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Chapter 2
Financial System and the
Economy
Indian Financial System, 5e
By: Bharati V. Pathak
Chapter Objectives
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To understand:
1. Types of economic units.
2. Role of financial system in the economy
3. National Income Accounts
4. Flow of Funds Analysis
5. Trends in Saving and Investment
6. Trends in Household Financial Savings and
Liabilities
7. Relationship between Financial System and
Economic growth
Indian Financial System, 5e
By: Bharati V. Pathak
Types of Economic Units
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•Surplus -spending economic units :
Income > Consumption + planned investment
• Deficit- spending economic units:
Income < Consumption + planned investment
Indian Financial System, 5e
By: Bharati V. Pathak
Figure 2.1
"Copyright © 2018 Pearson India Education Services Pvt. Ltd".
By: Bharati V. Pathak
Indian Financial System, 5e
Some Frameworks and
Concepts of Macroeconomics
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• Some frameworks and concepts of
Macroeconomics to understand the role of
the financial system in the economy
National income accounts
Flow of funds accounts
Trends in Saving and Investment
Indian Financial System, 5e
By: Bharati V. Pathak
National Income Accounts
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• Uses: To measure production in the economy
and earnings derived from production
• Classifies Indian economy into the following
industrial sectors:
Primary
Secondary
Transport, Communication and trade
Finance and real estate
Community and personal services
Foreign
• The combined gross output in all these sectors
except the foreign sector is called the GDP
Indian Financial System, 5e
By: Bharati V. Pathak
Flow of Funds Accounts
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•Provide information on six sectors:
Household, private corporate business,
banking, government, other financial
institutions and the rest of the world.
•Present a net flow of funds between sectors
and between two points of time.
•Disclose the level, depth and nature of
financial activities in the economy.
Indian Financial System, 5e
By: Bharati V. Pathak
Flow of Funds–based Indicator
of Financial Development
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Finance ratio: Total financial claim/Net
income
Financial inter-relation ratio: Financial
assets/Physical assets
Intermediation ratio: Total secondary
issues/Total primary issues
New Issue ratio: Primary issues/Net
physical investment
Indian Financial System, 5e
By: Bharati V. Pathak
Trends in Saving and
Investment
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To analyse fluctuations in economic activity
and process of economic growth
Divide economy into three broad institutional
sectors – a) Household b) Private Corporate
c) Public
Indian Financial System, 5e
By: Bharati V. Pathak
Household Sector Savings
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Two forms : Financial assets & Physical assets
Household sector financial assets portfolio
Deposits
Contractual savings
Share and debentures
Household sector financial liabilities
portfolio
Bank advances
Loans by financial corporations and non banking
companies
Loans and advances from government
Indian Financial System, 5e
By: Bharati V. Pathak
Relationship Between the Financial
System and Economic Growth
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Financial system:
Facilitates economic activity and growth
Helps accelerate the volume and rate of
savings.
Lowers financial intermediation costs
Makes innovation least costly
Helps in evaluating assets
Helps in central bank to conduct monetary
policy
Monitors the management of companies
Indian Financial System, 5e
By: Bharati V. Pathak
