29-01-2013, 04:43 PM
Indian Financial System
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Introduction
A Financial System plays a vital role in the economic growth of a country
It intermediates between those who have surplus funds and those who need them
It 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
Formal and informal Financial Sectors
Formal – Organized, institutional and regulated system
Informal – Unorganized, flexible, low transaction cost, minimal default risk, higher rate of interest
Interpenetration exists between formal and informal systems in terms of operation, participation and nature of activities which in turn have led to their coexistence. Priority should be accorded to development of efficient formal financial system
Financial Markets
Mechanism enabling participants to deal in financial claims. Markets provide a facility in which demand and supply interact to set a price for such claims
Organized markets in India are Money market and Capital Market. Money Market is for short term securities and Capital Market is for long term securities which are those having maturity period of one or more years
Financial Instruments
Different Financial Instruments can be designed to suit the risk and return preferences of different classes of investors
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), as including shares, scripts, stocks, bonds, debentures or other marketable securities of a similar nature
Key element of a Financial System
Strong legal and regulatory environment
Stable money
Sound public finances and public debt management
A Central Bank
Sound banking system
Information system
Well functioning securities market
Financial System Designs
Bank based – bank dominated system where few large banks play a dominant role and stock market is not important (Germany)
Market based – Financial markets play an important role while the banking industry is much less concentrated (US)
Financial Intermediaries
Liability, asset and size transformation consisting of mobilization of funds and their allocation by providing large loans on the basis of numerous small deposits
Maturity transformation by offering the savers tailor-made short-term claims or liquid deposits and so offering borrowers long-term loans matching the cash flows generated by their investment
Risk transformation by transforming and reducing the risk involved in direct lending by acquiring diversified portfolios
Functions of Capital Markets
Mobilize long-term savings to finance long-term investments
Provide risk capital in the form of equity or quasi-equity entrepreneurs
Encourage broader ownership of productive assets
Provide liquidity with a mechanism enabling the investor to sell financial assets
Lower the costs of transactions and information and
Improve the efficiency of capital allocation through a competitive pricing mechanism
Characteristics of Financial Markets
Large volume of transactions and the speed with which financial resources move from one market to another
Various segments – stock markets, bond markets- primary and secondary segments, where savers themselves decide when and where they should invest
Scope for instant arbitrage among various markets and types of instruments