Financial Systems

Business Capital Process

• Businesses, individuals, and governments often need to raise capital.
• Mini Case 1:
• Carolina Power & Light (CP&L) forecasts an increase in the
• Demand for electricity in North Carolina, and the company decides to
build a new power plant.
• Because CP&L almost certainly will not have the $1 billion or
• So necessary to pay for the plant, the company will have to raise this
capital in the financial markets.
• Mini Case 2:
• In 2012, 18 year old Ritesh Agarwal from Odisha, launched Oravel stays
• Later it changed in to OYO rooms in 2013
• OYO rooms is a company for booking budget rooms
• Operates in 500 cities in India
• Also expanded in China, Malaysia, Nepal, UK, Australia, Japan and
many more
• It is funded by Softbank group, Hero enterprises and many more
• On the other hand, some individuals and firms have incomes that are
greater than their expenditures, so they have funds available to invest.
 Financial System
• It is set of financial institutions, instruments, and markets which help in
mobilization of savings and
• Distributing to those who are really in need.
• E.g. OYO
• Financial system consists of two groups :
• 1) Financial Institutions : Who help in promoting savings among the
public, collect, and transfer the fund e.g. fixed deposit
• E.g. Banks, Insurance Companies, Mutual funds
• 2) Investors or Borrowers
• E.g. Individual investor, trading company & the government
 Function of financial system
• Functions and Role of financial system, market are given below.
• Pooling of Funds,
• Capital Formation,
• Facilitates Payment,
• Provides Liquidity,
• Short and Long Term Needs,
• Risk Function,
• Better Decisions,
• Finances Government Needs,
• Economic Development.
 Function of financial system
• Pooling of Funds
• In a financial system, the Savings of people are transferred from
households to business organizations.
• With these production increases and better goods are manufactured,
which increases the standard of living of people.
• Capital Formation
• Business require finance.
• These are made available through banks, households and different
financial institutions.
• They mobilize savings which leads to Capital Formation.
 Function of financial system
• Facilitates Payment
• The financial system offers convenient modes of payment for goods and
services.
• New methods of payments like credit cards, debit cards, cheques, etc.
facilitates quick and easy transactions.
• Provides Liquidity
• In financial system, liquidity means the ability to convert into cash.
• The financial market provides the investors the opportunity to liquidate
their investments, which are in instruments like shares, debentures, bonds,
etc.
• Price is determined on the daily basis according to the operations of the
market force of demand and supply.
 Function of financial system
• Short and Long Term Needs
• The financial market takes into account the various needs of different
individuals and organizations.
• This facilitates optimum use of finances for productive purposes.
• Risk Function
• The financial markets provide protection against life, health and income
risks.
• Risk Management is an essential component of a growing economy.
 Function of financial system
• Better Decisions
• Financial Markets provide information about the market and various
financial assets.
• This helps the investors to compare different investment options and choose
the best one.
• It helps in decision making in choosing portfolio allocations of their wealth.
• Finances Government Needs
• Government needs huge amount of money for the development of defense
infrastructure.
• It also requires finance for social welfare activities, public health, education,
etc. This is supplied to them by financial markets.
 Function of financial system
• Economic Development
• The Government intervenes in the financial system to influence
macro-economic variables like interest rate or inflation.
• Thus, credits can be made available to corporate at a cheaper rate.
• This leads to economic development of the nation.
How does financial system works
Flow of funds through the financial system
• Direct finance:
• It is done by issuing securities directly to households/Individuals
• E.g. Stock markets
• Indirect finance :
• In this middle persons, use the funds and purchase other financial
securities
• E.g Mutual fund companies
 Indian financial system
• The Indian Financial System is one of the most important aspects of
the economic development of our country.
• This system manages the flow of funds between the people
(household savings) of the country and the ones who may invest it
wisely (investors/businessmen) for the betterment of both the parties.
• Given below are the features of the Indian Financial system:
• It plays a vital role in the economic development of the country as it
encourages both savings and investment
• It helps in mobilizing and allocating one’s savings
• It facilitates the expansion of financial institutions and markets
 Indian financial system
• Plays a key role in capital formation
• It helps forms a link between the investor and the one saving
• It is also concerned with the Provision of funds
• The financial system of a country mainly aims at
• managing and governing the mechanism of production,
• distribution, exchange and holding of financial assets or instruments of all
kinds.
 Components of financial system
The Indian financial system consists of the following components:
1) Financial Institutions
2) Financial Markets
3) Financial Services
4) Financial Instruments
 Components of financial system
• Financial Institutions
• The Financial Institutions act as a mediator between the investor and
the borrower. The investor’s savings are mobilized 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 which
small loans
 Components of financial system
• The best example of a Financial Institution is 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.
 Components of financial system
• 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 etc. 
 Components of financial system
• Financial Assets
• The products which are traded in the Financial Markets are called the
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:
• 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 dematerialized 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.
 Components of financial system
• 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
 Components of financial system
• 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. 
 Components of financial system
• 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
• Money Market  the type of market is authorized for small-term investments
only
• Foreign exchange Market  deals with the requirements related to multi-
currency
• Credit Market – A market where short-term and long-term loans are granted to
individuals or Organizations by various banks and Financial & Non-Financial
Institutions is called Credit Market