INDIAN FINANCIAL SYSTEM

The

economic development of any country depends upon the existence of a well organized financial system. It is the financial system which supplies the necessary financial inputs for the production of goods and services which in turn promote the well being and standard of living of the people of a country.

Financial System The financial system is a broader term which brings under its fold the financial markets and the financial institution which support the system. The major assets traded in the financial system are money and monetary assets.

Financial System

Definition-A set of institutions, instruments and markets which promote savings and channel them to their most efficient use.

Funds

Financial Institutions
Commercial Banks Insurance Companies

Funds

Deposits/Shares

Loans agreement

Mutual Funds Provident Funds Non Banking Financial Companies

Suppliers of Funds
Individuals

Funds

Demanders of Funds

Businesses
Governments

Private Placement

Individuals Securities

Businesses
Governments

Financial Markets
Funds Securities Money Market/ Capital Markets Funds Securities

Importance of Financial System

Mobilize the savings Facilitates the free flow of funds

Provides the intermediation

Components / Organization of financial system

a. Financial assets b. Financial intermediaries c. Financial markets d. Financial instruments

Financial Instruments & Assets

It

refers to those documents which represent financial claim on assets; for ex. Bills of exchange, Promissory notes, Shares, Debentures

 Financial

assets: the basic product of any financial system is the financial assets. A financial asset is one, which is used for production or consumption or for further creation of assets

FINANCIAL INTERMEDIARIES

Financial

intermediaries are firms that provide services and products that customers may not be able to get more efficiently by them in financial markets.

FINANCIAL MARKETS

financial market is a market for creation and exchange of financial assets. If you buy or sell financial assets, you will participate in financial markets in some way or the other.

Functional of Financial Markets Financial markets facilitate price discovery Financial markets provide liquidity to financial assets Financial markets considerably reduce the cost of transacting

Main Classification of Financial Market

Financial markets can be referred to those centers and arrangement which facilitate buying and selling of financial assets and services. There are mainly two types of Financial Capital Unorganized Markets. Organized Markets

Organized markets

These organized markets can be further classified into two they are: Capital Market Money Market

Capital Market

Capital market may be defined as a market for borrowing and lending long-term capital funds required by business enterprises. Capital market is the market for financial assets that have long or indefinite maturity. Capital market offers an ideal source of external finance.

It refers to all the facilities and the institutional arrangements for borrowing and lending medium-term and long-term funds. Like any market, the capital market is also composed of those who demands funds (borrowers) and those who supply funds (lenders).

Capital Market:
The capital market is a market for financial assets, which have a long or indefinite maturity, which have a maturity period of more than one year. Capital market may be further divided into three namely: Industrial securities market Government securities market Long term market

Industrial Securities Market:

As the name implies, it is a market for industrial securities namely Equity shares or ordinary shares. Preference shares, and Debentures or bonds.

It is a market where industrial concerns raise their capital or debt by issuing appropriate instruments. It can be further sub-divided into two: Primary market or New issue market Secondary market or stock exchange.

Long-Term Loans Market

Development banks and commercial banks plan a significant role in this market by supplying long-term loans to corporate customers. Long-term loans market may further be classified into. Term loans market IDBI, IFCI Mortgage market HUDCO, LIC, Land Development Banks Financial guarantees market.

Primary Market

Primary market also known as New issues Market (NIM) is a market for raising fresh capital in the form of shares & debentures. A company, while raising its capital through issues in the capital market must comply with the guide the guidelines & clarifications issued by SEBI and the provisions of the companies Act. 1956.

Primary Market
There are three ways by which a company may raise capital in a primary market. They are: Public Issue Rights issue (Issue of additional shares to existing shareholders) Private placement selling of securities privately to a small group of investors.

Types of Issue:
A company can raise its capital through issue of shares & debentures by means of

Public Issue Rights Issue Private placement Bought-out deal Euro Issue

PUBLIC ISSUE: Companies issue securities to the public in the primary market . The public issue can be through a fixed price route or through bookbuilding route. RIGHTS ISSUE: When a company issues additional equity capital, the existing shareholders have a preemptive right on such capital issue on a prorate basis. The rights offer is to be kept open for a period of 60 days.

PRIVATE PLACEMENT: It involves direct selling of securities to a limited number of institutional or high net worth investors. BOUGHT-OUT DEALS (BOD): It is a process where by an investor or a group of investors buy-out a significant portion of the equity of an unlisted company with a view to sell the equity to public within an agreed time frame. It is very useful for small projects, which may find it very costly to go for a public issue. EURO-ISSUES: Indian companies have been permitted to float their stocks in foreign capital markets. The instruments, which a company can issue are Global Depositary Receipts (GDRs), American Depository Receipts (ADRs), Euro-Convertible Bonds (ECBs), Foreign Currency Convertible Bonds (FCCBs).

Secondary Market:

It is a market for secondary sale of securities. In other words, securities which have already passed through the new issue market are traded in this market. This market consists of all stock exchange recognized by government of India. The stock exchanges in India are regulated under the securities controls (Regulation) Act, 1956.

A market, which deals in securities that have been already issued by companies, is known as the secondary market. It is also called the stock exchange or the Share Market. For the efficient growth of the market, a Sound secondary market is an essential requirement. Currently 23 stock exchanges are in India of which 4 are national & 19 are regional exchanges. The 4 national level exchanges are BSE, NSE, OTCEI (Over the Counter Exchange of India) & ISE (Inter Connected Stock Exchange of India). All these exchanges operate with due recognition from the govt. under the securities & contracts (Regulations) Act. 1956, and SEBI (Securities & exchanges Board of India) by an act of parliament in 1992.

Stock Exchanges-Definition

As per the SCRA, 1956 a stock exchange has been defined as follows It is an association, organized or body of individual whether incorporated or not, established for the purpose of assisting, regulating and controlling business in buying, selling and dealing in securities.

Functions/Services of SEs.

Liquidity and Marketability of Securities. Safety of Funds. Continuous market for securities Supply of Long-term Funds. Flow of Capital to Profitable Ventures. Motivation for Improved Performance. Promotion of Investment. Reflection of Business Cycle. House of business information.

Functions/services of stock exchanges

The stock market occupies an important position in the financial system .It performs several economic functions and renders valuable services to the investors , companies, and to the economic as a whole .they may be summarized as follows. (1)Liquidity and marketability of securities:Stock exchanges provide liquidity to securities since securities can be converted into cash at any time according to the discretion of the investor by selling them of the listed price.

(2)Safety of Funds: Stock exchanges give safety to the funds because they have to function under strict rules & regulations of government & SEBI (securities exchange board of India). Speculation is prevented through carefully designed set of rules. This would enhance the investors confidence and promote larger investment.

(3) Supply of long term Funds: The securities traded in the stock market are negotiable and transferable in character and such they can be transformed with minimum of formalities from one person to another .so when a security is transacted one investor is substituted by another, but the company is assured of long term availability of funds . (4) Flow of Capital to profitable ventures: The profitability and popularity of companies are reflected in their stock prices. The market price of the share shows the relative profitability and performance of Companies .Funds are generally attracted towards securities of profitability companies and this facilitates the flow of capital into profitable channels.

(5) Motivation for improved performance: The performance of a company is reflected on the prices quoted in the stock market .These prices are more visible in the eyes of the public. This public exposure makes a company conscious of its status in the market and it acts as a motivation to improve its performance further. (6) Promotion of investment: Stock exchanges mobilize the savings of the public and promote investment through capital formation .Investors are motivated to invest in the stock market.

(8) Marketing of new issues: When the new issues are listed, they are, readily acceptable to the public , costs of underwriting such issues would be less. public response to such new issues are also relatively high. So, a stock market helps in the marketing of new issues also.

Importance Of Capital Market

It serves as an important source for the productive use of the economys saving. It provides incentives to savings and facilitates capital formation by offering suitable rates of interest. It provides an avenue for investors to invest in financial assets.

It facilitates increase in production and productivity in the economy and thus, enhances the economic welfare of the society. A healthy capital market consisting of expert intermediaries promotes stability in values of securities. It serves as an important source for technological up gradation in the industrial sector by utilizing the funds invested by the public

Money Market

Money market is a market for dealing with financial assets and securities which have a maturity period of up to one year. In other words, it is a market for purely short term funds.

Money Market

Money market is a market for shortterm loans or financial assets. It is a market for lending and borrowing of short term funds. It meets the short-term requirements of borrowers and provides liquidity or cash to lenders.

Features of Money Market

It is a market purely for short term funds or financial assets called near money. It deals with financial assets having a maturity period up to one year only. It deals with only those assets which can be converted into cash readily.

Generally transactions takes place through phone and relevant documents and written communication can be exchanged subsequently. Transactions have to be conducted without the help of brokers. The components of a money market are the central bank, commercial bank, NBFC, discount houses. Commercial banks generally play a dominant role in this market.

Important of money market

Development of trade and industries Development of Capital Market Smooth functioning of Commercial banks Effective central bank control Formation of suitable monetary policy

Types of Money Market

Call money market. Commercial bills market or Discount market. Treasury bill market. Short-Term Loan Market

Call Money Market

The call money market refers to the market for extremely short period loans; say one day to fourteen days. These loans are repayable on demand at the option of either the lender or the borrower.
.

The day to day surplus funds of commercial banks are traded in the market. The loans made in call market are of short-term nature . The demand for call money is the highest in the month of March of every year. Because it is the time to meet year end and tax payments and withdrawals of funds by financial institutions to meet their statutory obligations.

Commercial Bill Market or Discount Market

A commercial bill is one which arises out of a genuine trade transaction, i.e., credit transaction. As soon as goods are sold on credit, the seller draws a bill on the buyer for amount due. The buyer accepts it immediately agreeing to pay the amount mentioned therein after a certain specified date. It is drawn always for a short period ranging between 3 months and 6 months.

Treasury Bill Market

A TBs is nothing but a promissory note issued by the govt. with discount for a specified period stated therein. The period does not exceed a period of one year. It is purely a finance bill since it doesnt arise out of any trade transaction TBs are issued only by the RBI on behalf of govt

Money Market Instruments

Commercial Papers Certificate of Deposit (CD) Inter-Bank Participation Certificate Repo Instrument

Promissory Notes

As per negotiable instrument act 1881 - A promissory note is a written document in which the maker (buyer) promises to pay a specific sum of money either on demand or at a specified future date.

Bills of Exchange

According to sec 5 Negotiable Instrument Act 1881. a bill of exchange is an instrument in writing containing an unconditional order, signed by the maker, directing a person to pay a certain sum of money only to or to the order of a certain person or to the bearer of the instruments

Commercial Papers

Commercial paper is a new instrument introduced in India on 27th March, 1989. It used for financing working capital requirements of corporate enterprises. A commercial paper is an unsecured promissory note issued with a fixed maturity by a company approved by RBI, negotiable by endorsement and delivery.

Features of Commercial Paper

Commercial paper is a short-term money market instrument comprising promissory notes with a fixed maturity. It is a certificate evidencing an unsecured corporate debt of short-term maturity. Commercial paper is issued at a discount to face value basis but it can also be issued in interest bearing form.

The issue promises to pay the buyer some fixed amount on some future period but pledges no assets, only his liquidity and established earning power, to guarantee that promise. Commercial paper can be issued directly by a company to investors or through banks/merchant bankers.

Advantages of Commercial Paper

Simplicity Flexibility Diversification High Returns Movement of Funds:

Certificate of Deposit (CD)

The banks in the USA in 1960s introduced CDs which are freely negotiable and marketable any time before maturity. The CDs were issued by big banks in the USA in units of $ 1 million at face value bearing fixed interest with a maturity generally ranging from 1 to 6 months. Banks sold CDs direct to investors or through dealers who subsequently traded this instrument in secondary market.

On the recommendations of the Vaghul Committee; the RBI formulated a scheme in June 1989 permitting scheduled commercial banks (excluding RRBs) to issue CDs.

Meaning

Certificate of Deposits are short term deposit instruments issued by banks and financial institutions to raise large sums of money.

Features of CD

Document of title to time deposit. Freely transferable by endorsement and delivery. Issued at discount to face value. Repayable on a fixed date without grace days. Subject to stamp duty like the usance promissory notes.

Advantages of CD

Certificate of Deposits are the most convenient instruments to depositors as they enable their short-term surpluses to earn higher return. CDs also offer maximum liquidity as they are transferable easily. The holder can resell his certificate to another.

From the point of view of issuing bank, it is a vehicle to raise resources in times of need and improve their lending capacity. This is an ideal instrument for banks with short-term surplus funds to invest at attractive rates.

TREASURY BILLS MARKET :

A treasury bill is a promissory note issued by Government . The treasury bills transactions are carried out by RBI on behalf of central government . The interest rate is administered and fixed by the RBI.

Treasury bills in India is available in two kinds. Ordinary treasury bills Ad-hoc treasury bills

ordinary TBs are issued to the public and other financial institutions for meeting the short-term financial requirements of the Central Government. These bills are freely marketable and they can be bought and sold at any time and they have secondary market also.

On the other hand ad hocsare always issued in favour of the RBI only. They are not sold through tender or auction. However, the holders of these bills can always sell them back to the RBI. Participants in the TBM RBI & SBI, Commercial banks, State Governments, Financial Institutions like LIC, GIC, UTI, IDBI etc.

There are 4 kinds of treasury bills available in India . 14 days treasury bills 91 days treasury bills 182 days treasury bills 364 days treasury bills .

Money Market Mutual Funds

Money Market Mutual Funds (MMMFs) enable small investors to participate in the money market . MMMFs can be set up by Mutual Funds. commercial banks, public financial institutions and private sector. Only individuals can subscribe to MMMFs . The minimum lock-in period is 15 days .

The portfolio of MMMFs consists of short term money market instrument . Banks and FIs were required to seek clearance from RBI for setting up MMMFs. The private sector MMMFs are required to get clearance from SEBI . MMMFs cannot deploy their funds in capital market . MMMFs cannot be offered for a guaranteed return to the holders .

Inter-Bank Participation Certificate

The Governor of the RBI while dealing with credit policy measures in Oct. 1988 had informed the bank Chief about a proposal to authorize banks to fund their short-term needs from within the system through issuance of InterBank Participations. This announcement by the RBI was in line with the recommendation made by the Working Group on the Money Market.

Features

Inter-Bank Participation Certificate provides them an additional instrument for even out short-term liquidity within the perimeter of the banking system, particularly at times when there are imbalances affecting the maturity mix assets in bankers books.

The scheme is confined to scheduled commercial banks only and the period of participation is restricted to minimum 91 days and maximum 180 days. Participants permitted are of two types namely with and without risk to lender. The without risk type participants is confined to a tenure of 90 days only.

Repo Instrument

A repo/reverse repo/repurchase is a transaction in which two parties agree to sell and repurchase the same security. The seller sells specified securities, with an agreement to repurchase the same at a mutually decided future date and price. Like wise, the buyer purchases the securities, with an agreement to resell the same to the seller on an agreed date and at a predetermined price.

The difference between the price at which the securities are bought and sold is the lenders profit/interest earned for lending money. Repos are usually entered into with a maturity of 1-14 days. Generally, repo transactions take place in market lots of Rs. 5 crores. There are two types of repos namely, i) inter-bank repos, ii) RBI repos.

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