INDIAN FINANCIAL SYSTEM

By: Dr. Silony Gupta

Assistant Professor, Department of MBA,
Quantum School of Management,
Roorkee, Uttarakhand
 Financial system", is a set of complex and closely
connected or interlinked institutions, markets,
agents, practices, transactions, claims, and
liabilities in the economy.
It is the system that allows the transfer of money
between savers (and investors) and borrowers.
It is the set of Financial Intermediaries, Financial
Markets and Financial Assets.
helps in the capital formation.
meets the short term and long term capital needs
of households, corporate houses, Govt. and
foreigners.
Mobilize the savings in the form of money and
invest them in the productive manner.
 Financial Financial
Lenders Borrowers
Intermediar Markets
y

Banks Individuals
Interbank
Individual
Insurance Stock Companies
Companies Exchange
Companies Central
Money Market Government
Pension
Funds Bond Market Municipalities
Mutual Foreign
Funds Exchange Public
Corporations

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 To achieve optimum allocation of risk
bearing.
To inspire the operators to monitor the
performance of the investment
It makes available price - related
information.
It helps in promoting the process of financial
deepening and broadening.
To link the savers & investors.
helps in tfr of funds and rights
 Financial
Intermediaries

Financial
Markets

Ministry of Financial Financial

Finance system Assets

Fin Services

Regulators
 Come in between the ultimate borrowers
and ultimate lenders
provide key financial services such as
merchant banking, leasing, credit rating,
factoring etc.
Services provided by them are:
Convenience( maturity and divisibility),
Lower Risk(diversification), Expert
Management and Economies of Scale.
 Public sector
Banks

Pvt sector
Banks
Scheduled
Banks commercial
banks
Foreign Banks

Non Banking Fin

Co
Regional Rural
NBFCs
Financial Banks
Intermediaries Developmental
Fin Co

Mutual Funds

Insurance
Organizations
 Commercial Banks are banking institutions that
accept deposits and grant short, med and long -
term loans and Advances to their customers.
 Primary functions
Accepting deposits; and
Granting loans and advances.

Secondary functions

Providing facilities of foreign exchange dealings.

Discounting Bills of exchange
Agency services
General services
Tfr of Funds from one account to another; and from one
branch to another branch of the bank through cheque, pay
order, demand draft.
 Accepting Deposits
Demand or Current Account Deposits: -
A depositor can withdraw it in part or in full
at any time he likes without notice.
It carries no interest
Only for small savings of businessmen, Cheque
facilities
 Fixed deposits are for 15days to few years
Withdrawn at expiry of term
Higher rate of interest
A source of investment
 small saving deposits
salaried people
less rate of interest
money can be withdrawn through cheques
 This is the most important means of earnings
for the banks
Giving loans to businessmen
But it keeps a fine balance between deposits
and loans
Banks profitability depends on this as well.
 By allowing an over draft facility- cheques
are honoured even if deposits is less .

Facility for businessmen only .

Interest on overdraft amount

 Banks give loans to people by charging
interest
Bank asks for security
Simply opens an account in name of needy
person and issues a cheque book to transact
Loans granted mostly for business
 Ifa seller sells some goods to a buyer who does not
pay in cash. The seller draws a bill of exchange
which is signed by the .buyer
There is maturity or payment period in the bill.
The seller can give this exchange bill to a bank who
will give him cash against it after deducting the
commission.
 Collection of bills, cheques
Collection of dividends, interest, premium
Purchase and sale of shares and debentures
Payment of insurance premiums
Acts as trustee when nominated
 Travellerscheques, bank draft
Safe vaults for valuables
Supplying trade information
Economic surveys
Projects report preparation
 Central bank- RBI
Commercial Banks : short term credit
Industrial Banks: long term capital needs
Exchange Banks: Finance export import
Land Mortgage or land Development Bank:
long term credit for agriculture
Cooperative banks: small saving as joint
effort of members, low interest rate,
registered under Cooperative Societys
Acts.
 Non-banking financial companies, or NBFCs, are
financial institutions that provide certain types
of banking services, but do not hold a banking
license.
NBFCs can offer banking services such as loans
and credit facilities, retirement plg, money
markets, underwriting, and merger activities.
Generally, these institutions are not allowed to
take deposits from the public, which keeps them
outside the scope of banking regulations.
 NBFCsare doing functions similar to banks.
What is difference between banks &
NBFCs?

NBFC cannot accept demand deposits.

NBFCs do not form part of the payment

and settlement system and cannot issue
cheques drawn on itself.

Deposit insurance facility of Deposit

Insurance and Credit Guarantee
Corporation is not available to depositors of
NBFCs, unlike in case of banks.
 In terms of Section 45-IA of the RBI Act,
1934, no Non-banking Financial company can
carry on business of a non-banking financial
institution without obtaining a certificate of
registration from the Bank (RBI) and without
having a Net Owned Funds of Two crore.

To obviate dual regulation, certain

categories of NBFCs which are regulated by
other regulators are exempted from the
requirement of registration with RBI viz.
Venture Capital Fund/Merchant Banking
companies/Stock broking companies
registered with SEBI, Insurance Company
holding a valid Certificate of Registration
issued by IRDA
 Depending upon the nature and type of service
provided, they are categorised into (DHHFL
CAMSV)
Depositories
Housing finance companies
Hire Purchase/Consumer Finance Corpn
Factoring and forfaiting organisations
Leasing Co
Credit rating agencies
Asset finance companies
Merchant banking organisations
Stock brokering firms
Venture capital funds
 A mutual fund is a company that pools money from
many investors and invests in well diversified
portfolio of sound investment.
issues securities (units) to the investors (unit holders)
in accordance with the quantum of money invested
by them.
profit shared by the investors in proportion to their
investments.
It is set up in the form of trust and has a sponsor,
trustee, asset management company and custodian
advantages are in terms of convenience, lower risk,
expert management and reduced transaction cost.
All mutual funds must be registered with SEBI.
 They invest the savings of their policy
holders and in exchange promise them a
specified sum at a later stage or upon the
happening of a certain event.
Provide the combination of savings and
protection
Through the contractual payment of
premium creates the desire in people to
save.
 Any marketplace where buyers and sellers participate in the
trade of financial securities, commodities, and other tangible
items of value at low transaction costs and at prices that reflect
supply and demand.

Securities include stocks and bonds, and commodities include

precious metals or agricultural goods.

There are both general markets (where many commodities are

traded) and specialized markets (where only one commodity is
traded).

Financial markets facilitate:

The raising of capital (in the capital markets)
The transfer of risk (in the derivatives markets)
The transfer of liquidity (in the money markets)
International trade (in the currency markets)
Price discovery
Global transactions withCompany
integration
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of financial markets
Typically a borrower issues a receipt to the lender
promising to pay back the capital. These receipts are
securities which may be freely bought or sold.

In return for lending money to the borrower, the

lender will expect some compensation in the form
of interest or dividends.

This return on investment is a necessary part of markets

to ensure that funds are supplied to them.

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 Financial
Market

Capital/
Money Securities
Market Market

Primary
Market

Secondary/
Stock Market
 A market for dealing in monetary assets of short
term- less than one year.
Enables raising up of short term funds for
meeting temporary shortage of fund and
obligations and temporary deployment of excess
fund.
Major participant are: RBI and Commercial Banks
Major objectives:
equilibrium mechanism for evening out short
term surpluses and deficits
focal point for influencing liquidity in economy
access to users of short term funds at reasonable
cost
 Money
Market

Call T-bills Bills CP CD Repo

Market Market Market Market Market Market
 Bill rediscounting Certificates of Deposit

Instr
Treasury Bills ume Commercial Paper
nts

Inter-bank term money Inter-bank participation certificates

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 9/21/2017
CALL OR NOTICE MONEY MARKET
Mostly surplus funds of banks are traded with maturity
period of 1-15 days.
If borrowed for one day it is called call money or Overnight
Money
Holidays and Sundays are not counted for the purpose.
If borrowed for more than 1 day and upto 14 day, it is known
as Notice money.
Particpents are Sch & Non Sch banks, RBI, Cooperative
Banks,Foreign Banks, Discount & Finance House of
India, Security and Trading Corpn of India etc.

Purpose is-
1.To meet temporary gap
2. To meet CRR
3.To meet sudden demand of funds. Located in
commercial centres. 38
T-Bills are discounted instruments issued by the
govt and these may be traded with a repurchase
clause, called repos
Repos are allowed in 364, 182 and 91 days & 14
days.
They are issued by Government and largely
held by RBI.
Auctions of T-Bills are conducted by RBI.

When the liquidity position

in the economy is tight, returns are higher and
vice versa.
 These are short term funding instruments
issued by sch commercial banks, RRBs and
financial institutions at a discount to the
face value.
Banks can issue CDs for duration of less than
1 year while FIs can only issue this for more
than 1 year.
The issuing bank or financial institution cant
repurchase the instruments.
CDs have to be issued for a minimum of Rs. 5
lakhs with multiples of Rs. 1 lakh thereafter.
These are generally used by corporate to
meet their short-term requirements.
 These represent short-term promissory notes
issued by firms with a high credit rating such as
P-2 (CRISIL) or such equivalent rating agency..
The maturity of these varies from 7 days to 1
year.
Sold at a discount to the face value and
redeemed at the face value.
A company is eligible to issue CP subject to
the net worth of Co as per latest audited
balance sheet not less than 40 millions Rs.
Same is applicable to working capital.
 Means Repurchase Option .
It is a formal agreement between two
counterparties where one party sells securities
to another party with the explicit intention of
buying back the securities at a later date and
rate determined at the time of txn.
The Repo can be called a Sell-Buy transaction.
The Repo rate is the rate of interest charged
by the buyer of the securities to the seller of
securities
 The capital markets are for long term (greater
than one year maturity) financial instruments
(e.g. bonds and stocks).
Main participants are mutual funds, insurance
organizations, foreign institutional investors,
corporates and individuals.
Two segments: Primary market and secondary
market
 Their role can be summarized as follows

(a) It helps in channelling the savings pool in the

economy towards optimal allocation of capital in
the country.
(b) It offers a number of investment avenues to
investors.
(c) The Capital Market is the indicator of the
inherent strength of the economy.
(d) It is the largest source of funds with long and
indefinite maturity for companies and thereby
enhances the capital formation in the country.
A market where new securities are bought
and sold for the first time is called the New
Issues market or the IPO market.
The first public offering of equity shares or
convertible securities by a company, which is
followed by the listing of a companys shares
on a stock exchange, is known as an initial
public offering (IPO).
The Primary market also includes issues of
further capital by companies whose shares
are already listed on the stock exchange.
 It is the direct method of raising capital available
to the company from the public.
Primary market is a place where corporate may
raise capital by the way of (PRAISE)
Private Placements- A sale of stocks, bonds or
securities directly to a private investor, rather than
as part of a public offering.
Rights Issue- A rights issue is a dividend of
subscription rights to the company's existing
security holders to buy additional securities in the
company.
Bonus Shares-Bonus shares are shares distributed
by a company to its current shareholders as fully
paid shares free of charge
 Initial Public Offer (IPO)- It is the first time that
the stock of a private company is offered to
the public.
Bought out deals (Offer for sale)- It is a method
of offering securities to the public through a
sponsor (a bank, financial institution, or an
individual).
Employees stock option- It is a stock option
granted to specified employees of a company.
ESOs offers the options holder the right to buy a
certain amount of company shares at a
predetermined price for a specific period of time.
 It Is Related With New Issues
It Has No Particular Place
It Has Various Methods Of Float Capital
It comes before Secondary Market
A market in which an investor purchases a
security from another investor rather than
the issuer, subsequent to the original
issuance in the primary market.
Secondary markets are the stock exchanges
and over-the-counter market where the
securities are traded from the first holder to
another.
The issues are traded in these secondary
markets.
 It Creates Liquidity
It Comes After Primary Market
It Has A Particular Place
It Encourages New Investments
 A market for old/existing securities.
a place where buyers and sellers of securities
can enter into transactions to purchase and sell
shares, bonds, debentures etc.
enables corporates, entrepreneurs to raise
resources for their companies and business
ventures through public issues.
has physical existence
vital functions are:
nexus between savings and investments
liquidity to investors
continuous price formation
 Financial
Instruments/
Assets

Primary Indirect
Derivatives
Securities Securities

Innovative
Equity shares Pref shares Debentures Debt Mutual Funds Forward
Instruments

Security
Future
Receipts

Pass through
Option
Cert
Securities issued by the non-financial economic
units

Equity Shares: An equity share are the ownership

securities. They bear the risk and enjoy the rewards of
ownership.

Preference Shares: Holders enjoy preferential right

as to: (a) payment of dividend at a fixed rate during
the life time of the Company; and (b) the return of
capital on winding up of the Company

Debentures: An creditorship security. Holders are

entitled to predetermined interest and claim on the
assets of the company.
 Innovative Debt instruments: A variety of debt
innovative instruments emerges with the growth of
financial system to make them more attractive.
Participative Debentures: participate in the excess
profits of the company after the payment of dividend.
Convertible debentures with options:
Third party convertible debentures: entitle the
holder to subscribe to the equity of another firm at a
preferential price.
Convertible debenture redeemable at premium:
issued at face value with option to sell at premium.
Debt equity swap: offers to swap debentures for
equity.
Zero coupon convertible notes : convertible in to
shares and all the accrued /unpaid interest is forgone.
 Warrants: entitles the holder to purchase specified
number of shares at a stated price before a stated
date. Issued with shares or debentures

Secured premium notes with detachable warrants:

redeemable after lock-in period
warrants entitle the holder to receive shares after the
SPN is fully paid
no interest during lock-in period
option to sell back SPN to company at par after lock-
in.
no interest/ premium on redemption if option exercised
right to receive principal+interest in instalments, in
case of redemption after expiry of the term
detachables required to be converted in to shares
within specified period.
 Non -Convertible debenture with
detachable equity warrants: option to buy a
specified no. of share at a specified price and
time.
Zero interest Fully Convertible debentures:
carries no interest and convertible in to shares
after lock-in period.
Secured zero interest partly convertible
debentures with detachable and separately
tradable warrants:
Having two parts
Part A convertible at a fixed amount on the date of
allotment
Part B redeemable at par after specified period
from date of allotment.
Carries warrants of equity shares at a price to be
determined by company
 Fully convertible debentures with
interest(optional):
No interest for short period
After that option to apply for equities at
premium without paying for premium.
Interest is made from first conversion date to
the second/final conversion date
 Issued by financial intermediaries.
such as units of mutual funds, policies of
insurance companies, deposits of banks, etc.
Better suited to small investors
Benefits of pooling of funds by intermediaries
Convenience, lower risk and expert
management.
 Derivative is a product whose value is derived from the
value of one or more basic variables called base, in a
contractual manner
The underlying asset can be stock, commodity or currency
or any other assets.
Derivatives trading has started with Index Futures,
followed by Index Option and then Stock Option as per the
recommendation of the SEBI appointed L. C. Gupta
Committee.
The Securities Contracts (Regulation) Act, 1956 (SCIA)
defined derivative to include-
A security derived from a debt instrument, share, loan
whether secured or unsecured, risk instrument or any
other form of security.

A contract which derives its value from the prices, or

index of prices, of underlying securities.
 Derivatives

Forward Indirect
Options
Contract Securities
 isa customized contract between two
entities, where settlement takes place on a
specific date in the future at today's pre-
agreed price.

At the end, offsetting is done by paying the

difference in the price.
 isan agreement between two parties to buy
or sell an asset at a certain time in the
future at a certain price.

They are special types of forward contracts

which are standardized exchange-traded
contracts.
 Contracts that give the buyer the right to
buy or sell securities at a predetermined
price within/at the end of a specified period.
Two types - calls and puts.
Calls give the buyer the right but not the
obligation to buy a given quantity of the
underlying asset, at a given price on or
before a given future date.
Puts give the buyer the right, but not the
obligation to sell a given quantity of the
underlying asset at a given price on or before
a given date.
 RBI SEBI
Commercial Banks Primary Market
Forex Markets Secondary market

Financial Derivatives Market

Institutions
Primary Dealers
 9/21/2017
Reserve Bank Of India

Functions: To Maintan
ROLE
Monetary stability
Note Issue
Financial stability Govt.Banker
Stable payment system Banbkers Bank
Promote development of financial Regulator
infrastructure Ex.Control Authority
To ensure credit allocation to meet national Promotional Functions
economic priorities
Regulate volume of money and credit

68
 Commercial banks include public sector banks,
private banks and foreign banks.
Financial Institutions may be of all India level
like IDBI, IFCI,ICICI, NABARD or sectoral financial
institutions like, EXIM, TFCIL etc.
The participants in Foreign exchange market
include banks, financial institutions and are
regulated by RBI.
Primary dealers are registered participants of
the wholesale debt market. They bid at auctions
for government debts, treasury bills, which are
then retailed to banks and financial institutions,
which invest in these papers to maintain their
Statutory Liquidity Ratio (SLR).
 SEBI was set up as an autonomous regulatory
authority by the Government of India in
1988.
It acquired statutory form in 1992 with
SEBI Act 1992.
It is empowered by two acts namely The
SEBI Act, 1992 and The Securities Contract
(Regulation) Act, 1956
 OBJECTIVE
To protect the interest of the investors in the
securities so that there is a steady flow of
savings in to the capital market.
To promote the development of and to regulate the
securities market.
Ensure fair practices by the issuers of securities so that
they can raise resources at minimum cost.
To promote efficient services by brokers, merchant
bankers and other intermediaries so that they become
competitive and professional.
Under Section 11 of the SEBI Act , there are mainly two types of
functions. They are;

1.Regulatory Functions

2.Developmental Functions
Regulatory Functions
Regulation of stock exchange and self regulatory
organisations.
Regulating substantial acquisitions of shares and take over of
companies
Registration and regulation of stock brokers, sub-brokers, registrar
to all issue, merchant bankers, underwriters, portfolio managers
and such other intermediaries who are associated with securities
market.
Registration and regulation of the working of collective investment
schemes including mutual funds.
Prohibition of fraudulent and unfair trade practices relating to
securities market.
Prohibition of insider trading in securities.
 Developmental Functions

(a). Promoting investors education.

(b). Training of intermediaries.

(c). Conducting research and publish information useful to

all market participants.

d). Promotion of fair practices. Code of conduct for self-

regulatory organizations.

(e). Promoting self-regulatory organizations.

 SEBI has been vested with the following
powers:
1.Power to call periodical returns from
recognized stock exchange.
2.Power to control and regulate stock exchange.
3.Power to call any information or explanation
from recognized stock exchanges or their
members.
4. Power to levy fees or other charges for
carrying out the purpose of regulation.
5. Power to grant registration to market
intermediaries.
6.Power to direct enquiries to be made in
relation to affairs of stock exchanges or
members.
7. Power to grant approval to bye-laws of
recognized stock exchanges.
8. Power to make or amend bye-laws of
recognized stock exchanges.
9. Power to compel listing of securities by public
companies.
10. Power to declare applicability of Section 17
of the Securities Contract (Regulation) Act is
any state or area to grant licenses to dealers
in securities.
 9/21/2017
CAPITAL
MARKET

PRIMARY PLAYERS SECONDARY

COMPANY
METHOD OF QUANTUM OF COST OF SETTLEMENT
BROKERS LISTING TRADING
ISSUE ISSUE ISSUE CLEARING
PUBLIC

PUBLIC

RIGHT

BONUS

PRIVATE
PLACEMENT

BOUGHT OUT
DEALS
78
Main components of Unorganised Money Market:
1. Indigenous Bankers (IBs): The IBs are individuals or private
firms who receive deposits and give loans and thereby they
operate as banks. Unlike moneylenders who only lend money,
IBs accept deposits as well as lend money.
2. Money Lenders (MLs):They lend money in rural areas as well as
urban areas. They normally charge an invariably high rate of
interest ranging between 15% p.a. to 50% p.a. and even more.
3. Chit Funds and Nidhis: They collect funds from the members
for the purpose of lending to members (who are in need of
funds) for personal or other purposes.
4. Finance Brokers: They act as middlemen between lenders and
borrowers. They charge commission for their services.
5. Finance Companies: They operate throughout the country.
They borrow or accept deposits and lend them to others. They
provide funds to small traders and others. They operate like
indigenous bankers.

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