Indian Financial System

That needs to be explored

First podium side chat on:

1. Money Makes the World Go Round-Explore.

2. Does the financial system and economy go hand in hand?
Finance System
Six Elements of Financial System

 Lenders and Borrowers

 Financial Intermediaries
 Financial Instruments
 Creation of Money
 Financial Markets
 Price Discovery
Allied Participants/ Players
 Brokers and Dealers
 Foreign Exchange
 Fund Managers/ Portfolio Manager
 Credit Rating Agencies
 Financial Regulators
https://www.youtube.com/watch?
v=IcERDlgGxPU
Case to understand.
Financial System

 Financial Institutions
 Financial Markets
 Financial Instruments
 Financial Services
I. Financial Institutions

• A financial institution (FI) engages in the business of dealing with financial and
monetary transactions such as deposits, loans, investments, and currency exchange.
• Financial institutions encompass a broad range of business operations within the
financial services sector including banks, insurance companies, brokerage firms, and
investment dealers.
• Financial institutions are vital to the functioning of the economies in matching people
seeking funds with those who can lend or invest it.
Features of Financial Institutions

1. It is an institution as well as an intermediary.

2. It channelizes savings funds into an investment fund.

3. It creates financial assets such as deposits, loans, securities, etc.

4. It includes banking and non-banking institutions.

5. It includes both organized and unorganized institutions.

6. Established with a clear operating function.

7. Regulated by the government and regulating authority.

8. It accepts deposits.

9. It provides commercial loans, real estate loans, and mortgage loans.

10. Financial institutions keep money flowing through the economy among consumers, businesses and
government.
 Types of Financial Institutions

1. Banking: Banking financial institutions

are in the business of taking deposits
from the public and making loans. In
addition, they provide other services
such as investment banking, foreign
exchange, and safe deposit boxes.
2. Non- Banking: Non-banking financial
institutions (NBFCs) are companies
that provide financial services such as
lending, insurance, and investment
banking but that are not regulated as
banks.
Non-Banking Financial Institutions(NBFIs)

 NBFIs provide financial services such as lending, insurance, and investment banking but are
not regulated as banks. This means that they have a different set of rules and regulations to
follow.
 Types of Non-Banking Financial Institutions
1. Insurance companies:
2. Investment banks: JP Morgan India Private Ltd, Axis Capital.
3. Pension funds: SBI Pension Funds, LIC Pension Funds
4. Mutual funds: Aditya Birla Sun Life Asset Management, Reliance Capital Fund
5. Hedge funds: Grow Capital, CHFC
6. Private equity firms: Blackstone Group, Motilal Oswal Pvt Ltd.
7. Venture capital firms: India Quotient, 3one4 Capital
How do Non-Banking Financial Institutions
differ from Banks?

 There are a few critical ways that non-banking financial institutions differ from
banks.
1. Non-banking financial institutions are not regulated by the government like
banks are. This means that they are subject to different laws and regulations.
2. Non-banking financial institutions do not take deposits from customers. Instead,
they raise money by selling securities or borrowing money.
3. Non-banking financial institutions are not required to maintain a reserve ratio
like banks are. This ratio is the percentage of deposits a bank must keep in
reserve in case of withdrawals.
4. Non-banking financial institutions are not subject to the exact capital
requirements of banks. This means they are not required to have a certain
amount of money in the reserve to protect against losses.
5. Finally, non-banking financial institutions are not subject to the same lending
restrictions as banks. This means they can lend money to anyone they choose
without following the government’s guidelines.
Role of Financial Institutions

 Some of the key roles of financial institutions in India are

as follows.
1. Regulating the Financial System
2. Supporting Financial Inclusion
3. Mobilizing Savings
4. Providing Credit Access
5. Providing Investment Products and Services
II. Financial Markets

Financial markets refer to any marketplace where buyers and sellers participate in
the trading of assets such as shares, bonds, currencies, and other financial
instruments.
 A financial market may be further divided:
1. Equity Markets- National Stock Exchange of India (NSE) and the Bombay Stock
Exchange (BSE) .
2. Debt Markets-Securities and Exchange Board of India (SEBI)
3. Derivatives Markets-forward contracts, futures and options contracts, and
currency markets.
4. Commodity Markets- The National Commodity and Derivatives Exchange
(NCDEX) and Multi Commodity Exchange (MCX) are India's two major
commodity exchanges.
5. Foreign Exchange Market-Reserve Bank of India (RBI)
Functions of financial markets

1. To facilitate the creation and allocation of credit and liquidity.

2. To serve as intermediaries for mobilization of savings.

3. To assist the process of balanced economic growth.

4. To provide financial convenience.

5. To cater to the various credit needs of the business houses.

III. Financial Instruments
In any financial transaction, there should be a creation or transfer of
financial assets.
A financial asset is one that is used for production or consumption or
for the further creation of assets.
One must know the distinction between financial assets and physical
assets.
Financial assets are intangible assets that receive value due to
contractual transactions.
Equity shares, debentures, bonds etc., are some examples.
 Characteristics of Financial
Instruments
Liquidity: financial instruments provide liquidity. These can be easily and quickly converted
into cash.

Marketing: financial instruments facilitate easy trading on the market. They have a ready
market.

Collateral value: financial instruments can be pledged for getting loans.

Transferability: financial instruments can be transferred from one person to another.

Maturity period: the maturity period of financial instruments may be short-term, medium-term,
or long-term.

Transaction cost: financial instruments involve buying and selling costs. The buying and selling
costs are called transaction costs.
Risk: financial instruments carry risk. Equity-based instruments are riskier in comparison to
debt-based instruments because the payment of dividends is uncertain. A company may not
declare dividends in a particular year.

Future trading: financial instruments facilitate future trading to cover risks arising out of price
fluctuations, interest rate fluctuations etc.
Types of Financial Instruments

 Basic examples of financial instruments are cheques, bonds, securities.

Types of Financial Instruments

i. Cash Instruments
 Securities: A security is a financial instrument with monetary value traded on
the stock market.
 Deposits and Loans: Deposits and loans are considered cash instruments
because they represent monetary assets with some contractual agreement
between parties.
2. Derivative Instruments: Underlying Assets, such as resources, currency,
bonds, stocks, and stock indexes.
Types of Derivative Instruments

 Synthetic Agreement for Foreign Exchange (SAFE): A SAFE occurs in the over-the-
counter (OTC) market and is an agreement that guarantees a specified exchange rate
during an agreed period.
 Forward: A forward is a contract between two parties that involves customizable
derivatives in which the exchange occurs at the end of the contract at a specific price.
 Future: A future is a derivative transaction exchanging derivatives on a
predetermined future date at a predetermined exchange rate.
 Options: An option is an agreement between two parties in which the seller grants
the buyer the right to purchase or sell a certain number of derivatives at a
predetermined price for a specific time.
 Interest Rate Swap: An interest rate swap is a derivative agreement between two
parties that involves the swapping of interest rates where each party agrees to pay
other interest rates on their loans in different currencies.
 Difference between Forwards and Futures

Parameter Forward contract Future contract

Contract type Tailor-made contract Standardized contract

Traded on Over the counter Organized stock exchange

Settlement happens On the maturity date Daily

Risk High Low

The size of the contract is

No. It depends on the contract terms Yes
fixed

The maturity date is Based on the terms of the private contract Predetermined

Zero requirements for initial

Yes No
margin

The expiry date of the

Depends on the contract Standardized
contract

Liquidity Low High

3. Foreign Exchange Instruments

 Foreign exchange instruments are financial instruments represented on the

foreign market and primarily consist of currency agreements and derivatives.
i. Spot: (limited timeframe)
ii. Outright Forwards:
iii. Currency Swap:
Asset Classes of Financial Instruments

1. Debt-Based Financial Instruments: Examples include bonds, debentures,

mortgages, treasury bills, credit cards, and line of credit (LOC).
2. Equity-Based Financial Instruments: Examples include common stocks,
convertible debentures, preferred stock, and transferable subscription rights.
Podium Side Discussion 1.1

 Recollect the different types of financial services offered by financial institutions in

India.
 Can you recollect the top financial services companies in India?
 What is the Need of a Financial System?
Recollect the different types of financial services offered by
financial institutions in India.

 Banking
 Professional Advisory
 Wealth Management
 Mutual Funds
 Insurance
 Stock Market
 Treasury/Debt Instruments
 Tax/Audit Consulting
 Capital Restructuring
 Portfolio Management
Can you recollect the top financial services
companies in India
 Mahindra and Mahindra Financial Services Ltd.
 Bajaj Finance Ltd.
 Muthoot Finance Ltd.
 L&T Finance Holdings Ltd.
 Aditya Birla Finance Ltd.
 Tata Capital Financial Services Ltd.
 HDFC Bank
 J.P.Morgan
 ICICI Bank
 State Bank of India (SBI)
 Punjab National Bank (PNB)
 Bank of Baroda (BoB)
 Axis Bank
 Importance or The Need of a Financial System

 Links Savers and Borrowers

 Provides payment mechanism
 Improves liquidity
 Risk Allocation
 Promotes Capital Formation
 Employment Generation
 Attracts Foreign Capital
 Balanced Regional Development
Podium side
discussion
1.2
Connect the Financial System to
Economic Growth.
Role of financial system in
economic development of a country
 Interest Rates Stabilization:
 Aids Trade and Commerce:
 Aids International Trade:
 Aids in Attracting Capital:
 Aids Infrastructure Development:
 Help in Employment Creation:
Real Facts

 Few thoughts in the right direction, explore

and be a part of it.
 India’s growth can be faster if private
capital formation kicks into higher gear:
CEA-mr. V Anantha Nageswaran.
Capital Formation
Capital Formation

 Capital is the most critical factor of production, particularly in

a developing economy.
 Capital Formation is defined as that part of the country’s
current output and imports that are not consumed or
exported during the accounting period but are set aside as an
addition to its stock of capital goods.
 Total Capital Formation can be broadly classified into
1. Gross Fixed Capital Formation
2. Change in stock of raw materials, semi-finished and finished
goods.
Process of Capital Formation:
The three stages of capital
formation are:
1. Creation of Savings:

(i) Ability (or power) to save,

(ii) Willingness (or desire) to save, and
(iii) Opportunity to save.
II. Effective Mobilization of Savings:
Investment of Savings
Factors Affecting Capital Formation

1. Volume of Saving:
2. Ability to Save:
3. Willingness to Save:
4. Profit of Public and Private Sector Enterprises:
5. Market Conditions:
6. Facilities of Investment:
7. Modifying Income Tax Policies:
8. Monetary Policy:
9. Commodity Taxation:
Financial Deepening

 Financial deepening refers to increasing in the provision of financial services.

 Financial deepening refers to the process of enhancing and broadening financial systems
by increasing the depth, liquidity, efficiency, and volumes of financial institutions and
markets, diversifying domestic sources of finance, and extending access to banking and
other financial services.
 It refers both a wider choice of services and better access for different socio- economic
groups.
 Example- Unbanked and Underbanked
 Globally around 1.7 billion people do not have a bank account
 In India 190 million unbanked adults
 Self Help Group(SHG) for Underbanked group.
Financial Widening

 Financial Widening enables more institutions

to provide wider range of services.
 A wider range of financial goods and services
are offered with different maturities, risk and
return.
End of Unit One