Fis Handouts(1)

7/28/2019 Fis Handouts(1)

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Introduction:

Economic growth and development of any country depends upon a well-knit financial system.

Financial system comprises a set of sub-systems of financial institutions financial markets,

financial instruments and services which help in the formation of capital.

Financial system provides a mechanism by which savings are transformed into investments.

It can be said that financial system plays a significant role in economic growth of the country by

mobilizing surplus funds and utilizing them effectively for productive purpose.

Financial System

The word "system", in the term "financial system", implies a set of complex and closely

connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities

in the economy. The financial system is concerned about money, credit and finance-the three

terms are intimately related yet are somewhat different from each other. Indian financial system

consists of financial market, financial instruments and financial intermediation

Features of IFS

Presence of integrated organized and regulated financial markets and institutions. Help to meet the short term and long term financial needs of both the household and

corporate sector.

It renders various financial services to the community. They operate in close combinationwith each other.


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Role/ Functions of Financial System:

A financial system performs the following functions:

* It serves as a link between savers and investors. It helps in utilizing the mobilized savings of

scattered savers in more efficient and effective manner. It channelizes flow of saving into

productive investment.

* It assists in the selection of the projects to be financed and also reviews the performance of

such projects periodically.

* It provides payment mechanism for exchange of goods and services.

* It provides a mechanism for the transfer of resources across geographic boundaries.

* It provides a mechanism for managing and controlling the risk involved in mobilizing savings

and allocating credit.

* It promotes the process of capital formation by bringing together the supply of saving and the

demand for investible funds.

* It helps in lowering the cost of transaction and increase returns. Reduce cost motives people to

save more.

* It provides you detailed information to the operators/ players in the market such as individuals,

business houses, Governments etc.


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Components/ Constituents of Indian Financial system:

The following are the four main components of Indian Financial system

1. Financial institutions

2. Financial Markets

3. Financial Instruments/Assets/Securities

4. Financial Services.

Financial institutions:

Financial institutions are the intermediaries who facilitates 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 also

provide services to entities seeking advises on various issues ranging from restructuring to

diversification plans. They provide whole range of services to the entities who want to raise

funds from the markets elsewhere. Financial institutions act as financial intermediariesbecause

they act as middlemen between savers and borrowers. Were these financial institutions may be of

Banking or Non-Banking institutions.

Financial Markets:

Finance is a prerequisite for modern business and financial institutions play a vital role in

economic system. It's through financial markets the financial system of an economy works. The

main functions of financial markets are:

1. to facilitate creation and allocation of credit and liquidity;

2. to serve as intermediaries for mobilization of savings;


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3. to assist process of balanced economic growth;

4. to provide financial convenience

Financial Instruments

Another important constituent of financial system is financial instruments. They represent a

claim against the future income and wealth of others. It will be a claim against a person or an

institutions, for the payment of the some of the money at a specified future date.

Financial Services:

Efficiency of emerging financial system largely depends upon the quality and variety of financial

services provided by financial intermediaries. The term financial services can be defined as

"activites, benefits and satisfaction connected with sale of money, that offers to users and

customers, financial related value".

Deficiencies

Until the early 1990s, the role of the financial system in India was primarilyrestricted to the function of channeling resources from the surplus to deficit sectors.


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The banking sector suffered from lack of competition, low capital base, lowProductivity and high intermediation cost.

After the nationalization of large banks in 1969 and 1980, the Government-ownedbanks dominated the banking sector.

The role of technology was minimal and the quality of service was not givenadequate importance.

Banks also did not follow proper risk management systems and the prudentialstandards were weak.

All these resulted in poor asset quality and low profitability. In the insurance sector, there was little competition. The mutual fund industry also suffered from lack of competition and was

dominated for long by one institution, viz., the Unit Trust of India.

Non-banking financial companies (NBFCs) grew rapidly, but there was noregulation of their asset side.

Financial markets were characterized by control over pricing of financial assets,barriers to entry, high transaction costs and restrictions on movement of

funds/participants between the market segments.

REFORMS/ DEVELOPMENTS It was in this backdrop that wide-ranging financial sector reforms in India were

introduced as an integral part of the economic reforms initiated in the early 1990s

with a view to improving the macroeconomic performance of the economy.

The reforms in the financial sector focused on creating efficient and stable financialinstitutions and markets.

The Reserve Bank has been consistently working towards setting an enablingregulatory framework with prompt and effective supervision, development of

technological and institutional infrastructure, as well as changing the interface with

the market participants through a consultative process.

The reform of the interest regime constitutes an integral part of the financial sectorreform.


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The interest rates offered on Government securities were progressively raised sothat the Government borrowing could be carried out at market-related rates.

Banks now have sufficient flexibility to decide their deposit and lending ratestructures and manage their assets and liabilities accordingly.

Indian banking system operated for a long time with high reserve requirementsboth in the form of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR).

Meaning of Bank

Bank is a lawful organization, which accepts deposits that can be withdrawn on demand.

It also lends money to individuals and business houses that need it. Banks also render many other

useful serviceslike collection of bills, payment of foreign bills, safe-keeping of jewellery and

other valuable items, certifying the credit-worthiness of business, and so on.

Banks accept deposits from the general public as well as from the business community.

Businessmen have income from sales out of which they have to make payment for expenses.

They can keep their earnings from sales safely deposited in banks to meet their expenses from

time to time.

Banks give two assurances to the depositors

a. Safety of deposit, and

b. Withdrawal of deposit, whenever needed

Role of Banking

Banks provide funds for business as well as personal needs of individuals. They play a

significant role in the economy of a nation. Let us know about the role of banking.

It encourages savings habit amongst people and thereby makes funds available forproductive use.


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It acts as an intermediary between people having surplus money and those requiringmoney for various business activities.

It facilitates business transactions through receipts and payments by cheques instead ofcurrency.

It provides loans and advances to businessmen for short term and long-term purposes. It also facilitates import export transactions. It helps in national development by providing credit to farmers, small-scale industries and

self-employed people as well as to large business houses which lead to balanced

economic development in the country.

It helps in raising the standard of living of people in general by providing loans forpurchase of consumer durable goods, houses, automobiles, etc.

Central Bank

A bank which is entrusted with the functions of guiding and regulating the bankingsystem of a Country is known as its Central bank.

Such a bank does not deal with the general public. It acts Essentially as Governments banker, maintain deposit accounts of all other banks

and advances money to other banks, when needed.

The Central Bank provides guidance to other banks whenever they face any problem. It istherefore known as the bankers bank.

The Central Bank maintains record of Government revenue and expenditure undervarious heads.

It also advises the Government on monetary and credit policies and decides on theinterest rates for bank deposits and bank loans.

In addition, foreign exchange rates are also determined by the central bank. Another important function of the Central Bank is the issuance of currency notes,

regulating their circulation in the country by different methods.

Commercial Banks

Commercial Banks are banking institutions that accept deposits and grant short-term loans and

advances to their customers. In addition to giving short-term loans, commercial banks also give


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medium-term and long-term loan to business enterprises. Now-a-days some of the commercial

banks are also providing housing loan on a long-term basis to individuals. There are also many

other functions of commercial banks, which are discussed later in this lesson.

Types of Commercial banks: Commercial banks are of three types i.e., Public sector banks,

Private sector banks and Foreign banks.

(i) Public Sector Banks: These are banks where majority stake is held by the Government of

India or Reserve Bank of India. Examples of public sector banks are: State Bank of India,

Corporation Bank, Bank of Boroda and Dena Bank, etc.

(ii) Private Sectors Banks: In case of private sector banks majority of share capital of the

bank is held by private individuals. These banks are registered as companies with limited

liability. For example: The Jammu and Kashmir Bank Ltd., Bank of Rajasthan Ltd.,

Development Credit Bank Ltd, Lord Krishna Bank Ltd., Bharat Overseas Bank Ltd.,

Global Trust Bank, Vysya Bank, etc.

(iii) Foreign Banks: These banks are registered and have their headquarters in a foreign country

but operate their branches in our country. Some of the foreign banks operating in our

country are Hong Kong and Shanghai Banking Corporation (HSBC), Citibank, American

Express Bank, Standard & Chartered Bank, Grindlays Bank, etc. The number of foreign

banks operating in our country has increased since the financial sector reforms of 1991.

Co-operative Banks

People who come together to jointly serve their common interest often form a co-operative

society under the Co-operative Societies Act. When a co-operative society engages itself in

banking business it is called a Co-operative Bank. The society has to obtain a licence from the

Reserve Bank of India before starting banking business. Any co-operative bank as a society is

to function under the overall supervision of the Registrar, Co-operative Societies of the State.

As regards banking business, the society must follow the guidelines set and issued by the

Reserve Bank of India.


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Types of Co-operative Banks

There are three types of co-operative banks operating in our country. They are primary credit

societies, central co-operative banks and state co-operative banks. These banks are organized

at three levels, village or town level, district level and state level.

(i) Primary Credit Societies: These are formed at the village or town level with borrower

and non-borrower members residing in one locality. The operations of each society are

restricted to a small area so that the members know each other and are able to watch over

the activities of all members to prevent frauds.

(ii) Central Co-operative Banks: These banks operate at the district level having some of

the primary credit societies belonging to the same district as their members. These banks

provide loans to their members (i.e., primary credit societies) and function as a link between

the primary credit societies and state co-operative banks.

(iii) State Co-operative Banks: These are the apex (highest level) co-operative banks in all

the states of the country. They mobilize funds and help in its proper channelization among

various sectors. The money reaches the individual borrowers from the state co-operative

banks through the central co-operative banks and the primary credit societies.

Non-banking financial company

Non-bank financial companies (NBFCs) are financial institutions that provide banking services

without meeting the legal definition of a bank, i.e. one that does not hold a banking license.

These institutions are not allowed to take deposits from the public.

All operations of these institutions are still exercised underbank regulation

Gradually, they are being recognized as complementary to the banking sector due to their

customer-oriented services; simplified procedures; attractive rates of return on deposits;

flexibility and timeliness in meeting the credit needs of specified sectors; etc.

The working and operations of NBFCs are regulated by the Reserve Bank of India (RBI)within

the framework of the Reserve Bank of India Act, 1934 (Chapter III B) and the directions issued

by it under the Act.
http://en.wikipedia.org/wiki/Financial_institutionhttp://en.wikipedia.org/wiki/Bankinghttp://en.wikipedia.org/wiki/Bankhttp://en.wikipedia.org/wiki/Banking_licensehttp://en.wikipedia.org/wiki/Bank_regulationhttp://www.rbi.org.in/home.aspxhttp://business.gov.in/outerwin.php?id=http://indiacode.nic.in/rspaging.asp?tfnm=193402http://business.gov.in/outerwin.php?id=http://rbidocs.rbi.org.in/rdocs/notification/PDFs/71239.pdfhttp://business.gov.in/outerwin.php?id=http://rbidocs.rbi.org.in/rdocs/notification/PDFs/71239.pdfhttp://business.gov.in/outerwin.php?id=http://indiacode.nic.in/rspaging.asp?tfnm=193402http://www.rbi.org.in/home.aspxhttp://en.wikipedia.org/wiki/Bank_regulationhttp://en.wikipedia.org/wiki/Banking_licensehttp://en.wikipedia.org/wiki/Bankhttp://en.wikipedia.org/wiki/Bankinghttp://en.wikipedia.org/wiki/Financial_institution


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As per the RBI Act, a 'non-banking financial company' is defined as:- (i) a financial institution

which is a company; (ii) a non banking institution which is a company and which has as its

principal business the receiving of deposits, under any scheme or arrangement or in any other

manner, or lending in any manner; (iii) such other non-banking institution or class of such

institutions, as the bank may, with the previous approval of the Central Government and by

notification in the Official Gazette, specify.

Under the Act, it is mandatory for a NBFC to get itself registered with the RBI as a deposit

taking company.

The types of NBFCs registered with the RBI are:-

Equipment leasing company:- is any financial institution whose principal business isthat of leasing equipments or financing of such an activity.

Hire-purchase company:- is any financial intermediary whose principal business relatesto hire purchase transactions or financing of such transactions.

Loan company:- means any financial institution whose principal business is that ofproviding finance, whether by making loans or advances or otherwise for any activity

other than its own (excluding any equipment leasing or hire-purchase finance activity).

Investment company:- is any financial intermediary whose principal business is that ofbuying and selling of securities.

Now, these NBFCs have been reclassified into three categories:-

Asset Finance Company (AFC)


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Investment Company (IC) and

Loan Company (LC). Under this classification, 'AFC' is defined as a financial institutionwhose principal business is that of financing the physical assets which support various

productive/economic activities in the country.

MUTUAL FUND

Mutual Funds Definition refers to the meaning of Mutual Fund, which is a fund,

managed by an investment company with the financial objective of generating high Rate

of Returns. These asset management or investment management companies collects

money from the investors and invests those money in different Stocks, Bonds and other

financial securities in a diversified manner.

Few Investment Types

There can be different type -

1) Equity Oriented (High Risk, High return) : Go for this, if you can take high risk. Thistype of fund usually put your 100% money in Equity market, which is very much volatile

2) Hybrid/Balanced fund [Medium risk, Avg Return]: this type of fund invest your

money in both Equity market and Govt Bonds in 50-50 ratio.

3) Bond MF [Low risk, Return greater than Bank Fixed deposit] : These funds put money

in Govt bonds, RBI bonds etc, which are generally backed up for insured return.

Classification of Mutual Funds
http://www.economywatch.com/mutual-funds/definitionhttp://www.economywatch.com/mutual-funds/definitionhttp://www.economywatch.com/mutual-funds/definitionhttp://www.economywatch.com/mutual-funds/definition


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