INDIAN FINANCIAL

SYSTEM AND SERVICES

Subject Code: 18MBA202
Prof. Sipra Karmakar
 Introduction
 Financial System: The term ‘system’ in the term
‘Financial System’, implies a set of complex
and closely connected or interlined institution,
agents, practices, markets, transaction, claims
and liabilities in the economy.
 The financial system comprises of variety of
intermediaries, market and instruments. It
provides the principal means by which savings
are transformed into investment.
 Financial system
 The economic development of an economy
depends upon the well organized financial
system.
 Thus, a financial system can be said to play a
significant role in the economic growth of a
country by mobilizing the surplus funds and
utilizing them effectively for productive
purposes.
 FEATURES OF INDIAN FINANCIAL
SYSTEM
• It plays a vital role in economic development of a
country.
• It encourages both savings and investment.
• It links savers and investors.
• It helps in capital formation.
• It helps in allocation of risk.
• It facilitates expansion of financial markets
 COMPONENTS/ CONSTITUENTS OF
INDIAN FINANCIAL SYSTEM
The following are the four major components that
comprise the Indian Financial System:

1. Financial Institutions
2. Financial Markets

3. Financial Instruments/ Assets/ Securities

4. Financial Services.
 1. Financial Institution
 Facilitate smooth functioning of the financial
system by making investors and borrowers
meet.
 Financial institutions also provide services to
entities (individual, business, government)
seeking advice on various issue ranging from
restructuring to diversification plans.
 They provide whole range of services to the
entities who want to raise funds from the
markets or elsewhere.
 Cont…
 It is also act as intermediaries because they
accept deposits from a set of customers (savers
lend these funds to another set of customers
(borrowers). Like - wise investing institutions
such ICICI, mutual funds also accumulate
savings and lend these to borrowers, thus
perform the role of financial intermediaries.
Types of Financial Institutions

Banking Institutions NBFCs SIDBI, Mutual Fund

PNB, AXIS Bank NABARD SBI Mutual Fund

Housing Finance
Insurance Companies Regulatory
Companies
LIC, HDFC Standard Institutions RBI,
Indiabulls Housing
Life SEBI, IRDA
Finance Ltd.
 Cont…
A. Banking Institutions
1. Organised Sector
a. Commercial Bank
b. Co-operative bank: Saraswat Cooperative
bank
Rural Credit Societies
Urban Credit Societies
c. Regional Rural Banks(RRBs), Andhra
Pradesh Gramena Vikas Bank, sponsored by SBI
d. Foreign Banks: Citi bank, Bank of Ceylon
 Banking Institution
2. Unorganised Sector
a. Indigenous bankers
b. Money Lenders
c. Landlords
 B. Non Banking Institutions
 Organised NBIs
 Not banks but carry out some kind of financial
intermediation

Development Financial
NBFCs
Institutions

• Provide medium and

long term financial
• Not bank but carry out
assistant to promote
functions similar to
balanced
banks
development of the
• Muthoot Finance
country
• Bajaj Finance Ltd.
• EXIM, NABARD,
SIDBI
 Cont…
The institutions like IDBI, ICICI, IFCI, IRDC at all India
level.

The State Finance Corporations (SFCs), State Industrial

Development Corporations (SIDCs) at the state level.

Agriculture Development Finance Institutions as

NABARD,LDBS etc. Development banks provide medium
and long term finance to the corporate and industrial sector
and also take up promotional activities for economic
development
 Financial Institutions
B. Investment Institution
These include those financial institutions which
mobilise savings at the public at large through
various schemes and invest these funds in
corporate and government securities. These
include LIC, GIC, and mutual funds.
 Banking Institutions
2. Unorganised Non - Banking Financial
Institutions
It includes number of non - banking financial
companies (NBFCs) providing whole range of
financial services. These include hire - purchase
300 consumer finance companies, leasing
companies, housing finance companies, factoring
companies, Credit rating agencies, merchant
banking companies etc.
 2. Financial Markets
Functions of financial markets are:
(i) To facilitate creation and allocation of credit and
liquidity
(ii) To serve as intermediaries for mobilisaton of
savings.
(iii) To assist the process of balanced economic
growth.
(iv) To provide financial convenience.
(v) To cater to the various credit needs of the
business houses.
 Classification
A. Capital Market
1. Industrial securities market
As the very name implies, it is a market for industrial securities
namely:
 Equity shares or ordinary shares,

 Preference shares and

 Debentures or bonds.

It is a market where industrial concerns raise their capital or debt

by issuing appropriate instruments. It can be further subdivided
into two. They are:
 Primary market or New issue market
(a) Public issue (b) Rights issue (c) Private placement
 Secondary market or Stock exchange
 Financial Market
2. Government securities market
3. Long term loans market
 Term loans market

 Mortgages market: The mortgage market is a collection of

market, which includes a primary(origination) and a
secondary market where mortgages trade.

 Financial Guarantees market: Financial Guarantee refers to

the promise undertaken by a third party for any financial
obligation of another company and, therefore, assumes the
role of a guarantor for any unpaid financial obligations.
 Financial Market

B. Money market: It is a market for dealing with

financial assets and securities which have a
maturity period of upto one year. The money
market may be subdivided into four. They are:
(i) Call money market: is the part of national
money market where day to surplus funds, mostly
of banks are traded in.
(ii) Commercial bills market
(iii) Treasury bills market: is the promissory note
issued by the Govt. under discount for a specified
period stated therein.
(iv) Short term loan market.
3. Financial Instruments/Assets/Securities
Financial instruments refer to those documents
which represents financial claims on assets.
Financial asset refers to a claim to a claim to the
repayment of a certain sum of money at the end of
a specified period together with interest or
dividend.
Examples: Bill of exchange, Promissory Note,
Treasury Bill. Financial securities can be classified
into: (i) Primary or direct securities. (ii) Secondary
or indirect securities.
 Cont…
 Primary or direct securities:
These are securities directly issued by the ultimate
investors to the ultimate savers. Eg. shares and
debentures issued directly to the public.
 Secondary or indirect securities:

These are securities issued by some intermediaries

called financial intermediaries to the ultimate
savers.
.
 Cont…
 Example: Unit Trust of India and mutual
funds issue securities in the form of units to the
public and the money pooled is invested in
companies. Again these securities may be
classified on the basis of duration as follows:
(i) Short - term securities
(ii) Medium term securities
(iii) Long - term securities
 Cont…
 Short - term securities are those which mature
within a period of one year. Eg, Bill of
Exchange, Treasury bill, etc.
 Medium term securities are those which have a
maturity period ranging between one and five
years. Eg. Debentures maturing within a period
of 5 years
 Long - term securities are those which have a
maturity period of more than five years. Eg,
Government Bonds maturing after 10 years.
 4. Financial Services
 The term financial services can be defined as
“activities, benefits, and satisfactions,
connected with the sale of money, that offer to
users and customers, financial related value.
within the financial services industry the main
sectors are banks, financial institutions, and
non-banking financial companies.
 Cont…
Financial services provided by various financial
institutions, commercial banks and merchant
bankers can be broadly classified into two
categories.
1. Asset based/fund based services.

2. Fee based/advisory services.

 A. Asset based/fund based services
1. Equipment Leasing/ Lease Financing
2. Hire Purchase and Consumer Credit
Hire purchase means a transaction where goods are
purchased and sold on the terms that (i) payment will
be made in instalments, (ii) the possession of the
goods is given to the buyer immediately, (iii) the
property ownership) in the goods remains with the
vendor till the last instalment is paid,(iv) the seller can
repossess the goods in case of default in payment of
any instalment, and (v) each instalment is treated as
hire charges till the last instalment is paid.
 Cont…
 Consumer Credit: Consumer credit includes all
asset based financing plans offered to
individuals to help them acquire durable
consumer goods. In a consumer credit
transaction the individual/ consumer/ buyer
pays a part of the cash purchase price at the
time of the delivery of the asset and pays the
balance with interest over a specified period of
time.
 Cont…
3. Venture Capital: These venture capital
companies provide the necessary risk capital to the
entrepreneurs so as to meet the promoters
contribution as required by the financial
institutions. In addition to providing capital, these
VCFS (venture capital firms) take an active interest
in guiding the assisted firms.
4. Insurance Services: Depending upon the subject
matter, insurance services are divided into (i) life
(ii) general.
 Cont…
5. Factoring: Factoring, as a fund based financial
service provides resources to finance receivables as
well as it facilitates the collection of receivables. It
is another method of raising short - term finance
through account receivable credit offered by
commercial banks and factors.
B. FEE BASED ADVISORY SERVICES
 (i) Merchant Banking Fee based advisory
services includes all these financial services
rendered by Merchant Bankers. Merchant
bankers play an important role in the financial
services Sector. The Industrial Credit and
Investment Corporation of India (ICICI) was
the first development finance institution to
initiate such service in 1974.
 These include banks financial institutions, non
- banking financial companies (NBFCS),
brokers and so on
 Cont…
 (ii) Credit Rating Credit rating is the opinion of
the rating agency on the relative ability and
willingness of the issuer of debt instrument to
meet the debt service obligations as and when
they arise. As a fee based financial advisory
service, credit rating useful to investors,
corporates (borrowers), banks and financial
institutions. For the investors, it is an indicator
expressing the underlying credit quality of a
(debt) issue programme
 Cont…
 (iii) Stock - Broking Prior to the setting up of
SEBI, stock exchanges were being supervised
by the Ministry of Finance under the Securities
Contracts Regulation Act (SCRA) and were
operating more or less self-regulatory
organisations.
 Chart [Link]
Reforms in Indian Financial System
Before 1990 Indian Financial system
 Closed

 Restrictive

 Highly regulated

 Segmented

 Resource allocation were not sufficient

 Administered Interest rate

 Complex regulations

 Restriction on security markets

 High statutory reserve requirement

 Strong entry barriers for new entrants

 A failed economy
 Low level of competition, efficiency and
productivity.

 Not able to achieve higher economic growth

 Not able to generate resources for investment

 Not able to arouse public interest in savings

 1980-1990
 Need for Market led development
 Create an efficient , productive and profitable
structural improvement
 Strengthening of financial system
 Reforms
 Remove structural rigidities and inefficiencies
 Efficient channelize and allocate resources
 Improve efficiency, stability and integrate
components
 Operational and functional autonomy
 Financial system for international competition
 Easing of Capital control
Classification of Financial system Reforms

Banking Capital
Sector Market

Foreign
Govt. debt
Exchange
Market
Market
Banking Sector Reforms

Suppressing
High Taxes Profits Consumptio
n

Bank

Capital Accumulation
 Prior to Reforms
 CRR and SLR were high
 Govt. used to loan to priority sector at subsidized
rate. Sectors were also decided by Govt.
 Non Priority sector were charged high interest
rate.
 Govt. used to give less interest to depositors.
 In 1969 Govt. realized that rural sectors are not
getting enough financial support.
 In 1969, 14 banks were nationalized and then in
1980 another 6 banks were nationalized to provide
services to rural areas and neglected society.
 Cont…
 In 1990 it has been realized that Govt. banks lost
the operational efficiency.
 Low profitability
 High NPAs
 The planned economic development strategy
adopted based on the Mahalanobis model had its
limitations that started showing in the 1980s.
 Turbulent international events such as the war in
the Middle East and the fall of the USSR(Union
of Soviet Socialist Republic) increased the
pressure on the Foreign Exchange Reserves of
India.
 Narasimham Committee report (1991)

 It was established to give reforms pertaining to the

financial sector of India including the capital market
and banking sector.
 Some of its major recommendations have been
mentioned below:
 It recommended reducing the cash reserve ratio (CRR) to
10% and the statutory liquidity ratio (SLR) to 25% over the
period of time.
 It suggested fixing at least 10% of the credit for priority
sector lending to marginal farmers, small businesses, cottage
industries, etc.
 In order to provide required independence to the banks for
setting the interest rates themselves for the customers, it
recommended de-regulating the interest rates.
 Banking Reforms
 In 1991, Narasimham Committee 1 and in 1998 Narasimham
Committee 2 were formed and suggested some Banking reforms

1. Liberalization in Interest Rate

2. Reduction in CRR and SLR
3. Entry of new private banks: FDI allowed from 49% to 74%
4. Technology upgradation and Core Banking Solution(CBS):
ATM, Mobile banking, Net banking etc.,
5. Adequate capitalization of Banks
6. Board of Financial supervision was set up.
7. Human Resource Development
8. Set up of DRT(Debt Recovery Tribunals), SARFAESI Act. so
that banks can sell property of default borrowers.
9. Introduction of prudential norms of income recognition,
provisioning and capital adequacy.
 Cont…
 Reduction in CRR and SLR has given banks more financial resources
for lending to the agriculture, industry and other sectors of the
economy.
 The system of administered interest rate structure has been done
away with and RBI no longer decides interest rates on deposits paid
by the banks.
 Allowing domestic and international private sector banks to open
branches in India, for example, HDFC Bank, ICICI Bank, Bank of
America, Citibank, American Express, etc.
 Issues pertaining to non-performing assets were resolved through
Lok adalats, civil courts, Tribunals, The Securitisation And
Reconstruction of Financial Assets and the Enforcement of Security
Interest (SARFAESI) Act.
 The system of selective credit control that had increased the
dominance of RBI was removed so that banks can provide greater
 Reforms in the Debt Market
 The 1997 policy of the government that
included automatic monetization of the fiscal
deficit was removed resulting in the government
borrowing money from the market through the
auction of government securities.
 Borrowing by the government occurs at market-
determined interest rates which have made the
government cautious about its fiscal deficits.
 Introduction of treasury bills by the government
for 91 days for ensuring liquidity and meeting
short-term financial needs and for benchmarking.
 To ensure transparency the government introduced
a system of delivery versus payment settlement.
 Capital Market Reforms
 Capital Issues Act., 1947 repealed(Withdrawn)
 Free pricing of securities
 Dematerialization of securities
 Computer screen based trading
 Establishment of SEBI
 Investor education and Protection fund
 FII permitted too invest
 New instrument like ADR and GDR
 Improvement of clearing and settlement
system
 Financial institutions and market improved.
Foreign Exchange Market reforms
 Market based exchange rate system
 Introduced 1993
 Current account convertibility adopted
 Banks to undertake foreign exchange operations
 New products introduced
 Authorized dealer allowed
 Entry of new players
 Devaluation of Rupees
 FEMA, 1973 replaced with FEMA, 1999
 Reforms in the Foreign Exchange Market
 Market-based exchange rates and the current account
convertibility was adopted in 1993.
 The government permitted the commercial banks to
undertake operations in foreign exchange.
 Participation of newer players allowed in rupee foreign
currency swap market to undertake currency swap
transactions subject to certain limitations.
 Replacement of foreign exchange regulation act (FERA),
1973 was replaced by the foreign exchange management
act (FEMA), 1999 for providing greater freedom to the
exchange markets.
 Trading in exchange-traded derivatives contracts was
permitted for foreign institutional investors and non-
resident Indians subject to certain regulations and
limitations.
 Impact of Various Reforms in the Financial Sector

 It increased the resilience, stability and growth rate of the

Indian economy from around 3.5 % to more than 6% per
annum.
 A resilient banking system helped the country deal with
the Asian economic crisis of 1977-98 and the Global
subprime crisis.
 The emergence of private sector banks and foreign banks
increased competition in the banking sector which has
improved its efficiency and capability.
 Better performance by stock exchanges of the country and
adoption of international best practices.
 Better budget management, fiscal deficit, and public debt
condition have improved after the financial sector reforms
 Module II
Banking and Insurance Sectors
1. Advancing of Loans
Banks are profit-oriented business organizations. So
they have to advance a loan to the public and generate
interest from them as profit. After keeping certain
cash reserves, banks provide short-term, medium-
term, and long-term loans to needy borrowers.
2. Overdraft
Sometimes, the bank provides overdraft facilities to its
customers through which they are allowed to
withdraw more than their deposits. Interest is charged
from the customers on the overdrawn amount.
 Cont…
3. Discounting of Bills of Exchange
Discounting of Bills of Exchange is another popular
type of lending by modern banks. Through this
method, a holder of a bill of exchange can get it
discounted by the bank. In a bill of exchange, the
debtor accepts the bill drawn upon him by the
creditor (i.e., holder of the bill) and agrees to pay
the amount mentioned on maturity.
After making some marginal deductions (in the
form of commission), the bank pays the bill’s value
to the holder. When the bill of exchange matures,
the bank gets its payment from the party, which
had accepted the bill.
 Cont…
4. Check/Cheque Payment
Banks provide cheque pads to the account holders.
Account-holders can draw cheques upon the bank to
pay money.
Banks pay for cheques of customers after formal
verification and official procedures.
5. Collection and Payment Of Credit Instruments
Different credit instruments such as the bill of
exchange, promissory notes, cheques, etc., are used in
modern business.
Banks deal with such instruments. Modern banks
collect and pay different types of credit instruments as
the representative of the customers.
 Cont…
6. Foreign Currency Exchange
Banks deal with foreign currencies. As customers’
requirement, banks exchange foreign currencies
with local currencies, which is essential to settle
down the dues in the international trade.
7. Consultancy
Modern commercial banks are large
organizations. In this function, banks hire
financial, legal, and market experts who advise
customers regarding investment, industry, trade,
income, tax, etc. They can expand their function to
consultancy business.
 Cont…
8. Bank Guarantee
Customers are provided the facility of bank guarantee by
modern commercial banks
When customers have to deposit certain funds in governmental
offices or courts for a specific purpose, a bank can present itself
as the guarantee for the customer instead of depositing funds
by customers.
9. Remittance of Funds
Banks help their customers in transferring funds from one place
to another through cheques, drafts, etc.
10. Credit cards
A credit card is a card that allows its holders to make purchases
of goods and services in exchange for the credit card’s provider
immediately paying for the goods or service. The cardholder
promises to pay back the purchase amount to the card provider
over some time and with interest.
 Cont…
11. ATMs replace human bank tellers in performing giving banking
functions such as deposits, withdrawals, account inquiries. Key
advantages of ATMs include:
24-hour availability
Elimination of labor cost
Convenience of location
12. Debit cards
Debit cards are used to withdraw funds directly from the cardholders’
accounts electronically. Most debit cards require a Personal
Identification Number (PIN) to be used to verify the transaction.
13. Priority banking
Priority banking can include several various services, but some
popular ones include free checking, online bill pay, financial
consultation, and information.

.
 Cont…
14. Online banking
Banks offer online banking that allows account holders to access
their account data via the internet. Online banking is also known
as “Internet banking” or “Web banking.”
Online banking through traditional banks enables customers to
perform all routine transactions, such as account transfers,
balance inquiries, bill payments, and stop-payment requests.
Some even offer online loans and credit card applications.
Account information can be accessed anytime, day or night, and
can be done from anywhere.
15. Mobile Banking
Mobile banking (also known as M-Banking) is a term used for
performing balance checks, account transactions, payments,
credit applications, and other banking transactions through a
mobile device such as a mobile phone or Personal Digital
Assistant (PDA),
16. Accepting Deposit
Accepting deposits from savers or account
holders is the primary function of a bank. Banks
receive the deposit from those who can save
money but cannot utilize it in profitable sectors.
People prefer to deposit their savings in a bank
because by doing so, they earn interest.