Chapter No.1: The Financial System An Introduction

Chapter no.
The financial system

an introduction
Introduction
• A financial system plays a very effective role in
the economic growth of a country.
• It is complex yet it is well integrated set of
sub-systems of financial institutions, markets,
instruments, and services which facilitates the
transfer and allocation of funds, efficiently and
effectively.
• There are generally two type of financial
sectors are available in the economy.
• Formal sector
• Informal sector
• Formal financial sector is well organized,
institutional and regulated system.
• While informal financial sector in unorganized,
non institutional, and non regulated.
• Formal financial sector would be regulated by
the Ministry of finance, Reserve bank of India,
Security and Exchange Board of India.
• While informal financial sector consists of
individual, money lenders as neighbors,
relatives, land lords, traders and store owners.
COMPONENTS OF THE FORMAL FINANCIAL
SYSTEM.
• Financial institution
• Financial markets
• Financial instruments
• Financial services
Financial institution
INTRODUCTION
• Includes institutions and mechanisms which
– Affect generation of savings by the community
– Mobilization of savings
– Effective distribution of savings
• Institutions are banks, insurance companies,
mutual funds- promote/mobilize savings
• Individual investors, industrial and trading
companies- borrowers
Classification of financial institution.
• Banking and non banking.

• Term financing.
• Specialized.
• Sectoral.
• Investment.
• State level.
Financial markets
• Money Market- for short-term funds (less than
a year)
– Organized (Banks)
– Unorganized (money lenders, chit funds, etc.)
• Capital Market- for long-term funds

– Primary Issues Market
– Stock Market
– Bond Market
Financial instruments
• Enable channelizing funds from surplus units to deficit
units
• There are instruments for savers such as deposits,
equities, mutual fund units, etc.
• There are instruments for borrowers such as loans,
overdrafts, etc.
• Like businesses, governments too raise funds through
issuing of bonds, Treasury bills, etc.
• Instruments like PPF etc. are available to savers who
wish to lend money to the government
Classification of financial instrument
• Primary financial instrument.

• Secondary financial instrument.
Features of the financial instrument.
Marketable
Tradable
Financial services
• Need for financial services.
• Borrowing and funding.
• Lending and investing.
• Buying and selling securities.
• Making and enabling.
• Payments and settlements.
• Managing risk.
Functions of financial system
• Mobilize and allocating savings.

• Monitor corporate performance.
• Provide payment and settlement system.
• Optimum allocation of risk-bearing and
reduction of risk.
• Offer portfolio adjustment facility.
• Lower the cost of transactions
Money Market.
ORGANIZED MONEY MARKET.
• Call money market

• Bill Market
– Treasury bills
– Commercial bills
• Bank loans (short-term)
• Organized money market comprises RBI,
banks (commercial and co-operative)
1.Call money market
• Is an integral part of the Indian money market
where day-to-day surplus funds (mostly of
banks) are traded.
• The loans are of short-term duration (1 to 14
days). Money lent for one day is called ‘call
money’; if it exceeds 1 day but is less than 15
days it is called ‘notice money’. Money lent for
more than 15 days is ‘term money’
• The borrowing is exclusively limited to banks,
who are temporarily short of funds.
• Call loans are generally made on a clean basis- i.e. no
collateral is required
• The main function of the call money market is to
redistribute the pool of day-to-day surplus funds of
banks among other banks in temporary deficit of funds
• The call market helps banks economise their cash and
yet improve their liquidity
• It is a highly competitive and sensitive market
• It acts as a good indicator of the liquidity position
Bill Market
• Treasury Bill market- Also called the T-Bill market
– These bills are short-term liabilities (91-day, 182-day, 364-day) of
the Government of India
– They are issued at discount to the face value and at the end of
maturity the face value is paid
– The rate of discount and the corresponding issue price are
determined at each auction
– RBI auctions 91-day T-Bills on a weekly basis, 182-day T-Bills and
364-day T-Bills on a fortnightly basis on behalf of the central
government
Money Market Instruments
• Certificates of Deposit
• Commercial Paper
• Inter-bank participation certificates
• Inter-bank term money
• Treasury Bills
• Bill rediscounting
• Call/notice/term money
Capital Market
• Market for long-term capital. Demand comes
from the industrial, service sector and
government
• Supply comes from individuals, corporate,
banks, financial institutions, etc.
• Can be classified into:
– Gilt-edged market
– Industrial securities market (new issues and stock
market)
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Chapter No.1: The Financial System An Introduction

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Chapter no.

The financial system

• Banking and non banking.

• Capital Market- for long-term funds

• Primary financial instrument.

• Mobilize and allocating savings.

• Call money market

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