Chapter 2

The Financial System

THE INDIAN
FINANCIAL SYSTEM

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

LEARNING OBJECTIVES
Define system financial system
Say why to study financial system
Discuss the functions of financial system
Define, Classify financial assets
Define, Classify financial markets
List out the instruments of money market and capital market
Distinguish between money market and capital market
Give the structure of Indian financial intermediaries
Discuss the regulatory bodies RBI, SEBI, IRDA.

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

System
System is a set of inter-related components
working together to achieve some purpose

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

Financial System
Financial System

Financial Institutions Financial Markets Financial Instruments Financial Services

Shares
Commercial Banks
Merchant Banking
Money Market
Debentures / Bonds

Industrial Banks
Project
Commercial Paper (CPs)
Consultancy

Provident Funds Capital Market

Certificate of Deposits
(CDs)

Mutual Public DepositS PDs)

Funds

Mutual Fund Units

NBFCs

Insurance Policies

Government Bonds Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

Functions of Financial System

Payment system
Mobilisation of savings
Size transformation
Maturity transformation
Risk transformation
Provision of liquidity
Cost reduction
Price information
Financial advice

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

Savers / Lenders
Flow of Funds
Householders
Funds Securities:
Business Firms
Shares/Bonds
Government
Foreigners
Deposits/Policies/Units Funds

S
e
c
Financial Institutions u Financial
Banks r Markets
Provident Funds Funds i F
Insurance Companies t u Money Market
Mutual Funds i Private n Capital Market
e d
NBFCs Placement Over-the-Counter
s s Market
Mode
Securities

Investors/Borrowers

Householders
Loans Business Firms
Government Fund
Foreigners s
Securities:
Funds Shares/Bonds

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

Assets and Financial Assets

Assets are the rights of owners

Fixed assets can be seen and can be touched (Tangible)

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

Classification of Financial Assets

Financial Assets

Non-Marketable Marketable

Bank Post Office Insuranc Shares Govt. Debe - MF

Deposits Certificates e Securitie ntures Units
Schemes s

Equity Preference
Shares Shares

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

Return on Financial Assets

Bonds
Debentures
Interest
Debt

Preference share
Equity share Dividend

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

Functions of Financial Markets

Price information
Marketability/Liquidity
Reduction of Transaction cost
Promotes savings and investments

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

Distinguish between Money Market and

Capital Market
Points of Difference Money Market Capital Market
1.Maturity of Funds Less than one year Above one year

2.Instruments Call Money market, Treasury Bills Equity Shares, preference

(TBs) Market, Commercial Bills (CBs) shares, debentures,
market, Commercial Papers (CPs) Government securities and
market, Certificate of Deposits (CDs), loans
Bankers Acceptances (Bas),
Repurchase Agreements (Repos),
Money Market Mutual Funds
(MMMF), etc.

3. Existence of Secondary No Yes

market

4. Place of Market No specific place Stock Exchanges

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

Financial Instruments

Securities issued to public to raise funds

Example
Equity Share
Reference Share
Debenturers
Commercial papers
Certificate of Deposits etc.,

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

Financial Intermediaries

FIs that act as bridge between savers and investors and provides
needed funds to investors
Example:
Banks
NBFCs

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

Structure of Indian Financial

Intermediaries
Structure of Financial
Intermediaries in India

RBI SEBI IRDA

Public and Pvt.

Commercial
Banks
Mutual Funds Private Sector
Insurance
All India Companies
Development
Banks

Specialised
Financial
Institutions Exim
Bank, IFCI Venture Capital Public Sector
Funds Insurance
Companies
Refinance
Institutions
NABARD, NHB

NBFCs

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

Regulatory Institutions
RBI
SEBI
IRDA
NABARD
NHB

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

Reserve Bank of India (RBI)

Objectives
The objectives of establishment (Central Bank) of RBI are to:
Maintain the internal value of the nations currency;
Preserve the external value of the currency;
Secure reasonable price stability; and
Promote economic growth through increasing employment, output and real income.
Functions
The functions of RBI may be classified into two categories:
a) Traditional functions, and b) Developmental functions
a) Traditional Functions:
RBI acts as a lender of last resort;
It acts as a banker to banks;
It issues currency and operates the clearing system for banks;
It supervises the operations of credit institutions;

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

RBI Contd..
It acts as the custodian of the foreign reserves;
It formulates and implements monetary and credit policies;
It moderates the fluctuations in the exchange value of the rupee.
b) Developmental Functions:
The prime developmental function is to integrate the unorganized
financial sector with the organized financial sector;
It encourages opening of semi-urban and rural branches;
It provides education and training to banking personnel of commercial
and co-operative banks;
It influences the allocation of credit;
It promotes the collection pooling and dissemination of credit
information among banks;
It promotes the establishment of new institutions.

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

Securities Exchange Board of India (SEBI)

Objectives
The SEBI has been entrusted with both the regulatory and
developmental functions.
The following are the objectives of SEBI:
Investor protection with a view to get steady flow of savings into capital
market;
Ensuring fair practices by the issues of securities by which corporations
can raise resources of least cost;
Promotion of efficient services by brokers, merchant bankers, and other
intermediaries with a view to make them competitive and professional;
Development and regulation of securities market.

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

SEBI Contd..
Functions
a) Regulatory Functions
Registration and Regulation of capital market
intermediaries (Brokers, sub-brokers, and other players in
the market);
Register and regulate the working of venture capital
funds and Collective Investment Schemes including
mutual funds;
Regulate the business in Stock Exchanges and any other
securities market;
Promoting and regulating Self Regulatory Organisations
(SRO);
Prohibition of all fraudulent and unfair trade practices
relating to securities market;
Prohibition of insider trading and takeover bids and
imposing penalties for such practices;

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

SEBI Contd..
Registering and regulating the working of depositors,
custodians of securities, FIIs, credit rating agencies;
Regulating substantial acquisition of shares and takeover
of companies.
Development Function of SEBI is to promote investors
education, training intermediaries and conduct research
and publish information
b) Developmental Functions
Promote investors education;
Training of intermediaries;
Promotion of fair practices and code of conduct for all
SROs
Conduct research and publishing information useful to all
market participants.

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House
 Chapter 2
The Financial System

Insurance Regulatory
Functions Development Authority
To exercise all powers and functions of controller of insurance;
Protection of the interests of the policyholders;
To issue, renew, modify, withdraw or suspend certification of registration;
To specify requisite qualifications and training for insurance intermediaries and agents;
To promote and regulate professional organisations connected with insurance;
To conduct inspection / investigations etc.;
To regulate investment of funds and margins of solvency;
To prescribe method of insurance accounting;
To adjudication upon disputes;
To conduct inspection and audit of insurers, intermediaries and other organisations
concerned with insurance.

Financial Management: Principles and Practice

By G. Sudarsana Reddy
Himalaya Publishing House