Indian Financial System

The financial system consisting of a variety of Financial Institutions, Financial instruments, Financial
intermediaries, and Financial markets provides the principal means by which savings are transformed into
investments.

Financial instrument/asset/security represents claims against the future income/wealth of an entity.

Financial assets are direct (Shares, Debentures) and Indirect (Mutual Funds, Derivatives).

Financial Intermediaries are firms that provide services and products that customers may not be able to get
efficiently by themselves in financial markets. Financial Intermediaries act as a link between savers and
investors. Their main function is to convert a direct/primary security into an indirect security. In the process
of conversion, they offer to the investors the benefits of convenience, low risk, and expert management. Key
financial intermediaries in India are Commercial Banks, Financial Institutions, Insurance companies, Mutual
Funds, Non-banking financial companies, Non-banking financial services company.

Financial Markets facilitate transfer of funds from savers to investors. They are a market for creation and
exchange of financial assets. Financial markets facilitate price discovery, provide liquidity and reduce the
cost of transacting.

Functions of Financial System

1. Provides a payment system for the exchange of goods and services.
2. Enables pooling of funds for undertaking large scale enterprises.
3. Facilitates transfer of economic resources across time and space.
4. Provides a way for managing uncertainty and controlling risk.
5. Generates information that helps in coordinating decentralized decision making.
6. Helps in dealing with the incentive problem when one party has an informational advantage.
Financial Assets
Broadly speaking, an asset whether tangible or intangible is any possession that has value in exchange.

A tangible asset is one whose value depends on its physical properties. Eg. Land, Buildings, Machines,
Vehicles. An intangible asset represents a claim to some future benefits. Financial assets are intangible
assets as they represent claims to future cash flows. The terms financial asset, instrument or security are
used interchangeably.

A Financial Asset/instrument/security is a claim against another economic unit and is held as a store of value
and for the return that is expected. Financial assets are direct (Shares, Debentures) and Indirect (Mutual
Funds, Derivatives).

Financial assets represents a claim to future cash flows in the form of interest, dividends and so on.
Depending on the nature of claim/return, an instrument may be

i. Debt such as bonds, debentures, term loans,

ii. Equity shares and
iii. Hybrid such as preference shares and convertibles.

Financial asset examples

1. A 10 year bond issued by Government of India carrying an interest rate of 7%.

2. A 7 year non-convertible debenture issued by Reliance Industries Ltd carrying an interest rate of 8%.
3. A 3 year car loan provided by ICICI Bank to an individual at an interest rate of 13%.
4. Equity shares issued by Bandhan Bank to the general investing public through an Initial public
offering (IPO)
5. A call option granted by Infosys technologies to an employee that gives him the right to buy 100
shares of Infosys at an exercise price of Rs.2000.

A financial asset may entitle its owner to a fixed amount or a varying, residual amount. In the former case,
the financial asset is called a debt security (eg 1, 2 above). In the latter case, the financial asset is referred to
as an equity security (eg 4 above).
Financial markets
Financial Markets
A financial market is a market for creation and exchange of financial assets. Financial markets perform a
crucial function in the financial system as facilitating organizations. They provide a forum in which suppliers
of funds and demanders of loans/investments can transact business directly.

Two key financial markets are Money market and Capital/Securities market. Money market is market for
short term funds having maturities of one year or less. Capital market is market for long term funds.

Functions of Financial Markets

Financial Markets play a pivotal role in allocating resources in an economy by performing three important
functions:

1. Financial markets facilitate price discovery. The continual interaction among numerous buyers and
sellers who participate in financial markets helps in establishing the prices of financial assets.
2. Financial markets provide liquidity to financial assets. Investors can readily sell their financial assets
through the mechanism of financial markets. Negotiability and transferability of securities through
financial markets, helps companies to raise long term funds from investors with short term and
medium term horizons.
3. Financial markets considerably reduce the cost of transacting. Two major costs associated with
transacting are search and information costs. Search costs comprise explicit costs such as expenses
incurred on advertising when one wants to buy or sell an asset and implicit costs such as effort and
time one has to put in to locate a customer. Information costs refer to costs incurred in evaluating
the investment merits of financial assets.
Types of financial markets
Within the financial sector, the term "financial markets" is often used to refer just to the markets that are
used to raise finance. For long term finance, the Capital markets; for short term finance, the Money
markets. Another common use of the term is as a catchall for all the markets in the financial sector, as
per examples in the breakdown below.

 Capital markets which consist of:

o Stock markets, which provide financing through the issuance of shares or common stock, and
enable the subsequent trading thereof.
o Bond markets, which provide financing through the issuance of bonds, and enable the
subsequent trading thereof.
 Commodity markets, which facilitate the trading of commodities.
 Money markets, which provide short term debt financing and investment.
 Derivatives markets, which provide instruments for the management of financial risk.[2]
 Futures markets, which provide standardized forward contracts for trading products at some future
date; see also forward market.
 Foreign exchange markets, which facilitate the trading of foreign exchange.
 Cryptocurrency market which facilitate the trading of digital assets and financial technologies.
 Spot market
 Interbank lending market
The capital markets may also be divided into primary markets and secondary markets. Newly formed
(issued) securities are bought or sold in primary markets, such as during initial public offerings.
Secondary markets allow investors to buy and sell existing securities. The transactions in primary
markets exist between issuers and investors, while secondary market transactions exist among
investors.
Liquidity is a crucial aspect of securities that are traded in secondary markets. Liquidity refers to the ease
with which a security can be sold without a loss of value. Securities with an active secondary market
mean that there are many buyers and sellers at a given point in time. Investors benefit from liquid
securities because they can sell their assets whenever they want; an illiquid security may force the seller
to get rid of their asset at a large discount.
Classification of Financial Markets

There are different ways of classifying financial markets.

One way is to classify financial markets by the type of financial claim. Debt market is for fixed claims (debt
instruments). Equity market is for residual claims (equity instruments).

Second way to classify is by Maturity of claims. Money market is market for short term financial claims
(Normally for less than a year). Capital Market is for long term financial claims. Money market is market for
short term debt instruments. Capital market is market for long term debt and equity instruments.

Third way to classify is based on whether claims represent new issues or outstanding issues. Market where
issuers sell new claims is referred as Primary Market and market where investors trade outstanding
securities is called secondary market.

Fourth way to classify is by timing of delivery. A cash or spot market is one where the delivery occurs
immediately and a forward or futures market is one where the delivery occurs at a predetermined time in
future.

Fifth way to classify is by nature of the organizational structure. An exchange traded market is characterized
by a centralized organization with standardized procedures. An over the counter market is a decentralized
market with customized procedures.
Money market
The money market is created by a financial relationship between suppliers and demanders of short term
funds which have maturities on one year and less. It exists between investors (Individuals, business entities,
government and financial institutions) have temporarily idle funds that they wish to place in some type of
liquid asset or short term interest earning instrument. At the same time, other entities/organizations find
themselves in need of seasonal/temporary financing. The money market brings together these suppliers and
demanders of short term liquid funds.

Broad objectives of Money Market are:

i. An equilibrating mechanism for evening out short term surplus and deficiencies in the financial
system.
ii. A focal point of intervention by the central bank(RBI) intervention for influencing liquidity in the
economy.
iii. A reasonable access to the users of short term funds to meet their requirements at
realistic/reasonable cost and temporary deployment of funds for earning returns to the suppliers of
funds.
Capital Market
The capital market is a financial relationship created by a number of institutions and arrangements that
allows suppliers and demanders of long term funds (funds with maturities exceeding one year) to make
transactions. It is a market for long term funds.

Capital Market comprises of:

i. Stock/Security exchanges/markets (secondary markets)

ii. New Issue/Primary market (Initial Public offering (IPO) market.

Capital Market Reforms

For meeting the demand for long term funds, especially that for infrastructure requirements, a developed
capital market is needed. Capital Market reforms have been initiated with the objective of boosting
competitive conditions, improving price discovery process, reducing transaction costs, reducing information
asymmetries and strengthening institutional infrastructure. The reforms in the capital market have brought
about a visible improvement in trading and settlement infrastructure, increased transparency and brought in
a better risk management system in place, which has brought about a considerable reduction in the
transaction costs and improved the liquidity in the capital markets.

To strengthen the institutional framework, the Security Exchange Board of India (SEBI) was given statutory
powers with the mandate of protecting investors interests and ensuring the orderly development in the
capital market in 1992. Apart from stock exchanges, various intermediaries such as mutual funds, stock
brokers, merchant bankers, registrar to issue, share transfer agents and venture capital funds have been
brought under the purview of the SEBI.

The market mechanism has been strengthened by repealing the Capital Issues (Control) Act, 1947, in 1992,
and allowing the issuers of securities to raise capital from the market without any consent from any
authority. However, to protect the interests of investors, the norms for public issue have been strengthened
by improving the disclosure standards. Also, to improve the availability of information to investors, all listed
companies are required to publish unaudited financial results on a quarterly basis.

The trading platform has been modernized by replacing open outcry system with screen based, automatic,
anonymous, order driven system. The setting up of the National stock exchange as an electronic trading
platform, establishment of National Securities Depository Ltd (NSDL) and Electronic Fund Transfer (EFT)
facility, have facilitated the move towards modern practices. The trading system has been further
strengthened initially by shortening trading and settlement cycles from 14 days to 7 days, and subsequently,
shifting to the system of rolling settlement with shortening the trading cycle from T+5 to T+3, to T+2 within
the span of two years with the objective of reducing risks associated with unsettled trades due to market
fluctuations.

Inconvenience and problems related to physical custody and transfer of scrips such as late delivery, risk of
forgery and frauds have been resolved by dematerialization of the scrips. Mark to market and Value at Risk
(VAR) daily margining and exposure limits, online trading, monitoring of margins and provisioning, clearing
corporation and settlement guarantee fund mechanism for settlement have increased transparency and
strengthened the risk management system and functioning of the stock exchanges. Trading derivatives, both
index and scrip based such as stock index futures, stock index options, and futures and options in individual
stocks, have been permitted to hedge and manage the risk in the capital market.

To mitigate the impact of vested interest and to reduce the concentration of power in the stock exchanges,
the move has been towards corporatization and demutualization of stock exchanges. The NSE has been
setup as a demutualized corporate body with ownership, management and trading rights in the hands of
three different sets of groups. Similarly, the stock exchange, Mumbai has been corporatized and
demutualized and renamed as the Bombay stock exchange Ltd (BSE)

CAPITAL MARKET REFORMS AND DEVELOPMENTS

The number of Stock Exchanges has increased and the capital market has expanded substantially. However,
the functioning of the stock exchanges were characterised by many shortcomings with long delays, lack of
transparency in procedures and vulnerability to price rigging and insider trading. A number of measures have
been taken to overcome these problems.

The objectives of these measures, broadly, have been to:

• Provide for effective control of the stock exchange operations.

• Increase the information flow and disclosures so as to enhance the transparency.

• Protect the interests of investors.

• Check insider trading.

• Improve the operational efficiency of the stock exchanges.

• Promote healthy development of the capital market.

Important measures of reform and development include the following.6

Free Pricing

Raising of capital from the securities market before 1992 was regulated under the Capital Issues (Control)
Act, 1947, which required companies to obtain approval from the Controller of Capital Issues (CCI) for raising
resources in the market. New companies were allowed to issue shares only at par. Only the existing
companies with substantial reserves could issue shares at a premium, which was based on some prescribed
formula. In 1992, the Capital Issues (Control) Act, 1947 was repealed and with this ended all controls relating
to raising of resources from the market. Since then, the issuers of securities could raise the capital from the
market without requiring any consent from any authority either for making the issue or for pricing it.
Restrictions on rights and bonus issues have also been removed. New as well as established companies are
now able to price their issues according to their assessment of market conditions. However, issuers of capital
are required to meet the guidelines of SEBI on disclosure and investor protection. Companies issuing capital
are required to make sufficient disclosures, including justification of the issue price and also material
disclosure about the ‘risk factors’ in their offering prospectus. These guidelines have served as an important
measure for protecting investor interest and promoting the development of the primary market along sound
lines.

Introduction of Book Building

To help overcome the problem of determining the right price at which the market would clear an issue the
book building mechanism which introduced in 1995. The Book building mechanism is a method through
which an offer price of an Initial Public Offering (IPO) is based on investors’ demand. The introduction of
book building mechanism gave the issuer the choice to raise resources either through this or the fixed price
mechanism. The book building mechanism of floating new capital issues has been devised in such a way that
small investors are also able to subscribe to securities at a price arrived at through a transparent process. As
the book building process is both time and cost-effective, it is becoming quite popular.

Electronic Trading

Till recently, trading on the Indian stock exchanges took place through open outcry system barring NSE and
OTCEI, which adopted screen-based trading system from the beginning (i.e., 1994 and 1992 respectively). At
present, all other stock exchanges have adopted online screen-based electronic trading, replacing the open
outcry system.

There are three main advantages of electronic trading over floor-based trading as observed in India, viz.,
transparency, more efficient price discovery, and reduction in transaction costs. Transparency ensures that
stock prices fully reflect available information and lowers the trading costs by enabling the investor to assess
overall supply and demand. Owing to computer-based trading, the speed with which new information gets
reflected in prices has increased tremendously. The quantity and quality of information provided to market
participants during the trading process (pre-trading and post-trading) having significant bearing on the price
formation has also improved. Besides, the screen-based trading has the advantage of integrating different
trading centres all over the country into a single trading platform. It may be noted that prior to screen-based
trading, the very presence of stock markets in different regions implied segmentation of markets affecting
the price discovery process. Investors in other locations were, under such conditions, unable to participate in
the price formation process at the major stock exchange, namely the BSE. However, with screen-based
trading spread across various locations, the process of price discovery has improved in the Indian stock
markets. Screen-based trading has also led to significant reduction in the transaction cost since it enabled
the elimination of a chain of brokers for execution of orders from various locations at BSE and NSE.

Instruments and Market Participants

The capital market has widened and deepened considerably in the recent years with enlargement of
participants and emergence of new instruments. In the Indian capital market, traditionally mainly two
instruments were traded, i.e., debt and equity. However, starting from the mid-eighties and especially during
the first-half of the nineties, a wide range of innovative/ hybrid instruments combining both the features of
debt and equity were introduced to suit varied needs of investors and issuers/borrowers. Besides DFIs, PSUs
also issued many debt instruments with innovative features.

Markets have also widened with the increase in the number of players, such as, mutual funds and foreign
institutional investors.

Improvements in Trading, Clearing and Settlement Systems

The trading, clearing and settlement systems, which had suffered from several bottlenecks, have been
considerably improved with measures taken to shorten the settlement cycle through the introduction of
rolling settlement system and acceleration of the process of electronic book entry transfer through
depository.

Increased Dematerialisation

Safe and quick transfer of securities is an important element for smooth and efficient functioning of the
securities market. Apart from the problems involved in the movement of physical security certificates, bad
deliveries due to faulty paperwork, theft, forgery etc. added to the transaction cost and restricted liquidity.
To overcome these difficulties, legislative changes were carried out for maintaining ownership records in an
electronic book-entry form. Under this mode, securities are transferred in a speedy and safe manner without
interposition of issuers in the process, except in few circumstances. In order to catalyse the process of
dematerialisation of securities and dematerialised trading, an element of compulsion was introduced by
requiring the individual and institutional investors to settle trades compulsorily in dematerialised form in
shares of select companies.

Near Elimination of Counterparty Risk

One of the shortcomings of the clearing and settlement process of the Indian stock markets was the absence
of a system to reduce counterparty risk. Managing this risk is essential for promoting a safe and efficient
market. To provide the necessary funds and ensure timely completion of settlements in cases of failure of
member brokers to fulfil their settlement obligations, major stock exchanges have set up Settlement
Guarantee Funds. The aggregate corpus of the Fund at the stock exchanges is presently over ` 1,000 crore.
The NSE has set up a clearing corporation which guarantees settlement of all trades. The clearing
corporation, thus, assumes the counterparty risk involved in all the transactions. All stock exchanges in the
country have established clearing houses. Consequently, all transactions are settled through the clearing
houses. In the past, while some transactions were settled through the clearing houses, others were settled
directly between the members. Routing of transactions through clearing houses has substantially reduced
the credit risk in the settlement system.

Circuit Breakers/Price Bands

Circuit breakers were first introduced in 1987 in the US in the wake of sharp fall in the share prices. To
contain abnormal price variations, scrip-wise specific daily price bands or circuit breakers in India were
introduced in 1995 whereby the trading automatically got suspended if the prices varied either side beyond
8 per cent; further trading was allowed only up to the price band. Price bands, which were originally fixed at
8 per cent, were relaxed in January 2000, whereby a further variation of 4 per cent in the scrip beyond 8 per
cent, after a cooling off period of 30 minutes, was allowed. This was made applicable in the case of 100
scrips. In June 2000, for all scrips under compulsory rolling settlement, the price band was relaxed by 8 per
cent (from 4 per cent earlier) with half an hour cooling period after the scrip had hit the initial price band of
8 per cent.

While recent experiences in some countries, such as, Brazil, Taiwan and Thailand, showed that circuit filters
were successful in slowing down the market momentum, there has been some controversy over the
effectiveness of circuit filters over the medium to long-term. Although the circuit filters could have their
adverse effects on the process of price formation, they are favoured mainly on the ground that they are the
best available tool for containing volatility. This is based on the belief that containing of excess volatility
helps to maintain investor confidence in the market.

Structure of Informational Flows

Several measures have been taken to enhance the transparency of the companies. A company offering
securities in the Indian capital market is required to make a public disclosure of all relevant information
through its offer documents, as indicated earlier. After a security is issued to the public and subsequently
listed on a stock exchange, the stock exchange requires the issuing company to make continuing disclosures
under the listing agreement. In India, all listed companies are now required to furnish to the stock exchanges
and also publish mandated unaudited financial results on a quarterly basis. India is one of the few countries
in the world to have a system of quarterly disclosures and it has served a useful purpose in that price-
sensitive information on earnings and revenues is now available at greater frequency. The publication of
half-yearly corporate results on the basis of limited review by its auditors has also been made mandatory for
listed companies. The disclosures of material information, which would have a bearing on the
performance/operations of the company, are now required to be made available to the public immediately.
Recently, a decision has been taken that the companies would be required to make decisions regarding
dividend, bonus and rights announcements or any material event within 15 minutes of the conclusion of the
board meeting where the decisions are taken. Following the international practices, companies in India are
also required to provide shareholders with cash flow statements in the prescribed format along with the
complete balance sheet and profit and loss statement. Companies are also required to furnish to the stock
exchanges on a quarterly basis, a statement on the actual utilisation of funds and actual profitability, as
against projected utilisation of funds and projected profitability. As part of better corporate governance
practices, disclosures about segment reporting, related party transactions and consolidated balance sheet
are also expected to be introduced.

Emphasis on Fair Trading Practices

Insider trading has been made a criminal offence punishable in accordance with the provisions under the
SEBI Act, 1992. The Regulations define an insider as a person who has access to price sensitive non-public
information with regard to a company. Such a person is prohibited from trading in the securities of such a
company under the regulations. There are now separate regulations in place governing substantial
acquisition of shares and takeovers of companies. The regulations are aimed at making the takeover process
more transparent and to protect the interests of minority shareholders.

Increasing Integration of Various Segments of Securities Markets

In India, different stock exchanges have so far followed their own practices relating to settlement procedures
creating segmentation of the market. While stock exchanges continue to follow different systems, certain
developments have resulted in better integration of the various segments of the Indian securities market.
The two major stock exchanges, viz., BSE and NSE, have expanded their operations in different locations,
thus, providing investors across the country with the facility to trade in the stocks listed/permitted in these
stock exchanges. The Interconnected Stock Exchange of India Ltd. (ICSI) has been set up as an
interconnected market system and provides its trading members a facility to trade on the national market in
addition to the trading facility at the regional stock exchanges. This has integrated the various regional stock
exchanges, although the trading activity in the ICSI has not been very significant. Many regional stock
exchanges have also become members of BSE and NSE, which further strengthened the integration process
of various stock exchanges in the country. Equity market is also increasingly integrating with the
Government securities and private corporate sector debt market. The interest rate structure of Government
securities and securities issued by the corporate entities is better aligned at present than in the past.

The Impact of the Changing Structure

The changing structure of capital market has had some positive impact on the volatility, liquidity and
transaction cost.
Source: Speech by Shri Deepak Mohanty, Executive Director, Reserve Bank of India, at the Seminar on Issues
in Financial Markets, Mumbai, 15th December 2012.

Money market is at the heart of monetary operations. Over the last decade, there has been substantial
development in the Indian money market in terms of depth, variety of instruments and efficiency. This has
enabled the Reserve Bank to change its monetary operations from direct quantity based instruments to
indirect interest rate based instruments to enhance the efficiency of monetary transmission consistent with
international best practice. Against this background, I will briefly capture the developments in the money
market and discuss the experience with the recently modified operating procedure of monetary policy
before concluding with some thoughts on the way forward.

Role of money market

Money market can be defined as a market for short-term funds with maturities ranging from overnight to
one year and includes financial instruments that are considered to be close substitutes of money. It provides
an equilibrating mechanism for demand and supply of short-term funds and in the process provides an
avenue for central bank intervention in influencing both the quantum and cost of liquidity in the financial
system, consistent with the overall stance of monetary policy. In the process, money market plays a central
role in the monetary policy transmission mechanism by providing a key link in the operations of monetary
policy to financial markets and ultimately, to the real economy. In fact, money market is the first and the
most important stage in the chain of monetary policy transmission.

Typically, the monetary policy instrument, effectively the price of central bank liquidity, is directly set by the
central bank. In view of limited control over long-term interest rates, central banks adopt a strategy to exert
direct influence on short-term interest rates. Changes in the short-term policy rate provide signals to
financial markets, whereby different segments of the financial system respond by adjusting their rates of
return on various instruments, depending on their sensitivity and the efficacy of the transmission
mechanism. How quickly and effectively the monetary policy actions influence the spectrum of market
interest rates depends upon the level of development of various segments of financial markets, particularly
the money market. Cross-country studies suggest that as domestic financial markets grow, transmission of
monetary policy through various channels becomes better. As a crucial initial link in the chain through which
monetary policy aims at achieving ultimate goals relating to inflation and growth, money market
developments are closely monitored and influenced by central banks. Besides expecting money market rates
to respond to policy rate changes in a well anchored manner, central banks aim at ensuring appropriate
liquidity conditions through discretionary liquidity management operations so that money market functions
normally. Money market is also an important funding market for banks and financial institutions, and at
times, even for corporates. Stressed conditions in the money markets could increase moral hazard with
banks expecting a central bank to function as the lender of first resort. Following the recent global financial
crisis, money market funding for the financial system effectively got replaced with central bank funding in
advanced countries. Money market rates (like LIBOR and EURIBOR) are standard benchmarks for pricing of
bonds, loans and other financial products. Market manipulation of this key benchmark – as reportedly
happened to LIBOR recently - though undermined the faith in money market. A sound money market would
have to ensure conditions where banks can conduct business safely
Capital/Securities market
Financial sector development
Financial sector development in developing countries and emerging markets is part of the private
sector development strategy to stimulate economic growth and reduce poverty. The Financial sector is
the set of institutions, instruments, and markets. It also includes the legal and regulatory framework that
permit transactions to be made through the extension of credit.[1] Fundamentally, financial sector
development concerns overcoming “costs” incurred in the financial system. This process of reducing
costs of acquiring information, enforcing contracts, and executing transactions results in the emergence
of financial contracts, intermediaries, and markets. Different types and combinations of information,
transaction, and enforcement costs in conjunction with different regulatory, legal and tax systems have
motivated distinct forms of contracts, intermediaries and markets across countries in different times. [2]
The five key functions of a financial system in a country are: (i) information production ex ante about
possible investments and capital allocation; (ii) monitoring investments and the exercise of corporate
governance after providing financing; (iii) facilitation of the trading, diversification, and management of
risk; (iv) mobilization and pooling of savings; and (v) promoting the exchange of goods and services. [3]
Financial sector development takes place when financial instruments, markets, and intermediaries work
together to reduce the costs of information, enforcement and transactions. [2] A solid and well-functioning
financial sector is a powerful engine behind economic growth. It generates local savings, which in turn
lead to productive investments in local business. Furthermore, effective banks can channel international
streams of private remittances. The financial sector therefore provides the rudiments for income-growth
and job creation.
There are ample evidence suggesting that financial sector development plays a significant role
in economic development. It promotes economic growth through capital accumulation and technological
advancement by boosting savings rate, delivering information about investment, optimizing the allocation
of capital, mobilizing and pooling savings, and facilitating and encouraging foreign capital inflows. [4] A
meta-analysis of 67 empirical studies finds that financial development is robustly associated with
economic growth.[5]
Countries with better-developed financial systems tend to enjoy a sustained period of growth, and
studies confirm the causal link between the two: financial development is not simply a result of economic
growth; it is also the driver for growth.[6]
Additionally, it reduces poverty and inequality by enabling and broadening access for the poor and
vulnerable groups, facilitating risk management by reducing their vulnerability to shocks, and raising
investment and productivity that generates higher income.[7]
Financial sector development also assists the growth of small and medium-sized enterprises (SMEs) by
giving them with access to finance. SMEs are typically labor-intensive and create more jobs than large
firms, which contributes significantly to economic development in emerging economies.
Additionally, financial sector development also entails establishing robust financial policies and
regulatory framework. The absence of adequate financial sector policies could have disastrous outcome,
as illustrated by the global financial crisis. Financial sector development has heavy implication on
economic development‐‐both when it functions and malfunctions.[8]
The crisis has challenged conventional thinking in financial sector policies and sparked debate on how
best to achieve sustainable development. To effectively reassess and re-implement financial policies,
publications such as Global Financial Development Report (GFDR) by the World Bank and Global
Financial Stability Report (GFSR) by the IMF can play an important role.