Introduction to Financial System

Introduction to Financial System

• A financial system is a complex, well-integrated network of institutions, markets, instruments, and services
• It facilitates efficient transfer and allocation of funds.
• The system comprises of institutional arrangements that mobilize surplus income from units generating surplus and transferring to units in need.
• It includes financial transactions and the exchange of money between savers, lenders, and borrowers.

Functions of Financial System

• Provides a payment system for goods and services exchange.
• Regulates currency through the Reserve Bank of India (RBI).
• Handles banking functions.
• Facilitates long-term capital formation for both government and business organizations.
• Manages both short-term and long-term financial needs.
• Provides investment opportunities to investors.
• Manages international currency reserves.
• Links savers and investors, known as capital formation.
• Supports the provision of funds for productive use.
• Enhances long-term growth via investor education and new institutions while minimizing regulatory burdens.

Components of Financial System

• Financial System encompasses Financial Markets, Financial Products, Financial Institutions, and Financial Services.

Financial Markets

• Enable participants to trade financial claims.
• Deal with financial instruments like shares and debentures, and financial services.
• Allocate savings for investment.
• Provide investment avenues for investors and options for corporate finance.
• Consists of Capital Market and Money Market.

Capital Market

• A market for financial securities with long-term maturity.
• Includes instruments for direct and indirect claims on capital.
• Handles all types of lendings and borrowings.
• Issues and trades equity and debt financial instruments.
• Generally, securities mature for more than a year.
• Less liquid compared to money markets.
• Provides the resources for public, private, and government sectors.
• Offers a source of investment for investors by mobilizing savings to productive assets.
• Facilitates risk management, disinvestment, and investor protection.
• Consists of Primary and Secondary Market.

Primary Market

• Market for new securities not previously listed on the stock exchange.
• Issuers acquire resources for new or existing projects (expansion, modernization, diversification).
• The primary market creates and offers securities for the secondary market.

Secondary Market

• Deals with existing securities traded in the market.
• Provides options for risk assessment and return adjustments for security holders by allowing securities' sale and purchase.
• Facilitates liquidity via free marketability, negotiability, and price clarity.
• Consists of Spot and Future markets.
• Spot Market: Immediate delivery and payment for securities.
• Future Market: Future delivery and payment of securities.
• Options Market: Securities traded for conditional future delivery. - Put Options: Seller's right to sell securities at a predetermined price before a date. - Call Options: Buyer's right to purchase securities at a predetermined price before a date.

Money Market

• Market dealing with short-term monetary assets.
• Functions as a wholesale, low-risk, highly liquid debt market.
• Deals with short-term funds and financial assets as substitutes for money.
• Quickly convertible into cash with little transaction cost.
• Used for temporary monetary obligations.
• Influences liquidity and general interest rates.

Securities Market

• A market facilitating the transfer of transferable financial instruments.
• Categorized as Primary Market and Secondary Market.

Commodity Market

• Market to buy and sell commodities in physical or virtual markets
• Includes items such as metals, crude oil, natural gas, energy, and spices.
• Commodities are not manufactured
• Stock value changes based on current market trends
• Does not cover manufactured products

Financial Institutions

• These intermediaries mobilize savings to channel funds efficiently
• Engage in financial, monetary, and currency exchange matters
• Includes banking and non-banking institutions. (Both types are "purveyors of credit")

National Level Institutions

• All-India Development Banks (AIDBs) include Industrial Development Bank of India (IDBI), Small Industries Development Bank of India (SIDBI), Industrial Finance Corporation of India (IFCI), and Industrial Investment Bank of India Ltd (IIBI).
• Specialised Financial Institutions (SFIs) include IFCI Venture Capital Funds Ltd (IVCF) and ICICI Venture Funds Ltd.
• Investment Institutions include Life Insurance Corporation of India (LIC), Unit Trust of India (UTI), and General Insurance Corporation of India (GIC).

State Level Institutions

• State Financial Corporations (SFCs)
• State Industrial Development Corporations (SIDCs)

Qualified Institutional Buyers (QIBs)

• Institutions purchasing company shares on large scales.
• Have expertise to asses and invest in capital markets like Mutual Funds, FPIs, and others.

Foreign Portfolio Investors (FPIs)

• Individuals or entities meeting SEBI (Foreign Portfolio Investors) Regulations, 2019 eligibility criteria.
• Category I FPIs include government, sovereign wealth entities.
• Category II FPIs include regulated funds, endowments, and foundations, trusts.

Alternative Investment Funds (AIFs)

• Funds established in India as trusts, companies, or partnerships.
• Privately pooled investments collected from investors.
• Defined investment policy for investors under the SEBI (Mutual Funds) Regulations, 1996, and SEBI (Collective Investment Schemes) Regulations, 1999.

Financial Instruments

• Claims against a person or institution for future payment and/or periodic interest/dividend.
• Represented by shares, debentures, and bonds.
• Marketable and traded in organized markets.
• Various types suit different investor needs and risk tolerances.

Financial Services

• Activities supporting borrowing, funding, lending, investing, trading securities, payments, and managing risk.
• Fund intermediation, payments mechanism, liquidity provision, and risk management are key categories.
• Supports capital formation by linking savers and borrowers.
• Serves a crucial role in the increasingly complex global economy by enabling risk transfer and protection.

Key Elements of a Well-Functioning Financial System

• Strong legal and regulatory framework
• Stable currency
• Sound public finances and management of public debt
• Stable banking system
• Well-functioning securities market
• Effective information systems

Regulatory Framework in India

• Relevant acts and laws supporting the financial system in India. (Examples include Companies Act, 2013, Securities Contracts (Regulations) Act, 1956, Depositories Act, 1996, SEBI Act, 1992, Banking Regulations Act, 1949, RBI Act, 1934

Regulatory Bodies

• Reserve Bank of India (RBI)
• Securities and Exchange Board of India (SEBI)
• Insurance Regulatory and Development Authority of India (IRDAI)
• Pension Fund Regulatory and Development Authority (PFRDA)
• Ministry of Corporate Affairs (MCA)

This quiz explores the essentials of the financial system, focusing on its structure, functions, and key components. Participants will learn about the roles of various institutions and the importance of effective fund allocation. Understanding these concepts is crucial for navigating financial markets and making informed economic decisions.