Introduction to financial system and its components

Components of financial system

1. An Overview of
Indian Financial
System

2. Importance of Financial
regulations
The main aim of the financial
regulators is to maintain the
stability and integrity of the
financial system in the country.
Financial regulation also
influences thestructure of
bankingsectors by increasing the
diverse financial products
available.

3. Need of financial regulatory
body
Financial stability,
Consumer protection,
Maintaining market confidence,
and reducing possibilities of
financial crime or fraud are the
main objectives of the financial
regulatory bodies in India.

4. Finance and System
Financeexactlyisnotmoney,itisthesourceof
providingfundsforaparticularactivity.
Thuspublicfinancedoesnotmeanthemoneywiththe
Government,butitreferstosourcesofraisingrevenue
fortheactivitiesandfunctionsofaGovernment.
Afinancialsystemorfinancialsectorfunctionsasan
intermediaryandfacilitatestheflowoffundsfromthe
areasofsurplustotheareasofdeficit.
AFinancialSystemisacompositionofvarious
institutions,markets,regulationsandlaws,practices,
moneymanager,analysts,transactionsandclaimsand
liabilities.

5. FinancialSystemofanycountryconsistsoffinancial
markets,financialintermediationandfinancial
instrumentsorfinancialproducts.

6. Constituents of a Financial
System

7. FINANCIAL MARKETS
AFinancialMarketcanbedefinedasthemarketinwhichfinancialassets
arecreatedortransferred.
Asagainstarealtransactionthatinvolvesexchangeofmoneyforreal
goodsorservices,afinancialtransactioninvolvescreationortransferofa
financialasset.
FinancialAssetsorFinancialInstrumentsrepresentsaclaimtothe
paymentofasumofmoneysometimeinthefutureand/orperiodic
paymentintheformofinterestordividend.
MoneyMarket-Themoneymarketisawholesaledebtmarketforlow-
risk,highly-liquid,short-terminstrument.Fundsareavailableinthis
marketforperiodsrangingfromasingledayuptoayear.Thismarketis
dominatedmostlybygovernment,banksandfinancialinstitutions.

8. CapitalMarket-Thecapitalmarketisdesignedto
financethelong-terminvestments. The
transactionstakingplaceinthismarketwillbefor
periodsoverayear.
ForexMarket-TheForexmarketdealswiththe
multicurrencyrequirements,whicharemetbythe
exchangeofcurrencies.Dependingonthe
exchangeratethatisapplicable,thetransferof
fundstakesplaceinthismarket.Thisisoneofthe
mostdevelopedandintegratedmarketacrossthe
globe.
CreditMarket-Creditmarketisaplacewhere
banks,FIsandNBFCspurveyshort,mediumand
long-termloanstocorporateandindividuals.

9. FINANCIAL INTERMEDIATION
Havingdesignedtheinstrument,theissuershould
thenensurethatthesefinancialassetsreachthe
ultimateinvestorinordertogarnertherequisite
amount.
Whentheborroweroffundsapproachesthe
financialmarkettoraisefunds,mereissueof
securitieswillnotsuffice.Adequateinformationof
theissue,issuerandthesecurityshouldbepassed
ontotakeplace.Thereshouldbeaproper
channelwithinthefinancialsystemtoensuresuch
transfer.
Toservethispurpose,Financialintermediaries
cameintoexistence.Financialintermediationin
theorganizedsectorisconductedbyawiderange
ofinstitutionsfunctioningundertheoverall
surveillanceoftheReserveBankofIndia.

10. Contd…
Intheinitialstages,theroleoftheintermediarywasmostlyrelatedto
ensuretransferoffundsfromthelendertotheborrower.Thisservicewas
offeredbybanks,FIs,brokers,anddealers.
However,asthefinancialsystemwidenedalongwiththedevelopments
takingplaceinthefinancialmarkets,thescopeofitsoperationsalso
widened.Someoftheimportantintermediariesoperatinginkthefinancial
marketsinclude;investmentbankers,underwriters,stockexchanges,
registrars,depositories,custodians,portfoliomanagers,mutualfunds,
financialadvertisersfinancialconsultants,primarydealers,satellite
dealers,selfregulatoryorganizations,etc.
Thoughthemarketsaredifferent,theremaybeafewintermediaries
offeringtheirservicesinmovethanonemarkete.g.
underwriter.However,theservicesofferedbythemvaryfromonemarket
toanother.

11. Contd..
Intermediary Market Role
Stock Exchange Capital Market Secondary Market to
securities
Investment Bankers Capital Market, Credit MarketCorporateadvisoryservices,
Issueofsecurities
Underwriters Capital Market, Money MarketSubscribetounsubscribed
portionofsecurities
Registrars, Depositories,
Custodians
Capital Market Issuesecuritiestothe
investorsonbehalfofthe
companyandhandleshare
transferactivity
Primary Dealers Satellite
Dealers
Money Market Market making in
governmentsecurities
Forex Dealers Forex Market Ensure exchange ink
currencies

12. FINANCIAL INSTRUMENTS
MoneyMarketInstruments:Themoneymarketcanbedefinedasa
marketforshort-termmoneyandfinancialassetsthatarenearsubstitutes
formoney.Thetermshort-termmeansgenerallyaperioduptooneyear
andnearsubstitutestomoneyisusedtodenoteanyfinancialassetwhich
canbequicklyconvertedintomoneywithminimumtransactioncost.
Some of the important money market instruments are briefly discussed
below;
1. Call/Notice Money
2. Treasury Bills
3. Term Money
4. Certificate of Deposit
5. Commercial Papers

13. Call /Notice-Money Market:
Call/Noticemoneyisthemoneyborrowedorlenton
demandforaveryshortperiod.Whenmoneyis
borrowedorlentforaday,itisknownasCall
(Overnight)Money.
Interveningholidaysand/orSundayareexcludedfor
thispurpose.Thusmoney,borrowedonadayand
repaidonthenextworkingday,(irrespectiveofthe
numberofinterveningholidays)is"CallMoney".
Whenmoneyisborrowedorlentformorethanaday
andupto14days,itis"NoticeMoney".Nocollateral
securityisrequiredtocoverthesetransactions.

14. Inter-Bank Term Money
Inter-bankmarketfordepositsofmaturitybeyond14
daysisreferredtoasthetermmoneymarket.The
entryrestrictionsarethesameasthoseforCall/Notice
Moneyexceptthat,asperexistingregulations,the
specifiedentitiesarenotallowedtolendbeyond14
days.

15. Treasury Bills.
TreasuryBillsareshortterm(uptooneyear)
borrowinginstrumentsoftheunion
government.ItisanIOUoftheGovernment.
ItisapromisebytheGovernmenttopaya
statedsumafterexpiryofthestatedperiod
fromthedateofissue(14/91/182/364days
i.e.lessthanoneyear).
Theyareissuedatadiscounttotheface
value,andonmaturitythefacevalueispaid
totheholder.Therateofdiscountandthe
correspondingissuepricearedeterminedat
eachauction.

16. Certificate of Deposits
CertificatesofDeposit(CDs)isanegotiablemoney
marketinstrumentandissuedindematerialisedformor
asaUsancePromissoryNote,forfundsdepositedata
bankorothereligiblefinancialinstitutionfora
specifiedtimeperiod.
GuidelinesforissueofCDsarepresentlygovernedby
variousdirectivesissuedbytheReserveBankofIndia,
asamendedfromtimetotime.

17. Contd..
CDscanbeissuedby(i)scheduledcommercial
banksexcludingRegionalRuralBanks(RRBs)and
LocalAreaBanks(LABs);and(ii)selectall-India
FinancialInstitutionsthathavebeenpermittedby
RBItoraiseshort-termresourceswithinthe
umbrellalimitfixedbyRBI.
BankshavethefreedomtoissueCDsdependingon
theirrequirements.AnFImayissueCDswithinthe
overallumbrellalimitfixedbyRBI,i.e.,issueofCD
togetherwithotherinstrumentsviz.,termmoney,
termdeposits,commercial papersand
intercorporatedepositsshouldnotexceed100per
centofitsnetownedfunds,asperthelatest
auditedbalancesheet.

18. Capital Market Instruments
Thecapitalmarketgenerallyconsistsofthefollowing
longtermperiodi.e.,morethanoneyearperiod,
financialinstruments;IntheequitysegmentEquity
shares,preferenceshares,convertiblepreference
shares,non-convertiblepreferencesharesetcandin
thedebtsegmentdebentures,zerocouponbonds,deep
discountbondsetc.