Financial System Overview

Financial System

• Refers to a set of activities facilitating resource transfer from savers to borrowers
• An institutional framework in a country to enable financial transactions
• Includes financial institutions, financial markets, financial instruments and financial services

Features of Financial System

• Characterized by an integrated, organized and well-regulated financial market
• Features innovative financial instruments, services and dynamic institutions
• Meets short-term and long-term financial needs of individuals, government and corporate segments
• Regulates transactions between various economic units (govt., industry and household)
• Provides linkage between depositors and investors
• Promotes efficient allocation and development of financial resources

Components of Financial System

• Consists of financial markets, financial instruments, financial institutions and financial services
• Indian financial system includes these components

Financial Markets

• An institutional arrangement facilitating the exchange of financial assets (e.g., deposits, stocks, bonds, options, futures)
• Can be organised or unorganised
• Organised markets are recognised, formal markets with rules and regulations, controlled by regulators
• Consists of money markets and capital markets
• Money markets: Deal in short-term money & monetary assets (e.g., call money, treasury bills, bills of exchange)
• Capital markets: Deal in long-term securities (e.g., equity, debentures, bonds)
• Include Primary & Secondary markets
• Primary market: Securities are issued for the first time
• Secondary market: Securities are traded on exchanges (stock exchanges)

Financial Institutions

• Organizations that mobilize savings and provide finance/credit to individuals/organizations
• Act as intermediaries between lenders and borrowers
• Can be classified into monetary (banking) and non-monetary (non-banking) institutions
• Monetary: Central banks, commercial banks, regional rural banks, co-operative banks
• Non-monetary: Non-banking finance companies (NBFCs), investment companies, leasing firms, venture capital firms, etc.
• Specialized: Industrial development banks, state level financial institutions

Financial Instruments

• Written legal claims on money, transferable between parties
• Evidence of a claim for payment of principal/interest/dividend (specified maturity)
• Issued by financial intermediaries in financial markets for channeling funds from lenders to borrowers
• Classified as primary (direct) and secondary (indirect)
• Primary: Issued directly by ultimate borrowers to ultimate savers (e.g., equity shares, debentures)
• Secondary: Issued by financial intermediaries to ultimate savers (e.g., mutual fund units, insurance policies)

Financial Services

• Activities/benefits connected with the sale of money or money's worth
• Facilitate transactions for individuals & institutional investors
• Cover a wide range of activities (insurance, banking, credit, merchant banking, mutual funds, venture capital, leasing, stock broking, hire purchase, etc.)
• Can be categorized into Funds Intermediation, Payments Mechanism, Provision of Liquidity, Risk Management , and Financial Engineering

Development of Indian Financial System

• Pre-independence: Unorganised and weak
• Since independence: Mixed economic system, govt controls credit, establishment of development & term lending institutions, nationalized banks, strengthening of institutional infrastructure

Recent Developments in Indian Financial System

• Increased foreign investment
• New bank licenses issued
• Reforms in regulatory structure
• Digitalization and technology integration

Role of Financial Institutions

• Facilitate capital mobilization and formation
• Facilitate investment
• Manage risk
• Develop payment systems
• Support financial inclusion/social impact
• Stimulate innovation and technology integration
• Promote global integration

Indian Money Market Instruments

• Commercial Paper (CPs): Unsecured promissory notes issued by companies (short-term)
• Certificate of Deposits (CDs): Negotiable instruments issued by banks (short-term)
• Treasury Bills (T-Bills): Short-term debt instruments issued by the government
• Commercial Bills(CBs): Arise from trade transactions (short-term)
• Call Money: Very short-term loans between banks (typically overnight)
• Repurchase Agreements (repos): Sale of securities, with an agreement to repurchase them at a future date (short-term)

Money Market Features

• No geographical constraints
• Wholesale market for short-term debt instruments
• Not a single market, composed of sub-markets
• Links RBI and banks for policy implementation

This quiz covers the fundamentals of the financial system, including its features, components, and the role it plays in facilitating resource transfers between savers and borrowers. Learn about the various financial institutions, markets, and instruments that make up this crucial system. Test your knowledge on how the financial system operates in India and its impact on the economy.