Indian Financial System Overview

Indian Financial System

• The Indian financial system consists of a complex network of institutions, markets, instruments, and services enabling funds transfer between savers and investors.
• Key entities include banks, non-banking financial companies (NBFCs), insurance companies, stock exchanges, mutual funds, pension funds, and financial intermediaries.

Components of the Indian Financial System

• Categorized into Financial Institutions, Financial Markets, Financial Instruments, and Financial Services.
• Banking institutions create credit. Non-banking financial institutions are credit sources.
• Types of financial institutions include commercial banks, cooperative banks, public sector banks, private sector banks, regional rural banks (RRBs), and foreign banks. Organized and unorganized financial institutions also exist.
• Financial instruments include primary and secondary securities, including equity shares, debentures, primary securities, secondary securities, and innovative instruments.
• Examples of financial markets include money markets (short-term securities) and capital markets (long-term securities).

Constituents of the Financial System

• Financial institutions act as intermediaries to mobilize savings and efficiently allocate funds.
• India's non-banking financial institutions (e.g., developmental financial institutions (DFIs), non-banking financial companies (NBFCs), and housing finance companies (HFCs)) are major credit providers.
• Specific types of financial institutions include Industrial Development Bank of India (IDBI), Industrial Financial Corporation of India (IFCI), Small Industries Development Bank of India (SIDBI), and Industrial Investment Bank of India (IIBI).

Financial Markets

• Financial markets facilitate the exchange of financial claims, establishing prices for them.
• Key organized financial markets in India include the money market and capital market.
• Money markets trade short-term securities, while capital markets trade long-term securities with maturity periods of one year or more.

Financial Instruments

• Financial instruments represent a claim against a person or institution for future payment, potentially including interest or dividends.
• Securities can be primary (direct issues by borrowers to savers) or secondary (issued by financial intermediaries).

Financial Services

• Financial intermediaries offer services like merchant banking, leasing, hire purchase, and credit rating.
• The gap between investor knowledge and the sophistication of financial instruments and markets is bridged by financial intermediaries.
• Investors need reassurance about the safety of security exchanges for funds. The financial regulator manages the market, and intermediaries, ensuring investor protection.

Regulation

• The Reserve Bank of India (RBI) regulates the money market, while the Securities and Exchange Board of India (SEBI) regulates the capital market.

Functions of the Indian Financial System

• Intermediation: Channels funds from savers to borrowers, promoting economic growth.
• Mobilization of savings: Pools individual and business savings for productive investments.
• Facilitation of investments: Provides various investment options to support productive activities.
• Risk Management: Provides instruments and mechanisms to mitigate investment risks.
• Price discovery: Markets facilitate the determination of fair prices for financial instruments.
• Facilitation of payments: Enables smooth and secure fund transfers.
• Capital Formation: Promotes capital accumulation through savings mobilization and efficient investment allocation.
• Monetary Policy Implementation: Central banks control money supply, interest rates, and liquidity.

Impact of Liberalization

• Liberalization (elimination of state control) provides businesses greater autonomy and reduced government interference.
• Liberalization (since 1991) has led to fewer restrictions on conducting business transactions, attracting foreign companies and investments.
• Liberalization reduced barriers (e.g., tax laws, foreign investment restrictions).

Objectives of Liberalization

• Increased competition among domestic businesses.
• Promotion of foreign trade and export regulation.
• Improvement in technology acquisition and foreign capital inflow.
• Global market development and reduced national debt.
• Encouraging private sector investment and reducing public sector involvement in industrial development.
• Increased competition in the financial sector.

Positive Impacts of Liberalization

• Enhanced flow of capital.
• Diversification of investment opportunities.

Negative Impacts of Liberalization

• Weakened economy.
• Technological adjustments for small-scale industries.
• Mergers and acquisitions impacting small businesses.

Weaknesses of the Indian Financial System

• Lack of coordination: Many financial institutions, largely government-owned, lead to coordination problems.
• Monopolistic Structures: Some financial institutions are too large, creating monopolistic market structures that potentially slow the financial system's development.
• Dominance of Development Banks: The significant role of development banks in financing may result in uneven and lopsided capital structures for borrowing concerns.
• Imprudent Financial Practices: Development banks may encourage imprudent financial practices among corporate customers.