A financial system is an important part of the
economic growth of any country. It intermediates between the flow of funds
belonging to those who save a part of their income and those who invest in
productive assets. It mobilizes and usefully allocates scarce resources of a
country. A financial system is a well-connected and complex set of sub-systems
of financial institutions, financial instruments, financial markets, and
financial services that enables the transfer and allocation of funds,
effectively and efficiently.
Financial System in India
Indian financial system can also be broadly classified into to the formal
financial system and the informal financial system. The formal financial system
comes under the purview of the ministry of finance, the reserve bank of India,
the securities and exchange board of India, and other regulatory bodies. The
informal system consists of individual moneylenders such as neighbors,
relatives, landlords, traders and storeowners; it also includes groups of
persons operating as ‘funds’ or ‘associations’.
formal financial system consists of four components. These are financial
institutions, financial instruments, financial services and financial markets.
Financial institutions are intermediaries that mobilize
savings and facilitate the allocations of funds in an efficient manner.
Financial institutions can be classified as banking and non-banking financial
institutions. Banking institutions are creators and purveyors of credit, while
non-banking institutions are purveyors of credit.
instrument is a claim against a person or an institution for payment, at
a future date, of a sum of money and/or a periodic payment in the form of
interest or dividend. The term ‘and/or’ implies that either of the payments
will be sufficient but both of them may be promised. Financial instruments
represent paper wealth shares, debentures, like bonds and notes.
Financial services are those that help with
borrowing and funding, lending and investing buying and selling securities,
making and enabling payments and settlements, and managing risk exposures in
financial markets. The major categories of financial services are funds
intermediation, payments mechanism, and provision of liquidity, risk management
and financial engineering
Financial markets are a mechanism enabling
participants to deal in financial claims. The market also provides a facility
in which their demands and requirement interact to set a price for such claims.
The main organized financial markets in India are the money market and the
capital market. The first is a market for short-term securities while the
second is a market for long-term securities i.e., securities having a maturity
period of one year or more.
1.1.1 Characteristics of Financial Markets
markets are characterized by a large volume of transactions and the speed with
which financial resources move from one market to another. There are various
segments of financial markets such as stock market, bond markets – primary and
secondary segments, where savers themselves decide when and where they should
invest money. Financial markets are highly volatile and susceptible to panic
and distress selling as the behavior of a limited group of operators
can be generalized. There is scope for instant arbitrage among various markets
and types of instruments. Financial intermediaries who take investment
decisions as well as risks on behalf of their depositors often dominate
markets. Domestics financial markets are now getting integrated with worldwide
of Financial Markets
cost of acquiring information and making transactions creates incentives for
the emergence of financial markets and institutions. Different types and
combinations of information and transactions costs motivate distinct financial
contracts, instruments and institutions. A financial market performs various
functions, such as:
Enabling economic units to exercise their time preference
Separation, distribution, diversification and reduction of risk
Efficient payment mechanism
Providing information about companies. This spurs investors to make inquiries
themselves and keep track of the companies’ activities with a view to trading
in their stock efficiently.
Enhancing liquidity of financial claims through trading in securities
Providing portfolio management services.
markets provide a variety of services as they can alter the rate of economic
growth by altering the quality of these services.