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Financial system

Overview
The financial system is a link between the savers (savings – surplus
economic units) and the investors (savings – deficit economic units). It is
made up of all those channels through which savings become available for
investment.

FUNCTIONS
 Collection of SAVINGS & Distribution for INDUSTRIAL
INVESTMENT.
 Stimulating CAPITAL FORMATION & ACCELERATING THE
ECONNOMIC GROWTH

STRUCTURES
 Regulatory Bodies (RBI/SEBI/IRDA/PFRDA)
 Financial Intermediaries
 Financial Markets
 Financial Assets / Instruments
Process of Capital Formation
 Savings: The ability by which resources are set aside and
become available for other purpose.

 Finance: The activity by which claims to resources are


either assemble from those released by domestic savings,
obtained from abroad, or specially created usually as bank
deposits or notes and then placed in the hands of the investor.

 Investments: The activity by which resources are actually


committed to production.
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Indian financial system – an overview
What they do Who They Are
Financial (a) Collect Savings Banks, NBFC, MF
Intermediaries (b) ) Issue claim against themselves insurance
(c) Use Funds, thus raised, to purchase organizations etc.
ownership or debt-claims
Financial Markets (a) Not a Source of funds Call Market, T-Bill
(b) Act as a facilitating organisation and link Market, CP-Market,
saver & investor Repo market, CD
(c) Based on nature of work they are market
classified as (1) Money Market (2)
Capital/Security market
Financial (a) Financial Product – innovation Shares, Debt
Asset/Instrument/ (b) Three broad categories (1) Instrument,
security Direct/Primary e.g. Share, Debt., Debentures etc.
Pref. Share etc.
(2) Indirect MF, Security Receipts,
Securitized Debt Investment.
(3) Derivatives Forward, Future,
Options.
Financial intermediaries
Services provided by financial
intermediaries
 Convenience: convert securities into more convenient
vehicle for the mobilization of savings
 Divisibility: securities of various sizes
 Maturity
 Lower risk: benefit of diversification
 Expert management
 Economies of scale: channel funds from the ultimate lenders
to the ultimate borrowers at a lower cost
Types
 Commercial banks: collect savings in the form of deposits and
traditionally finance working capital requirements of corporates
 Other activities:
1. Term lending
2. Capital market directly / indirectly
3. Retail finance
 Non Banking Financial Companies (NBFCs):
 Provide fund / asset based and non fund based / advisory services
 Categories:
 Asset finance companies
 Housing finance companies
 Venture capital funds
 Credit rating agencies
Types
 Mutual funds:
 Pools savings of relatively small investors an a well diversified
portfolio of sound investment
 Insurance organizations:
 Invest the savings of their policyholders (insurance premium)
and in exchange promise them and/or beneficiaries a specified
sum at a later stage (on maturity of insurance policy) or upon
happening of a certain event (i.e. death of the policyholder)
 Motives:
1. Emergency fund to guard against financial misfortune
2. Build up a potential family estate, in case head of a family is removed by
death
3. Assist in the accumulation of fund by the time of retirement
Financial Markets
Facilitating organisations in the saving – investment process
Classification
 Money market
 Capital / security market
Money market
 Deals in monetary assets of short term nature (generally < 1
year): source of working capital finance
 Major participants: RBI and commercial banks
 Objectives:
 Balance out short term surpluses and deficiencies
 Focal point of RBI for influencing liquidity in the economy
 Reasonable access to users of short term funds to meet their
requirement at a reasonable cost/price.
 Sub-markets:
 T-bill market
 CPs market
 CDs market etc……
Capital market
 Market for long term funds – finance fixed assets
 Main participants: mutual funds, insurance organisations,
FIIs, corporates etc.
 Segments:
1. New issue market (NIM) / primary market
2. Secondary stock market / exchange (SE)
New issue market / primary market
 Securities which are not available previously and are offered
first time to the investors
 Capital formation occurs: as it supplies funds directly to
corporates
 No organizational set up located in particular place, only
specialist institutional services
 Triple service function:
1. Origination: investigation, analysis, processing new proposals
2. Underwriting: guarantee that the issue will be sold
irrespective of public response
3. Distribution: of securities to investors
Secondary stock market / exchange
 For old existing securities
 Provides indirect role in industrial financing by providing
liquidity to investments already made
 Functions:
1. Nexus between savings and investments
2. Liquidity to investors by offering a place for transaction of
securities
3. Continuous price formation
Financial assets / instruments
(securities)
Introduction
 Represent claim on a stream of income and/or assets of
another economic unit
 Promote financial product innovation
 Categories:
 Direct / primary securities
 Indirect securities
 Derivatives
Direct / primary securities
 Issued by non-financial economic units
 Types:
1. Ordinary equity shares
2. Preference shares
3. Debentures / bonds including innovative debt instruments
1. Participating debentures
2. Convertible debentures
3. Debt equity swaps etc…
Indirect securities
 Coined from underlying primary security
 Attractiveness:
 Pooling of funds by Financial Intermediary adds to efficiency
and effectiveness
 Variety of services provided by intermediary
 Lower risk
 Expert management
 E.g.
 Mutual funds
 Policies issued by insurance companies
 Securitised debt instruments
Derivatives
 Forward contract
 Future contract
 Options
 ------------------------Presentation