FINANCIAL MARKETS AND SERVICES
MODULE1
OVERVIEW OF FINANCIAL SYSTEM
Introduction to Financial System
• A financial system refers to
a structured network of
financial institutions,
markets, instruments, and
services that facilitate the
flow of funds between
lenders and borrowers. It
plays a crucial role in
economic development by
mobilizing savings,
allocating capital
efficiently, and ensuring
financial stability.
Meaning and Definition of Financial
system:
• A financial system is a total of financial institutions, financial markets, financial services, financial
practices and procedures.
• A financial system is a network of institutions, markets, and instruments that
facilitate the flow of funds between savers and borrowers, enabling efficient
allocation of capital and promoting economic growth.
• Banks
• Government treasuries
• Insurance companies
• Loan companies
• Mutual funds
• Stock exchanges
Definitions of Financial system
• According to Prof. Prasanna Chandra
• “The financial system consists of a variety of institutions, markets and
instruments related in a systematic manner and provide the principal
means by which savings are transformed into investments”
• According to Robinson
• “ Financial system is the primary function of the system which is to
provide a link between savings and investment for the creation of
new wealth and to portfolio adjustments in the composition of the
existing wealth”
components of a financial system:
• Money: Money provides the basis of financial systems. While the consistency of money
may vary based on changes in technology and financial systems themselves, money most
often relates to electronic funds.
• Financial markets: Financial markets are the environments where buyers and sellers
interact with one another to purchase, trade and sell assets like bonds and shares. These
markets include trading houses, such as the New York Stock Exchange and NASDAQ.
• Financial institutions: Financial institutions, such as banks, provide a range of products
and services and act as a mediator between borrowers and investors. They offer services
like mortgages, brokerage accessibility and insurance. They help mobilize savings directly
or indirectly and raise funds for financial assets like loans, securities and deposits.
• Financial instruments or financial assets: Financial instruments or assets are the
products traded in financial markets, such as securities, stocks, bonds, insurance and
mortgages. There may be different requirements for each credit seeker, and trading
stocks or securities may involve mutual funds or pooling the savings of investors.
• Financial services: Financial services are the services provided by liability and
asset management companies, such as investment, insurance and banking services.
These services help acquire and efficiently invest funds.
• Regulatory agencies: Regulatory agencies oversee all activities of markets and
institutions, and they often rely on government review systems to help ensure best
practices. They review and enforce guidelines related to the practices of systems. They
also supervise specific members of the system to protect the public's money and
Features of a Financial System
• Mobilization of Savings – Encourages individuals and businesses to
save and invest.
• Efficient Allocation of Capital – Ensures funds are directed towards
productive investments.
• Risk Management – Provides financial instruments to hedge and
transfer risk.
• Liquidity Provision – Facilitates easy conversion of assets into cash.
• Regulatory Framework – Governed by financial regulators such as
RBI, SEBI, and IRDAI in India.
• Economic Growth Catalyst – Strengthens capital formation,
employment generation, and innovation.
Constituents of Financial System
• Financial Institutions – Banks, NBFCs, insurance companies, mutual funds,
etc. that facilitate financial intermediation.
• Financial Markets – Platforms where financial assets are traded, Money
market, capital market, forex market, derivatives market.
• Financial Instruments – Various financial securities such as Equity, bonds,
derivatives, treasury bills, etc.
• Financial Services – Encompasses various services such as Banking, insurance,
investment advisory, credit rating and risk management.
Financial Institutions in India
• Financial institutions play a crucial role in mobilizing funds and providing
financial services. They can be classified as follows:
1. Regulatory Bodies:
• Reserve Bank of India (RBI) – Regulates monetary policy, banking sector.
• Securities and Exchange Board of India (SEBI) – Regulates stock
markets.
• Insurance Regulatory and Development Authority of India (IRDAI) –
Governs the insurance sector.
• Pension Fund Regulatory and Development Authority (PFRDA) –
Supervises pension funds.
• Scheduled Commercial Banks (SCBs) – Includes public sector
banks (SBI, Bank of Baroda), private sector banks (HDFC Bank,
ICICI Bank), and foreign banks.
• Regional Rural Banks (RRBs) – Focus on rural credit and financial
inclusion (e.g., Prathama Bank, Andhra Pragathi Grameena Bank).
• Cooperative Banks – Operate at state, district, and village levels to
support rural and agricultural finance (e.g., Maharashtra State
Cooperative Bank).
Objectives of financial systems
1. Efficient Allocation of Resources
o A financial system helps allocate funds from savers to borrowers efficiently.
o It ensures that capital is directed to the most productive uses in the economy.
2. Facilitating Economic Growth and Development
o By mobilizing savings and channeling them into investments, the financial system supports economic growth.
o It also helps in the development of infrastructure, industries, and services, leading to overall economic development.
3. Liquidity Provision
o Financial systems provide liquidity by offering mechanisms (like banks and financial markets) for the buying and selling of assets.
o Liquidity is essential for individuals and businesses to meet their short-term financial needs.
4. Risk Sharing and Diversification
o Financial systems help in the distribution of risks among various participants.
o It allows investors to diversify their portfolios, reducing the impact of potential losses from individual investments.
5. Price Discovery
o Financial systems establish prices for financial assets through the functioning of financial markets.
o It allows participants to understand the value of assets, like stocks and bonds, based on market demand and supply.
6. Facilitation of Payments
o Financial systems provide payment mechanisms such as electronic transfers, checks, and credit facilities.
o This supports the smooth flow of transactions in the economy, allowing goods and services to be exchanged efficiently.
7.Efficient Management of Savings and Investments
o Financial systems help individuals and institutions manage their savings and investments effectively.
o It provides a variety of investment options that cater to different risk appetites and financial goals.
8. Credit Availability
o Financial systems ensure the availability of credit to businesses, consumers, and governments.
o Access to credit fosters consumption, production, and investment activities, thus stimulating economic growth.
9.Economic Stabilization
o A well-functioning financial system can help in stabilizing the economy by controlling inflation, unemployment, and maintaining
steady growth.
o It can also aid in reducing the impact of economic shocks by adjusting policies, interest rates, and capital flow.
10.Transparency and Confidence in the Economy
o Financial systems promote transparency in the market by enforcing disclosure requirements and regulations.
o This builds investor confidence, as it reduces information asymmetry and ensures fair transactions.
11. Encouraging Savings
o By offering various financial products like savings accounts, mutual funds, and insurance, financial systems
encourage people to save.
o Savings are then converted into investments, which play a key role in the economy.
o12. Government Financing
o The financial system helps the government raise funds for public spending through debt instruments like bonds and
securities.
o This is crucial for financing infrastructure projects, social welfare programs, and national defense.
2. Commercial Banks:
• Public Sector Banks – SBI, Bank of Baroda, PNB, etc.
• Private Sector Banks – HDFC Bank, ICICI Bank, Axis Bank, etc.
3. Non-Banking Financial Companies (NBFCs)
• Bajaj Finance, HDFC Ltd, Mahindra Finance, etc.
4. Development Financial Institutions (DFIs):
Small Industries Development Bank of India (SIDBI) – Supports MSMEs.
EXIM Bank – Facilitates international trade.
National Bank for Agriculture and Rural Development (NABARD) – Supports rural
financing.
Indian Renewable Energy Development Agency (IREDA).
5. Insurance Companies:
Life Insurance Corporation of India (LIC), HDFC Life, ICICI Lombard, etc.
Financial Services
Financial services provide support to individuals and businesses in managing
finances. Major financial services include:
• Banking Services – Deposit accounts, loans, fund transfers, credit cards, digital
banking.
• Investment Services –Wealth management, portfolio advisory. Mutual funds,
stock brokerage (SBI Mutual Fund, Zerodha).
• Insurance Services – Life, general, health insurance.
• Pension & Retirement Planning – NPS, provident funds.
• Fintech & Digital Payments – UPI, NEFT, IMPS, digital wallets (NPCI,
Paytm, PhonePe, Google Pay), RTGS.
• Wealth Management – Financial planning, portfolio management (Kotak
Wealth Management).
Financial Markets in India
a) Money Market
• Deals with short-term financial instruments (maturity <1 year).
• Instruments: Treasury Bills (T-Bills), Commercial Papers, Certificates of Deposit.
• Regulated by: Reserve Bank of India (RBI).
b) Capital Market
• Deals with long-term securities such as stocks and bonds.
• Primary Market – Where new securities are issued (IPO of LIC, Zomato).
• Secondary Market – Where existing securities are traded in Stock Exchanges (NSE, BSE).
• Regulated by: Securities and Exchange Board of India (SEBI).
c) Foreign Exchange Market
• Facilitates currency exchange (USD/INR, EUR/INR).
• Regulated by: RBI and Foreign Exchange Management Act (FEMA).
d) Derivatives Market – Futures & options trading.
e) Commodity Market – Trading in gold, silver, crude oil (MCX, NCDEX).
Financial Instruments
Financial instruments are assets that can be traded in financial markets.
a) Debt Instruments
• Treasury Bills, Corporate Bonds (Reliance Industries Bonds, SBI Bonds).
b) Equity Instruments
• Common stocks and preferred stocks (Tata Motors, Infosys shares).
c) Derivatives
• Futures, Options, Swaps (Nifty50 Options, Currency Futures).
d) Hybrid Instruments
• Convertible Debentures, Preference Shares.
Latest Statistics & Trends - 2024
• Banking Growth: India’s banking sector grew at 11.3% YoY in 2023, with total
assets reaching ₹225 lakh crore.
• Digital Banking Growth – UPI transactions crossed ₹18.41 lakh crore in
February 2024.
• Stock Market Boom: BSE Sensex crossed 75,000 points in early 2024, with
record IPOs.
• Mutual Funds: AUM (Assets Under Management) of mutual funds in India
surpassed ₹50 lakh crore in 2024.
• FDI Inflows: India received $83.5 billion in FDI in FY 2023-24, led by fintech
and IT sectors.
• Green Finance Expansion – SEBI introduced ESG disclosure norms, and India
issued $2 billion in green bonds.
• Financial Inclusion Drive – Over 50 crore Jan Dhan accounts opened since
2014.
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