What is Indian Financial System? Its Components, Function, and Definitions
Indian Financial System.The economic development of a country is greatly influenced by its financial system, especially for developing countries like India. Finance in India facilitates the mobilization of funds for the economic development and growth of the country and its people. In India, the financial system creates a bridge between people who have surplus funds and those who are short of funds, so that any surplus funds can be employed by individuals, businesses, or corporations who know how to maximize the value of money. Learn about the Indian financial system's overall structure, central components, definition, functions, and features in this blog. The financial system is made up of various financial institutions such as banks, insurance companies, pension plans, funds, etc. Here are some characteristics of the Indian financial system:
- It promotes both savings and investments, which are essential for the economic development of any country.
- One can use it to mobilize and allocate one's savings.
- Financial institutions and markets can expand with it.
- Helps to create capital.
- Connects investor and saver.
- Responsible for providing funds as well.
What are the Functions of the Financial System?
- A financial system is responsible for supplying funds to the business sectors.
- The allocation of funds to those who can use them effectively leads to economic growth.
- Investments result in capital formation.
- Facilitates investment by business sectors.
- Connects investor and saver.
- Savings are encouraged, bringing the money back into circulation.
How to define a financial system/ What is the definition of a Financial System?
Financial institutions comprise the Financial System as well as markets, regulators, transactions, analysts, and money managers. By developing a common platform for borrowers and investors, the financial system allows investors to invest their money and borrowers to arrange loans.
In this regard, let's analyze the Indian financial system. The financial system of India can be divided into two categories.
Financial institutions comprise the Financial System as well as markets, regulators, transactions, analysts, and money managers. By developing a common platform for borrowers and investors, the financial system allows investors to invest their money and borrowers to arrange loans.
In this regard, let's analyze the Indian financial system. The financial system of India can be divided into two categories.
Indian Financial System: What are its Components?
The Indian financial system is made up of five main components.
Institutional investors/depositors are intermediaries between borrowers (who need funds) and investors (who have surplus funds). By serving as an intermediary, financial institutions fill the gap between lenders and borrowers. Financial institutions include, for example, commercial banks, cooperative banks, insurance companies, stock brokerage firms, and mutual fund companies.
There are two types of financial institutions.
In order for a country to function effectively, scheduled banks must play a crucial role in managing money at the foundation level.
There are three general categories of financial markets.
A. Money Market – Generally, this is a marketplace where short-term securities like Treasury bills, Repos, commercial papers, and so on are issued and traded (sold and bought) between people.
B. Capital Market – Stocks, bonds, debentures, and other long-term securities are issued and traded. An example of a capital market is the BSE (Bombay Stock Exchange), NSE (National Stock Exchange), and NYSE (New York Stock Exchange). There are three types of capital markets - Primary Market, Secondary market, Derivative Market
C. Forex Market – In addition to exchanging currencies, it also determines the exchange rate.
D. Commodity Market – This market deals with commodities such as gold, silver, crude oil, etc.
Financial instruments can be categorized into three types:
Certificate of Deposit: An interest-bearing loan given to corporations for a stipulated period of time in a dematerialized form. As long as any special negotiations are made, the operating procedures are the same as for fixed deposits (FDs).
Commercial Papers: Large-cap companies usually issue it to raise money. It is an unsecured short-term debt instrument with a maturity period of 7 days to 1 year.
Treasury Bills: In addition, it consists of short-term debt instruments issued by the central government of India with maturities of up to one year.
Repurchase Agreement (Repo): By selling government-approved securities with a promise to repurchase in a future date, commercial banks, and other financial institutions borrow funds from the Reserve Bank of India for a shorter period (overnight) through Repurchase Agreements.
Call Money: Call money refers to a loan granted for one day and due for repayment the next day.
Commercial Bills: In addition to being traded on the money market, commercial bills are also used to raise funds to meet payments due. Obtaining funds through discounting is known as bill/invoice discounting.
Banker’s Acceptance: Also categorized as a money market instrument, Banker’s Acceptance is commonly used in the financial market. The banker's acceptance refers to the allocation of credit to stipulated banks in exchange for a signed promise of future repayments.
In India, financial services generally fall into four categories.
The Indian financial system is made up of five main components.- Financial Institutions
- Financial Markets
- Financial Instruments
- Financial Services
- Financial Regulators
1. The Financial Institutions -
Financial institutions are the first element of the financial system. In the financial sector, financial institutions are private or public organizations that manage funds and offer services to the general public and businesses.Institutional investors/depositors are intermediaries between borrowers (who need funds) and investors (who have surplus funds). By serving as an intermediary, financial institutions fill the gap between lenders and borrowers. Financial institutions include, for example, commercial banks, cooperative banks, insurance companies, stock brokerage firms, and mutual fund companies.
There are two types of financial institutions.
A. Banking Institutions –
A banking institution is an institution that accepts deposits as well as lends money to individuals and businesses.B. Non-Banking Institutions –
A non-banking institution doesn't accept deposits (cash) from the public, but they do offer their customers a range of financial products and services. Some examples of non-banking institutions are insurance companies, mutual funds, stockbrokers, and primary dealers.In order for a country to function effectively, scheduled banks must play a crucial role in managing money at the foundation level.
2. The Financial Market –
On a financial market, financial instruments are transacted between parties and persons.There are three general categories of financial markets.
A. Money Market – Generally, this is a marketplace where short-term securities like Treasury bills, Repos, commercial papers, and so on are issued and traded (sold and bought) between people.
B. Capital Market – Stocks, bonds, debentures, and other long-term securities are issued and traded. An example of a capital market is the BSE (Bombay Stock Exchange), NSE (National Stock Exchange), and NYSE (New York Stock Exchange). There are three types of capital markets - Primary Market, Secondary market, Derivative Market
C. Forex Market – In addition to exchanging currencies, it also determines the exchange rate.
D. Commodity Market – This market deals with commodities such as gold, silver, crude oil, etc.
3. The Financial Instruments –
Financial instruments can be defined as monetary documents/contracts between two parties that are traded on financial markets (Money Market, Capital Market, and Derivatives Market). It represents the assets of one party and, at the same time, liabilities for another party.Financial instruments can be categorized into three types:
A. Money Market Instruments –
As the name implies, money market instruments are short-term debt financing instruments that is usually traded over the counter to enhance liquidity.Certificate of Deposit: An interest-bearing loan given to corporations for a stipulated period of time in a dematerialized form. As long as any special negotiations are made, the operating procedures are the same as for fixed deposits (FDs).
Commercial Papers: Large-cap companies usually issue it to raise money. It is an unsecured short-term debt instrument with a maturity period of 7 days to 1 year.
Treasury Bills: In addition, it consists of short-term debt instruments issued by the central government of India with maturities of up to one year.
Repurchase Agreement (Repo): By selling government-approved securities with a promise to repurchase in a future date, commercial banks, and other financial institutions borrow funds from the Reserve Bank of India for a shorter period (overnight) through Repurchase Agreements.
Call Money: Call money refers to a loan granted for one day and due for repayment the next day.
Commercial Bills: In addition to being traded on the money market, commercial bills are also used to raise funds to meet payments due. Obtaining funds through discounting is known as bill/invoice discounting.
Banker’s Acceptance: Also categorized as a money market instrument, Banker’s Acceptance is commonly used in the financial market. The banker's acceptance refers to the allocation of credit to stipulated banks in exchange for a signed promise of future repayments.
B. Capital Market Instruments –
An instrument of the capital market refers to a long-term capital financing instrument, such as debt or equity, which trades on recognized exchanges. In such cases, corporations raise public funds with such financial instruments.- Equity Shares
- Preference Shares
- Debentures
- Corporate Bonds
C. Derivative Instruments –
Using a derivative means that financial instruments that do not have their own value, but instead derive their value from underlying assets. Securities can be hedged against price fluctuations by using it.- Forward
- Futures
- Options
- Swaps
- Exchange-traded Funds
4. The Financial Services –
Services offered by financial institutions for managing, lending, borrowing, and investment funds are referred to as financial services.In India, financial services generally fall into four categories.
A. General Banking Services –
A commercial bank or another banking institution that offers various services such as depositing money, granting loans/advances, discounting bills, issuing credit/debit cards, and opening accounts.B. Insurance Services –
Under the category of these kinds of services, a variety of insurance policies are offered, including life insurance, health insurance, and car insurance.C. Investment Services –
Businesses and corporations can turn to financial institutions for investments and asset management services, including stockbrokers, merchant and investment bankers, and primary dealers.- Mergers and acquisitions
- Fundraising services
- Trading in stocks and other securities
- Depository services
- Online share trading
- Credit rating services
- Loan syndication
- Underwriting of securities
D. Foreign Exchange Services –
Foreign exchange services are specialized services involved in converting foreign currencies.5. The Financial Regulators –
Regulatory agencies are government-sponsored agencies responsible for overseeing, inspecting, and regulating financial institutions such as banks, insurance companies, business entities, and nonbanking financial firms (NBFCs). A financial regulator is an organization that regulates the activities of financial institutions in their respective sectors. These financial regulatory bodies regulate and supervise financial institutions. The following are examples of financial regulatory bodies in India.- RBI (Reserve Bank of India)
- FMC (Forward Market Commission)
- IRDA (Insurance Regulatory and Development Authority)
- PFRDA (Pension Fund Regulatory and Development Authority)
Indian Financial System Financial institutions Informal Section Formal Section Financial Markets Financial Instruments Financial Services Financial Regulators Banking Institutions Non Banking Institutions Money Market Capital Market Forex Market Commodity
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