Introduction:

Economic growth and development of any country depends upon a well-knit financial system. Financial system comprises a set of sub-systems of financial institutions financial markets, financial instruments and services which help in the formation of capital. Financial system provides a mechanism by which savings are transformed into investments. It can be said that financial system plays a significant role in economic growth of the country by mobilizing surplus funds and utilizing them effectively for productive purpose.

Financial System

The word "system", in the term "financial system", implies a set of complex and closely connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities in the economy. The financial system is concerned about money, credit and finance-the three terms are intimately related yet are somewhat different from each other. Indian financial system consists of financial market, financial instruments and financial intermediation

Features of IFS Presence of integrated organized and regulated financial markets and institutions. Help to meet the short term and long term financial needs of both the household and corporate sector. It renders various financial services to the community. They operate in close combination with each other.

Role/ Functions of Financial System:

financial

system

performs

the

following

functions:

* It serves as a link between savers and investors. It helps in utilizing the mobilized savings of scattered savers in more efficient and effective manner. It channelizes flow of saving into productive investment.

* It assists in the selection of the projects to be financed and also reviews the performance of such projects periodically.

It

provides

payment

mechanism

for

exchange

of

goods

and

services.

* It provides a mechanism for the transfer of resources across geographic boundaries. * It provides a mechanism for managing and controlling the risk involved in mobilizing savings and allocating credit.

* It promotes the process of capital formation by bringing together the supply of saving and the demand for investible funds.

* It helps in lowering the cost of transaction and increase returns. Reduce cost motives people to save more.

* It provides you detailed information to the operators/ players in the market such as individuals, business houses, Governments etc.

Components/ Constituents of Indian Financial system:

The following are the four main components of Indian Financial system

1. Financial institutions 2. Financial Markets 3. Financial Instruments/Assets/Securities 4. Financial Services.

Financial institutions:

Financial institutions are the intermediaries who facilitates smooth functioning of the financial system by making investors and borrowers meet. They mobilize savings of the surplus units and allocate them in productive activities promising a better rate of return. Financial institutions also provide services to entities seeking advises on various issues ranging from restructuring to diversification plans. They provide whole range of services to the entities who want to raise funds from the markets elsewhere. Financial institutions act as financial intermediaries because they act as middlemen between savers and borrowers. Were these financial institutions may be of Banking or Non-Banking institutions.

Financial Markets:

Finance is a prerequisite for modern business and financial institutions play a vital role in economic system. It's through financial markets the financial system of an economy works. The main functions of financial markets are:

1. to facilitate creation and allocation of credit and liquidity; 2. to serve as intermediaries for mobilization of savings;

3. to assist process of balanced economic growth; 4. to provide financial convenience

Financial Instruments

Another important constituent of financial system is financial instruments. They represent a claim against the future income and wealth of others. It will be a claim against a person or an institutions, for the payment of the some of the money at a specified future date.

Financial Services:

Efficiency of emerging financial system largely depends upon the quality and variety of financial services provided by financial intermediaries. The term financial services can be defined as "activites, benefits and satisfaction connected with sale of money, that offers to users and customers, financial related value".

Deficiencies Until the early 1990s, the role of the financial system in India was primarily restricted to the function of channeling resources from the surplus to deficit sectors.

The banking sector suffered from lack of competition, low capital base, low Productivity and high intermediation cost. After the nationalization of large banks in 1969 and 1980, the Government-owned banks dominated the banking sector. The role of technology was minimal and the quality of service was not given adequate importance. Banks also did not follow proper risk management systems and the prudential standards were weak. All these resulted in poor asset quality and low profitability. In the insurance sector, there was little competition. The mutual fund industry also suffered from lack of competition and was dominated for long by one institution, viz., the Unit Trust of India. Non-banking financial companies (NBFCs) grew rapidly, but there was no regulation of their asset side. Financial markets were characterized by control over pricing of financial assets, barriers to entry, high transaction costs and restrictions on movement of funds/participants between the market segments.

REFORMS/ DEVELOPMENTS It was in this backdrop that wide-ranging financial sector reforms in India were introduced as an integral part of the economic reforms initiated in the early 1990s with a view to improving the macroeconomic performance of the economy. The reforms in the financial sector focused on creating efficient and stable financial institutions and markets. The Reserve Bank has been consistently working towards setting an enabling regulatory framework with prompt and effective supervision, development of technological and institutional infrastructure, as well as changing the interface with the market participants through a consultative process. The reform of the interest regime constitutes an integral part of the financial sector reform.

The interest rates offered on Government securities were progressively raised so that the Government borrowing could be carried out at market-related rates. Banks now have sufficient flexibility to decide their deposit and lending rate structures and manage their assets and liabilities accordingly. Indian banking system operated for a long time with high reserve requirements both in the form of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR).

Meaning of Bank Bank is a lawful organization, which accepts deposits that can be withdrawn on demand.

It also lends money to individuals and business houses that need it. Banks also render many other useful services like collection of bills, payment of foreign bills, safe-keeping of jewellery and other valuable items, certifying the credit-worthiness of business, and so on.

Banks accept deposits from the general public as well as from the business community.

Businessmen have income from sales out of which they have to make payment for expenses. They can keep their earnings from sales safely deposited in banks to meet their expenses from time to time. Banks give two assurances to the depositors a. Safety of deposit, and b. Withdrawal of deposit, whenever needed

Role of Banking Banks provide funds for business as well as personal needs of individuals. They play a significant role in the economy of a nation. Let us know about the role of banking. It encourages savings habit amongst people and thereby makes funds available for productive use.

 It acts as an intermediary between people having surplus money and those requiring money for various business activities. It facilitates business transactions through receipts and payments by cheques instead of currency. It provides loans and advances to businessmen for short term and long-term purposes. It also facilitates import export transactions. It helps in national development by providing credit to farmers, small-scale industries and self-employed people as well as to large business houses which lead to balanced economic development in the country. It helps in raising the standard of living of people in general by providing loans for purchase of consumer durable goods, houses, automobiles, etc.

Central Bank A bank which is entrusted with the functions of guiding and regulating the banking system of a Country is known as its Central bank. Such a bank does not deal with the general public. It acts Essentially as Governments banker, maintain deposit accounts of all other banks and advances money to other banks, when needed. The Central Bank provides guidance to other banks whenever they face any problem. It is therefore known as the bankers bank. The Central Bank maintains record of Government revenue and expenditure under various heads. It also advises the Government on monetary and credit policies and decides on the interest rates for bank deposits and bank loans. In addition, foreign exchange rates are also determined by the central bank. Another important function of the Central Bank is the issuance of currency notes, regulating their circulation in the country by different methods.

Commercial Banks Commercial Banks are banking institutions that accept deposits and grant short-term loans and advances to their customers. In addition to giving short-term loans, commercial banks also give

medium-term and long-term loan to business enterprises. Now-a-days some of the commercial banks are also providing housing loan on a long-term basis to individuals. There are also many other functions of commercial banks, which are discussed later in this lesson.

Types of Commercial banks: Commercial banks are of three types i.e., Public sector banks, Private sector banks and Foreign banks.

(i) Public Sector Banks: These are banks where majority stake is held by the Government of India or Reserve Bank of India. Examples of public sector banks are: State Bank of India, Corporation Bank, Bank of Boroda and Dena Bank, etc.

(ii) Private Sectors Banks: In case of private sector banks majority of share capital of the bank is held by private individuals. These banks are registered as companies with limited liability. For example: The Jammu and Kashmir Bank Ltd., Bank of Rajasthan Ltd., Development Credit Bank Ltd, Lord Krishna Bank Ltd., Bharat Overseas Bank Ltd., Global Trust Bank, Vysya Bank, etc.

(iii) Foreign Banks: These banks are registered and have their headquarters in a foreign country but operate their branches in our country. Some of the foreign banks operating in our country are Hong Kong and Shanghai Banking Corporation (HSBC), Citibank, American Express Bank, Standard & Chartered Bank, Grindlays Bank, etc. The number of foreign banks operating in our country has increased since the financial sector reforms of 1991.

Co-operative Banks People who come together to jointly serve their common interest often form a co-operative society under the Co-operative Societies Act. When a co-operative society engages itself in banking business it is called a Co-operative Bank. The society has to obtain a licence from the Reserve Bank of India before starting banking business. Any co-operative bank as a society is to function under the overall supervision of the Registrar, Co-operative Societies of the State. As regards banking business, the society must follow the guidelines set and issued by the Reserve Bank of India.

Types of Co-operative Banks There are three types of co-operative banks operating in our country. They are primary credit societies, central co-operative banks and state co-operative banks. These banks are organized at three levels, village or town level, district level and state level. (i) Primary Credit Societies: These are formed at the village or town level with borrower and non-borrower members residing in one locality. The operations of each society are restricted to a small area so that the members know each other and are able to watch over the activities of all members to prevent frauds. (ii) Central Co-operative Banks: These banks operate at the district level having some of the primary credit societies belonging to the same district as their members. These banks provide loans to their members (i.e., primary credit societies) and function as a link between the primary credit societies and state co-operative banks. (iii) State Co-operative Banks: These are the apex (highest level) co-operative banks in all the states of the country. They mobilize funds and help in its proper channelization among various sectors. The money reaches the individual borrowers from the state co-operative banks through the central co-operative banks and the primary credit societies.

Non-banking financial company

Non-bank financial companies (NBFCs) are financial institutions that provide banking services without meeting the legal definition of a bank, i.e. one that does not hold a banking license. These institutions are not allowed to take deposits from the public. All operations of these institutions are still exercised under bank regulation

Gradually, they are being recognized as complementary to the banking sector due to their customer-oriented services; simplified procedures; attractive rates of return on deposits; flexibility and timeliness in meeting the credit needs of specified sectors; etc. The working and operations of NBFCs are regulated by the Reserve Bank of India (RBI)within the framework of the Reserve Bank of India Act, 1934 (Chapter III B) and the directions issued by it under the Act.

As per the RBI Act, a 'non-banking financial company' is defined as:- (i) a financial institution which is a company; (ii) a non banking institution which is a company and which has as its principal business the receiving of deposits, under any scheme or arrangement or in any other manner, or lending in any manner; (iii) such other non-banking institution or class of such institutions, as the bank may, with the previous notification in the Official Gazette, specify. Under the Act, it is mandatory for a NBFC to get itself registered with the RBI as a deposit taking company. approval of the Central Government and by

The types of NBFCs registered with the RBI are:

Equipment leasing company:- is any financial institution whose principal business is that of leasing equipments or financing of such an activity.

Hire-purchase company:- is any financial intermediary whose principal business relates to hire purchase transactions or financing of such transactions.

Loan company:- means any financial institution whose principal business is that of providing finance, whether by making loans or advances or otherwise for any activity other than its own (excluding any equipment leasing or hire-purchase finance activity).

Investment company:- is any financial intermediary whose principal business is that of buying and selling of securities.

Now, these NBFCs have been reclassified into three categories:

Asset Finance Company (AFC)

Investment Company (IC) and

Loan Company (LC). Under this classification, 'AFC' is defined as a financial institution whose principal business is that of financing the physical assets which support various productive/economic activities in the country.

MUTUAL FUND

Mutual Funds Definition refers to the meaning of Mutual Fund, which is a fund, managed by an investment company with the financial objective of generating high Rate of Returns. These asset management or investment management companies collects money from the investors and invests those money in different Stocks, Bonds and other financial securities in a diversified manner.

Few Investment Types

There can be different type 1) Equity Oriented (High Risk, High return) : Go for this, if you can take high risk. This type of fund usually put your 100% money in Equity market, which is very much volatile

2) Hybrid/Balanced fund [Medium risk, Avg Return]: this type of fund invest your money in both Equity market and Govt Bonds in 50-50 ratio.

3) Bond MF [Low risk, Return greater than Bank Fixed deposit] : These funds put money in Govt bonds, RBI bonds etc, which are generally backed up for insured return.

Classification of Mutual Funds