financial markets and services unit 1

A V V S PRASAD
Assoc. Prof.
MBA.,M.Phil.,Ph.D.

UNIT 1
 Financial System in India: Introduction
 Evolution of Banking
 Phases of development
 RBI and the Financial System
 Committees on Banking Sector
Reforms
 Prudential Banking
 RBI Guidelines and directions.

FINANCIAL SYSTEM:-
 System  “a set of complex and closely
connected or intermixed institutions,
agents, practices, markets, transactions,
claims, and liabilities in the economy”.
 Financial System is concerned about
○ Money –current medium of exchange
○ Credit –money returned normally with
interest
○ Finance –monetary resources comprising
debt and ownership funds

Financial
System
Financial
Institutions
Financial
Markets
Financial
Instruments
(Claims, Assets,
Securities)
Financial
Services
Regulatory Intermediaries
Non-
Intermediaries
Others
Banking
Non-
Banking
Organized Unorganized Primary Secondary
Short
Term
Medium
Term
Long
Term
Secondary
Capital
Markets
Primary
Money
Markets
Equity Market
Debt Market
Derivative Market

FINANCIAL
INSTITUTIONS
REGYLATORY
BANKING
INTERMEDARIES OTHERS
NON-
INTERMEDARIES
NON
BANKING
RBI
NFBIS, UTI,
LIC, GIC
COMM.
BANKS
IDBI,
NABARD

FINANCIAL INSTITUTIONS
 Business organizations that act as mobilizes and
depositories of savings, and as purveyors of credit
or finance
 Intermediaries intermediate between savers
and investors
—lend money as well as mobilize savings
—liability towards the ultimate savers
—assets are from the investors or borrowers
 Intermediaries– all banking institutions, non-
banking Financial intermediaries (NBFIs) –UTI,
LIC, GIC
 Non-intermediary institutions --> do loan business
 but resources not directly obtained from the
savers
 Non-intermediaries – IDBI, NABARD, IFC—also
called non-banking statutory financial
organizations(NBFSO)

FINANCIAL
MARKETS
UNORGANISED
ORGANISED
SECONDARY
PRIMARY
CO-
OPERATIVE
SECTOR
MONEY
LENDERS
CHIT
FUNDS
MONEY
MARKET
CAPITAL
MARKET
TREASURY
COMMERCIAL
BILLS
CALL
MONEY

FINANCIAL MARKETS
 Provide facilities for buying and selling of
financial claims and services
 Primary and Secondary Markets
 Money and Capital Markets
○ Both perform same function of transferring resources
to the producers
○ Distinction based on – differences in period of maturity
of financial assets issued in these markets
○ Money market – short-term claims (<1 year) – T-bills,
call money market, commercial bills
○ Capital market – long-term claims (>1 year) – stock
market, govt. bonds market
○ Commercial banks belong to both

FINANCIAL
INSTRUMENTS
(CLAIMS,
SECURITIES,ASSETS.)
SECONDRY
FINANCIAL
INSTRUMENTS
PRIMARY
MARKETFINANCIAL
INSTRUMENTS
SHORT
LONG
MEDIUM

FINANCIAL INSTRUMENTS AND
SERVICES
Financial asset – represents a claim to the
payment of a sum of money in the
future and/or a periodic payment in the
form of interest or dividend.
Financial securities – primary and
secondary

 Financial services are the
economic services provided by
the finance industry, which
encompasses a broad range of
businesses that manage money,
including credit unions, banks, credit-
card companies, insurance companies,
accountancy companies, consumer-
finance companies, stock
brokerages, investment funds,
individual ...

FINANCIAL
SERVICES
Project
advisory
services.
Planning M&A.
JVs.
Hedging risk.
MODERN
NON-FUND
BASED
TRADITIONAL
FUND BASED
1.Lease
financing.
2.Consumer
credit.
3.Bill discounting.
4.Factoring.
5.Forfeiting.
1. Hire purchase.
2. Venture capital.
3. Housing finance.
4. Insurance
service

FUNCTIONS
OF
FINANCIAL
SECTOR
Liability- Asset
transformation
function
Size
transformation
function
Risk
transformation
function.
Maturity
transformation
function.

Liability- Asset
transformation function
 Asset transformation is the process of
creating a new asset (loan)
from liabilities (deposits) with different
characteristics by converting small
denomination, immediately available
and relatively risk free bank deposits
into loans

size transformation function
of financial system
 A type of transformation that is
performed by banks and other
depositary institutions whereby small
deposits by different types of depositors
are pooled in order to issue large loans
to seekers of funds

risk transformation function
of financial system
 Risk transformation is about how to
mitigate risk and in parallel develop
competitive advantages. ... Risk may
include financial risk, security/safety-
related risks, uncertainty,
and risk through action or lack of action.

maturity transformation
function of financial system
 Maturity transformation is the practice
by financial institutions of borrowing
money on shorter timeframes than they
lend money out.

Equilibrium in Financial Markets
 Equilibrium in financial markets– usually determined by
assuming perfect competition
 Financial markets are said to be perfect when
 A large number of savers and investors operate in markets
 The savers and investors are rational
 All operators in the market are well-informed and information is
freely available to all of them
 There are no transaction costs
 The financial assets are infinitely divisible
 The participants in markets have homogenous expectations
 There are no taxes
 Under these ideal conditions, the financial markets attain
equilibrium position when supply and demand are equal
 the interest rate at which the supply curve and
demand curve intersect with each other

EQUILIBRIUM CONTD.,
 The equilibrium in financial markets is
established when the expected demand
for funds (credit) for short-term and long-
term investments matches with the
planned supply of funds generated out
of saving and credit creation.
 Supply of funds
○ Aggregate savings by household, business
and govt. sectors

EQUILIBRIUM CONTD.,
 Demand of funds
○ Investment in fixed and circulating (working)
capital
○ Demand for consumer durables
○ Investment in housing
○ Current level of capital stock
○ Capacity utilization
○ Desired capital stock
○ Availability of internal funds
○ Cost of funds
○ Technological changes

RELATIONSHIP
BETWEEN
FINANCIAL SYSTEM
AND
ECONOMIC
DEVELOPMENT

Economic
development
Spending
economic
units
Income-
expenses
Surplus/
saving
Financial
system
Capital
formation
Industrialization
RELATIONSHI
P BETWEEN
FINANCIAL
SYSTEM
AND
ECONOMIC
DEVELOPMENT

Financial System and Economic
Development
1.Finance is not important at all
Ex: environment- friendly, appropriate
technology.
2.Finance is very important.
3. Cautionary View:
Economic Growth – growth results
predominantly not from the increase in labor
and capital but from the technical progress,
which is external  money and finance and
the policies about them cannot contribute to the
growth process.

A well developed financial system can
contribute significantly to the acceleration of
economic development through –
 Technical progress is endogenous ( human and
physical capital are its important sources 
dependent on financial system)
 Good financial system  rate of capital formation
(finance available in time, in adequate quantity and
on favorable terms)  economic development
 Financial system enhances the efficiency of the
function of medium of exchange  helps in
economic development.

financial markets and services unit 1

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