SEMESTER 2: MBA 2021–23

Course: Indian Financial System and Financial Markets

(IFSFM)
COURSE CODE: 21MBACC201
MODULE 1: OVERVIEW OF THE INDIAN FINANCIAL
SYSTEM
FACULTY: DR. FIRDAUS KHAN 1
ADJUNCT PROFESSOR,
FINANCE AREA

CMS Business School, JAIN (Deemed-to-be University)

 MODULE 1: OVERVIEW OF THE INDIAN FINANCIAL
SYSTEM

▪ Overview of the Financial System, Financial Institutions, Financial Markets, Financial Instruments and

Services, Financial Intermediation Process: Role of Intermediaries- Source of Funds, Application of

Funds. Financial sector reforms, Financial Regulatory and Promotional Institutions- RBI, SEBI, IRDA,
PFRDA, Board of Financial Supervision, *Financial stability-Assessment, Ethics and Principles in
Financial Markets.

▪ Learning Outcome: At the end of this module, students will be able to recognise the initiatives in

strengthening the financial infrastructure by Regulators

CMS Business School, JAIN (Deemed-to-be University) 2

 INDIAN FINANCIAL SYSTEM
&
FINANCIAL MARKETS

CMS Business School, JAIN (Deemed-to-be University) 3

 INTRODUCTION TO INDIAN FINANCIAL SYSTEM

The term ‘financial system’ refers to: Financial Financial

Institutions Markets
❖ a system that is concerned with the
mobilization of the savings of the
public and
Savers Users
❖ providing of necessary funds to of of
Flow
the needy persons and institutions Money Money
for
❖ enabling the production of goods
and/or for provision of services. Financial Financial
Instruments Services

CMS Business School, JAIN (Deemed-to-be University) 4

❖ Thus, a financial system can be understood as a system that allows
the exchange of funds between lenders, investors, and borrowers.

❖ In other words, the system that facilitates the movement of

finance from the persons who have surplus funds to the persons
who need it is called as financial system.

❖ It consists of complex, closely related services, markets, and

institutions used to provide an efficient and regular linkage
between investors and depositors

CMS Business School, JAIN (Deemed-to-be University) 5

 FUNCTIONS OF INDIAN FINANCIAL SYSTEM
❑ Provision of liquidity
❑ Mobilization of savings
❑ Size transformation/Capital formation
❑ Maturity transformation
❑ Risk transformation
❑ Lowering of cost of transaction
❑ Payment mechanism
❑ Assisting new projects
❑ Enable better decision making
❑ Meet short and long term financial needs
❑ Provide necessary finance to the Government
❑ Accelerate the process of economic growth of the country
CMS Business School, JAIN (Deemed-to-be University) 6
 FEATURES/CHARACTERISTICS OF FIN. SYSTEM

❑ Financial system acts as a bridge between savers and borrowers

❑ It consists of a set of inter-related activities and services
❑ It consists of both formal and informal financial sectors. The existence of
both formal and informal system is also called as financial dualism.
❑ It formulates capital, investment and profit generation
❑ It is universally applicable at individual level, firm level, regional level,
national level and international level
❑ It consists of financial institutions, financial markets, financial services,
financial instruments, financial practices and financial transactions.

CMS Business School, JAIN (Deemed-to-be University) 7

 FINANCIAL INTERMEDIATION
The process performed by banks of taking in funds from a depositor and
then lending them out to a borrower. It allows them to lend out money at
relatively high rates of interest while receiving money on deposit at
relatively low rates of interest.

A financial intermediary does not only act as an agent for other institutional
units, but places itself at risk by acquiring financial assets and incurring
liabilities on its own account.

CMS Business School, JAIN (Deemed-to-be University) 8

 Financial Intermediation
Users of Money

Savers of Money

FI
NA
NC FIN
IA ANC
L IAL
IN INST
STI RUM
TU ENT
TI S
ON
S

Financial Markets
CMS Business School, JAIN (Deemed-to-be University) Financial Services 9
 Self
Employment
Generation

Development Entrepreneurial
of Backward Development
Areas Programs

Role of Financial
Intermediaries

Priority Integrated
Sector Rural
Lending Development

Housing
Finance

CMS Business School, JAIN (Deemed-to-be University) 10

 INDIAN FINANCIAL SYSTEM
&
FINANCIAL MARKETS

CMS Business School, JAIN (Deemed-to-be University) 11

 FINANCIAL INSTITUTIONS
Non
Banking
Financial
Institutions
Regulatory Insurance
authorities companies

Micro Mutual
Finance Fund
Institutions Companies
Financial
Institutions

Commercial
Post Offices
Banks

Cooperative
Developmen
banks &
tal Financial
Regional
Institutions
Rural Banks
CMS Business School, JAIN (Deemed-to-be University) 12
 FUNCTIONS OF FINANCIAL INSTITUTIONS
❑ Financial institutions mobilize the savings of the public
❑ They provide credit facility to the needy persons
❑ They render various other financial services like transfer of funds
from one place to another, payment mechanism, etc.

CMS Business School, JAIN (Deemed-to-be University) 13

 Broad Classification of Financial Institutions in India
Financial
Institutions

Non Deposit Accepting

Deposits Accepting Institutions
Institutions
(Banking Institutions)
(Non Banking Institutions)

All India
Commercial Developmental State Level
Cooperative Regional Rural Insurance Mutual Fund
Banks Financial Financial
Banks Banks Companies Companies
Institutions Institutions
IDBI, IFCI
SIDBI

Public Sector Private Sector Foreign

Commercial Commercial Commercial
Banks banks Banks

CMS Business School, JAIN (Deemed-to-be University) 14

 BROAD CLASSIFICATION OF OTHER
INSTITUTIONS IN INDIA

CMS Business School, JAIN (Deemed-to-be University) 15

 FINANCIAL MARKETS

CMS Business School, JAIN (Deemed-to-be University) 16

 FINANCIAL MARKETS

CMS Business School, JAIN (Deemed-to-be University) 17

CMS Business School, JAIN (Deemed-to-be University) 18
CMS Business School, JAIN (Deemed-to-be University) 19
CMS Business School, JAIN (Deemed-to-be University) 20
 Financial
Instruments

CMS Business School, JAIN (Deemed-to-be University) 21

 CLASSIFICATION OF FINANCIAL ASSETS
ON THE BASIS OF MARKETABILITY
1. Marketable –
▪ The financial assets that can be bought and sold are called as
marketable financial assets. They include Shares, Government
Securities, Bonds, Mutual Funds, Units of UTI, Bearer Debentures
2. Non-marketable –
▪ The financial assets that cannot be bought and sold are called as non-
marketable finance assets. They include Bank Deposits, Provident
Funds, LIC Policies, Company Deposits, Post Office Certificates

CMS Business School, JAIN (Deemed-to-be University) 22

 CLASSIFICATION OF FINANCIAL ASSETS
ON THE BASIS OF NATURE

Money or Cash Asset – Debt Asset –

Coins, Currency Notes, Bank
Deposits Debenture & Bonds

Stock Assets –
Equity Shares & Preference
Shares

CMS Business School, JAIN (Deemed-to-be University) 23

 FINANCIAL SERVICES IN INDIA

CMS Business School, JAIN (Deemed-to-be University) 24

 FINANCIAL INSTRUMENTS/PRODUCTS
Based on the Repayment
period

Medium Term Financial

Long term Financial Short Term Financial
Instruments (>1 year and <5
Instruments (>5 Years ) Instruments (<1 year)
Years)

1. Loans from Financial 1. Bank OD

1. Equity Shares
Institutions
2. Preference Shares 2. Factoring
2. Public Deposits
3. Debentures/Bonds 3. Trade Credit
3. Bonds or Debentures
4. Term Loans from Term repayable within 5 Years 4. Commercial Papers
Lending Institutions

CMS Business School, JAIN (Deemed-to-be University) 25

CMS Business School, JAIN (Deemed-to-be University) 26
 FINANCIAL SECTOR REFORMS
IN INDIA
SINCE 1991-92
27

CMS Business School, JAIN (Deemed-to-be University)

 Banking Sector Reforms
FINANCIAL SECTOR REFORMS
Government Debt Market Reforms

Foreign Exchange Market Reforms

Financial Sector
Reforms in India
since 1991-92
Reforms in Indian Capital Markets

Reforms in Monetary Policy Framework

CMS Business School, JAIN (Deemed-to-be University) Reforms in Pension Fund Sector 28
 Reduce rigidity

Give relief to stressed

Promote flexibility
zones/segments

Remove/reduce problems Make room for innovation

WHAT DO
REFORMS DO?
Introduce new ideas to catch
up with change/dynamism of Add or promote transparency
business environment

Remove bottlenecks Enhance reach

CMS Business School, JAIN (Deemed-to-be University) 29
CMS Business School, JAIN (Deemed-to-be University) 30
 REFORMS IN INDIAN BANKING SECTOR
1. Reduction in SLR and CRR:- which was 39% of deposits has been reduced to 18% of deposits.
Similarly, CRR was 15% in the past reduced to 3%.
2. Competition Enhancing Measures:-
- Granting of Operational Autonomy for Commercial banks
- Reduction of Government Stake in equity in Public sector commercial banks
- Public Sector banks are allowed to raise financial resources in the form of equity and debt from
capital markets subject to RBI guidelines.
- Transparent norms for the entry of Private sector banks, foreign banks and joint venture banks,
- Autonomy is given to banks to diversify their product portfolios and business activities.
3. Measures enhance the role of Market Forces:
- Discontinuation of administered interest rate mechanism
- Improved payment and settlement mechanism

CMS Business School, JAIN (Deemed-to-be University) 31

4. End of Administrative Interest Rate Regime

5. Prudential Norms: High Capital Adequacy Ratio

6. Competitive Financial System

7. Non-Performing Assets and Income Recognition

8. Elimination of Direct Controls

9. Promoting Micro Finance Institutions (MFIs)/Financial Inclusion

10. Setting up of Rural Infrastructure Development Fund (RIDF)

11. Termination of automatic monetization of budget deficits

CMS Business School, JAIN (Deemed-to-be University) 32

▪ https://economictimes.indiatimes.com/markets/stocks/news/deficit-monetisation-is-it-really-as-
simple-as-rbi-printing-more-money/articleshow/75968757.cms?from=mdr#:~:text=Monetisati
on%20of%20deficit%20was%20in,through%20ad%2Dhoc%20treasury%20bills.

▪ ET Article on monetization of budget

▪ May 2020

CMS Business School, JAIN (Deemed-to-be University) 33

 BANK-WISE CAPITAL ADEQUACY RATIOS
PUBLIC SECTOR BANKS BASEL-III PRIVATE SECTOR BANKS

ALLAHABAD BANK 12.01 AXIS BANK LIMITED 17.53

ANDHRA BANK 11.12 BANDHAN BANK LIMITED 27.43

BANK OF BARODA 13.3 CITY UNION BANK LIMITED 16.76

BANK OF INDIA 13.1 CSB BANK LIMITED 22.46

BANK OF MAHARASHTRA 13.516 DCB BANK LIMITED 17.75

CANARA BANK 13.65 FEDERAL BANK LTD 14.35

CENTRAL BANK OF INDIA 11.72 HDFC BANK LTD. 18.52

CORPORATION BANK 11.53 ICICI BANK LIMITED 16.11

INDIAN BANK 14.12 IDBI BANK LIMITED 13.31

INDIAN OVERSEAS BANK 10.72 IDFC FIRST BANK LIMITED 13.38

ORIENTAL BANK OF COMMERCE 11.55 INDUSIND BANK LTD 15.04

PUNJAB AND SIND BANK 12.76 JAMMU & KASHMIR BANK LTD 11.41

PUNJAB NATIONAL BANK 14.14 KARNATAKA BANK LTD 12.66

STATE BANK OF INDIA 13.06 KARUR VYSYA BANK LTD 17.17

SYNDICATE BANK 11.51 KOTAK MAHINDRA BANK LTD. 17.89

UCO BANK 11.7 LAKSHMI VILAS BANK LTD 1.12

UNION BANK OF INDIA 12.81 NAINITAL BANK LTD 12.94

UNITED BANK OF INDIA 5.56 RBL BANK LIMITED 16.45

SOUTH INDIAN BANK LTD 13.41

TAMILNAD MERCANTILE BANK LTD 16.74

THE DHANALAKSHMI BANK LTD 14.41

CMS Business School, JAIN (Deemed-to-be University)
YES BANK LTD. 8.5
34
CMS Business School, JAIN (Deemed-to-be University) 35
 IT MEANS…
▪ The capital Adequacy Ratio (CAR) is a measurement of a bank's available capital
expressed as a percentage of a bank's risk-weighted credit exposures.

▪ The capital adequacy ratio, also known as Capital-to Risk weighted Assets’ Ratio (CRAR), is
used to protect depositors and promote the stability and efficiency of financial systems
around the world.

▪ Two types of capital are measured: tier-1 capital which can absorb losses without a bank
being required to cease trading, and tier-2 capital which can absorb losses in the event of
a winding-up and so provides a lesser degree of protection to depositors. (Investopedia)
▪ https://www.investopedia.com/terms/c/capitaladequacyratio.asp

CMS Business School, JAIN (Deemed-to-be University) 36

CMS Business School, JAIN (Deemed-to-be University) 37
CMS Business School, JAIN (Deemed-to-be University) 38
 GOVERNMENT DEBT MARKET REFORMS
1. Administered interest rates on government securities were replaced by an auction
system for price discovery
2. Automatic monetization of fiscal deficit through the issue of ad hoc Treasury Bills was
phased out.
3. Primary Dealers (PD) were introduced as market makers in the government securities
market.
4. Transparency in government securities trading by introducing Delivery versus Payment
(DvP) settlement system was introduced.
5. Repurchase agreement (repo) was introduced as a tool of short-term liquidity
adjustment.
6. Market Stabilization Scheme (MSS) expanded the instruments available to the RBI for
managing the surplus liquidity in the system
CMS Business School, JAIN (Deemed-to-be University) 39
7. Increase in Instruments: 91-day TB introduced for managing liquidity and benchmarking.
Zero Coupon Bonds, Floating Rate Bonds, Capital Indexed Bonds and exchange traded
interest rate futures were introduced.

8. OTC interest rate derivatives such as Interest Rate Swaps and Forward Rate Agreements
introduced to enable FIIs to invest in Govt. secs. subject to certain limits.

9.Introduction of automated screen-based trading in government securities through

Negotiated Dealing System (NDS). Setting up of risk-free payments and settlement system
in government securities through Clearing Corporation of India Limited (CCIL). Phased
introduction of Real Time Gross Settlement System (RTGS).

10. Introduction of trading of government securities on stock exchanges for promoting

retailing in such securities, permitting non-banks to participate in repo market.
CMS Business School, JAIN (Deemed-to-be University) 40
 3. REFORMS IN FOREIGN EXCHANGE MARKETS
India had a highly controlled forex market and foreign exchange was made available to
RBI in a very complex manner. The steps taken for reforming:
In 1993, India moved to market-based exchange rates, current account convertibility
allowed and Commercial banks allowed to undertake operations in forex.
Rupee foreign currency swap market developed. New players allowed to enter this
mkt. and undertake currency swap transactions subject to certain limitations.
Authorized dealers of forex given permission for activities such as initiating trading
positions, borrowing and investing in foreign markets etc. subject to certain limitations
and regulations.
The Foreign Exchange Regulation Act (FERA), 1973 replaced by Foreign Exchange
Management Act (FEMA), 1999 for providing greater freedom to the exchange
markets.
The foreign institutional investors and non-resident Indians were allowed to trade in
theCMS exchange-traded derivatives contracts subject to certain regulations and41
Business School, JAIN (Deemed-to-be University)
 REFORMS IN THE INDIAN CAPITAL MARKETS
1. Creation of a Strong & Efficient Regulatory Agency – Securities and Exchange Board of India
(SEBI) in 1992
2. Dematerialization of Shares
3. Screen Based Trading
4. Establishment of National Stock Exchange (NSE), 1992
5. Trading in Central Government securities started from January, 2003
6. Setting up of Credit Rating Agencies
7. Buyback of Shares started in 1999
8. Derivatives trading started June, 2000
9. PAN made Mandatory
10. Accessing Global Financial Markets
11. Internet Trading

CMS Business School, JAIN (Deemed-to-be University) 42

 REFORMS IN MONETARY POLICY FRAMEWORK
✔ Move from direct instruments (such as, administered interest rates, reserve requirements, selective credit
control) to indirect instruments (such as, open market operations, purchase and repurchase of government
securities) for the conduct of monetary policy.

✔ Introduction of Liquidity Adjustment Facility (LAF), which operates through repo and reverse repo auctions to
set up a corridor for short-term interest rate

✔ Introduction of Market Stabilization Scheme (MSS) as an additional instrument to deal with capital inflows
without affecting short-term liquidity management role of LAF.

✔ Development of pure inter-bank call money market. Non-bank participants to participate in other money market
instruments.

✔ Increase of the linkage between various segments of the financial market including money, government security
and forex markets

CMS Business School, JAIN (Deemed-to-be University) 43

 PENSION SECTOR REFORMS
❑ Since October 2003, a New Pension Scheme introduced for Central Govt. employees.

❑ Pension authority named as Pension Fund Regulatory and Development Authority

(PFRDA). Oct. 2003-Sept. 2013, pension authority has been functioning under
executive authority. In Sept. 2013, the Indian Parliament passed the Pension Fund
Regulatory Development Authority Bill, 8 years after it was introduced in March 2005.

❑ The Finance Minister has clarified that foreign investment in the pension sector will be

26% and linked to that in the insurance sector. The government has already approved
49% foreign investment (FDI) in the insurance sector.

CMS Business School, JAIN (Deemed-to-be University) 44

 ASSESSMENT OF FINANCIAL SECTOR REFORMS
❖ After the financial sector reforms, the resilience and stability of Indian economy has
increased. The growth rate has increased from around 3.5 % to more than 6% per
annum.
❖ The country has been able to deal with the Asian economic crisis of 1997-98 and the
recent Global subprime crisis of 2008 which affected the banking system of the world
but did not have much impact on the economy of India.
❖ The banking sector and Insurance sector have grown considerably. The entry of private
sector banks and foreign banks brought much-needed competition in the banking sector
which has improved its efficiency and capability.
❖ The Insurance sector has also transformed over the period of time. All these have
benefited the customer with diversified options.
❖ The stock exchanges of the country have seen growth and stability, and it has
adopted the international best practices.
CMS Business School, JAIN (Deemed-to-be University) 45
❖ RBI has effectively regulated and managed the growth and operations of the Non-Banking Financial
Companies (NBFCs) of India.

❖ The budget management, fiscal deficit, and public debt condition have improved after the financial
sector reforms. The country is moving with more such future reforms in different sectors of the
economy.

❖ However, all the issues of Indian economy have ‘NOT BEEN RESOLVED’. The social sector indicators such
as the provision of health facilities, quality of education, empowerment of women etc. have not been at
par with the economic growth.

❖ Further, the new issues like the recent rise in non-performing assets (NPAs) of banks, slow growth of
investments in the economy, the issues of jobless growth, high poverty rate, a much lower growth rate
in the agriculture sector etc. need to be resolved with more concrete efforts.
CMS Business School, JAIN (Deemed-to-be University) 46
 SELF LEARNING PORTION
▪ Financial Regulatory and Promotional Institutions – RBI, SEBI, IRDA, PFRDA, Board of
Financial Supervision

▪ Who, What, Why, How

▪ Visit their websites to explore more

CMS Business School, JAIN (Deemed-to-be University) 47

 FINANCIAL STABILITY – ASSESSMENT
Part A of ACCA Rulebook establishes the fundamental principles of professional
ethics for accountants and provides a conceptual framework, which professional
accountants should apply to:
▪ identify threats to compliance with the fundamental principles;
▪ evaluate the significance of the threats identified; and
▪ apply safeguards, when necessary, to eliminate the threats or reduce them to an
acceptable level.
▪ In determining whether any threats are at an acceptable level, you should consider
whether a reasonable and informed third party would be likely to conclude,
weighing all the specific facts and circumstances available to you at that time, that
compliance with the fundamental principles isn’t compromised. You should use
professional judgment in applying this conceptual framework.
CMS Business School, JAIN (Deemed-to-be University) 48
 ETHICS AND PRINCIPLES IN FINANCIAL MARKETS
The five fundamental ethical principles set out in our ACCA (Association of Certified Chartered
Accountants) Rulebook are:
▪ Integrity - being straightforward and honest in all professional and business relationships;
▪ Objectivity - not allowing bias, conflicts of interest or undue influence of others to override professional
or business judgements;
▪ Professional competence and due care - to maintain professional knowledge and skill at a level required
to ensure that a client or employer receives competent professional service based on current
developments in practice, legislation and techniques, and act diligently and in accordance with applicable
technical and professional standards;
▪ Confidentiality - to respect the confidentiality of information acquired as a result of professional and
business relationships and, therefore, not disclose any such information to third parties without proper
and specific authority, unless there's a legal or professional right or duty to disclose, nor use the
information for the personal advantage of the professional accountant or third parties; and
▪ Professional behaviour - to comply with relevant laws and regulations and avoid any action that
discredits the profession.
CMS Business School, JAIN (Deemed-to-be University) 49
 FINANCE CODE OF ETHICS – BY SEC, USA
FINANCIAL CODE PRINCIPLES AND RESPONSIBILITIES

▪ Financial Professionals shall adhere to and advocate to the best of their knowledge and ability the
following principles and responsibilities governing their professional and ethical conduct.

▪ Act with honesty and integrity, avoiding actual or apparent conflicts of interest in personal and
professional relationships.
▪ Provide constituents with information that is accurate, complete, objective, relevant, timely and
understandable
▪ Comply with rules and regulations of federal, state, provincial and local governments, and other
appropriate private and public regulatory agencies

▪ Act in good faith, responsibly, with due care, competence and diligence, without misrepresenting
material facts or allowing their independent judgment to be subordinated

CMS Business School, JAIN (Deemed-to-be University) 50

▪ Protect and respect the confidentiality of information acquired in the course of their work except
when authorized or otherwise legally obligated to disclose. Confidential information acquired in the
course of their work is not used for personal advantage.

▪ Share knowledge and maintain skills important and relevant to their constituents’ needs.

▪ Proactively promote ethical behavior as a responsible partner among peers in their work
environment.

▪ Achieve responsible use of and control over all assets and resources employed or entrusted to them.

▪ Report known or suspected violations of this Code to a supervisor, a human resources representative,
the Director of Internal Audit, and/or the Chairman of the Audit Committee.

▪ Are accountable for adhering to this Code.

CMS Business School, JAIN (Deemed-to-be University) 51

 ABBREVIATIONS USED
▪ RBI – Reserve Bank of India
▪ SEBI – Securities Exchange Board of India
▪ IRDA – Insurance Regulatory and Development Authority
▪ PFRDA – Pension Fund Regulatory and Development Authority
▪ ECGC – Export Credit Guarantee Corporation of India
▪ SFC – State Financial Corporation
▪ NHB – National Housing Board
▪ NABARD – National Bank for Agriculture and Rural Development
▪ DICGC – Deposit Insurance & Credit Guarantee Corporation of India
▪ SEC – Securities Exchange Commission (from USA)

CMS Business School, JAIN (Deemed-to-be University) 52

 REFERENCES

▪ Images courtesy: Google images

▪ Reference books as given
▪ rbi.org.in
▪ sebi.in
▪ ET Articles
▪ Mint Articles
▪ Moneycontrol.com

CMS Business School, JAIN (Deemed-to-be University) 53