STRUCTURE OF INDIAN FINANCIAL SYSTEM

INTRODUCTION :
The economic expansion of any country depends upon the existence of a well-ordered
financial system. It helps in the creation of wealth by linking savings with investment.
The financial system is an organized and regulated structure where an exchange of
funds takes place between the lender and the borrower.
MEANING :
The term financial system is a set of inter-related activities/services working together to
achieve some predetermined purpose or goal. It includes different markets, the
institutions, instruments and services which influence the generation of savings,
investment capital formation and growth. The primary function of the financial system is
the mobilisation of savings, their distribution for industrial investment and stimulating
capital formation to accelerate the process of economic growth.
DEFINITION :
Mishkin defines financial system as "a set of institutional arrangements and practices
that facilitate the flow of funds from savers to borrowers."
STRUCTURE / COMPONENTS OF INDIAN FINANCIAL SYSTEM
There are four main components of the Indian Financial System. This includes:

1. Financial Institutions
2. Financial Assets
3. Financial Services
4. Financial Markets
Let’s discuss each component of the system in detail .

A) FINANCIAL INSTITUTIONS

Financial institutions are the intermediaries who facilitate smooth functioning Of the
financial system by making investors and borrowers meet. They mobilize savings of the
surplus units and allocate them in productive activities promising a better rate of return.
Financial institutions are also termed as financial intermediaries because they Act as
middle between savers by accumulating Funds them and borrowers by lending these
funds.
TYPES OF FINANCIAL INSTITUTIONS: Financial institutions can be classified into 3
categories:

1. Regulatory and Promotional Institutions

2. Banking Institutions

3. Non - Banking Institutions

1. Regulatory and Promotional Institutions : Regulatory financial institutions

establish and enforce rules for financial markets, while promotional financial institutions
aim to foster economic development through financial support and incentives. The two
major Regulatory & Promotional Institutions in India are :

I. Reserve Bank of India (RBI)

ii. Securities Exchange Board of India (SEBI)

2. Banking Institutions : Banking institutions are financial intermediaries that provide

various financial services, including accepting deposits, granting loans, and facilitating
payments. They play a crucial role in the economy by channeling funds from savers to
borrowers and providing essential financial services to individuals, businesses, and
governments.

The 3 basic categories of banking institutions are :

1. Commercial Banks

2. Cooperative Banks

3. Developmental Banks

Commercial Banks: Commercial bank are institutions that accept deposits, makes
loans and offers related services. These institutions run to make profit. Some services
offered by commercial banks include fixed deposits, issuing bank draft and bank
cheques, giving overdraft facilities, bond investment schemes, cash management etc.

Commercial banks can be further classified into :

 1. Public sector banks

2. Private sector banks

3. Foreign banks

4. Regional rural banks

Public sector banks : Public sector banks are banks wherein the majority stake (i.e.
more than 50% ) is held by Government of India. Some examples of public sector banks
include State Bank of India, Punjab National Bank and Bank of Baroda. Public sector
banks account for more than 90% of total banking business in India.

Private sector banks : Private sector banks are banks where the majority of the bank's
equity is owned by a private company or a group of individuals. These banks are
registered as companies with limited liability. Some examples of private sector banks
include ICICI Bank, Axis Bank and Kotak Mahindra Bank.

Foreign banks : These banks are registered and have their headquarters in foreign
country but operate their branches in India. Some of the foreign banks operating in India
are Hong Kong and Shanghai Banking Corporation (HSBC), Citibank, Standard
Chartered Bank and Bank of Tokyo. At present, there are 46 total foreign banks in India
as per the RBI (As on 2020).

Regional rural banks : Regional Rural Banks (RRBs) are financial institutions in India
that were established to provide banking services in rural areas and promote rural
development. These banks were created to address the credit needs of the rural
population, especially farmers, agricultural labourers, artisans, etc. Regional rural banks
are regulated by National Bank for Agriculture and Rural Development (NABARD).

Non – Banking Institutions : Non-banking financial institutions (NBFI) is a financial

institution that does not have a full banking license and cannot accept deposits from the
public but provide services similar to banks. They can include things like insurance
companies, investment firms, pension funds, and microfinance institutions. These
entities offer various financial products and services, such as loans, investments, and
insurance, but they operate under different regulations than traditional banks.

Some examples of NBFI include :

 i) LIC Housing Finance

ii) Bajaj Finance

iii) Shriram Finance

iv) Tata Sons

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

Financial markets can be categorized into several types based on the instruments
traded and the maturity of those instruments:

Money Market: Deals with short-term debt instruments, usually with a maturity of less
than one year. Examples include Treasury bills, commercial paper, certificates of
deposit, and repurchase agreements (repos). Money markets are often used for liquidity
management by institutions and investors.

Capital Market: Involves long-term securities, typically with a maturity of more than one
year. Capital markets can be further divided into:

Stock Market: Where equities (stocks) are bought and sold. It provides a platform for
companies to raise capital by issuing shares and for investors to buy and sell those
shares.

Bond Market: Deals with debt securities, such as government bonds, corporate bonds,
and municipal bonds. Bonds represent loans made by investors to issuers, who promise
to repay the principal along with interest over a specified period.

Derivatives Market: Involves financial contracts whose value is derived from an

underlying asset or index. Derivatives include futures, options, swaps, and forwards,
and they are used for hedging, speculation, and arbitrage.

Forex (Foreign Exchange) Market: Where currencies are traded. It’s the largest
financial market globally, with participants including central banks, commercial banks,
corporations, and individual traders.
Commodity Market: In commodity markets, raw materials such as gold, oil, agricultural
products, and metals are bought and sold. Commodity markets serve producers,
consumers, and investors who seek to hedge against price fluctuations.

Each type of financial market serves different purposes and caters to different
participants, but they all play crucial roles in facilitating the flow of capital and managing
financial risk in the economy.

C) FINANCIAL INSTRUMENTS: According to International Accounting Standards

(IAS) financial instruments refers to “any contract that gives rise to a financial asset of
one entity and a financial liability or equity instrument of another entity”.

Financial instruments are further classified into:

1) Primary or Direct instruments: These instruments are issued directly by

borrowers to lenders. Equity shares, preference shares and debentures are
some examples of primary securities.

2) Secondary or Indirect Instruments: These instruments are not directly issued

by borrowers to lenders. These securities are issued via a financial intermediary
to an ultimate lender. Following are some types of secondary instruments:

Derivative Instruments: These derive their value from the performance of an

underlying asset, index, or interest rate. Forward contracts, future contracts, option
contracts and swaps are some types of derivatives

Mutual Funds: A mutual fund is a company that pools money from many investors and
invests the money in securities such as stocks, bonds, and short-term debt. The
combined holdings of the mutual fund are known as its portfolio. Investors buy shares in
mutual funds.

D) FINANCIAL SERVICES: Financial services are the services provided by the Asset
Management Companies and Liability Management Companies. They help to get the
required funds and also make sure that they are efficiently invested. 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. The financial
services in India include:
Banking Services - Any small or big service provided by banks like granting 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.

CONCLUSION:

This intricate structure facilitates the efficient functioning of India’s financial system,
catering to the diverse financial needs of individuals, businesses, and the government.
Overall, the Indian financial system is dynamic, continually evolving to meet the diverse
needs of a growing economy.