Chapter 1: Introduction To Financial System: S.T Gonsalo Garcia College

S.
T GONSALO GARCIA COLLEGE
CHAPTER 1: INTRODUCTION TO FINANCIAL SYSTEM
In finance, the financial system is the system that allows the transfer of
money between savers and borrowers. It comprises a set of complex and
closely interconnected financial institutions, markets, instruments, services,
practices, and transactions.
Financial systems are crucial to the allocation of resources in a modern

economy. They channel household savings to the corporate sector and
allocate investment funds among firms; they allow intertemporal smoothing
of consumption by households and expenditures by firms; and they enable
households and firms to share risks. These functions are common to the
financial systems of most developed economies. Yet the form of these
financial systems varies widely.
Financial System of any country consists of financial markets, financial

intermediation and financial instruments or financial products. This paper
discusses the meaning of finance and Indian Financial System and focus on
the financial markets, financial intermediaries and financial instruments. The
brief review on various money market instruments are also covered in this
study.
In this respect providing or securing finance by itself is a distinct activity or

function, which results in Financial Management, Financial Services and
Financial Institutions. Finance therefore represents the resources by way
funds needed for a particular activity. We thus speak of 'finance' only in
relation to a proposed activity. Finance goes with commerce, business,
banking etc. Finance is also referred to as "Funds" or "Capital", when
FINANCIAL SYSTEM IN INDIA Page 1

S.T GONSALO GARCIA COLLEGE
referring to the financial needs of a corporate body. When we study finance

as a subject for generalizing its profile and attributes, we distinguish
between 'personal finance" and "corporate finance" i.e. resources needed
personally by an individual for his family and individual needs and
resources needed by a business organization to carry on its functions
intended for the achievement of its corporate goals.

INDIAN FINANCIAL SYSTEM
The economic development of a nation is reflected by the progress of the

various economic units, broadly classified into corporate sector, government
and household sector. While performing their activities these units will be
placed in a surplus / deficit / balanced budgetary situations.
There are areas or people with surplus funds and there are those with a
deficit. A financial system or financial sector functions as an intermediary
and facilitates the flow of funds from the areas of surplus to the areas of
deficit. A Financial System is a composition of various institutions,
markets, regulations and laws, practices, money manager, analysts,
transactions and claims and liabilities.
Pre-reforms Phase:
Until the early 1990s, the role of the financial system in India was primarily
restricted to the function of channelling resources from the surplus to deficit
sectors. Whereas the financial system performed this role reasonably well,
its operations came to be marked by some serious deficiencies over the
years. The banking sector suffered from lack of competition, low capital
base, low productivity and high intermediation cost. After the nationalisation
of large banks in 1969 and 1980, the Government-owned banks dominated
the banking 3 sector. The role of technology was minimal and the quality of
service was not given adequate importance. Banks also did not follow proper
risk management systems and the prudential standards were weak. All these
resulted in poor asset quality and low profitability. Among non-banking
financial intermediaries, development finance institutions (DFIs) operated in
an over-protected environment with most of the funding coming from
assured sources at concessional terms. In the insurance sector, there was

little competition. The mutual fund industry also suffered from lack of
competition and was dominated for long by one institution, viz., the Unit
Trust of India. Non-banking financial companies (NBFCs) grew rapidly, but
there was no regulation of their asset side.
Financial markets were characterized by control over pricing of financial
assets, barriers to entry, high transaction costs and restrictions on movement
of funds / participants between the market segments. This apart from
inhibiting the development of the markets also affected their efficiency.
Financial Sector Reforms in India:
It was in this backdrop that wide-ranging financial sector reforms in India

were introduced as an integral part of the economic reforms initiated in the
early 1990s with a view to improving the macroeconomic performance of
the economy. The reforms in the financial sector focussed on creating
efficient and stable financial institutions and markets. The approach to
financial sector reforms in India was one of gradual and non-disruptive
progress through a consultative process. The Reserve Bank has been
consistently working towards setting an enabling regulatory framework with
prompt and effective supervision, development of technological and
institutional infrastructure, as well as changing the interface with the market
participants through a consultative process. Persistent efforts have been
made towards adoption of international benchmarks as appropriate to Indian
conditions. While certain changes in the legal infrastructure are yet to be
effected, the developments so far have brought the Indian financial system
closer to global standards.

The reform of the interest regime constitutes an integral part of the financial
sector reform. With the onset of financial sector reforms, the interest rate
regime has been largely deregulated with a view towards better price
discovery and efficient resource allocation. Initially, steps were taken to
develop the domestic money market and freeing of the money market rates.
The interest rates offered on Government securities were progressively
raised so that the Government borrowing could be carried out at market-
related rates. In respect of banks, a major effort was undertaken to simplify
the administered structure of interest rates. Banks now have sufficient
flexibility to decide their deposit and lending rate structures and manage
their assets and liabilities accordingly. At present, apart from savings
account and NRE deposit on the deposit side and export credit and small
loans on the lending side, all other interest rates are deregulated. Indian
banking system operated for a long time with high reserve requirements both
in the form of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio
(SLR). This was a consequence of the high fiscal deficit and a high degree of
monetisation of fiscal deficit. The efforts in the recent period have been to
lower both the CRR and SLR. The statutory minimum of 25 per cent for
SLR has already been reached, and while the Reserve Bank continues to
pursue its medium-term objective of reducing the CRR to the statutory
minimum level of 3.0 per cent, the CRR of SCBs is currently placed at 5.0
per cent of NDTL.

Financial System: Current Status

There has been a notable reduction in the ratio of non-performing assets
(NPAs) to advances in response to various initiatives, such as, improved risk
management practices and greater recovery efforts driven, inter alia, by the
recently enacted Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest (SARFAESI) Act, 2002. The financial
performance of most of the PSBs has improved in recent times as reflected
in their comfortable capital adequacy ratios and declining NPL ratios. The
CRAR in respect of all categories of banks has improved. New private sector
banks have displayed impressive performance particularly in terms of
efficiency and customer service
Financial System
The word "system", in the term "financial system", implies a set of complex
and closely connected or interlined institutions, agents, practices, markets,
transactions, claims, and liabilities in the economy. The financial system is
concerned about money, credit and finance-the three terms are intimately
related yet are somewhat different from each other. Indian financial system
consists of financial market, financial instruments and financial
intermediation.

CHAPTER 2: FINANCIAL INSTITUTION
In financial economics, a financial institution is an institution that provides

financial services for its clients or members. Probably the most important
financial service provided by financial institutions is acting as financial
intermediaries. Most financial institutions are highly regulated by
government.
Broadly speaking, there are three major types of financial institutions:
1. Deposit-taking institutions that accept and manage deposits and make
loans, including banks, building societies, credit unions, trust

companies, and mortgage loan companies
2. Insurance companies and pension funds; and
3. Brokers, underwriters and investment funds.
• BANKS: A bank is a financial intermediary that accepts deposits and

channels those deposits into lending activities, either directly or
through capital markets. A bank connects customers with capital
deficits to customers with capital surpluses.
• INSURANCE COMPANIES: Insurance is a form of risk

management primarily used to hedge against the risk of a
contingent, uncertain loss. Insurance is defined as the equitable
transfer of the risk of a loss, from one entity to another, in exchange
for payment. An insurer is a company selling the insurance;
an insured, or policyholder, is the person or entity buying the
insurance policy.

• Brokers: A broker is a party that mediates between a buyer and

a seller. A broker who also acts as a seller or as a buyer becomes
a principal party to the deal.
• Underwriters: Underwriting refers to the process that a large
financial service provider (bank, insurer, investment house) uses to
assess the eligibility of a customer to receive their products (equity
capital, insurance, mortgage, or credit).
• Mutual funds: A mutual fund is a professionally managed type
of collective investment scheme that pools money from many
investors and invests typically in investment securities (stocks, bonds,
short-term money market instruments, other mutual funds, other
securities, and/or commodities such as precious metals)

CHAPTER 3: FINANCIAL MARKETS
In economics, a financial market is a mechanism that allows people to buy

and sell (trade) financial securities (such as stocks and bonds), commodities
(such as precious metals or agricultural goods), and other fungible items of
value at low transaction costs and at prices that reflect the efficient-market
hypothesis.
Both general markets (where many commodities are traded) and specialized
markets (where only one commodity is traded) exist. Markets work by
placing many interested buyers and sellers in one "place", thus making it
easier for them to find each other. An economy which relies primarily on
interactions between buyers and sellers to allocate resources is known as a
market economy in contrast either to a command economy or to a non-
market economy such as a gift economy.
In finance, financial markets facilitate:
• The raising of capital (in the capital markets)

• The transfer of risk (in the derivatives markets)
• International trade (in the currency markets)
– and are used to match those who want capital to those who have it.
Typically a borrower issues a receipt to the lender promising to pay back the
capital. These receipts are securities which may be freely bought or sold. In
return for lending money to the borrower, the lender will expect some
compensation in the form of interest or dividends.

• Money Market- The money market ifs a wholesale debt market for
low-risk, highly-liquid, short-term instrument. Funds are available in
this market for periods ranging from a single day up to a year. This
market is dominated mostly by government, banks and financial
institutions.
• Capital Market - The capital market is designed to finance the long-
term investments. The transactions taking place in this market will be
for periods over a year.
• Forex Market - The Forex market deals with the multicurrency
requirements, which are met by the exchange of currencies.
Depending on the exchange rate that is applicable, the transfer of
funds takes place in this market. This is one of the most developed
and integrated market across the globe.
• Credit Market- Credit market is a place where banks, FIs and
NBFCs purvey short, medium and long-term loans to corporate and
individuals.

FINANCIAL MARKETS IN INDIA:
Generally the world Market denotes a specific place or location where

transactions take place. But this is not true in case of financial markets.
Wherever financial transactions take place, it is deemed to have taken place in
financial market.
Financial markets in India are classified in major two categories:
1. unorganized markets and

2. organized markets
1. Unorganized markets: Players in unorganized markets are money
lenders, indigenous bankers, traders etc. who lend money to the public,
indigenous bankers even collect money from public in the form of
deposits. There are also private finance companies, chit fund etc.
however activities of these players are not controlled by RBI. Directions
were issued in 1998 to bring private finance companies and chit funds
under strict control of RBI. Steps have also been taken to bring the
unorganized sector under organized fold. But these regulations and
inadequate and did not have much success. Therefore, financial
instruments in unorganized markets are not standardized.
2. Organized markets: In organized markets, there are standardized rules
and regulations for financial transactions, these markets are under strict
supervision and control of RBI or other regulatory bodies.

PRIMARY MARKET
Primary market is the market for new issue of financial instruments.

Therefore, it is also called as new issue market. It deals in those securities
which are issued to the public for the first time.
Role of the ‘Primary Market’
The primary market provides the channel for sale of new securities. Primary
market provides opportunity to issuers of securities; Government as well as
corporates, to raise resources to meet their requirements of investment
and/or discharge some obligation. They may issue the securities at face
value, or at a discount/premium and these securities may take a variety of
forms such as equity, debt etc. They may issue the securities in domestic
market and/or international market.
FUNCTIONS OF PRIMARY MARKET

1. Companies need to issue shares to the public
Most companies are usually started privately by their promoter(s). However,
the promoters’ capital and the borrowings from banks and financial
institutions may not be sufficient for setting up or running the business over
a long term. So companies invite the public to contribute towards the equity
and issue shares to individual investors. The way to invite share capital from
the public is through a ‘Public Issue’. Simply stated, a public issue is an
offer to the public to subscribe to the share capital of a company. Once this
is done, the company allots shares to the applicants as per the prescribed
rules and regulations laid down by SEBI.

2. Issue price
The price at which a company's shares are offered initially in the primary
market is called as the Issue price. When they begin to be traded, the
market price may be above or below the issue price.
3. Market Capitalization
The market value of a quoted company, which is calculated by multiplying
its current share price (market price) by the number of shares in issue is
called as market capitalization. E.g. Company A has 120 million shares in
issue. The current market price is Rs. 100. The market capitalisation of
company A is Rs. 12000 million.
4. Initial Public Offer (IPO)

An Initial Public Offer (IPO) is the selling of securities to the public in the
primary market. It is when an unlisted company makes either a fresh issue
of securities or an offer for sale of its existing securities or both for the first
time to the public. This paves way for listing and trading of the issuer’s
securities. The sale of securities can be either through book building or
through normal public issue.

SECONDARY MARKET
Secondary market refers to a market where securities are traded after being
initially offered to the public in the primary market and/or listed on the
Stock Exchange. Majority of the trading is done in the secondary market.
Secondary market comprises of equity markets and the debt markets.
Role of the Secondary Market

For the general investor, the secondary market provides an efficient platform
for trading of his securities. For the management of the company, Secondary
equity markets serve as a monitoring and control conduit—by facilitating
value-enhancing control activities, enabling implementation of incentive-
based management contracts, and aggregating information (via price
discovery) that guides management decisions.
The secondary market, also known as the aftermarket, is the financial market
where previously issued securities and financial instruments such as stock,
bonds, options, and futures are bought and sold. The term "secondary
market" is also used to refer to the market for any used goods or assets, or an
alternative use for an existing product or asset where the customer base is
the second market (for example, corn has been traditionally used primarily
for food production and feedstock, but a "second" or "third" market has
developed for use in ethanol production). Another commonly referred to
usage of secondary market term is to refer to loans which are sold by a
mortgage bank to investors such as Fannie Mae and Freddie Mac.
With primary issuances of securities or financial instruments, or the primary

market, investors purchase these securities directly from issuers such as

corporations issuing shares in an IPO or private placement, or directly from

the federal government in the case of treasuries. After the initial issuance,
investors can purchase from other investors in the secondary market.
FUNCTIONS OF SECONDARY MARKET
Secondary marketing is vital to an efficient and modern capital market. In

the secondary market, securities are sold by and transferred from one
investor or speculator to another. It is therefore important that the secondary
market be highly liquid (originally, the only way to create this liquidity was
for investors and speculators to meet at a fixed place regularly; this is how
stock exchanges originated, As a general rule, the greater the number of
investors that participate in a given marketplace, and the greater the
centralization of that marketplace, the more liquid the market.
Fundamentally, secondary markets mesh the investor's preference for

liquidity (i.e., the investor's desire not to tie up his or her money for a long
period of time, in case the investor needs it to deal with unforeseen
circumstances) with the capital user's preference to be able to use the capital
for an extended period of time.
Accurate share price allocates scarce capital more efficiently when new
projects are financed through a new primary market offering, but accuracy
may also matter in the secondary market because:
1) Price accuracy can reduce the agency costs of management, and make
hostile takeover a less risky proposition and thus move capital into the hands
of better managers, and

2) Accurate share price aids the efficient allocation of debt finance

whether debt offerings or institutional borrowing.
THEY ARE FURTHER CLASSIFIED INTO:
A. Capital market
B. Money market
A. CAPITAL MARKET:
The CAPITAL MARKET is the market for financial assets which have long
and indefinite maturity. It generally deals with long term securities which
have a maturity period of more than one year. Capital markets may be
classified as primary markets and secondary markets. In primary markets,
new stock or bond issues are sold to investors via a mechanism known as
underwriting. In the secondary markets, existing securities are sold and
bought among investors or traders, usually on a securities exchange, over-
the-counter, or elsewhere.
• STOCK EXCHANGE
A stock exchange is an entity which provides "trading" facilities for stock

brokers and traders, to trade stocks and other securities. Stock exchanges
also provide facilities for the issue and redemption of securities as well as
other financial instruments and capital events including the payment of
income and dividends. The securities traded on a stock exchange include
shares issued by companies, unit trusts, derivatives, pooled investment
products and bonds.

The major stock exchanges in India are NSE, BSE
ROLE OF STOCK EXCHANGE
1. Raising capital for businesses
The Stock Exchange provide companies with the facility to raise capital for
expansion through selling shares to the investing public.
2. Mobilizing savings for investment
When people draw their savings and invest in shares, it leads to a more
rational allocation of resources because funds, which could have been
consumed, or kept in idle deposits with banks, are mobilized and redirected
to promote business activity with benefits for several economic sectors such
as agriculture, commerce and industry, resulting in stronger economic
growth and higher productivity levels of firms.
3. Facilitating company growth
Companies view acquisitions as an opportunity to expand product lines,

increase distribution channels, hedge against volatility, increase its market
share, or acquire other necessary business assets. A takeover bid or a merger
agreement through the stock market is one of the simplest and most common
ways for a company to grow by acquisition or fusion.

4. Profit sharing
Both casual and professional stock investors, through dividends and stock
price increases that may result in capital gains, will share in the wealth of
profitable businesses.
5. Corporate governance
By having a wide and varied scope of owners, companies generally tend to

improve on their management standards and efficiency in order to satisfy the
demands of these shareholders and the more stringent rules for public
corporations imposed by public stock exchanges and the government.
Consequently, it is alleged that public companies (companies that are owned
by shareholders who are members of the general public and trade shares on
public exchanges) tend to have better management records than privately
held companies (those companies where shares are not publicly traded, often
owned by the company founders and/or their families and heirs, or otherwise
by a small group of investors).
Despite this claim, some well-documented cases are known where it is

alleged that there has been considerable slippage in corporate governance on
the part of some public companies. The dot-com bubble in the late 1990's,
and the subprime mortgage crisis in 2007-08, are classical examples of
corporate mismanagement. Companies like Pets.com (2000), Enron
Corporation (2001), One.Tel (2001), Sunbeam (2001), Webvan (2001),
Adelphia (2002), MCI WorldCom (2002), Parmalat (2003), American
International Group (2008), Bear Stearns (2008), Lehman Brothers (2008),

General Motors (2009) and Satyam Computer Services (2009) were among
the most widely scrutinized by the media.
However, when poor financial, ethical or managerial records are known by

the stock investors, the stock and the company tend to lose value. In the
stock exchanges, shareholders of underperforming firms are often penalized
by significant share price decline, and they tend as well to dismiss
incompetent management teams.
6. Creating investment opportunities for small investors
As opposed to other businesses that require huge capital outlay, investing in

shares is open to both the large and small stock investors because a person
buys the number of shares they can afford. Therefore the Stock Exchange
provides the opportunity for small investors to own shares of the same
companies as large investors.
7. Government capital-raising for development projects
Governments at various levels may decide to borrow money in order to

finance infrastructure projects such as sewage and water treatment works or
housing estates by selling another category of securities known as bonds.
These bonds can be raised through the Stock Exchange whereby members of
the public buy them, thus loaning money to the government. The issuance of
such bonds can obviate the need to directly tax the citizens in order to
finance development, although by securing such bonds with the full faith
and credit of the government instead of with collateral, the result is that the
government must tax the citizens or otherwise raise additional funds to make

any regular coupon payments and refund the principal when the bonds
mature.
Capital market may further divided into:
(a) Equity Shares or ordinary shares:

An equity share, commonly referred to as ordinary share, represents the form
of fractional ownership in a business venture. They do not get fixed rate of
dividend, they carry second preferential right in the payment of dividend.
The person who holds equity shares are the holder of those shares, they are
the real owner of the company.
(b) Preference shares:

Owners of these kind of shares are entitled to a fixed dividend or dividend
calculated at a fixed rate to be paid regularly before dividend can be paid in
respect of equity share. They also enjoy priority over the equity shareholders
in payment of surplus. But in the event of liquidation, their claims rank
below the claims of the company’s creditors, bondholders/debenture holders.
(c) Debentures or bonds:

Debentures can be defined as “acknowledgement of debt, given under the
seal of the company and containing a contract for the repayment of the
principal sum at a specified date and for the payment of interest at fixed rate
percent until the principal sum is repaid and it may or may not give the
charge on the assets to the company as security of the loan”.
Bond is a negotiable certificate evidencing indebtedness. It is normally

unsecured. A debt security is generally issued by a company, municipality or
government agency. A bond investor lends money to the issuer and in

exchange, the issuer promises to repay the loan amount on a specified
maturity date. The issuer usually pays the bond holder periodic interest
payments over the life of the loan.
Industrial entities raise their required capital or debt by issuing appropriate

instruments. The market where these securities/instruments are transacted is
called as industrial securities market.
2. Government securities market
It is the market where government securities are traded. Govt. securities can
be short term or long term. Short-term are traded in money market whereas
long term are traded in capital market. The securities are issued by central
govt., state governments, semi-governments authorities like city
corporations, port trusts etc.; state electricity boards, All India and State
level financial institutions and public sector enterprises. It consists of central
and state government securities. It means that, loans are being taken by the
central and state government. It is also the most dominant category in the
India debt market. The government securities market is at the core of
financial markets in most countries. It deals with tradable debt instruments
issued by the Government for meeting its financing requirements.1 The
development of the primary segment of this market enables the managers of
public debt to raise resources from the market in a cost effective manner
with due recognition to associated risks. A vibrant secondary segment of the
government securities market helps in the effective operation of monetary
policy through application of indirect instruments such as open market
operations, for which government securities act as collateral. The

government securities market is also regarded as the backbone of fixed

income securities markets as it provides the benchmark yield and imparts
liquidity to other financial markets. The existence of an efficient government
securities market is seen as an essential precursor, in particular, for
development of the corporate debt market. Furthermore, the government
securities market acts as a channel for integration of various segments of the
domestic financial market and helps in establishing inter-linkages between
the domestic and external financial markets.
MAJOR PARTICIPANTS IN FINANCIAL MARKETS
• Commercial Banks: A commercial bank is a type of financial

intermediary and a type of bank. Commercial banking is also known
as business banking. It is a bank that provides checking accounts,
savings accounts, and money market accounts and that accepts time
deposits
• Mutual funds: Mutual funds can be defined as the money-managing
systems that are introduced to professionally invest money collected
from the public. The Asset Management Companies (AMCs) manage
different types of mutual fund schemes. The AMCs are supported by
various financial institutions or companies. Investment in mutual
funds in India means pooling money in bonds, short-term money
market, financial institutions, stocks and securities and dishing out
returns as dividends. In India, Fund Managers manage the mutual
funds.

• Underwriters: A company or other entity that administers the public

issuance and distribution of securities from a corporation or other
issuing body. An underwriter works closely with the issuing body to
determine the offering price of the securities, buys them from the
issuer and sells them to investors via the underwriter's distribution
network.
• Insurance companies: Insurance is a form of risk

management primarily used to hedge against the risk of a
contingent, uncertain loss. Insurance is defined as the equitable
transfer of the risk of a loss, from one entity to another, in exchange
for payment. An insurer is a company selling the insurance;
an insured, or policyholder, is the person or entity buying the
insurance policy. The insurance rate is a factor used to determine the
amount to be charged for a certain amount of insurance coverage,
called the premium. Risk management, the practice of appraising and
controlling risk, has evolved as a discrete field of study and practice.
The transaction involves the insured assuming a guaranteed and
known relatively small loss in the form of payment to the insurer in
exchange for the insurer's promise to compensate (indemnify) the
insured in the case of a loss. The insured receives a contract, called
the insurance policy, which details the conditions and circumstances
under which the insured will be compensated.
• Financial Institution: Financial Institution is an institution that

provides financial services for its clients or members. Probably the
most important financial service provided by financial institutions is

acting asfinancial intermediaries. Most financial institutions are

highly regulated by government.
B. MONEY MARKET:
Money market means market where money to its equivalent are traded.
Money is synonym of liquidity. Money market includes financial
institutions and dealers in money or credit who wish to generate liquidity.
Therefore, money market is the market for short term funds. It is a
market for dealing in financial assets which have maturity period of one
year or less. Due to highly liquid nature of securities and there short term
maturities, money market is treated as a safe place. In money market,
short term obligations such as treasury bills, commercial papers and
banker’s acceptance etc, are bought and sold.
There are various categories of money market:
Money market can be divided into four categories:
(i) Call money market
(ii) Commercial bills market
(iii) Treasury bills market
(iv) Short - term loan market

(i) Call money market:
It is the market for very short period of time having maturity

from one day to fourteen days. Commercial banks participate in
this market to meet their CRR and SLR requirements. Loans are
repayable on demand at the option of either the lender or the
borrower. Interest rate varies from day-to-day and even from
hour-to-hour. It is very sensitive to changes in demand and
supply of call loans.
(ii) Commercial Bills Market:
It is the market for bills of exchange arising out genuine credit

transactions. Creditor(drawer) draws the bill on his debtor which
is accepted by the debtor(drawee). On due date, the bill amount is
paid by the drawee. In case of urgent need of cash, drawer can
discount the bill and get the amount of bill.
(iii) Treasury bills market:
It is the market for treasury bills which have short term maturity.
Treasury bill is a promissory notes or a finance bill issued by the
government. It is highly liquid as its repayment is guaranteed by
the government. These bills have maturity period of 91 days or
182 days or 364 days only.

(iv) short term loan market:
It is a market for short term loans. These loans are given to

corporate customers to meet their working capital requirements.
Commercial banks play a significant role in this market. The
loans are provided in the forms of cash credit and overdraft.
Overdraft facility is provided on current account while in case of
cash credit a separate account is op

CHAPTER 4: FINANCIAL INSTRUMENT
Financial instruments differ from each other in respect of their

investment characteristics which are independent and interrelated.
Among the investment characteristics of financial assets or financial
products.
The following are important:
1. Liquidity
2. Marketability
3. Reversibility
4. Transferability
5. Transaction cost
6. Risk and default
7. Maturity period
8. Tax status
9. Option such as call back or buy back option
10.Volatility
11.Rate of return

There are various Financial Instruments.
1. Financial Assets:
The financial assets represents a claim to the payment of sum of money

sometime in future. (repayment of principal amount) and/ or a payment in
the form of interest or dividend.
2. There are two types of securities, it is further classified into:
Primary and Secondary:
• Financial securities are classified as Primary(direct)

Secondary(indirect) securities.
• Primary securities are issued by ultimate investor directly to the
ultimate savers as ordinary shares or debentures.
• Secondary securities are issued by financial intermediaries to the
ultimate savers as bank deposits, units, insurance policies and so on.
3. It is further classified into three terms:
• Short-term: Short-term securities have a maturity a period of a

year or less. Examples: shares
• Medium-term: Medium-term securities have a maturity period of

1, 3, or 5 years. Examples: certificate of deposits, commercial
papers, T- bills
• Long term: Long-term securities have a maturity period of more
than 3 or 5 years. Examples: venture capital

TYPES OF FINANCIAL MARKET INSTRUMENTS IN INDIA:
• Money Market:
The money market can be defined as a market for short-term money and
financial assets that are near substitutes for money. The term short-term means
generally a period upto one year and near substitutes to money is used to denote
any financial asset which can be quickly converted into money with minimum
transaction cost.
Benefits and functions of money market:
Money market facilitates efficient transfer of short term funds between lenders
and borrowers of money. For the lender/ investor, it provides a good return on
their funds, for the borrower, it enables rapid and relatively inexpensive
acquisition of money to meet short –term liabilities
Money market instruments:
1. Call /Notice-Money Market:
Call/Notice money is the money borrowed or lent on demand for a very short
period. When money is borrowed or lent for a day, it is known as Call
(Overnight) Money. Intervening holidays and/or Sunday are excluded for this
purpose. Thus money, borrowed on a day and repaid on the next working day,
(irrespective of the number of intervening holidays) is & quot; Call Money&
quot;. When money is borrowed or lent for more than a day and up to 14 days,
it is & quot; Notice Money& quot;. No collateral security is required to cover
these transactions.

2. Inter-Bank Term Money:

Inter-bank market for deposits of maturity beyond 14 days is referred to as the
term money market. The entry restrictions are the same as those for Call/Notice
Money except that, as per existing regulations, the specified entities are not
allowed to lend beyond 14 days.
3. Treasury Bills:
Treasury Bills are short term (up to one year) borrowing instruments of the
union government. It is an IOU of the Government. It is a promise by the
Government to pay a stated sum after expiry of the stated period from the date
of issue (14/91/182/364 days i.e. less than one year). They are issued at a
discount to the face value, and on maturity the face value is paid to the holder.
The rate of discount and the corresponding issue price are determined at each
auction.
4. Certificate of Deposits:
Certificates of Deposit (CDs) is a negotiable money market instrument and

issued in dematerialised form or as a Usance Promissory Note, for funds
deposited at a bank or other eligible financial institution for a specified time
period. Guidelines for issue of CDs are presently governed by various directives
issued by the Reserve Bank of India, as amended from time to time.
CDs can be issued by (i) scheduled commercial banks excluding Regional Rural
Banks (RRBs) and Local Area Banks (LABs); and (ii) select all-India Financial
Institutions that have been permitted by RBI to raise short-term resources
within the umbrella limit fixed by RBI.
Banks have the freedom to issue CDs depending on their requirements. An FI

may issue CDs within the overall umbrella limit fixed by RBI, i.e., issue of CD
together with other instruments viz., term money, term deposits, commercial
papers and intercorporate deposits should not exceed 100 per cent of its net
owned funds, as per the latest audited balance sheet.
5. Commercial Paper:
CP is a note in evidence of the debt obligation of the issuer. On issuing

commercial paper the debt obligation is transformed into an instrument. CP is
thus an unsecured promissory note privately placed with investors at a discount
rate to face value determined by market forces. CP is freely negotiable by
endorsement and delivery.
A company shall be eligible to issue CP provided - (a) the tangible net worth of
the company, as per the latest audited balance sheet, is not less than Rs. 4 crore;
(b) the working capital (fund-based) limit of the company from the banking
system is not less than Rs.4 crore and (c) the borrowal account of the company
is classified as a Standard Asset by the financing banks. The minimum maturity
period of CP is 7 days. The minimum credit rating shall be P-2 of CRISIL or
such equivalent rating by other agencies.

Capital Market Instruments:
The capital market generally consists of the following long term period i.e.,
more than one year period, financial instruments; In the equity segment Equity
shares, preference shares, convertible preference shares, non-convertible
preference shares etc and in the debt segment debentures, zero coupon bonds,
deep discount bonds etc.
1. Equity Shares:
An equity share, commonly referred to as ordinary share, represents the form

of fractional ownership in a business venture.
2. Preference shares:
Owners of these kind of shares are entitled to a fixed dividend or dividend
calculated at a fixed rate to be paid regularly before dividend can be paid in
respect of equity share. They also enjoy priority over the equity shareholders
in payment of surplus. But in the event of liquidation, their claims rank
below the claims of the company’s creditors, bondholders/debenture holders.
3. Zero Coupon Bond:

Bond issued at a discount and repaid at a face value. No periodic interest is
paid. The difference between the issue price and redemption price represents
the return to the holder. The buyer of these bonds receives only one
payment, at the maturity of
the bond.

4. Convertible Bond:
A bond giving the investor the option to convert the bond into equity at a
fixed conversion price.
5. Treasury Bills:
Short-term (up to one year) bearer discount security issued by government
as a means of financing their cash requirements
HYBRID INSTRUMENTS:
Hybrid instruments have both the features of equity and debenture. This kind of
instruments is called as hybrid instruments. Examples are convertible
debentures, warrants etc.
There are different types of hybrid instruments:
1. Premium Bonds:
Premium bonds are bonds that are priced higher than their face value. These
bonds are sold at a premium because the interest rate paid on them is higher
than the prevailing interest rates.
2. Convertible bonds:
Convertible bonds means corporate bonds that are converted into common
stock of the issuing company at the behest of the bond holder. However, the
conversion of convertible bonds is subject to certain restrictions, depending
on the policies of the issuing authority.

3. Zero Coupon Bond:
Bond issued at a discount and repaid at a face value. No periodic interest is

paid. The difference between the issue price and redemption price represents
the return to the holder. The buyer of these bonds receives only one
payment, at the maturity of the bond.
4. Mortgage Bonds:
A Mortgage bond are a special type of bond and is essentially a debt

instrument. In such a case bond is secured against real estate or any assets
like machines. The risk involved is considerably low and is more secured
than any other instruments. These bonds are purchased or sold under
secondary market. The people who purchase these bonds is known as holder.
These people are entitled to receive a payment on the basis of rate of interest
or principal amount.
5. High yield Bonds:
High yield bonds are debt securities that are issued by low credit quality
organizations. These are organizations that have poor financial health and do
not qualify for investment-grade ratings conferred by leading credit rating
agencies.

CHAPTER 5: FINANCIAL SERVICES
Financial services refer to services provided by the finance industry. The

finance industry encompasses a broad range of organizations that deal with
the management of money. Among these organizations are banks, credit
card companies, insurance companies, consumer finance companies, stock
brokerages, investment funds and some government sponsored enterprises.
As of 2004, the financial services industry represented 20% of the market
capitalization of the S&P 500 in the United States.
 BANKS
A "commercial bank" is what is commonly referred to as simply a "bank".

The term "commercial" is used to distinguish it from an "investment bank,"
a type of financial services entity which, instead of lending money directly
to a business, helps businesses raise money from other firms in the form of
bonds (debt) or stock (equity).
Banking services
The primary operations of banks include:
• Keeping money safe while also allowing withdrawals when needed

• Issuance of checkbooks so that bills can be paid and other kinds of
payments can be delivered by post
• Provide personal loans, commercial loans, and mortgage loans
(typically loans to purchase a home, property or business)
• Issuance of credit cards and processing of credit card transactions and
billing

• Issuance of debit cards for use as a substitute for checks

• Allow financial transactions at branches or by using Automatic Teller
Machines (ATMs)
• Provide wire transfers of funds and Electronic fund transfers between
banks
• Facilitation of standing orders and direct debits, so payments for bills
can be made automatically
• Provide overdraft agreements for the temporary advancement of the
Bank's own money to meet monthly spending commitments of a
customer in their current account.
• Provide Charge card advances of the Bank's own money for
customers wishing to settle credit advances monthly.
• Provide a check guaranteed by the Bank itself and prepaid by the
customer, such as a cashier's check or certified check.
• Notary service for financial and other documents
Other types of bank services
• Private banking - Private banks provide banking services exclusively

to high net worth individuals. Many financial services firms require a
person or family to have a certain minimum net worth to qualify for
private banking services. Private banks often provide more personal
services, such as wealth management and tax planning, than normal
retail banks.
• Capital market bank - bank that underwrite debt and equity, assist
company deals (advisory services, underwriting and advisory fees),
and restructure debt into structured finance products.

• Bank cards - include both credit cards and debit cards. Bank Of
America is the largest issuer of bank cards.
• Credit card machine services and networks - Companies which
provide credit card machine and payment networks call themselves
"merchant card providers".
 FOREIGN EXCHANGE SERVICES
Foreign exchange services are provided by many banks around the world.
Foreign exchange services include:
• Currency Exchange - where clients can purchase and sell foreign

currency banknotes.
• Wire transfer - where clients can send funds to international banks
abroad.
• Foreign Currency Banking - banking transactions are done in
foreign currency.
 INVESTMENT SERVICES
• Asset management - the term usually given to describe companies

which run collective investment funds. Also refers to services
provided by others, generally registered with the Securities and
Exchange Commission as Registered Investment Advisors.
• Hedge fund management - Hedge funds often employ the services of
"prime brokerage" divisions at major investment banks to execute
their trades.

• Custody services - the safe-keeping and processing of the world's

securities trades and servicing the associated portfolios. Assets under
custody in the world are approximately $100 trillion
 INSURANCE
• Insurance brokerage - Insurance brokers shop for insurance

(generally corporate property and casualty insurance) on behalf of
customers. Recently a number of websites have been created to give
consumers basic price comparisons for services such as insurance,
causing controversy within the industry.
• Insurance underwriting - Personal lines insurance underwriters
actually underwrite insurance for individuals, a service still offered
primarily through agents, insurance brokers, and stock brokers.
Underwriters may also offer similar commercial lines of coverage for
businesses. Activities include insurance and annuities, life insurance,
retirement insurance, health insurance, and property & casualty
insurance.
• Reinsurance - Reinsurance is insurance sold to insurers themselves,
to protect them from catastrophic losses.

CHAPTER 6: CONCLUSION
Thus, the financial system is the system that allows the transfer of
money between savers and borrowers. It comprises a set of complex and
closely interconnected financial institutions, markets, instruments,
services, practices, and transactions. Thus, financial system in India has
various sections. Primary markets and secondary markets are the major
markets in Financial System and has various roles to the economy,
The financial system is concerned about money, credit and finance-the

three terms are intimately related yet are somewhat different from each
other. These markets help the investors to invest in certain products and
get good returns. Indian financial system consists of financial market,
financial instruments and financial intermediation.

BIBLIOGRAPHY:
WEBSITES:
www.nse-india.com
• Refered from NCFM-module
www.google.com
www.wikipedia.com
www.investopedia.com
BOOKS:
Indian Financial Institutions and Financial Markets.
Debt Markets- Sandeep gupta and Sachin Bhandarkar.

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S.

T GONSALO GARCIA COLLEGE

CHAPTER 1: INTRODUCTION TO FINANCIAL SYSTEM

Financial systems are crucial to the allocation of resources in a modern

Financial System of any country consists of financial markets, financial

In this respect providing or securing finance by itself is a distinct activity or

FINANCIAL SYSTEM IN INDIA Page 1

referring to the financial needs of a corporate body. When we study finance

FINANCIAL SYSTEM IN INDIA Page 2

INDIAN FINANCIAL SYSTEM

The economic development of a nation is reflected by the progress of the

assured sources at concessional terms. In the insurance sector, there was

Financial Sector Reforms in India:

It was in this backdrop that wide-ranging financial sector reforms in India

FINANCIAL SYSTEM IN INDIA Page 4

FINANCIAL SYSTEM IN INDIA Page 5

Financial System: Current Status

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CHAPTER 2: FINANCIAL INSTITUTION

In financial economics, a financial institution is an institution that provides

Broadly speaking, there are three major types of financial institutions:

1. Deposit-taking institutions that accept and manage deposits and make

loans, including banks, building societies, credit unions, trust

3. Brokers, underwriters and investment funds.

• BANKS: A bank is a financial intermediary that accepts deposits and

• INSURANCE COMPANIES: Insurance is a form of risk

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• Brokers: A broker is a party that mediates between a buyer and

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CHAPTER 3: FINANCIAL MARKETS

In economics, a financial market is a mechanism that allows people to buy

In finance, financial markets facilitate:

• The raising of capital (in the capital markets)

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FINANCIAL SYSTEM IN INDIA Page 10

FINANCIAL MARKETS IN INDIA:

Generally the world Market denotes a specific place or location where

Financial markets in India are classified in major two categories:

1. unorganized markets and

1. Unorganized markets: Players in unorganized markets are money

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Primary market is the market for new issue of financial instruments.

Role of the ‘Primary Market’

FUNCTIONS OF PRIMARY MARKET

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4. Initial Public Offer (IPO)

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Role of the Secondary Market

With primary issuances of securities or financial instruments, or the primary

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corporations issuing shares in an IPO or private placement, or directly from

FUNCTIONS OF SECONDARY MARKET

Secondary marketing is vital to an efficient and modern capital market. In

Fundamentally, secondary markets mesh the investor's preference for

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2) Accurate share price aids the efficient allocation of debt finance

THEY ARE FURTHER CLASSIFIED INTO:

A stock exchange is an entity which provides "trading" facilities for stock

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The major stock exchanges in India are NSE, BSE

ROLE OF STOCK EXCHANGE

1. Raising capital for businesses