MODULE 1

INDIAN FINANCIAL SYSTEM

Savings and Investment.

Savings refers to the portion of income that is not spent but saved for
future use.
Investment is the use of savings to earn returns, like buying stocks,
bonds, or real estate.

Financial Intermediation
Financial intermediation is the process by which financial
institutions act as middlemen between savers and borrowers..

Indian Financial System.

The Indian Financial System is a set of institutions, markets, and
instruments that helps in the flow of money and funds in the
economy. It connects savers (those with money) to borrowers (those
who need money). It includes banks, financial markets, and financial
institutions that enable savings, investments, and lending.

Features of Financial System

• It encourage savings by providing individuals and businesses

with various financial instruments .
 • A well-developed financial system includes financial markets
where securities such as shares, bonds, and commodities are
traded.

• It consists of various institutions such as banks, insurance

companies, mutual funds, stock exchanges, and regulatory
bodies.

• It promotes efficient allocation of financial resources.

• It promotes economic development.

The role and functions of Financial System

• Mobilization of savings and allocating them to various

projects.
• Reallocation of accumulated old savings into projects and
firms.
• Provision of liquidity of financial securities
• Provision of good corporate governance system
• Generation of information for decision making
• Creation of innovative schemes to make financial instruments
attractive to investors
• Promoting capital formation by channelising flow of savings
into productive investments
• Facilitate globalization of economy
• Encourage investments by lowering cost if transactions
 • Organisation of payment and settlement system to encourage
safe and quick movement of funds

Recent developments in Indian Financial System.

Few major developments happened in our financial system are ;

• Establishment of Micro Units Development and Refinance

Agency ( MUDRA) .This aims to provide funding to non
corporate small business sector.
• RBI has granted licenses to ten small finance banks and eleven
payment banks. These banks will reach into unranked areas
and undeserved sections of the population . Small finance
banks can undertake banking operations in a limited
geographical area. Payment banks can accept deposits but
cannot lend.
• Shift towards digital economy and digital payments after
demonstration. The demand for digital payment options and
mobile payment systems increased with government support
• Introduction of Goods and Services Tax in 2017 is the biggest
tax reform in India.
• There's a growing focus on sustainable finance, with increased
attention to Environmental, Social, and Governance (ESG)
factors in investment decisions.
• Efforts continue to expand financial inclusion, particularly in
rural areas, through initiatives like the Jan Dhan Yojana and
the expansion of banking networks.
• Government initiatives and technological advancements have
expanded access to financial services, particularly in
previously underserved areas.
 • Artificial intelligence (AI) and machine learning (ML) are
increasingly being used in lending, risk assessment, and
customer services.

Components of Financial System

The financial system consists of various components that facilitate
the flow of funds in an economy. The 4 major components are
financial markets, financial institutions, financial instruments and
financial services.
1. Financial Markets : Financial markets are platforms where
buyers and sellers trade financial assets like stocks, bonds, and
currencies. There are two types of financial markets : a)
Capital market and b) Money market.
o Capital Market: Where long-term investments are
made (like stocks and bonds).
Money Market: Where short-term funds are traded.

2. Financial Institutions: Financial institutions are

organizations that provide financial services like lending,
borrowing, and managing investments. Examples include:
Banks (for saving and borrowing), insurance companies (for
protection against risks) and pension funds (for retirement
savings.

. 3. Financial Instruments : These are documentary evidence.

They are of 2 types :a) Money Market instruments and b)
 Capital Market instruments.
Money Market instruments : treasury bills, commercial
papers, certificate of deposits
Capital Market instruments : equity shares, preference
shares, debentures etc.

4. Financial Services : These services help in financial

transactions. These activities include insurance, banking and
credit services.

Classification of Financial Markets

• Capital Market : It is a market for trading long term capital.

It is a segment of the financial market where buyers and sellers
engage in trade of long-term financial instruments.
• Money Market : It is a market for trading short-term capital.
It is a segment of the financial market where financial
instruments with high liquidity and short maturities are traded.

Capital Market Instruments

• Equity Shares : Equity shares represent ownership in a

company. They have voting rights in company’s decisions.
Equity shareholders have the potential to earn high returns in
the form of dividends and capital appreciation. However, the
 dividends are not fixed and depend on the company's
profitability. In case of liquidation, equity shareholders are the
last to be paid after all debts and liabilities are settled, making
equity shares a high-risk investment.

• Preference Shares : Preference shares are a type of share that

provides shareholders with a fixed dividend, which is paid
before any dividends are given to equity shareholders. These
shares don’t carry voting rights. They have a higher claim on
assets in the event of liquidation of the company. These have
lower risk compared to equity shares.

• Debentures : These are a type of long-term debt Instrument

issued by companies to borrow money from investors. They
offer a fixed rate of interest. They don’t carry voting rights.
Lower risk compared to equity shares.

Money Market Instruments

• Treasury Bills : These are short term instruments issued by

Government of India to meet short-term needs. They are one of
the safest investments as they are backed by the government.
They are issued at a discount. They are highly liquid. They
have no risk. These instruments are available to investors,
banks and other financial institutions.

• Commercial Papers : These are issued by corporations and

financial institutions to meet their short-term requirements.
The maturity period ranges from 7 days to 1 year. They are
issued at a discount. They are not backed by any collateral.
 They are available to financial institutions, mutual funds and
large investors.

• Certificate of Deposits : They are issued by banks and

financial institutions to raise funds. The maturity period
ranges from 7 days to 1 year. They are issued at a discount.
They have a fixed period and cannot be withdrawn before
maturity. They are available to individuals, corporations etc

Weaknesses of Indian Money Market.

The Indian money market plays a crucial role in short-term lending

and borrowing, but it has several weaknesses that hinder its
efficiency. Some of the key weaknesses include:
1. Undeveloped Markets
Despite reforms, many segments of the Indian money market remain
underdeveloped.
2. No Active Secondary Market
In India, many money market instruments, such as commercial
papers and certificates of deposit, lack an active secondary market.

3. Seasonality in Demand and Supply of Funds

The Indian money market experiences seasonal fluctuations in
demand and supply of funds. This seasonality affects stability and
efficient fund allocation.
4. Lack of Integration Among Different Segments
The Indian money market is divided into various segments, such as
the organized sector and the unorganized sector . There is a lack of
integration between these segments, leading to inefficiencies.

Role of RBI in the Money Market.

The Reserve Bank of India (RBI) plays a vital role in regulating the
Indian money market by managing liquidity, controlling inflation,
and stabilizing short-term interest rates.

The role of RBI is given below :

• The RBI regulates the money market to ensure stability and
efficiency.
• The RBI manages liquidity in the money market through
various instruments
• The RBI influences interest rates in the money market through
its monetary policy decisions.
• The RBI oversees the money market to prevent irregularities
and maintain confidence.
• The RBI acts as a lender of last resort, providing emergency
funding to banks and other financial institutions.

Difference between Treasury Bills and Commercial Papers.

Features Treasury Bills (T- Commercial Papers
Bills) (CPs)

Issuer Government Corporations/Financial

(Central/Sovereign) Institutions

Purpose Raise short-term Raise short-term funds for

funds for government business operations

Tenure 91 days to 364 days 7 days to 1 year

Liquidity Highly liquid and Liquid but less marketable

marketable than T-Bills

Interest Rate Lower returns (safe Higher returns (riskier

investment) investment)

Difference between Capital Market and Money Market

The capital market and money market are both components of the
financial market, but they serve different purposes and operate in
distinct ways. Here’s a comparison:

Features Capital Market Money Market

 Definition A market for long-term A market for short-term
financial instruments financial instruments used
where companies and for liquidity and short-
governments raise term borrowing.
funds.

Time Long-term (more than Short-term (less than one

Horizon one year) year)

Instruments Stocks, bonds, Treasury bills,

debentures, mutual commercial paper,
funds certificates of deposit,
repurchase agreements

Risk & Higher risk, but Lower risk, but lower

Return potential for higher returns
returns

Participants Corporations, Banks, financial

governments, institutions, corporations,
institutional and retail and the central bank
investors

Components of Indian Money Market.

The Indian Money Market is a segment of the financial system that deals
with short-term borrowing and lending, typically for a period of less
than one year. It plays a crucial role in maintaining liquidity and
ensuring the smooth functioning of the financial system. The key
components of the Indian money market include:

1. Call Money Market

● A market where banks and financial institutions borrow and lend

funds for very short periods
● Used by banks to meet short-term liquidity needs and maintain
reserve requirements.

● Participants: Commercial banks, cooperative banks, primary

dealers.

2. Treasury Bills (T-Bills) Market

● Issued by: The Government of India to manage short-term

borrowing.

● Purpose: Helps the government manage short-term funding needs

and control inflation.

● Participants: Banks, financial institutions, mutual funds,

corporations, and individuals.

3. Commercial Paper (CP) Market

● Issued by: Large creditworthy corporations to raise short-term

funds.

● Maturity Period: Ranges from 7 days to 1 year.

 ● Purpose: An alternative to bank loans for companies needing
working capital.

● Participants: Companies, banks, mutual funds, insurance firms, and

high-net-worth individuals.

4. Certificate of Deposit (CD) Market

● Issued by: Commercial banks and financial institutions to raise

funds.

● Maturity Period: Ranges from 7 days to 1 year.

● Features: , tradable in the secondary market.

● Purpose: Helps banks manage short-term liquidity needs.

SEBI and its powers.

SEBI stands for Securities and Exchange Board of India. It is

the regulator of the securities market in India. It's primary goal
is to protect the interests of investors in the securities [Link]
 also aims to promote the development and regulate the
securities market.

Powers of SEBI : The powers of SEBI are given below

• SEBI create rules, regulations, and guidelines to govern

the securities market.
• Issue directions in the interest of investors and orderly
development of securities market.
• It regulates various market participants, including stock
exchanges, brokers, mutual funds, and other
intermediaries.
• Cancel or suspense registration of intermediaries
• Regulate the issue of capital
• Grant and renew recognition of stock exchanges.
• Conduct enquiries and audit of stock exchanges
• Specify the content of Prospectus
• Investigate fraudulent transactions in securities
• Levying fees or penalties for non-compliance.

Describe Financial Institution, Financial Instruments and

interaction among components.
Financial Institutions are intermediaries that facilitate financial
transactions and the allocation of capital. They are divided into:

● Banks (commercial and central banks) – Provide loans, accept

deposits, and regulate money supply.

● Non-Banking Financial Companies (NBFCs) – Offer financial

services like lending, insurance, and investment without
 holding banking licenses.

● Insurance Companies – Provide risk management through

insurance policies.

● Mutual Funds – Pool money from investors and invest in

stocks, bonds, and other securities.
Financial Instruments represents a contract that has a monetary
value. It's a formal agreement between two or more parties. They
are issued by financial intermediaries for channelising funds from
lenders to borrowers. They are broadly classified into money market
instruments ( like treasury bills, call money etc. ) and capital market
instruments ( like equity shares, preference shares, debentures etc.)

• Treasury Bills (T-Bills) are issued by the Government of India

to manage short-term borrowing. Maturity Period ranges from
91-day, 182-day, and 364-days. It helps the government
manage short-term funding needs and control inflation.
The participants are banks, financial institutions, mutual funds,
corporations, and individuals.
• Equity Shares represent ownership in a company. Investors
who hold equity shares are called shareholders. It bears highest
risk but also have potential for higher returns through capital
appreciation and dividends.

Interactions among the components

Financial Institutions, by issuing different types of financial

instruments mobilize savings from the financial markets. To
facilitate this credit mobilization and allocation process ,different
specialised financial services are offered to financial intermediaries.
Thus the four components of the financial system are interdependent
and interact with each other . This facilitates the development and
efficient functioning of financial system.

Objectives and functions of SEBI.

SEBI stands for Securities and Exchange Board of India. It is the

regulator of the securities market in India. It's primary goal is to
protect the interests of investors in the securities [Link] also aims
to promote the development and regulate the securities market.

Objectives of SEBI

• To protect the interests of investors in securities

• To promote the development of securities market
• To regulate the securities market

Functions of SEBI

The functions performed by SEBI can be classified into two

categories

1) Developmental Functions of SEBI

• promoting investors education
• Training intermediaries of securities market
• Promotion of fair practices and code of conduct
• Conducting research and publishing information useful to
all market participants.
2) Regulatory Functions of SEBI
• Regulating the business in stock exchanges and any other
securities markets
• Registering and regulating the working of stock brokers
and other intermediaries.
• Cancelling the registration of market intermediaries
• Prohibiting fraudulent and unfair trade practices
• Investigating the business of Mutual funds and their
trustees.