvest
Kotak Mahindra Finance
(6) Allied services
Credit rating
Merchant banker
Depositories

2.6 Regulatory Authorities

(1) Reserve Bank of India (RBI)
Central bank of India
Provide currency
Bankers bank
Supervise the credit institutes
Regulate foreign exchange
Promote development of new
institutions

(2) Securities Exchange Board of India

Regulate stock exchanges
Regulate securities market
Regulate capital market intermediaries
Register and regulate mutual fund
industry
Prohibit fraudulent and unfair trade
practices
provide investor education
Prohibit insider trading
Regulate acquisitions and mergers