Lecture 1 Financial System PDF

AN INTRODUCTION TO Dr. Mayank Tiwari Assistant Professor of Law FINANCIAL SYSTEM National Law University Odisha Global Financial Crisis 2008 LETS THINK If A an entrepreneur has an idea to manufacture e-bike with solar charging and is not having sufficient funds for t...

AN INTRODUCTION TO Dr. Mayank Tiwari Assistant Professor of Law FINANCIAL SYSTEM National Law University Odisha Global Financial Crisis 2008 LETS THINK If A an entrepreneur has an idea to manufacture e-bike with solar charging and is not having sufficient funds for the manufacturing B is a salaried employee having saving of Rs. 2 Lakhs per year but not having any idea regarding its investment Is there any solution in this case so that the funds might move from B to A If yes, how? INTRODUCTION Modern Economies are based on sound financial system How the saving takes place? How the investment takes place? What is the function of Financial Institutions (Banks and Non- Banking Institutions) in an economy? What is Financial Market? What are Financial Products? FINANCIAL SYSTEM A financial system is a complex, well-integrated set of sub-systems of financial institutions, markets, instruments, and services which facilitates the transfer and allocation of funds, efficiently and effectively. Set of institutional arrangements through which the financial surpluses are mobilised from units generating surplus income and transferring to others in need to them. It deals with the financial transactions and the exchange of money between savers, lenders and borrowers. FINANCIAL SYSTEM Help to mobalise the idle savings of household into investment Covers both credit and cash transactions It includes banks, non-banking sector, market, central banks, regulatory authority It provides a framework for carrying out economic transactions and monetary policy. FUNCTIONS OF FINANCIAL SYSTEM Provides payment system for exchange of goods and services Regulation of currency through RBI Performance of banking functions through banks Provides long term capital formation for the government and business organisations Take care of both long-term and short-term requirements FUNCTIONS OF FINANCIAL SYSTEM Provides investment opportunities to investors Management of international currency reserve Links savers and investors. This process is known as capital formation Supply of funds for productive use Ensure long term growth through investor education, entry of new institutions, minimising regulatory measures etc. THINK Why the channelling of funds from savers to spenders so important to the economy? COMPONENTS OF FINANCIAL SYSTEM Financial System Financial Financial Financial Institutions and Financial Markets Products Intermediaries Services FINANCIAL MARKETS FINANCIAL MARKETS Financial markets are a mechanism enabling participants to deal in financial claims. Deals with various financial instruments like shares, debentures etc. and financial services. Allocation of saving to investment Provides investment avenues to investors Options to Corporate for raising finance Financial Market is composed of  Capital Market  Money Market  Financial Markets Money Capital Market Market Certificate Other form Call Treasury of Deposits, Securities of lending Money Bills Commercial Market and Papers borrowings CAPITAL MARKET It is a market for financial securities having long term maturity It has the financial instruments which are direct and indirect claims to the capital It covers all types of lendings and borrowings Capital funds including equity and debt are issued and traded Generally the maturity of securities is for more than one year duration It is lesser liquid in comparison to the money markets WHY CAPITAL MARKET IS REQUIRED? Important source to arrange the funds for public, private and government sector Provides a source of investment to the investors Mobilising the savings in productive assets Allows risk management Provides a route for disinvestment Provides protection to the interest of the investors CAPITAL MARKET The institutional arrangements for borrowing the medium and long term requirements and it also provide the facility marketing and trading of the securities. Primary Market Secondary Market  Capital Market Other Forms Securities of lending Market and borrowing Primary Secondary Market Market Spot Derivative Market Market Future Options MONEY MARKET It is the market to deal in the monetary assets of short-term duration Short term funds and financial assets which are substitute for money are being dealt with in Money Market Stocks are liquid, quickly convertible into money with very less transaction cost Used for temporary shortage of monetary obligations It is a mechanism through which the RBI influence liquidity and general level of interest rates in the economy MONEY MARKET The money market functions as a wholesale debt market for low- risk, highly liquid, short term instruments. It is a formal financial market to deals with short-term fund management. The transactions are settled on daily basis The instruments used in the money markets include deposits, collateral loans, acceptances, and bills of exchange MONEY MARKET Section of the financial market where financial instruments with high liquidity and short-term maturities are traded. General duration is less than 1 year like commercial papers and treasury bills It consists of various financial institutions and dealers, who seek to borrow or loan securities. SECURITIES MARKET It is the market for financial instruments which are commonly and readily transferable by sale. It can be further classified as : Primary Market and Secondary Market PRIMARY MARKET Market for sale of new securities which were never listed with the stock exchange Issuer Company need to resources for new projects as well as for existing projects with a view to expansion, modernization and diversification etc. The primary market creates and offers the securities for the secondary market SECONDARY MARKET It deals with the dealing of securities available in the market Provides an option to the existing security holders to change their assessment of risk and return by selling and purchasing the securities Provides liquidity It comprises of the stock exchange It helps in free marketability, negotiability and price discharge Spot Market: Where securities are traded for immediate delivery and payment Future Market: Where the securities are traded for future delivery and payment SECONDARY MARKET Options Market: Where securities are traded for conditional future delivery  Put Option: It permits the owner to sell a security to the writer of the option at a pre-determined price before a certain date  Call Option: It permits the buyer to purchase a security from the writer of the option at a particular price before a certain date FUNCTIONS OF SECURITIES MARKETS Provides investment options Opportunity for the Companies or borrowers to raise finance Provides a channel of linkage between the lenders and borrowers Liquidity of Securities Provides option for risk management Boost the Economic Development Help in internationalisation of economy WHAT YOU KNOW ABOUT THE COMMODITY MARKET? We can trade the Commodity through MCX We need not to have physical possession of commodities Stock Value changes according to the current trend of prices in the market Products like Gold, Crude Oil, Natural Gas etc. Does not cover the manufactured products Trading in future contracts Base Metals, Bullion, Agricultural Produce and Energy COMMODITY Commodity is produce of nature It is the group of goods in form of agricultural produce and non-agricultural produce Commodity is exchangeable by nature COMMODITY MARKET Commodity Market is the place for buying and selling the commodity in physical or virtual market Risk and Problems in Physical market: Storage, Authenticity Only Futures and Options Commodity Market through Commodity Exchange: MCX, NCDEX etc. Market for trading in metals, crude oil, natural gas, energy, and spices, among others. FINANCIAL INSTITUTIONS FINANCIAL INSTITUTIONS Intermediaries that mobilise savings and facilitate the allocation of funds in an efficient manner. Corporation affianced in the business of dealing with financial and monetary matters such as deposits, loans, investments, and currency exchange. Divided into Banking - creators and purveyors of credit Non- banking institutions - purveyors of credit  NATIONAL LEVEL INSTITUTIONS All-India Development Banks (AIDBs)  Industrial Development Bank of India (IDBI)  Small Industries Development Bank of India (SIDBI)  Industrial Finance Corporation of India (IFCI)  Industrial Investment Bank of India Ltd (IIBI) Specialised Financial Institutions (SFIs)  IFCI Venture Capital Funds Ltd (IVCF)  ICICI Venture Funds Ltd Investment Institutions  Life Insurance Corporation of India (LIC)  Unit Trust of India (UTI)  General Insurance Corporation of India (GIC)  State Level Institutions State Financial Corporations (SFCs) State Industrial Development Corporations (SIDCs) QUALIFIED INSTITUTIONAL BUYERS Institutions who buy the shares of a company on a large scale. They have an expertise and the financial proficiency to evaluate and to invest in the Capital Markets eg Mutual Fund, FPI etc.  QUALIFIED INSTITUTIONAL INVESTOR REGULATION 2(1)(SS) OF SEBI (ICDR) REGULATIONS, 2018  a mutual fund, venture capital fund, Alternative Investment Fund and foreign venture capital investor registered with SEBI  a foreign portfolio investor other than Category III foreign portfolio investor, registered with SEBI  a public financial institution as defined in section 4A of the Companies Act, 1956  a scheduled commercial bank  multilateral and bilateral development financial institution  a state industrial development corporation  an insurance company registered with the Insurance Regulatory and Development Authority  QUALIFIED INSTITUTIONAL INVESTOR REGULATION 2(1)(SS) OF SEBI (ICDR) REGULATIONS, 2018  a provident fund with minimum corpus of twenty five crore rupees  pension fund with minimum corpus of twenty five crore rupees  National Investment Fund set up Government of India  insurance funds set up and managed by army, navy or air force of the Union of India  insurance funds set up and managed by the Department of Posts, India  systemically important non-banking financial companies FOREIGN PORTFOLIO INVESTOR Person who satisfies the eligibility criteria prescribed under SEBI (Foreign Portfolio Investors) Regulations, 2019. Regulation 5 Category I FPIs  Government and Government-related investors like central banks, sovereign wealth funds, international or multilateral organizations etc. When 75% directly or indirectly owned by such Government and Government related investor  Pension funds and university funds  Appropriately regulated entities like insurance or reinsurance entities, banks, asset management companies, investment manager  Entities from the Financial Action Task Force member countries FOREIGN PORTFOLIO INVESTOR Regulation 5 Category II FPIs  appropriately regulated funds not eligible as Category-I  endowments and foundations;  charitable organisations;  corporate bodies;  family offices;  Individuals;  appropriately regulated entities investing on behalf of their client, as per conditions specified by the Board from time to time;  Unregulated funds in the form of limited partnership and trusts; ALTERNATIVE INVESTMENT FUNDS Regulation 2(1) (b) of SEBI(Alternative Investment Funds) Regulations, 2012: any fund established or incorporated in India in the form of a trust or a company or a limited liability partnership or a body corporate which:  is a privately pooled investment vehicle which collects funds from investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors  is not covered under the SEBI (Mutual Funds) Regulations, 1996, SEBI (Collective Investment Schemes) Regulations, 1999 or any other regulations of the Board to regulate fund management activities ALTERNATIVE INVESTMENT FUNDS Not Covered under AIF: family trusts set up for the benefit of ‘relatives’ ESOP Trusts set up under the SEBI (Share Based Employee Benefits) Regulations, 2014 Employee welfare trusts or gratuity trusts set up for the benefit of employees Holding companies Other special purpose vehicles not established by fund managers, including securitization trusts, regulated under a specific regulatory framework; funds managed by securitisation company or reconstruction company which is registered with the Reserve Bank of India any such pool of funds which is directly regulated by any other regulator in India; FINANCIAL INSTRUMENTS FINANCIAL INSTRUMENTS A financial instrument is a claim against a person or an institution for payment, at a future date, of a sum of money and/or a periodic payment in the form of interest or dividend. Financial instruments represent shares, debentures and bonds. Many financial instruments are marketable as they are denominated in small amounts and traded in organized markets Different types of financial instruments can be designed to suit the risk and return preferences of different classes of investors. FINANCIAL INSTRUMENTS Savings and investments are linked through a wide variety of complex financial instruments known as ‘securities.’ Securities are defined in the Securities Contracts Regulation Act (SCRA), 1956 as includ ing shares, scrips, stocks, bonds, debentures, debenture stocks or other marketable securities of a similar nature or of any incorporated company or body corporate, government securities, derivatives of securities, units of collective investment scheme, security receipts, interest and rights in securities, or any other instruments so declared by the central government. Financial securities are financial instruments that are negotiable and tradeable. FINANCIAL INSTRUMENTS On the basis of duration: On the basis of type: Short Term Primary Securities Medium Term  Equity  Preference Long Term  Debt  Hybrid Secondary Securities  Time Deposits  Mutual Fund Units FINANCIAL SERVICES FINANCIAL SERVICES Services that help with borrowing and funding, lending and investing, buying and selling securities, making and enabling payments and settlements, and managing risk exposures in financial markets. The major categories of financial services are funds intermediation, payments mechanism, provision of liquidity, risk management. Funds intermediating services link the saver and borrower which, in turn, leads to capital formation. Financial services are necessary for the management of risk in the increasingly complex global economy. They enable risk transfer and protection from risk FINANCIAL SERVICES The producers of these financial services are financial intermediaries, such as, banks, insurance companies, mutual funds, and stock exchanges. Financial intermediaries provide key financial services such as merchant banking and credit-rating The regulator regulates the conduct of issuers of securities and the intermediaries to protect the interests of investors in securities and increases their confidence in markets KEY ELEMENTS OF A WELL-FUNCTIONING FINANCIAL SYSTEM Strong legal and regulatory environment Stable money Sound public finances and public debt management Central bank Sound banking system An information system Well-functioning securities market REGULATORY FRAMEWORK IN INDIA The Companies Act, 2013 Securities Contracts (Regulations) Act, 1956 Depositories Act, 1996 SEBI Act, 1992 Banking Regulations Act, 1949 RBI Act, 1934 REGULATORY BODIES Reserves 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) Thank You