Indian Financial

System

By : Gaurang Badheka
MFS, Sem - 3
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 To start with …..

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 Reference material
• Business daily ( ET, BS, FE, Mint, etc.)
• Magazines and journals on financial
services / system
• Important websites (RBI, SEBI, IRDA,
DEA, etc.)
• Business news channels (CNBC, Aawaz,
NDTV Profit, etc.)

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 Meaning of Financial services
• All types of activities which are of financial nature may
be regarded as financial services.
• In simple words, the term financial services means
mobilizing and allocating savings. Thus, it includes all
activities in the transformation of savings into
investments.,
• The financial services is also called financial
intermediation.
• Financial intermediation is the process by which funds
are mobilized from savers and make them available to
the corporate customers for investments.

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 Meaning of Financial services
• Financial services comprise of various functions and
services that are provided by financial institutions in
financial system.
• financial services help not only in raising the required
funds but also in ensuring their efficient utilization
• Financial services are provided by stock exchanges,
specialized and general financial institutions, banks and
insurance companies.
• Financial services are regulated by SEBI, RBI and the
department of banking and insurance, government of
India through legislations.

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 Scope of Financial Services
TRADITIONAL ACTIVITIES:
A. FUND BASED ACTIVITIES:
- Dealing in shares, debentures of new issues
- Dealing in secondary market activities
- Dealing in money market instruments
- Involving in hire purchase, leasing etc.
- Dealing in foreign exchange market activities.

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 Scope of Financial Services
TRADITIONAL ACTIVITIES:
B. NON FUND BASED ACTIVITIES(FEE BASED):
These are not connected with provision of finance.
- Managing capital issues
- Arranging placement of capital and debt instruments with
investment institutions.
- Arrangement of project finance and working capital funds
from financial institutions
- Assisting in the process getting all clearances from the
government departments.

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 Scope of Financial services
II. MODERN ACTIVITIES: new financial products and
services:
- Merchant banking
- Venture capital
- Factoring
- Forfeiting
- Credit rating
- Mutual funds
- Under writing
- Stock investment
- securitization
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 Financial services
Characteristics of financial services

i) Customer-Specific
ii) Intangibility
iii) Tendency to Perish
iv) People based services
v) Market Dynamics

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 Financial services
Evolution of financial services

The Stage of Infancy

Modern Financial Services
The Third Flush
New Financial Instruments

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 Financial System
A system that aims at establishing and providing a
regular, smooth, efficient, and cost effective
linkage between depositors and investors is
known as financial system

An institutional framework existing in a country to

enable financial transactions

A set of complex and closely connected

instructions, agents, markets, transactions, relating
to financial aspects of an economy
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 Financial System - components
• An institutional framework existing in a country to
enable financial transactions
• Three main parts
– Financial assets (loans, deposits, bonds, equities, etc.)
– Financial institutions (banks, mutual funds, insurance
companies, etc.)
– Financial markets (money market, capital market, forex
market, etc.)
• Regulation is another aspect of the financial system
(RBI, SEBI, IRDA, FMC)

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 Financial system
 The financial system of a country means a set of financial
arrangements by which the savings in the economy are
mobilized for investment in productive assets.

 The financial system deals with all types of finance,

agricultural, industrial, developmental and governmental
finance.

 The suppliers and users of funds are a part of the financial

system.

 Thus, the financial system is concerned with borrowing and

lending of funds or the demand and supply of funds of all
individuals, institutions, companies and the Government.

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 Borrowers acquire funds from
financial intermediaries who in
turn acquire funds from savers.
Involves Asset Transformation

Borrowers acquire funds directly from savers – usually by

selling them securities.
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 Financial system
Process of Capital Formation
Involves three distinct, although inter-related activities.

(i) Savings
(ii) Finance
(iii) Investments

The financial system is a link between the savers (savings –

surplus economic units) and the investors (savings – deficit
economic units). It is made up of all those channels through
which savings become available for investment.

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 Functions of financial system
• provides a payment system for exchange of goods
and services
• Permits multiple payment mechanisms- cash,
cheque, DD, credit card…….
• Supplies a diversified portfolio of financial
investments
• It provides an ideal linkage between depositors
and investors
• facilitates Expansion of financial market
• Efficient allocation of financial resources
• Helps for economic development

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 Functions of financial system
• Stabilize the interest rates
• Undertake matured financial engineering
techniques for financial inclusion
• Perfect financial market knowledge.
• Encourages direct finance mechanisms
• Better corporate governance-securities
markets impose a discipline..

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 Financial assets / instruments
 Enable channelising 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, KVP, etc. are available to
savers who wish to lend money to the government

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 Financial institutions
• Includes institutions and mechanisms which
– Affect generation of savings by the
community
– Mobilisation of savings
– Effective distribution of savings
• Institutions are banks, insurance co.s, mutual
funds - promote/ mobilise savings
• Individual investors, industrial and trading
companies- borrowers

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Constituents of financial system
1. Financial Markets: Provide facilities for raising
long term and short term funds.

2. Financial Institutions: Serve as intermediaries

between borrowers and lenders of funds.

3. Financial Instruments: Are used to raise funds

in the financial markets

4. Financial Services: Services offered by various

financial institutions.
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 Regulation of financial system

Capital Banks
Debt Forex Market Insurance (including Mutual Funds,
Market
Market Primary / Life/General RRBs, co-op Venture Funds,
Primary /
Secondary & etc) Investment
Secondary
Depository Bonds

RBI RBI SEBI IRDA RBI RBI/SEBI

REGULATORY AUTHORITY

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 Functions of these components
Component What they do Who They Are

Financial (a) Collect Savings Banks,

Intermediatories (b) Issue claim against themselves NBFC, MF,

(c) Use Funds, thus raised, to insurance purchase
ownership/ debt-claims etc.

Financial Markets (a) Not a Source of funds Call Market

(b) Act as a facilitating organisation and T-Bill Market
link saver & investor CP-Market
(c) Based on nature of work they are Repo Market
classified as (1) Money Market Stock
(2) Capital/Security Markets. Exchange

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 Functions of these components
Component What they do Who They
Are

Financial Asset/ (a) Financial Product – innovation Shares, Debt

Instrument/Security (b) Three broad categories
Instruments,
(1) Direct/Primary e.g. Share, Debentures,
Debt., Pref. Share etc. etc.
(2) Indirect MF, Security Receipts,
Securitized Debt Investment.
(3) Derivatives Forward, Future,
Options.

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 Important phases

• Up to 1951 Pvt. Sector

• 1951 to 1990 Public Sector

• Early Ninties Privatisation

• Present Status Globalisation

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 Phase – up to 1951
1. Control of Money Lenders
2. No Laws / Total Private Sector
3. No Regulatory Bodies
4. Hardly any industrialization
5. Banks – Traditional lenders for Trade and that too short
term
6. Main concentration on Traditional Agriculture
7. Narrow industrial securities market (i.e. Gold/Bullion/ Metal
but largely linked to London Market)
8. Absence of intermediatory institutions in long-term financing
of industry
9. Industry had limited access to outside saving / resources

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 Phase – 1951 to 1990
Moneylenders ruled till 1951. No worth-while Banks at that time.
Industries depended upon their own money. 1951 onwards 5
years PLAN commenced.

PVT. SECTORS TO PUBLIC SECTOR – MIXED ECONOMY

1st 5 year PLAN in 1951 – Planned Economic Process. As part of
Alignment of Financial Systems – Priorities laid down by Govt. –
Policies.
MAIN Elements of Fin. Organisations
i. Public ownership of Financial Institution
ii.Strengthening of Institutional Structure
iii.Protection to Investors
iv.Participation in Corporate Management
v.Organisational Deficiencies.

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 Phase – 1951 to 1990
Nationalisation
RBI 1948
SBI 1956 (take-over of Imperial Bank of
India)
LIC 1956 (Merges of over 250 Life Insurance
Companies)
Banks 1969 (14 major banks with Deposits of
over Rs. 50 Crs. nationalised)
1980 (6 more Banks)
Insurance 1972 (General Insurance Corp. GIC by
New India, Oriental, united and
National insurance )

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 Phase – 1951 to 1990
Developmental Financial Institutions
• Directing the Capital in confirmity with Planning priorities
• Encouragement to new entrepreneurs and small set-ups
• Development of Backward Region
• IFCI (1948)
• State Finance Corporation (1951) Purely Mortgage institution
• IDBI (1964) As subsidiary of RBI to provide Project / Term Finance
• ICICI (1966) Channellising of Foreign Currency Loan from World
Bank to Pvt. Sector and underwriting of Capital issues.
• SIDC’s & SIIC State Level Corporations for SME sector
• UTI (1964) to enable small investors to share Industrial Growth
• IRCI (1971) to take care of rehabilitation of sick-mills promoted by
IDBI, Banks & LIC-Name changed to IIBI in 1997.

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 Phase – 1951 to 1990
Developmental Financial Institutions
• NCC (1968) National Credit Council to assess the demand of Credit
& determine priorities for grant of Loans, advances, investment &
requirements of priority sector (presently 40%)
• Credit Guarantee Scheme (1960) for SSI Finance upto 75% of
defaulted amount or guarantee amount whichever is lower with
ceiling of Rs. 7.5 Lacs for W/Cap & Rs. 2.5 Lacs for T/L per
borrower.
• Agriculture Finance Corp. (AFC) for financing agriculture projects
and help Banks. Lead Districts (580) Service Area Approach.
Scrapped in 2006.
• ARC (1963) Agriculture Refinance Corp. for refinance of medium &
long term loans.
• ECGC (1964) FOR Export Performance

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 Phase – 1951 to 1990
Commercial Banks
• Continued old way of Deposit – Banking & short term credit to
trade
• Selective Credit Control (Control through quantum, rate of
interest margin etc).
• Extensive Branch Expansion.
• Refinance Facility to share risk & also cost of Banks’ funds
 Better needs of Economic development
 Create job opportunities
 Fulfillment of Plan objectives
 Servicing maximum population by Branch expansion
 Setting up Committees. Tandon (1974) to regulate Bank
Credit & follow-up
 Bank Credit to Priority Sector. (substantial increase)
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 Phase – 1951 to 1990
PROTECTION TO INVES TORS
B uilding up co nf idence o f investo rs shattered due to di strust in P vt. Lt d.
Redesigning Legal & A dministrative set up o f Compani es.
B an on Fo rward Tradi ng
A bo liti on of Managing A gency S yst em

ST EP S TAKEN (LE GAL/ADMINISRTATIV E)

Companies A ct 1956 t o regulate Companies, Capital S tructure.
Capi tal Issues (Contro l) A ct, 1947 implemented thro ugh CCI in MOF to
regulate Capit al I ssues & Fo reign I nvest ment (repeall ed in 1992)
S ecuriti es Co ntract (Regulati on) A ct, 1956 enfo rced through Directo rate of
S to ck Exchange under MOF to regulate Capital Market.
MRT PA (1970) t o avo id (a) concentratio n of eco no mic power and
(b ) Co ntro l monopo list ic and restrictive trade practi ces.
FE RA (1973) t o regulate f oreign investment & f oreign b usiness.
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 Phase – post 1990s
Development Financial Institutions : (DFIs)
• Started providing Working Capital also
• Set up CREDIT RATING AGENCIES
CRISIL(IPO IN 1993-94; standard & poor acquires 9.68% in 1996-97 S & P
acquires shares / holding upto 58.46%)
ICRA Set up in 1991 by leading FIs/Banks/Fin. Ser. Cos. And Moody’s CARE
Set-up by IFCI/Banks.
FITCH a 100% subsidiary of FITCH Group.

Privatisation of DFI
Reduction in Govt. holding & Public Participation e.g. IFCI Ltd., IDBI Ltd., ICICI
Ltd.
• Conversion into Banking / Merger into Banking Companies IDBI Bank & ICICI
Bank
• Issuance of Bond by DFIs without Govt.’s Guarantees to mobilise resources.
• Reduction in holding of Govt. in Banks, i.e. Public Participation / Listing

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 Phase – post 1990s
INDUSTRIES
• Rise & Growth of Service Sector industries.
• Reliance & Dependence on technology.
• E-mail & mobile made sea-change in communication, data collection etc.
• Computerisation – a catch phrase and inevitable need of an hour.
• Dependent on Capital Market rather than only Debts dependency.
• Scalability of operations through globally competitive size.
• Broad basing of Board.
• Professional Management.

NBFC
• NBFC under RBI governance to finance retail assets and mobilise
small/medium sized savings.
• Very large NBFCs are emerging (Shri Ram Transport Finance, Birla, Tata
Finance, Sundaram Finance, Reliance Finance, DLF, Religare etc.
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 Phase – post 1990s
Commercial Bank

• Govt. holding reduced even by upto 40%

• Setting up of Universal Banks (from CASA to Corp. Finance)
• One-stop Banking.
• Capital Adequacy. (Basel II accepted) 9%
• Assets classification (Regular, Problem, Anxiety, Causing,
Non-Performing) and Provisioning norms identified/reviewed
& revised.
• NPA classification – substandard, Doubtful & Loss Assets.
• Focus on Non-Fund Business like L/C, Guarantees,
Acceptance, FOREX etc.

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 Phase – post 1990s
• Commercial banks
• Promoting Signature-based and consultancy services
like Project Counselling, Merchant Banking, New Issues
Management, Capital Market related activities, Merger &
Acquisitions, debt syndication, trusteeship of debts,
sponsoring Mutual Funds, Wealth Management, Sales &
Services of insurance (both life & non-life) products etc.
• New Private Sector Banks (AXIS, YES, HDFC, KOTAK
MAHINDRA etc.)
• CAMELS’ Rating (C-Capital Adequacy, A-Asset Quality,
M-Management, E-Earning, L-Liquidity, & S-Systems &
controls).
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 Phase – post 1990s
Mutual Funds
• Bifurcation of UTI and UTI (AMC) put under SEBI.
• Banks, Broking Houses, Finance Companies Insurance
Companies, Pvt. Sector in Foreign collaboration, FII and
Merchant Banks set up Mutual Funds with a varieties of
schemes.
• Helps small investors in big way
• Backbone of Capital Markets
• AIG, Baroda Pioneer, Birla Sunlife, Canara Robeco, DBS
Chola, Edelweiss, Fidelity, Fortis, Franklin, HSBC, HDFC,
ICICI Prudential, IDFC, ING, JM, Kotak, LIC, Magnum, Mirae,
Morgan, Quantum, Reliance, Religare, Sahara, Sundaram
BNP, Tata Tourus, UTI etc.
• Mutual Funds Investment Schemes (over 1000 in Nos.)

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 Phase – post 1990s
Primary Market
- Phenomenal increase in number of investors.

- New intermediatories i.e. Merchant Bankers, Lead

Manager & Book-Builders, Underwriters, Bankers to
Issue, Registrar to Issue, Share Transfer Agents,
Portfolio Managers, Depositories, FIIs, Custodians,
Rating Agencies, etc. are playing important role.

- FIIs are allowed to invest & participate in public issues of

Debt & Equities within sectoral limits fixed by the Govt.

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 Phase – post 1990s
Secondary Market
- Over 90% Securities Dematerialised.
- Depository Act 1996; 2 Depositories NSDC & CDSL.
- Settlement Cycle reduced from 15 days to T + 2.
- Clearing & Settlement by Clearing Corp.
- Securities related derivatives introduced.
- Future, Option, Arbitrage, Hedging permitted.

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 Phase – post 1990s
Money Market
- Primary Dealers
- Money Market Mutual Funds came up
- Call/Notice Market
- Treasury Bills Market
- Commercial Paper Market (CP)
- Certificate of Deposit Market (CD)
- Repo Market
- FOREX Market

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 Additional reading
• Growth and Development of financial
services
• Major reforms and their impact
• Present issues and future challenges to
Indian financial system
• Impact of global factors on Indian financial
system
• Present status

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