UNIT -1

Financial System In India

Meaning of Financial system

Financial system refers to a set of complex and closely connected or interlinked financial
institutions or organized and unorganized financial markets, financial instruments and services
which facilitate the transfer of funds.
Definition of financial system

According to Robinson, “Financial system is the primary function of the system which is to
provide a link between savings and investment for the creation of new wealth and to permit
portfolio adjustment in the composition of the existing wealth.

Features of financial system

• To grow of the economy

• To bring investment
• To encourage savings
• To allocation of funds
Objectives of financial system

▪ To mobilize the resources.

▪ To create link between savers and investors.
▪ To establish a regular smooth and efficient market.
▪ To create assets for the use of people.
▪ To encourage savings and investment.
▪ To facilitate economic development of the country.
▪ To facilitate the expansion of financial markets.
▪ To promote efficient allocation of financial resources.
▪ To make sound decisions based on cash flow and available resources.
▪ To establish financial control and clear accounting procedures which ensure that funds
are used for intended purposes.

Purposes of financial system

 ❖ Financial system is required for mobilization of savings and converting it into
investments.
❖ Financial system is essential for providing the required capital to the business
organizations to carry out their activities.
❖ It is required for generating income or profit for both household and corporate sector.
❖ It is necessary for increasing the productivity of capital through efficient and effective
allocation of funds and resources.
❖ It is essential to accelerate the rate of economic growth and development.
❖ It is helpful in providing a mechanism to control risk and uncertainties in financial
transactions.
❖ It is required to transfer the resources from one section or part of the economy to
another through effective allocation of resources to different investment channels.
Financial concepts
 Compound interest
 Risk and return
 Diversification
 Stocks and shares
 Bonds
 Mutual funds
 Exchange traded funds (ETFs)
 Asset allocation
 Liquidity
 Inflation
 Risk tolerance
 Capital gains and losses
Constituents of Financial system
♦ Financial Institutions
♦ Financial services
♦ Financial Markets
♦ Financial Intermediaries
 1. Financial Institutions
Meaning of Financial Institutions

Financial institutions or financial intermediaries are those institutions which provide financial
services and products which customers need. Financial institutions provide all those services,
which a customer may not be able to get more efficiently on his own.
Benefits of Financial Institutions

➢ Economy of scale
➢ Lower transaction cost
➢ Diversification

2. Financial services
Meaning of Financial services

Financial services are the economic services provided by the finance industry, which
encompasses a broad range of organizations that manage money, including credit unions,
banks, credit card companies, insurance companies, consumer finance companies, stock
brokerages, investment funds and some government sponsored enterprises.
Classification of Financial service

✓ Fee based services

✓ Fund based services

3. Financial Markets
Meaning of Financial Markets

A financial market is a market in which people and entities can trade financial securities,
commodities and other financial stocks at low transaction costs and at prices that reflect
supply and demand. Securities include stocks and bonds and commodities include precious
metals or agricultural goods.
Objectives of Financial markets

❑ To facilitate creation and allocation of credit and liquidity.

❑ To serve as intermediaries for mobilization of savings.
❑ To assist in the process of balanced economic growth.
❑ To provide financial convenience.
 4. Financial Intermediaries
Financial intermediation consists of "channeling funds between surplus and def agents". A
financial intermediary is a financial institution that connects surplus and deficits agents.
Financial Intermediaries are the firms that provide services and products which Customers may
not be able to get more efficiently by themselves in final markets. In other words, they act as
middlemen between investors and borrowers in financial system.
Financial intermediaries may be classified into two:

 Capital market intermediaries

 Money market intermediaries
Classification of Financial Intermediaries

🞳 Deposit taking organizations

🞳 Contractual savings organizations
🞳 Investment type organizations
🞳 Fee based intermediaries
Functions of Financial Intermediaries
1.Traditional Functions

i. Underwriting of investments in shares/debentures etc.

ii. Dealing in secondary market activities.
iii. Participating in money market instruments.
iv. Involving in leasing, hire purchase, venture capital, seed capital etc.
v. Dealing in foreign exchange market activities.
vi. Managing capital issues.
vii. Making arrangements for the placement of capital and debt instruments with investing
institutions.
viii. Arrangement of funds from financial institutions for the clients' project.
ix. Assisting in the process of getting all Government and other clearances.
2. Modern Functions
(a) Rendering project advisory services.
(b) Planning for mergers and acquisitions and assisting with their smooth execution.
(c) Guiding corporate customers in capital restructuring.
(d) Acting as trustees to the debenture holders.
(e) Structuring financial collaboration through joint venture by identifying suitable partner
and preparing joint venture agreement.
(f) Rehabilitating and reconstructing sick units.
 (g) Hedging of risks by using swaps and derivatives.
(h) Managing portfolio of large public sector corporations.
(i) Undertaking risk management services like insurance service, buy back options etc.
(j) Advising the clients on the best source of funding overall.
(k) Guiding the clients in the minimization of the cost of debt.
(l) Capital market services such as clearing, registration and transfers, safe custody of
securities, collection of income on securities.
(m) Promoting credit rating agencies .
(n) Recommending suitable changes in the management structure and management style
with a view to achieving better results.
Indian Financial System

Structure of Financial Systems

A. Financial Institutions
⯌ Commercial banks
⯌ Co-operative banks
⯌ Non- banking financial companies (NBFCs)
B. Financial Markets
🟆 Capital markets
🟆 Money markets
🟆 Foreign exchange (Forex) market
🟆 Commodity markets
🟆 Derivatives markets
C. Financial Intermediaries
🟆 Insurance companies
🟆 Mutual funds
 🟆 Pension funds
🟆 Development financial institutions (DFIs)
D. Regulatory Authorities
🟆 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)
E. Payment and Settlement Systems
🟆 The National payments corporation of India (NPCI)
F. Microfinance Institutions
🟆 These institutions provide financial services to low-income individuals and small
businesses, aiming to promote financial inclusion.
G. Government Institutions
🟆 Institutions like the small industries development bank of India (SIDBI) provide funding
and support to small and medium sized enterprises (SMEs).
Role of Financial System

🞽 Intermediation
🞽 Capital Formation
🞽 Facilitating investment
🞽 Risk management
🞽 Liquidity provision
🞽 Price discovery
🞽 Monetary policy implementation
🞽 Financial inclusion
🞽 Wealth management
🞽 Promoting innovation
🞽 Stabilizing the economy
🞽 Facilitating international trade
Functions of Financial System

 Savings function
 Liquidity function
 Payment function
 Risk function
 Policy function
 Provides financial services
 Lowers the cost of transactions
 Financial deepening and broadening
Development of Financial System in India

✶ Pre independence era

✶ 1950s-1960s
✶ 1980s-1990s
✶ Banking sector reforms
✶ Capital market reforms
✶ Liberalization and privatization
✶ Banking sector consolidation
✶ Financial inclusion
✶ Digital transformation
✶ Insolvency and bankruptcy code (IBC)
✶ Regulatory reforms
✶ Infrastructure development
Financial sector reforms

i) Wealth accumulation
ii) Poverty reduction
Weakness of Indian Financial system

(a) Non-performing assets (NPAs) and bad loans

(b) Lack of financial inclusion
(c) Weak infrastructure finance
(d) Lack of deep corporate bond market
(e) High dependence on banks
(f) Limited pension coverage
(g) Complex regulatory environment
(h) Lack of investor awareness and education
(i) Informal financial sector
(j) Cybersecurity and fraud concerns
(k) Insufficient credit information
(l) Regulatory challenges for fintech
 Unit-2

Capital market and money market

Meaning of Capital market

Capital market is a place where the medium-term and long-term financial needs of Business
and other undertakings are met by financial institutions which supply medium and long-term
resources to borrowers.

Features of capital market

❖ It deals with long and medium-term funds.
❖ It consists of the primary market, secondary market and special financial institutions.
❖ It covers both individual and institutional investors.
❖ It makes funds available to industrial and commercial undertakings.

Nature of capital markets

i. The capital market consists of series of channels through which savings of the public and
made available for industrial and commercial enterprises.
ii. The capital market directs the savings of the public (Investor) into their most productive
investment plan, leading to growth and development of the economy.
iii. Participants in the capital market include corporate entities, stock exchanges,
development banks, commercial banks, financial institutions, foreign investors andordinary
retail investors from members of the public.

Need for capital market

• It helps in mobilizing the savings on a large scale.
• It helps in the capital formation in the country.
• It helps in the effective distribution of the mobilized funds for balanced economic
development.
• It provides a continuous market for long term funds .

Importance of capital market

1. It mobilizes the savings of people and channelize them into productive uses.
2. It helps industrial establishments to increase production by providing necessary funds.
3. It leads to economic growth of the economy.
4. It leads to technological upgradation.
5. A healthy capital market consisting of expert intermediaries promotes stability in the
values of securities representing capital funds.
Functions of capital market
✓ Link between savers and investors
✓ Encouragement to savings
✓ Encouragement to investment
✓ Promotes economic growth
✓ Stability in security prices
✓ Benefits to investors

Role of capital market

I. Mobilization of savings
II. Capital formation
III. Provision of investment avenue
IV. Speed up economic growth and development
V. Proper regulation of funds
VI. Service provision
VII. Continuous availability of funds
VIII. Technological upgradation

Players in the capital market

➢ Fund raisers
➢ Fund providers
➢ Intermediaries
➢ Organization
➢ Market regulators

Instruments issued in capital market

 Debt instruments
 Equities (Also called common stock)
 Preference shares
 Derivatives
 Mutual fund

Structure of capital market

♦ Primary market
♦ Secondary market
♦ Equity market
♦ Debt market
♦ Derivatives market
♦ Commodity market
 ♦ Currency market (Forex)
♦ Regulatory framework
♦ Investor participation
♦ Technological advancements

Recent trends in capital market

▪ SPACs (Special purpose acquisition companies)
▪ Rise of retail investors
▪ Sustainable and ESG investing
▪ SPDRs and ETFs
▪ Remote work impact
▪ Regulatory changes
▪ Global economic recovery
▪ Alternative investments
▪ Tech and Healthcare sectors
▪ Crypto and digital assets
▪ Resurgence of IPOs

Meaning of money market

Money market refers to the market where money and highly liquid marketable securities are
bought and sold having a maturity period of one or less than one year. The money market
constitutes a very important segment of the Indian financial system.

Definition of money market

According to Geoffrey, “Money market is the collective name given to the various firms and
institutions that deal in the various grades of near money “.

Objectives of money market

a. To provide a parking place to employ short-term surplus funds.
b. To provide room for overcoming short-term deficits.
c. To enable the Central bank to influence and regulate liquidity in the economy through its
intervention in this market.
d. To provide reasonable access to the users of short-term funds to meet their
requirements quickly, adequately and at reasonable costs.
e. To provide an equilibrium mechanism for ignoring short-term surplus and deficits.
f. To provide a focal point for central bank intervention for influencing liquidity in the
economy.

Features of money market

 ➢ It is a market purely for short-term funds or financial assets called near money.
➢ It deals with financial assets having a maturity period up to one year only.
➢ It deals with only those assets which can be converted into cash readily without loss and
with minimum transaction cost.
➢ Generally, transactions take place through phone i.e., oral communication. Relevant
documents and written communications can be exchanged subsequently. There is no
formal place like a stock exchange as in the case of a capital market.
➢ Transactions have to be conducted without the help of brokers.
➢ The components of a money market are the Central Bank, Commercial Banks, Non-
banking financial companies, discount houses and acceptance houses. Commercial
banks generally play a dominant role in this market.

Importance and functions of money market

A. Financing trade
B. Financing industry
C. Profitable investment
D. Self-sufficiency of commercial bank
E. Help to central bank
F. Money market helps the central bank in two ways

Role of Reserve Bank of India in the money market

i) To ensure that liquidity and short-term interest rates are maintained at levels consistent
with the monetary policy objectives of maintaining price stability.
ii) To ensure an adequate flow of credit to the productive sector of the economy.
iii) To bring about order in the foreign exchange market.

Structure of money market

A. Organized money market
o The call money
o The treasury bill market
o The commercial bill markets
o The certificate of deposit market
o The commercial paper markets
o Money market mutual funds
B. Unorganized money market
o Indigenous bankers
o Money lenders
o Chit funds and Nidhi
o Finance brokers
 o Finance companies

Participants of money market

* Central government
* Public sector undertakings
* Insurance companies
* Mutual funds
* Banks
* Corporates

Instruments of money market

❑ Treasury bills
❑ Commercial papers
❑ Certificate of deposits
❑ Repurchase agreement (Repo)
❑ Reverse Repo
❑ Inter corporate deposits (ICD)

Players of money market

# Reserve Bank of India
# Government
# Commercial Banks
# Financial Institutions
# Corporate Firms
# Discount Houses and primary Dealers
# Money Market mutual fund

Limitations of money market

 Absence of Integration
 Multiple rate of interest
 Insufficient funds or resources
 Shortage of investment instruments
 Shortage of commercial bill
 Lack of organized banking system
 Less number of dealers

Recent trends in money market

 Low interest rate environment
 Digital payment systems
 Cash management strategies
 Shifts in demand for short-term instruments
 Government stimulus and market Liquidity
 Investor preference for safety
 Regulatory reforms
 Short-term funding market
 Global economic recovery
 Alternative cash investments
 Environmental, social and governance (ESG) considerations
 Central bank digital currencies (CBDCs)
 Unit-3

Primary Markets

Meaning of Primary market

In this market, funds are raised by industrial and commercial enterprises from investors
through the issue of shares, debentures and bonds. It is also called as new issues market.

Features of primary market

• Market for new long term equity capital
• Securities are issued by the company
• The money and issues new security certificates
• Used by companies for the purpose of setting up new business
• Performs the crucial function of facilitating capital
• The new issue market does not include
• Redeemed by the original holder

Significance of primary market

❖ Capital growth by enabling individuals
❖ Issues new stocks to raise money directly
❖ Channel for the government to raise funds.
❖ Trades listed shares between buyers and sellers
❖ Expansion and growth for domestic and foreign companies

Importance of Primary market

➢ Capital formation
➢ Liquidity
➢ Diversification
➢ Reduction in cost
➢ Business expansion

Functions of Primary market

✓ Organization
✓ Underwriting
✓ Distribution
✓ Household savings
✓ Global investments
✓ Sale of government securities
Disadvantages of Raising capital in Primary market
1. The shares are allotted proportionately if there is over subscription which means the
small investors may not get any allotment.
2. Money is locked in for a longer time, as it is a long-term investment.
3. The shares allotment for the investor takes few days in the primary market compared to
secondary market where it takes only 3 days to allot the shares.

Players in Primary Market

 Merchant bankers
 Registrars
 Collecting and coordinating bankers
 Underwriters
 Transfer agents
 Debenture trustees
 Portfolio managers
 Printers, advertising agencies and mailing agencies

Types of Issues in Primary Market

 Initial public offering (IPO)
 Follow on public offer (FPO)
 Rights issue
 Preferential issue
 Private Placements

Initial Public Offerings

Fresh issue of shares or selling existing securities by an unlisted company for the first. time is
known as IPO. Listing and trading of securities of a company takes place in IPO. When a
(unlisted) company makes a public issue for the first time and gets its shares listed on stock
exchange, the public issue is Called as initial public offer (IPO).

Reasons for going Public

I) To raise funds for financing capital expenditure needs like expansion, diversification etc.
II) To finance increased working capital requirement.
III) To provide an exit route for existing investors.
IV) To the purpose for debt financing.
Benefits of Going Public
▪ Access to capital
▪ Stockholder diversification
▪ Easier to raise new capital
 ▪ Enhances liquidity
▪ Images
▪ Signals from the market
▪ Other advantages
Disadvantages or costs of Going Public
🞶 Disclosure
🞶 Dilution
🞶 Loss of flexibility
🞶 Accountability
🞶 Self-dealings
🞶 Inactive market - low price
🞶 Control
🞶 Costs
🞶 Other Disadvantages

Advantages of Rights Issue

🟆 It is a very economical method of raising fresh capital. More expenses like underwriting
and brokerage are not incurred at all and other expenses such as advertisement and
administration expenses on the issue are much less.
🟆 Management of applications and allotment is easier because the company has to handle
only a limited number.
🟆 Existing shareholders pattern is not disturbed.
🟆 Existing shareholders earn the first right to share in the prosperity of the company if it is
doing well.
🟆 Troubled companies typically use rights issues to pay down debt, especially when they are
unable to borrow more money.

Disadvantages of Rights Issue

(a) This method can be used only by the existing companies and not by the new companies.
(b) Subscriptions of issues remain limited to existing shareholders.

Advantages of Private Placements

✹ Staying private allows your company to choose its own investors, unlike a public offering
which is open to the general public.
✹ It saves your company's the time and money required to make a public offering and
maintain the financial records for the SEC.
✹ With a private placement you can take more time to arrive at the agreed upon return.
✹ Stock exchange requirements concerning contents of prospectus and its publicity are less
onerous in the case of private placements.
 ✹ Those shares which do not arouse public interest can be sold through private placements.
✹ Finally, the options for type and amount of funding give you more flexibility and get you
capital much faster than searching for venture capitalists or waiting for your shares to sell
on the public market.

Disadvantages of Private Placements

✯ Fear of issue getting concentrated in few hands.
✯ Artificial scarcity of these securities may be created for jacking up their prices temporarily,
thus misleading investors.
✯ Placement of shares does not generate confidence in the minds of the investing public.

Problems of Indian Primary Market

❑ Volatility and uncertainty
❑ Lack of investor confidence
❑ Over Regulation
❑ Lengthy approval processes
❑ Underdeveloped bond market
❑ Lack of retail participation
❑ High issue costs
❑ Inefficient pricing
❑ Limited liquidity post IPO
❑ Preferential allotments
❑ Retail participation in private placements
❑ Investor Education