The financial system of a country is an important tool for the economic development of a

country as it helps the creation of wealth by linking savings with investments.

Components of Indian Financial System

There are four main components of the Indian Financial System:

1. Financial Institutions
2. Financial Markets
3. Financial Instruments
4. Financial Services

1. Financial Institutions

The Financial Institutions act as a mediator between the investor and the borrower. The
investor’s savings are mobilised either directly or indirectly via the Financial Markets. 

The main functions of the Financial Institutions are as follows:

 A short term liability can be converted into a long term investment

 It helps in conversion of a risky investment into a risk-free investment
 Also acts as a medium of convenience denomination, which means, it can match a small
deposit with large loans and a large deposit with small loans

The best example of a Financial Institution is a Bank. People with surplus amounts of money
make savings in their accounts, and people in dire need of money take loans. The bank acts as
an intermediate between the two.

The financial institutions can further be divided into two types:

 Banking Institutions or Depository Institutions – This includes banks and other credit
unions which collect money from the public against interest provided on the deposits
made and lend that money to the ones in need
 Non-Banking Institutions or Non-Depository Institutions – Insurance, mutual funds
and brokerage companies fall under this category. They cannot ask for monetary deposits
but sell financial products to their customers.

Further, Financial Institutions can be classified into three categories:

 Regulatory – Institutes that regulate the financial markets like RBI, IRDA, SEBI, etc.
 Intermediates – Commercial banks which provide loans and other financial assistance
such as SBI, BOB, PNB, etc. 
 Non Intermediates – Institutions that provide financial aid to corporate customers. It
includes NABARD, SIBDI, etc. 

2. Financial Markets

The marketplace where buyers and sellers interact with each other and participate in the
trading of money, bonds, shares and other assets is called a financial market. 

The financial market can be further divided into four types:

 Capital Market – Designed to finance the long term investment, the Capital market deals
with transactions which are taking place in the market for over a year. The capital market
can further be divided into three types:

i. Corporate Securities Market

ii. Government Securities Market 
iii. Long Term Loan Market 

 Money Market – Mostly dominated by Government, Banks and other Large Institutions,
the type of market is authorised for small-term investments only. It is a wholesale debt
market which works on low-risk and highly liquid instruments. The money market can
further be divided into two types:

i. Organised Money Market

ii. Unorganised Money Market

 Foreign exchange Market – One of the most developed markets across the world, the
Foreign exchange market, deals with the requirements related to multi-currency. The
transfer of funds in this market takes place based on the foreign currency rate.

 Credit Market – A market where short-term and long-term loans are granted to
individuals or Organisations by various banks and Financial and Non-Financial
Institutions is called Credit Market.

3. Financial Services
Services provided by Asset Management and Liability Management Companies. They help to
get the required funds and also make sure that they are efficiently invested.

The financial services in India include:

 Banking Services – Any small or big service provided by banks like granting a loan,
depositing money, issuing debit/credit cards, opening accounts, etc. 
 Insurance Services – Services like issuing of insurance, selling policies, insurance
undertaking and brokerages, etc. are all a part of the Insurance services
 Investment Services – It mostly includes asset management
 Foreign Exchange Services – Exchange of currency, foreign exchange, etc. are a part of
the Foreign exchange services

The main aim of the financial services is to assist a person with selling, borrowing or
purchasing securities, allowing payments and settlements and lending and investing. 

4. Financial Assets

The products which are traded in the Financial Markets are called Financial Assets. Based on
the different requirements and needs of the credit seeker, the securities in the market also
differ from each other. 

Some important Financial Assets have been discussed briefly below:

 Call Money – When a loan is granted for one day and is repaid on the second day, it is
called call money. No collateral securities are required for this kind of transaction. 
 Notice Money – When a loan is granted for more than a day and for less than 14 days, it
is called notice money. No collateral securities are required for this kind of transaction.
 Term Money – When the maturity period of a deposit is beyond 14 days, it is called term
money.
 Treasury Bills – Also known as T-Bills, these are Government bonds or debt securities
with maturity of less than a year. Buying a T-Bill means lending money to the
Government.
 Certificate of Deposits – It is a dematerialised form (Electronically generated) for funds
deposited in the bank for a specific period of time.
 Commercial Paper – It is an unsecured short-term debt instrument issued by
corporations.

The four financial system components discussed do not function in isolation. They are
interdependent and interact continuously with each other. Their interaction leads to the
development of a smoothly functioning financial system.(From text book)

Market Size

The Indian banking system consists of 12 public sector banks, 22 private sector banks, 46
foreign banks, 56 regional rural banks, 1485 urban cooperative banks and 96,000 rural
cooperative banks in addition to cooperative credit institutions As of November 2020, the
total number of ATMs in India increased to 209,282.
Asset of public sector banks stood at Rs. 107.83 lakh crore (US$ 1.52 trillion) in FY20.

During FY16-FY20, bank credit grew at a CAGR of 3.57%. As of FY20, total credit
extended surged to US$ 1,698.97 billion. During FY16-FY20, deposits grew at a CAGR of
13.93% and reached US$ 1.93 trillion by FY20.

According to the RBI, bank credit stood at Rs. 109.12 trillion (US$ 1.47 trillion), as of
September 10, 2021. Credit to non-food industries stood at Rs. 108.42 trillion (US$ 1.46
trillion), as of September 10, 2021.(from https://www.ibef.org/industry/banking-india.aspx)

Modern banking in India originated in the last decade of the 18th century. Among the first
banks were the Bank of Hindustan, which was established in 1770 and liquidated in 1829–32;
and the General Bank of India, established in 1786 but failed in 1791.

For many years, the presidency banks had acted as quasi-central banks, as did their
successors, until the Reserve Bank of India[5] was established in 1935, under the Reserve
Bank of India Act, 1934.[6][7] The largest and the oldest bank which is still in existence is the
State Bank of India (SBI).

The Indian banking sector is broadly classified into scheduled and non-scheduled banks. The
scheduled banks are those included under the 2nd Schedule of the Reserve Bank of India Act,
1934. The scheduled banks are further classified into: nationalised banks; State Bank of India
and its associates; Regional Rural Banks (RRBs); foreign banks; and other Indian private
sector banks. The term commercial banks refers to both scheduled and non-scheduled
commercial banks regulated under the Banking Regulation Act, 1949.

The major steps to regulate banking included:

 The Reserve Bank of India, India's central banking authority, was established in April
1935, but was nationalized on 1 January 1949 under the terms of the Reserve Bank of
India (Transfer to Public Ownership) Act, 1948 (RBI, 2005b).
 In 1949, the Banking Regulation Act was enacted, which empowered the Reserve Bank
of India (RBI) to regulate, control, and inspect the banks in India.
 The Banking Regulation Act also provided that no new bank or branch of an existing
bank could be opened without a license from the RBI, and no two banks could have
common directors.

The Government of India issued the Banking Companies (Acquisition and Transfer of
Undertakings) Ordinance, 1969 and nationalized the 14 largest commercial banks with effect
from the midnight of 19 July 1969. These banks contained 85 percent of bank deposits in the
country.

The following banks were nationalized in 1969:

 Allahabad Bank (now Indian Bank)

 Bank of Baroda
 Bank of India
 Bank of Maharashtra
 Central Bank of India
 Canara Bank
 Dena Bank (now Bank of Baroda)
 Indian Bank
 Indian Overseas Bank
 Punjab National Bank
 Syndicate Bank (now Canara Bank)
 UCO Bank
 Union Bank of India
 United Bank of India( now Punjab National Bank)

Nationalisation in 1980

A second round of nationalizations of six more commercial banks followed in 1980. The
stated reason for the nationalization was to give the government more control of credit
delivery. With the second round of nationalizations, the Government of India controlled
around 91% of the banking business of India.

The following banks were nationalized in 1980:

 Punjab and Sind Bank

 Vijaya Bank (Now Bank of Baroda)
 Oriental Bank of India (now Punjab National Bank)
 Corporation Bank (now Union Bank of India)
 Andhra Bank (now Union Bank of India)
 New Bank of India (now Punjab National Bank)

Liberalisation in the 1990s

In the early 1990s, the then government embarked on a policy of liberalisation,[26] licensing a
small number of private banks.[27] These came to be known as New Generation tech-savvy
banks, and included Global Trust Bank (the first of such new generation banks to be set up),
which later amalgamated with Oriental Bank of Commerce, IndusInd Bank, UTI Bank (since
renamed Axis Bank), ICICI Bank and HDFC Bank.[28

PSB Amalgamations in the 2000s and 2010s

SBI

SBI merged with its associate bank State Bank of Saurashtra in 2008 and State Bank of
Indore in 2009.

Following a merger process, the merger of the 5 remaining associate banks, (viz. State Bank
of Bikaner and Jaipur, State Bank of Hyderabad, State Bank of Mysore, State Bank of
Patiala, State Bank of Travancore and the Bharatiya Mahila Bank) with the SBI was given an
in-principle approval by the Union Cabinet on 15 June 2016. This came a month after the SBI
board had, on 17 May 2016, cleared a proposal to merge its five associate banks and
Bharatiya Mahila Bank with itself.
On 15 February 2017, the Union Cabinet approved the merger of five associate banks with
SBI. An analyst foresaw an initial negative impact as a result of different pension liability
provisions and accounting policies for bad loans. The merger went into effect from 1 April
2017.

BOB

On 17 September 2018, the Government of India proposed the amalgamation of Dena Bank
and Vijaya Bank with erstwhile Bank of Baroda, pending (namesake) approval from the
boards of the three banks. The Union Cabinet and the boards of the banks approved with the
merger on 2 January 2019. Under the terms of the amalgamation, Dena Bank and Vijaya
Bank shareholders received 110 and 402 equity shares of the Bank of Baroda, respectively, of
face value ₹2 for every 1,000 shares they held. The amalgamation became effective from 1
April 2019.

PNB

On 30 August 2019, Finance Minister announced that the Oriental Bank of Commerce and
United Bank of India would be merged with Punjab National Bank, making PNB the second
largest PSB after SBI with assets of ₹17.95 lakh crore (US$240 billion) and 11,437 branches.
MD and CEO of UBI, Ashok Kumar Pradhan, stated that the merged entity would begin
functioning from 1 April 2020. The Union Cabinet approved the merger on 4 March 2020.
PNB announced that its board had approved the merger ratios the next day. Shareholders of
OBC and UBI will receive 1,150 shares and 121 shares of Punjab National Bank,
respectively, for every 1,000 shares they hold. The merge came into effect since 1 April
2020. Post merger, Punjab National Bank has become the second largest public sector bank in
India.

Canara Bank

On 30 August 2019, Finance Minister announced that Syndicate Bank would be merged with
Canara Bank. The proposal would create the fourth largest PSB trailing SBI, PNB, BoB with
assets of ₹15.20 lakh crore (US$200 billion) and 10,324 branches. The Board of Directors of
Canara Bank approved the merger on 13 September 2019. The Union Cabinet approved the
merger on 4 March 2020. Canara Bank assumed control over Syndicate Bank on 1 April 2020
with Syndicate Bank shareholders receiving 158 equity shares in the former for every 1,000
shares they hold.

Union Bank

On 30 August 2019, Finance Minister announced that Andhra Bank and Corporation Bank
would be merged into Union Bank of India. The proposal would make Union Bank of India
the fifth largest PSB with assets of ₹14.59 lakh crore (US$190 billion) and 9,609 branches.
The Board of Directors of Andhra Bank approved the merger on 13 September. The Union
Cabinet approved the merger on 4 March, and it was completed on 1 April 2020.
Indian Bank

On 30 August 2019, Finance Minister announced that Allahabad Bank would be merged with
Indian Bank. The proposal would create the seventh largest PSB in the country with assets of
₹8.08 lakh crore (US$110 billion).

Payment Bank

Payments bank is a new model of banks conceptualized by the Reserve Bank of India (RBI).
These banks can accept a restricted deposit, which is currently limited to ₹1 lakh per
customer. These banks may not issue loans or credit cards, but may offer both current and
savings accounts. Payments banks may issue ATM and debit cards, and offer net-banking and
mobile-banking. The draft guidelines for licensing of payments banks in the private sector
were formulated and released for public comments on July 17, 2014. The banks will be
licensed as payments banks under Section 22 of the Banking Regulation Act, 1949, and will
be registered as public limited company under the Companies Act, 2013.

Small finance banks

To further the objective of financial inclusion, the RBI granted approval in 2016 to ten
entities to set up small finance banks. Since then, all ten have received the necessary licenses.
A small finance bank is a niche type of bank to cater to the needs of people who traditionally
have not used scheduled banks. Each of these banks is to open at least 25% of its branches in
areas that do not have any other bank branches (unbanked regions). A small finance bank
should hold 75% of its net credits in loans to firms in priority sector lending, and 50% of the
loans in its portfolio must be less than ₹25 lakh (US$36,000).

Technology in Banking

Information Technology has had a great impact on the Indian banking system. The use of
computers led to the introduction of online banking in India. The use of computers in the
banking sector increased many fold after the economic liberalisation of 1991 as the country's
banking sector has been exposed to the world's market. Indian banks were finding it difficult
to compete with the international banks in customer service without the use of information
technology.

Automatic teller machine growth

The total number of automated teller machines (ATMs) installed in India by various banks as
of 2018 was 2,38,000.[71] The new private sector banks in India have the most ATMs,
followed by off-site ATMs belonging to SBI and its subsidiaries and then by nationalised
banks and foreign banks, while on-site is highest for the nationalised banks of India.
Real-time gross settlement (RTGS)
RTGS systems are specialist fund transfer systems where the transfer of money or securities[1]
takes place from one bank to any other bank on a "real-time" and on a "gross" basis.
Settlement in "real time" means a payment transaction is not subjected to any waiting period,
with transactions being settled as soon as they are processed. "Gross settlement" means the
transaction is settled on a one-to-one basis, without bundling or netting with any other
transaction. "Settlement" means that once processed, payments are final and irrevocable.

National Electronic Funds Transfer (NEFT)

NEFT is an electronic funds transfer system maintained by the Reserve Bank of India (RBI).
Started in November 2005, the setup was established and maintained by Institute for
Development and Research in Banking Technology.[1] NEFT enables bank customers in India
to transfer funds between any two NEFT-enabled bank accounts on a one-to-one basis. It is
done via electronic messages.

Unlike real-time gross settlement, fund transfers through the NEFT system do not occur in
real-time basis. Previously, NEFT system settled fund transfers in hourly batches with 23
settlements occurring between 00:30 hrs. to 00:00 hrs.

Immediate Payment Service (IMPS) public launch happened on 22nd November 2010 by
Smt. Shyamala Gopinath, DG RBI at Mumbai and this service is now available to the Indian
public.

IMPS provides robust & real time fund transfer which offers an instant, 24X7, interbank
electronic fund transfer service that could be accessed on multiple channels like Mobile,
Internet, ATM, SMS. IMPS is an emphatic service which allow transferring of funds instantly
within banks across India which is not only safe but also economical. Currently on IMPS,
639 members are live which includes banks & PPIs.

This facility is provided by NPCI through its existing NFS switch.

Unified Payments Interface (UPI)

UPI is an instant real-time payment system developed by National Payments Corporation of

India (NPCI) facilitating inter-bank peer-to-peer (P2P) and person-to-merchant (P2M)
transactions.[1] The interface is regulated by the Reserve Bank of India (RBI) and works by
instantly transferring funds between two bank accounts on a mobile platform. As of
December 2020, there are 207 banks available on UPI with a monthly volume of
2334.16 million transactions[2][3] and a value of ₹4,162 billion (US$55 billion) UPI witnessed
22102.3 million transactions till November 2020.