Financial System

Module I
Financial System

Financial systemis the system that allows the transfer ofmoneybetween

savers (andinvestors) andborrowers.A financial system can operate on a
global, regional or firm specific level.

They Channel Household savings to the corporate sector and allocate

investment funds amongst firms.
Simple Financial System Financial
Markets

Surplus units Deficit Units

Financial
[ Lenders / [ Borrowers /
Savers ] System Spenders ]

Financial
Intermediaries
Functions and role of financial system
Pooling of funds
In a financial system, the Savings of people are transferred from households to
business organizations.
Capital formation
Business requires finance. These are made available through banks, households and
different financial institutions. The pooled savings leads to Capital Formation.
Facilities payment
The financial system offers convenient modes of payment for goods and services.
New methods of payments like credit cards, debit cards, cheques, etc. facilitates
quick and easy transactions.
Provides Liquidity
In financial system, liquidity means the ability to convert into cash. The financial
market provides the investors the opportunity to liquidate their investments, which
are in instruments like shares, debentures, bonds, etc.
Functions and role of financial system
Short and Long term needs
The financial market takes into account the various needs of different individuals
and organizations. This facilitates the short term and long term needs.

Risk Function
The financial markets provide protection against life, health and income risks. Risk
Management is an essential component of a growing economy.

Better Decisions
Financial Markets provide information about the market and various financial
assets. This helps the investors to compare different investment options and choose
the best one.

Finances Government Needs

Government needs huge amount of money for the development infrastructure.
Constituents

Financial Institutions
Financial Markets
Financial Instruments
Financial Services
1. Financial Institutions:

A financial institution is an establishment that conducts financial transactions

such as investments, loans and deposits.

Everything from depositing money to taking out loans and exchanging

currencies is done through financial institutions.
Some of the major categories of
financial institutions:
Commercial Banks
Investment Banks
Insurance Companies
Brokerages
Investment Companies
Commercial Banks

Acommercial bankis a type ofbankthat provides services such as accepting

deposits, making business loans, and offering basic investment products.

Commercial banks accept deposits and provide security and convenience to

their customers. Part of the original purpose of banks was to offer customers
safe keeping for their money.

Commercial banks also provide loans to individuals and businesses which they
use to buy goods/assets or to expand business operations.

Examples: IDBI, BOI, Axis, HDFC, Union Bank of India, etc.

Investment Banks

An investment bank is a financial intermediary that performs a variety of

services. These services include
Underwriting debt and equity offerings.
Making markets, facilitating mergers and acquisitions.

Examples of Investment Banks: JP Morgan Chase, Morgan Stanley, Citi Group,

Barclays Investment Bank, Deutsche Bank, Credit Suisse, etc.
Insurance Companies:

Insurance companies pool risk by collecting premiums from a large group of

people who want to protect themselves and/or their loved ones or the
properties against a particular loss, such as a fire, road accident, illness,
disability or death.

Insurance helps individuals and companies manage risk and preserve wealth.
By insuring a large number of people, insurance companies can operate
profitably and at the same time pay for claims that may arise.

Example: LIC, Tata AIG, Bajaj Alliance, and many more

Brokerages and Investment Companies

A broker acts as an intermediary between buyers and sellers to facilitate

securities transactions. Brokerage companies are compensated via
commission after the transaction has been successfully completed.
Example: ShareKhan, ICICI Direct, Indiabulls Ventures, etc.

An investment company is a corporation or a trust through which individuals

invest in diversified, professionally managed portfolios of securities by
pooling their funds with those of other investors.
Example: Goldman Sachs Group, Inc., L&T Mutual Fund, Infrastructure
Development Finance Company Ltd. (IDFC LTD), etc.
2. Financial Markets

A financial market is a broad term describing any marketplace where buyers

and sellers participate in the trade of assets such as equity, derivatives,
currencies and bonds.
 Different Types of Financial Markets

Capital Market:
Capital Market is a place where long term securities such as equity and bonds are
traded.
Capital Market consists of primary market and secondary market. In primary market
newly issued bonds and stocks are exchanged and in secondary market buying and
selling of already existing bonds and stocks take place.

So, the Capital Market can be divided into Bond Market and Stock Market.
Bond Market provides financing by bond issuance and bond trading.
Stock Market provides financing by shares or stock issuance and by share trading.

As a whole, Capital Market facilitates raising of capital.

Different Types of Financial Markets
Money Market:
A money market is a market for borrowing and lending of short-term funds. It deals
in funds and financial instruments having a maturity period of one day to one year.

Derivatives Market:
Derivatives market provides instruments which help in controlling financial risk.

Foreign Exchange Market:

Foreign Exchange market facilitates the foreign exchange trading.

Insurance Market:
Insurance market helps in relocation of various risks.

Commodities Market:
Commodity market organizes trading of commodities.
3. Financial Instruments

Capital Market
Stocks
Bond

Money Market
Treasury Bills
Commercial Papers
Certificate of Deposits
Commercial Bills
4. Financial services

Servicesandproductsprovided toconsumersand businesses byfinancial

institutionssuch asbanks,insurance companies,brokerage firms,consumer
finance companies, andinvestment companiesall of which comprise the
financial servicesindustry.

Example: Borrowing & Lending of funds, Wealth Management, Investments,

Tax Consulting, Auditing, etc.
Thank you!