The Indian financial system can be broadly classified into the formal (organized) financial system and the informal (unorganized) financial system. The formal financial system comes under the purview of the Ministry of Finance (MOF) Reserve Bank of India (RBI), Securities Exchange Board of India (SEBI) and other regulatory bodies. The informal financial system consists of: (i) Individual money lenders such as neighbors, relatives, land lords, traders, store owners and so on. (ii) Groups of persons operating as funds or ‘associations’.
These groups function under a system of their own rules. (iii) Partnership firms consisting of local brokers, pawn brokers and non banking financial intermediaries such as finance, investment, chit fund companies. In India the spread of banking in rural areas has helped in enlarging the scope of the formal financial system.
66 Components of formal financial system Formal financial system consist of four segments, these are financial institutions, financial markets, financial instruments and financial services. Financial institutions are intermediaries that mobilize the savings and facilitate the allocation of funds in an efficient manner. Financial institutions are classified as banking and non banking financial institutions. Banking institutions are creator of credit while non banking financial institutions are purveyors of credit.
In India non banking financial institutions namely the Development Financial Institutions (DFIs) and Non Banking Financial Companies (NBFCs) as well as Housing Finance Companies (HFCs) are the major institutional purveyors of credit. Financial institutions are further classified as Term Finance Institutions such as Industrial Development Bank of India (IDBI), Industrial Credit and Investment Corporation of India (ICICI), Industrial Financial Corporation of India (IFCI), Small Industries Development Bank of India (SIDBI) and Industrial Investment Bank of India (IIBI). Specialized finance institutions like the Export Import Bank of India (EXIM), Tourism Finance Corporation of India (TFCI), ICICI Venture, Infrastructure Development Finance Company (IDFC) and sectoral financial institutions such as National Bank for Agricultural and Rural Development (NABARD) and National Housing Bank (NHB). Investment institutions in the business of mutual funds (UTI, Public Sector and Private Sector Mutual Funds) and insurance activity (LIC, GIC and 67 its subsidiaries) are also classified as financial institutions.
There are state level financial institutions such as State Financial Corporation and State Industrial Development Corporation (SIDCs) which are owned and managed by the State Governments. Financial markets are a mechanism enabling participants to deal in financial claims. Money market and capital market are the organized financial markets in India. Money market is for short term securities while capital market is for long term securities. Primary market deals in new issues, the secondary market is meant for trading in outstanding or existing securities. Financial instrument is a claim against a person or an institution for the payment at a future date a sum of money or a periodic payment in the form of interest or dividend. Financial instruments may be primary or secondary securities.
Primary securities are issued by the ultimate borrowers of funds to the ultimate savers e.g. Bank Deposits, Mutual Fund Units, Insurance Policies, etc. Financial instruments help the financial markets and the financial intermediaries to perform the important role of channelising funds from leaders to borrowers.
Financial services include merchant banking, leasing, hire purchase, credit rating etc. Financial services rendered by the financial intermediaries’ bridge the gap between lack of knowledge on the part of the investors and increasing sophistication of financial market and instruments.