Main

Indian Financial System
SUMMARY
India has a financial system that is regulated by independent regulators in the sectors of
banking, insurance, capital markets, competition and various services sectors. In a
number
of
sectors
Government
plays
the
role
of
regulator.
Ministry of Finance, Government of India looks after financial sector in India. Finance
Ministry every year presents annual budget on February 28 in the Parliament. The annual
budget proposes changes in taxes, changes in government policy in almost all the sectors
and budgetary and other allocations for all the Ministries of Government of India. The
annual budget is passed by the Parliament after debate and takes the shape of law.
Reserve bank of India (RBI) established in 1935 is the Central bank. RBI is regulator for
financial and banking system, formulates monetary policy and prescribes exchange
control norms. The Banking Regulation Act, 1949 and the Reserve Bank of India Act,
1934 authorize the RBI to regulate the banking sector in India.
India has commercial banks, co-operative banks and regional rural banks. The
commercial banking sector comprises of public sector banks, private banks and foreign
banks. The public sector banks comprise the State Bank of India and its seven associate
banks and nineteen other banks owned by the government and account for almost three
fourth of the banking sector. The Government of India has majority shares in these public
sector
banks.
India has a two-tier structure of financial institutions with thirteen all India financial
institutions and forty-six institutions at the state level. All India financial institutions
comprise term-lending institutions, specialized institutions and investment institutions,
including in insurance. State level institutions comprise of State Financial Institutions and
State Industrial Development Corporations providing project finance, equipment leasing,
corporate loans, short-term loans and bill discounting facilities to corporate. Government
holds
majority
shares
in
these
financial
institutions.
Non-banking Financial Institutions provide loans and hire-purchase finance, mostly for
retail
assets
and
are
regulated
by
RBI.
Insurance sector in India has been traditionally dominated by state owned Life Insurance
Corporation and General Insurance Corporation and its four subsidiaries. Government of
India has now allowed FDI in insurance sector up to 26%. Since then, a number of new
joint venture private companies have entered into life and general insurance sectors and
their share in the insurance market in rising. Insurance Development and Regulatory
Authority (IRDA) is the regulatory authority in the insurance sector under the Insurance
Development
and
Regulatory
Authority
Act,
1999.
RBI also regulates foreign exchange under the Foreign Exchange Management Act
(FERA). India has liberalized its foreign exchange controls. Rupee is freely convertible
on current account. Rupee is also almost fully convertible on capital account for nonresidents. Profits earned, dividends and proceeds out of the sale of investments are fully
repatriable for FDI. There are restrictions on capital account for resident Indians for
incomes earned in India.
Securities and Exchange Board of India (SEBI) established under the Securities and
Exchange aboard of India Act, 1992 is the regulatory authority for capital markets in
India. India has 23 recognized stock exchanges that operate under government approved
rules, bylaws and regulations. These exchanges constitute an organized market for
securities issued by the central and state governments, public sector companies and
public limited companies. The Stock Exchange, Mumbai and National Stock Exchange
are the premier stock exchanges. Under the process of de-mutualization, these stock
exchanges have been converted into companies now, in which brokers only hold minority
share holding. In addition to the SEBI Act, the Securities Contracts (Regulation) Act,
1956 and the Companies Act, 1956 regulates the stock markets.
INDIAN FINANCIAL SYSTEM
Financial System of any country consists of financial markets, financial intermediation

and financial instruments or financial products. This paper discusses the meaning of
finance and Indian Financial System and focus on the financial markets, financial
intermediaries and financial instruments. The brief review on various money market
instruments are also covered in this study.
The term "finance" in our simple understanding it is perceived as equivalent to 'Money'.
We read about Money and banking in Economics, about Monetary Theory and Practice
and about "Public Finance". But finance exactly is not money, it is the source of
providing funds for a particular activity. Thus public finance does not mean the money
with the Government, but it refers to sources of raising revenue for the activities and
functions of a Government. Here some of the definitions of the word 'finance', both as a
source and as an activity i.e. as a noun and a verb.
The American Heritage Dictionary of the English Language, Fourth Edition defines the
term as under1:"The science of the management of money and other assets.";
2: "The management of money, banking, investments, and credit. ";
3: "finances Monetary resources; funds, especially those of a government or corporate
body"
4: "The supplying of funds or capital."
Finance as a function (i.e. verb) is defined by the same dictionary as under1:"To provide or raise the funds or capital for": financed a new car
2: "To supply funds to": financing a daughter through law school.
3: "To furnish credit to".
Another English Dictionary, "WordNet 1.6, 1997Princeton University " defines the
term as under1:"the commercial activity of providing funds and capital"
2: "the branch of economics that studies the management of money and other assets"
3: "the management of money and credit and banking and investments"
The same dictionary also defines the term as a function in similar words as under1: "obtain or provide money for;" " Can we finance the addition to our home?"
2:"sell or provide on credit "
All definitions listed above refer to finance as a source of funding an activity. In this
respect providing or securing finance by itself is a distinct activity or function, which
results in Financial Management, Financial Services and Financial Institutions. Finance
therefore represents the resources by way funds needed for a particular activity. We thus
speak of 'finance' only in relation to a proposed activity. Finance goes with commerce,
business, banking etc. Finance is also referred to as "Funds" or "Capital", when referring
to the financial needs of a corporate body. When we study finance as a subject for
generalising its profile and attributes, we distinguish between 'personal finance" and
"corporate finance" i.e. resources needed personally by an individual for his family and
individual needs and resources needed by a business organization to carry on its functions
intended for the achievement of its corporate goals
Financial System is an institutional framework existing in a country to enable financial

transactions. There are three main parts in Indian financial system. They are as follows:
Financial assets comprises of loans, deposits, bonds, equities, etc.
Financial institutions such as banks, mutual funds, insurance companies, etc.
Financial markets include money market, capital market, forex market, etc.
Regulation is another aspect of the financial system. The regulatory authorities are RBI,
SEBI, IRDA, and FMC.
The economic development of a nation is reflected by the progress of the various

economic units, broadly classified into corporate sector, government and household
sector. While performing their activities these units will be placed in a
surplus/deficit/balanced budgetary situations.
There are areas or people with surplus funds and there are those with a deficit. A
financial system or financial sector functions as an intermediary and facilitates the flow

of funds from the areas of surplus to the areas of deficit. A Financial System is a
composition of various institutions, markets, regulations and laws, practices, money
manager, analysts, transactions and claims and liabilities.
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. These are briefly discussed below;
FINANCIAL MARKETS
A Financial Market can be defined as the market in which financial assets are created or
transferred. As against a real transaction that involves exchange of money for real goods
or services, a financial transaction involves creation or transfer of a financial asset.
Financial Assets or Financial Instruments represents a claim to the payment of a sum of
money sometime in the future and /or periodic payment in the form of interest or
dividend.
Money Market- The money market ifs a wholesale debt market for low-risk, highlyliquid, short-term instrument. Funds are available in this market for periods ranging from
a single day up to a year. This market is dominated mostly by government, banks and
financial institutions.
Capital Market - The capital market is designed to finance the long-term investments.
The transactions taking place in this market will be for periods over a year.

Forex Market - The Forex market deals with the multicurrency requirements, which are
met by the exchange of currencies. Depending on the exchange rate that is applicable,
the transfer of funds takes place in this market. This is one of the most developed and
integrated market across the globe.
Credit Market- Credit market is a place where banks, FIs and NBFCs purvey short,
medium and long-term loans to corporate and individuals.
The financial system is possibly the most important institutional and functional vehicle
for economic transformation. Finance is a bridge between the present and the future and
whether the mobilization of savings or their efficient, effective and equitable allocation
for investment, it the access with which the financial system performs its functions that
sets the pace for the achievement of broader national objectives.
According to Christy, the objective of the financial system is to supply funds to various
sectors and activities of the economy in ways that promote the fullest possible utilization
of resources without the destabilizing consequence of price level changes or unnecessary
interference with individual desires.
According to Robinson, the primary function of the system is to provide a link
between savings and investment for the creation of new wealth and to permit portfolio
adjustment in the composition of the existing wealth.
A financial system or financial sector functions as an intermediary and facilitates the flow
of funds from the areas of surplus to the deficit. It is a composition of various institutions,
markets, regulations and laws, practices, money manager analyst, transactions and claims
and liabilities.
CONSITUENTS OF FINANCIAL SYSTEM:
1.FINANCIAL INTERMEDIATION
Having designed the instrument, the issuer should then ensure that these financial assets
reach the ultimate investor in order to garner the requisite amount. When the borrower of
funds approaches the financial market to raise funds, mere issue of securities will not
suffice. Adequate information of the issue, issuer and the security should be passed on to
take place. There should be a proper channel within the financial system to ensure such
transfer. To serve this purpose, Financial intermediaries came into existence. Financial
intermediation in the organized sector is conducted by a widerange of institutions
functioning under the overall surveillance of the Reserve Bank of India. In the initial
stages, the role of the intermediary was mostly related to ensure transfer of funds from
the lender to the borrower. This service was offered by banks, FIs, brokers, and dealers.
However, as the financial system widened along with the developments taking place in
the financial markets, the scope of its operations also widened. Some of the important
intermediaries operating ink the financial markets include; investment bankers,
underwriters, stock exchanges, registrars, depositories, custodians, portfolio managers,
mutual funds, financial advertisers financial consultants, primary dealers, satellite
dealers, self regulatory organizations, etc. Though the markets are different, there may be
a few intermediaries offering their services in move than one market e.g. underwriter.
However, the services offered by them vary from one market to another.

Financial institutions are intermediaries that mobilize savings & facilitate the allocation
of funds in an efficient manner.
Financial institutions can be classified as banking & non-banking financial institutions.
Banking institutions are creators of credit while non-banking financial institutions are
purveyors of credit. While the liabilities of banks are part of the money supply, this may
not be true of non-banking financial institutions. In India, non-banking financial
institutions, namely, the developmental financial institutions (DFIs) & non-banking
financial companies (NBFCs) as well as housing finance companies (HFCs) are the major
institutional purveyors of credit. Financial institutions can also be classified as termfinance institutions such as the industrial development bank of India (IDBI), industrial
credit & Investment Corporation of India (ICICI), industrial financial corporation of India
(IFCI), small industries development bank of India (SIDBI) & industrial investment bank
of India (IIBI).
Financial Services:
Financial intermediaries provide key financial services such as merchant banking, leasing
hire purchases, credit-rating, and so on. Financial services rendered by the financial
intermediaries bridge the gap between lack of knowledge on the part of investors and
increasing sophistication of financial instruments and markets. These financial services
are vital for creation of firms, industrial expansion, and economic growth.
Before investors lend money, they need to be reassured that it is safe to exchange
securities for funds. This reassurance is provided by the financial regulator, who regulates
the conduct of the market, and intermediaries to protect the investors interests. The
Reserve Bank of India regulates the money market and Securities Exchange Board of
India (SEBI) regulates capital market.
Intermediary
Stock Exchange
Investment Bankers
Underwriters
Registrars, Depositories,
Custodians
Primary Dealers Satellite
Dealers
Forex Dealers
Market
Capital Market
Role
Secondary Market to securities
Corporate advisory services,
Capital Market, Credit Market
Issue of securities
Capital Market, Money
Subscribe to unsubscribed
Market
portion of securities
Issue securities to the investors
Capital Market
on behalf of the company and
handle share transfer activity
Market making in government
Money Market
securities
Ensure exchange ink
Forex Market
currencies
2. FINANCIAL MARKETS
Financial markets are a mechanism enabling participants to deal in financial claims.
The markets also provide a facility in which their demands & requirements interact to set
a price for such claims. The main organized financial markets in India are the money
market & capital market. The first is a market for short-term securities. Money market is
a market for dealing with financial assets & securities which have a maturity period of
upto one year. While the second is a market for long term securities, that is, securities
having a maturity period of one year or more. The capital market is a market for financial
assets which have a long or indefinite maturity.
Money market consists of:
Call money market:
Call money market is a market for extremely short period loans say one day to fourteen
days. It is highly liquid.
Commercial bills market:
It is a market for bills of exchange arising out of genuine trade transactions. In the case of
credit sale, the seller may draw a bill of exchange on the buyer. The buyer accepts such a
bill promising to pay at a later date the amount specified in the bill. The seller need not
wait until the due date of the bill. Instead, he can get immediate payment by discounting
the bill.
Treasury bills market:
It is a market for treasury bills which have short-term maturity. A treasury bill is a
promissory note or a finance bill issued by the government. It is highly liquid because its
repayment is guaranteed by the government
Short-term loan market:
It is a market where short- term loans are given to corporate customers for meeting their
working capital requirements. Commercial banks play a significant role in this market.
Capital market consists of:
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Industrial securities market:

It is a market for industrial securities namely equity shares or ordinary shares, preference
shares & debentures or bonds. It is a market where industrial concerns raise their capital
or debt by issuing appropriate instruments. It can be further subdivided into primary &
secondary market.
Government securities market:
It is otherwise called gilt-edged securities market. It is a market where government
securities are traded. In India there are many kinds of govt securities- short-term & longterm. Long-term securities are traded in this market while short term securities are traded
in the money market.
Long-term loans market:
Development banks & commercial banks play a significant role in this market by
supplying long term loans to corporate customers. Long-term loans market may further
be classified into:
Term loans market
Mortgages market
Financial guarantees market
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3.FINANCIAL INSTRUMENT/ FINANCIAL ASSETS

Financial instruments refers to those document which represents financial claims on
assets. As discussed earlier, financial assets refers to a claim to the repayment of certain
sum of money at the end of specified period together with interest or dividend.
Examples : bills of exchange, promissory notes, treasury bills, government bonds, deposit
receipts, shares debentures etc..It is divided as:
1.Money Market Instruments
The money market can be defined as a market for short-term money and financial assets
that are near substitutes for money. The term short-term means generally a period upto
one year and near substitutes to money is used to denote any financial asset which can be
quickly converted into money with minimum transaction cost.
Some of the important money market instruments are briefly discussed below;
1. Call/Notice Money
2. Treasury Bills
3. Term Money
4. Certificate of Deposit
5. Commercial Papers
1. Call /Notice-Money Market
Call/Notice money is the money borrowed or lent on demand for a very short period.
When money is borrowed or lent for a day, it is known as Call (Overnight) Money.
Intervening holidays and/or Sunday are excluded for this purpose. Thus money, borrowed
on a day and repaid on the next working day, (irrespective of the number of intervening
holidays) is "Call Money". When money is borrowed or lent for more than a day and up
to 14 days, it is "Notice Money". No collateral security is required to cover these
transactions.
2. Inter-Bank Term Money
Inter-bank market for deposits of maturity beyond 14 days is referred to as the term
money market. The entry restrictions are the same as those for Call/Notice Money except
that, as per existing regulations, the specified entities are not allowed to lend beyond 14
days
3. Treasury Bills.
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Treasury Bills are short term (up to one year) borrowing instruments of the union
government. It is an IOU of the Government. It is a promise by the Government to pay a
stated sum after expiry of the stated period from the date of issue (14/91/182/364 days i.e.
less than one year). They are issued at a discount to the face value, and on maturity the
face value is paid to the holder. The rate of discount and the corresponding issue price are
determined at each auction.
4. Certificate of Deposits
Certificates of Deposit (CDs) is a negotiable money market instrument nd issued in
dematerialised form or as a Usance Promissory Note, for funds deposited at a bank or
other eligible financial institution for a specified time period. Guidelines for issue of CDs
are presently governed by various directives issued by the Reserve Bank of India, as
amended from time to time. CDs can be issued by (i) scheduled commercial banks
excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs); and (ii) select
all-India Financial Institutions that have been permitted by RBI to raise short-term
resources within the umbrella limit fixed by RBI. Banks have the freedom to issue CDs
depending on their requirements. An FI may issue CDs within the overall umbrella limit
fixed by RBI, i.e., issue of CD together with other instruments viz., term money, term
deposits, commercial papers and intercorporate deposits should not exceed 100 per cent
of its net owned funds, as per the latest audited balance sheet.
5. Commercial Paper
CP is a note in evidence of the debt obligation of the issuer. On issuing commercial paper
the debt obligation is transformed into an instrument. CP is thus an unsecured promissory
note privately placed with investors at a discount rate to face value determined by market
forces. CP is freely negotiable by endorsement and delivery. A company shall be eligible
to issue CP provided - (a) the tangible net worth of the company, as per the latest audited
balance sheet, is not less than Rs. 4 crore; (b) the working capital (fund-based) limit of
the company from the banking system is not less than Rs.4 crore and (c) the borrowal
account of the company is classified as a Standard Asset by the financing bank/s. The
minimum maturity period of CP is 7 days. The minimum credit rating shall be P-2 of
CRISIL or such equivalent rating by other agencies. (for more details visit
www.indianmba.com faculty column)
2.Capital Market Instruments
13
The capital market generally consists of the following long term period i.e., more than
one year period, financial instruments; In the equity segment Equity shares, preference
shares, convertible preference shares, non-convertible preference shares etc and in the
debt segment debentures, zero coupon bonds, deep discount bonds etc.
3.Hybrid Instruments
Hybrid instruments have both the features of equity and debenture. This kind of
instruments is called as hybrid instruments. Examples are convertible debentures,
warrants etc.
Financial instruments can also be called financial securities. Financial

securities can be classified into:
i. Primary or direct securities
ii. Secondary or indirect securities.
Primary securities
These are securities directly issued by the ultimate investors to the ultimate savers.
Examples, shares and debentures issued directly to the public.
Secondary securities
These are securities issued by some intermediaries called financial intermediaries to the
ultimate savers. E.g. unit trust of India and Mutual funds issue securities in the form of
units to the public and money pooled is invested in companies.
Again these securities may be classified on the basis of duration as follows:
i. Short-term securities
ii. Medium-term securities
iii. Long-term securities.
Short-term securities are those which mature within a period of one year. E.g. Bills of
exchange, treasury bills, etc. medium term securities are those which have a maturity
period ranging between one and five years.
e.g. Debentures maturing within a period of 5 years. Long-term securities are those which
have a maturity period of more than five years. E.g. government Bonds maturing after 10
years.
FEATURES /CHARACTERISTICS:
14
Features of financial system

The features of a financial system are as follows
1. Financial system provides an ideal linkage between depositors and investors, thus
encouraging both savings and investments.
2. Financial system facilitates expansion of financial markets over space and time.
3. Financial system promotes efficient allocation of financial resources for socially
desirable and economically productive purposes.
4. Financial system influences both the quality and the pace of economic development.
Characteristic Features of Financial Instruments

Generally speaking, financial instruments possess the following characteristic features:
i.
Most of the instruments can be easily transferred from one hand to another
without many cumbersome formalities.
ii.
They have a ready market, i.e., they can be bought and sold frequently and
thus, trading in these securities is made possible
iii.
They possess liquidity, i.e., some instruments can be converted into cash
readily. For instance, a bill of exchange can be converted into cash readily by
means of discounting and rediscounting.
iv.
Most of the securities posses security value, i.e., they can be given as security
for the purpose of raising loans.
v.
Some securities enjoy tax status, i.e., investment in these securities are
exempted from income tax, wealth tax, etc., subject to certain limits. E.g.
public sector tax free bonds, magnum tax saving certificates.
vi.
They carry risk in the sense that there is uncertainty with regard to the
payment of principle or interest or dividend as the case may be.
vii.
These instruments facilitates future trading so as to cover risks due to price

fluctuations, interest rates, etc.
viii.
These instruments involve less handling costs since expenses involved in

buying and selling these securities are generally much less..
ix.
The return on these instruments is directly in proportion to the risk undertaken
x.
These instruments may be short-term or medium term or long term depending

upon the
maturity period of these instruments
FUNCTIONS OF FINANCIAL SYSTEM

15
Good financial system search in the following ways :

1. Promotion of liquidity:
The major function of financial system is the provision of money and monetary assets for
the production of goods and services. There should not be any shortage of money for
productive ventures. In financial language, the money and monetary assets are referred to
as liquidity. The term liquidity refers to cash or money and other assets which can be
converted into cash readily without loss of value and time.
2. Link between savers and investors:
One of the important functions of financial system is to link the savers and investors and
thereby help in mobilizing and allocating the savings effectively and efficiently. By
acting as an efficient medium for allocation of resources, it permits continuous up
gradation of technologies for promoting growth on a sustained basis.
3. Information available:
It makes available price- related information which is a valuable assistance to those who
need economic and financial decision.
4. Helps in projects selection:
A financial system not only helps in selecting projects to be funded but also inspires the
operators to monitor the performance of the investment. It provides a payment
mechanism for the exchange of goods and services, and transfers economic resources
through time and across geographic regions and industries.
5. Allocation of risk:
One of most important function of the financial system is to achieve optimum allocation
of risk bearing. It limits, pools, and trades the risks involved in mobilizing savings and
allocating credit. An effective financial system aims at containing risk within acceptable
limit and reducing cost of gathering and analyzing information to assist operators in
taking decisions carefully.
6. Minimizes situations of Asymmetric information:
16

A financial system minimizes situations where the information is Asymmetric and likely
to affect motivations among operators or when one party has the information and the
other party does not. It provides financial services such as insurance and pension and
offers portfolio adjustments facilities.
7. Reduce cost of transaction and borrowing:
A financial system helps in creation of financial structure that lowers the cost of
transactions. This has a beneficial influence on the rate of return to the savers. It also
reduces the cost of borrowings. Thus , the system generates an impulse among the people
to save more.
8. Financial deepening and broadening:
A well functioning financial system helps in promoting the process of financial
deepening and broadening. Financial deepening refers to an increase of financial assets as
a percentage of the gross domestic product. Financial broadening refers to building an
increasing number and a variety of participants and instruments.
Indian Financial Markets: Fuelling the Growth of the Indian Economy
17

SPEECH GIVEN BY RBI GOVERNOR:
Dr. Arvind Mayaram, Secretary, Department of Economic Affairs, Ministry of
Finance, Mr. S. Gopalakrishnan, President, Confederation of Indian Industry
(CII), Mr. Jignesh Shah, Chairman, CII National Committee on Financial
Markets, Mr. Chandrajit Banerjee, Director General, CII, distinguished delegates.
Let me start by complimenting CII for selecting Indian Financial Markets:
Fuelling the Growth of the Indian Economy as the theme of the session. It is now
well known that a well-developed financial sector plays an important role in
economic growth. As John Hicks observed, the technology that made industrial
revolution in England possible was in existence for a long time before it was
commercially exploited; it had to wait till the financial sector developed well
enough to make the necessary resources available2. But it has to be recognized
that while absence of a robust financial sector can retard growth, financial
development on its own cannot secure growth. Finance thus is a necessary but
not a sufficient condition for economic growth.
In India, we have traversed a long way since the economic reforms started in the
early 1990s. The reforms of the early 90s were focused on three pillars
Liberalization, Privatization and Globalization (LPG). The financial sector has
also undergone significant changes during the period to not only to support the
rapid growth but also to do so without disruptive episodes. Let me briefly
mention some of these changes, if only to stress that our confidence to meet
future challenges is based on the bedrock of past achievements. I am deliberately
not touching upon the issues relating to capital markets as they are not my areas
of competence.
Bank-based financial sector of India

Indian financial sector has traditionally been bank based. The banking sector has so far
played a seminal role in supporting economic growth in India. The assets of the banking
sector have expanded nearly 11 times from ` 7.5 trillion at end-March 1998 to ` 83 trillion
at end-March 2012. The non-food credit has expanded by more than 14 times from ` 3.1
trillion 1998 to ` 45.30 trillion during the same period. The credit to GDP ratio which
stood at about five per cent in 1950-51 improved to about 25 per cent in 2000-01 and
further to about 52 per cent at the end of 2011-12
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The pre-emption by way of Statutory Liquidity Ratio (SLR) has declined considerably
from 38.5 per cent in 1991 to 23.0 per cent of the Net Demand & Time Liabilities
(NDTL) in 2013 (Chart 2). All the while, the banking sector has been robust, meeting all
prudential standards as per best international practice. During the recent global financial
crisis and slowdown in the global and domestic economy, the Indian banking sector has
proved to be resilient. There are, however, issues relating to liquidity, asset quality,
capital adequacy in the context of Basel III and earnings which have surfaced in the
recent past mainly due to economic slowdown and have to be tackled expeditiously for
continued resilience of the Indian banking system.
19

The Indian Financial Markets
. The Indian financial markets have also grown considerably. The market capitalization of
the equity market (National Stock Exchange) has grown from approximately ` 6.5 trillion
in 2000-01 to approximately ` 60 trillion in 2009-10 and further to approximately ` 61
trillion in 2011-12. The total corporate debt outstanding which stood at ` 7.9 trillion in
June 2010, has grown to` 12.9 trillion in March 2013. The outstanding CP has grown
from ` 575 million in 2003 to ` 11 billion in 2013. Similarly, outstanding CD has grown
from ` 91 million in March 2003 to ` 39 billion as on March 22, 2013. Notwithstanding
the impressive growth of the debt markets, there is a great deal still to be done. I shall
shortly return to this.
Debt Markets
Government Bond Market
With a large section of population underprivileged, the welfare commitments of the
Indian state have to be supported by a large government borrowing program. The
outstanding marketable government debt has grown from ` 4.3 trillion in 2000-01
to ` 29.9 trillion in 2012-13. The size of the annual borrowing of the central government
through dated securities has grown from ` 1.0 trillion to ` 5.6 trillion during this period. It
is no mean achievement to manage such large issuances in a non-disruptive manner in the
post Fiscal Responsibility & Budget Management (FRBM) regime and declining SLR. A
large number of initiatives have been taken over the years, such as, the Primary Dealer
(PD) system, Delivery Vs Payment (DVP), centralised clearing, anonymous dealing
system based on order matching, floating rate bonds, STRIPS, Inflation Index Bonds
(IIBs), etc. The liquidity in the secondary market has also increased significantly from a
daily average trading volume of ` 9 billion in February 2002 to ` 344 billion in March,
2013. The development of the debt and the derivatives market in India needs to be seen
from the perspective of a central bank and a financial sector regulator which has a
mandate to facilitate development of debt markets of the country.
Corporate bond market
. The need for development of the debt market has assumed some urgency in recent times
for several reasons. A vibrant debt market plays an important role in enabling the
newcomers to bring their ideas and enterprise to fruition. The impending large scale
expenditure for improving our infrastructure critically depends on the debt market. It is
difficult for the public sector to finance development of a world-class infrastructure of the
magnitude envisaged because of its other commitments and the limitations imposed by
fiscal prudence. Though the banking sector has been playing an active role in
infrastructure finance, there are limitations imposed by Asset Liability Mismatch (ALM)
mismatch, exposure norms, and de-risking the financial system to provide stability to the
financial system.
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Developing a vibrant bond market

A vibrant corporate bond market provides an alternative to conventional bank finances,
thereby providing the corporates an additional avenue for raising resources and reducing
reliance on bank finance. A robust corporate bond market also ensures lower dependency
and therefore vulnerability of foreign currency sources of funds. A vibrant market will
also help in matching the investment needs of savers with the borrowing needs of the
corporates. A well-developed debt market enables efficient pricing of risk, promotes
product innovations and leads to greater financial stability. Further, mobilization of longterm funding for the infrastructure sector critically depends on a deep and liquid debt
market with a large set of diverse and sophisticated investors and a wide array of
instruments not only to provide vehicles of investment but also to manage the risk
entailed. In a developed bond market, banks, who would require long-term funds in the
context of Basel III requirements, would also be able to raise resources easily.
Development of government and corporate debt market may be approached within a
framework of seven key components, viz.,Issuers, Investors, Intermediaries,
Infrastructure, Innovation, Incentives and Instruments what I have called a 7i
framework.Sovereign securities dominate the fixed income markets almost everywhere.
In India too, the central and state governments remain the main issuers. The large supply
of securities, due to enhanced borrowings, has enabled creation of benchmark securities
with sufficient outstanding stock and issuances across the yield curve. The issuances
across the risk-free yield curve in turn, have provided benchmarks for valuation of other
bonds/financial assets and benefitted the corporate bond market. Fiscal consolidation
efforts of the Government of India and the State Governments enhance the quality of the
issuers. In the field of corporate bonds besides financial sector entities, large well rated
non-finance companies have also been issuers. The traditional investor base for G-Sec in
India comprised banks, provident funds and insurance companies with a dominance of
domestic investors and limited foreign participation. In the corporate debt market,
investor base is mostly confined to banks, insurance companies, provident funds, PDs
and pension funds. An approach of gradual opening of the domestic bond market to the
foreign investors has been adopted in India keeping in view the macro-economic risks
involved in providing unfettered access to them. Intermediaries play an important role in
development of the market by facilitating the transactions, providing value-added
services and increasing efficacy of the processes. In India, the major intermediaries are
the PDs, industry associations like Fixed Income Money Market & Derivatives
Association/Primary Dealers Association of India, Gilt Mutual Funds and the
Infrastructure Development Funds (IDFs). Infrastructure plays an important role in
development of markets and want of an efficient, transparent and robust infrastructure
can keep market participants away on one extreme or cause market crisis on the other.
India can boast of being one of the few emerging countries with such a state of the art
financial market infrastructure for the G-Sec market. A state-of-the-art primary issuance
process with electronic bidding and fast processing capabilities, dematerialized
depository system, DvP mode of settlement, electronic trading platforms (Negotiated
21

Dealing Systems and Negotiated Dealing Systems-Order Matching) and a separate
Central Counter Party in the Clearing Corporation of India Ltd. (CCIL) for guaranteed
settlement are among the steps that have been taken by the Reserve Bank over the years
towards this end. Financial innovation is an essential feature in the history of
development of financial markets. Innovations that are motivated by the need to match
the needs of the investor and the issuer or made possible by advancement in technology
or knowledge are essential for evolution of financial markets. Incentives play a
significant role in shaping the development, stability and functioning of the financial
markets. Reserve Bank has been trying to align incentives by regulation and supervision
though regulation itself may have created unintended incentives/disincentives as in the
case of requirement regarding Held To Maturity (HTM) dispensation. In the process of
development of new instruments, Reserve Banks endeavour has been to ensure
calibrated and orderly development of the markets with emphasis on prudent risk
management and promotion of financial stability
Within the limited scope of its engagement with the corporate debt segment as the
Securities and Exchange Board of India (SEBI) being the main regulator of this segment,
Reserve Bank has taken steps, such as, introducing Credit Default Swaps (CDS) to
manage credit risk, repo in corporate bonds to enable funding of positions, limited market
making role for the Primary Dealers, providing a pooling account facilities to the clearing
corporations of the exchanges to settle the trades in the books of the Reserve Bank of
India, etc. There has been a demand for increased direct or indirect support from the
banking sector for expanding the corporate debt market. Reserve Bank views such
proposals with caution because of the prudential concern for the health of the banking
sector as well as the fact that the intention is to generate incremental resources and not
redistribute the existing ones. As we know banks are already substantially exposed to the
infrastructure sector. Hence, demand for credit enhancement by banks has to be seen in
the context of the fact that it would only increase their exposure. Further, credit
enhancement by banks will not lead to development of a real corporate bond market.
Credit enhancements by way of partial guarantees by multilateral institutions, such as, the
Asian Development Bank is likely to attract investments from insurance and pension
funds in the infrastructure sector and lower the cost of funds for companies. Such credit
enhancement measures outside the banking system could be the way out.
22
Foreign exchange market

Current Account Deficit & Capital Flows
In the context of foreign exchange market, one of the most talked about issue is the rising
current account deficit (CAD). In recent times, CAD has been increasing and reached a
historic high of 6.7 per cent during the quarter October-December, 2012. It is of course
not sustainable in the long run. Therefore, a structural shift in the composition of our
trade account increasing exports and curtailing non-productive imports, such as, gold
is imperative. What needs to be emphasized is that the current account deficit has so far
been successfully financed without any drawdown on our foreign exchange reserves. This
has been possible with sustained capital inflows, which though not as buoyant as in the
pre-crisis days, has still been impressive. Nevertheless capital inflows cannot be taken for
granted and there is a need to create the enabling conditions to attract and retain longterm foreign capital. The urgency now comes from two sources: the need to bridge the
current account deficit and the need to provide resources particularly of the long term
type for infrastructure and other investment needs..
Capital account management
In the Indian context, management of capital account has been challenging. So far, the
approach of Reserve Bank of India has been that of cautious gradualism, informed by the
experience of other developing countries in Latin America and East Asia who perhaps
liberalized their capital account too soon and too fast. Yet, it should be recognized that as
far as the real sector is concerned, the capital account is substantially open with regard to
sourcing debt and equity from abroad as well as exploiting investment opportunity
abroad. The restrictions in capital account are pronounced as far as the financial sector is
concerned. The policy caution is motivated by apprehensions of sudden cessation or
reversal of flows, which some influential commentators believe to be unfounded. Even
within the constraints imposed by a gradualist approach, Reserve Bank and the
Government of India have taken several steps that include progressive increase in
investment limits for Foreign Institutional Investors (FIIs) in government and corporate
debt, introduction of Qualified Foreign Investor (QFIs) as a separate investor class, etc.
23

Exchange rate volatility
Talking about the external sector, I would like to briefly touch upon the issue of Rupee
volatility, because next perhaps only to the stock indices, sharp movements in the Rupee
usually agitate market participants, including those who have no direct exposure
In this context it must be recognized that in the post-Bretton Woods era, most currencies
have had their own episodes of volatility and particularly in the past few years during and
after the crisis, exchange rate volatility has become a way of life. Stance of Reserve Bank
of India has been not to target any band or level for the exchange rate, thereby enabling
Indian Rupee to move as per the market fundamentals but being ready to intervene to
curb excessive volatility. Second, Reserve Bank of India, over the years, has introduced a
wide array of hedging instruments which can be used by the real sector to deal with
volatility in the exchange rate. If on the other hand, businesses are unwilling to pay the
cost of hedging (which is directly proportional to the degree of volatility) and intend to
take a view on the exchange rate rather than concentrating on their own line of business,
they must be fully aware of the consequences.
Issues in liquidity management
At this particular point in time, Reserve Bank of India does not see paucity of resources
constraining economic growth, particularly in view of the fact that banks are holding
about ` 3.5 trillion of government debt in excess of the mandated limit. During the first
half of the year 2012-13, average net liquidity injection under the daily liquidity
adjustment facility (LAF) stood at `730 billion which increased to more than ` one trillion
during the second half. To alleviate liquidity pressures during the year, the Reserve Bank
has lowered the Cash Reserve Ratio (CRR) by 75 bps and the SLR by 100 bps besides
24

additional liquidity injection of more than ` 1.5 trillion through the open market
operations (OMOs). Reserve Bank remains alive to the requirements in time to come and
will appropriately manage liquidity to ensure adequate credit flow to the productive
sectors of the economy.
Financial Inclusion
Let me now turn to an area of weakness of the Indian financial system lack of depth of
financial inclusion that needs to be addressed with alacrity. Taking cognizance of the
extent of the problem and recognizing importance of financial inclusion based on the
principle of equity and inclusive growth with stability, Reserve Bank of India has
initiated a number of policies. In its recent Annual Monetary Policy 2013-14, Reserve
Bank has extended the Lead Bank Scheme to the metropolitan districts of the country.
Extension of the scheme to these areas is expected to provide an institutional mechanism
for co-ordination between government authorities and banks for reaching doorstep
banking to the financial excluded population. To further improve the banking penetration
through alternate channels, Reserve Bank of India has permitted non-bank entities to setup White Label ATMs (WLAs), to operate as Business Correspondents and to facilitate
large scale use of electronic banking and alternate delivery channels. Under the new bank
license policy of the Reserve Bank, new entities are expected to enhance the banking
penetration in India. These measures are also expected to provide platforms for
launching innovative processes, partnerships and products for ensuring a deeper financial
sector with a focus on sustainable financial inclusion. Enriched access to the financial
sector is expected to enable the marginal population to deal better with uncertainties,
enhance their productivity and bring them to the mainstream of the growth process.
25
Concluding thoughts
In conclusion, I would like to mention that the role of financial markets in the process of
a countrys economic development needs no emphasis. At the same time, as the recent
crisis has shown, financial markets can be the epicenter of crises that derail the growth
process itself and unleash great misery. Thus, in countries like India, where financial
markets are yet to achieve the size and sophistication as those of the more developed
countries, perhaps there is merit in adopting a cautious approach to financial
development.
That said, I wish to emphasize that Reserve Bank remains committed to ensure
availability of funding for all productive endeavour across the spectrum of economic
activities. Though the banking sector has done a great job so far in this regard, financial
markets have to play an increasingly important role in generating incremental funding,
particularly for expansion of the infrastructure sector. This explains the regulatory push
towards the development of the corporate bond market as an adjunct to the bankdominated financial system of India. Importance of the banking sector in the Indian
financial system, however, remains critical. The agenda to make the financial sector
responsive yet resilient has to include improving liquidity in the G-Sec market across the
tenor, create a liquid yield curve to provide a basis for pricing private debt, further
development of the corporate bond market, expanding the set of products and participants
in the derivative market to provide adequate hedging options for credit, interest rate and
forex risks, particularly at the long end and gradual capital account liberalization within
the framework of financial and macro-economic stability.
18. It may be noted that the role of the financial sector as well as its regulators is only
enabling. Ultimately, the enterprise and entrepreneurship in the real sector should be
unshackled to exploit and implement opportunities and ideas. As Joan Robinson
remarked, economic growth creates demand for financial instruments, and, where
enterprise leads, finance follows3.
Thank you for your attention.
26
GROWTH OF INDIAN FINANCIAL SYSTEM

The growth of financial sector in India at present is nearly 8.5% per year. The rise in the
growth rate suggests the growth of the economy. The financial policies and the monetary
policies are able to sustain a stable growth rate.
The reforms pertaining to the monetary policies and the macro economic policies over
the last few years has influenced the Indian economy to the core. The major step towards
opening up of the financial market further was the nullification of the regulations
restricting the growth of the financial sector in India. To maintain such a growth for a
long term the inflation has to come down further.
The financial sector in India had an overall growth of 15%, which has exhibited stability
over the last few years although several other markets across the Asian region were going
through a turmoil. The development of the system pertaining to the financial sector was
the key to the growth of the same. With the opening of the financial market variety of
products and services were introduced to suit the need of the customer. The Reserve Bank
of India (RBI) played a dynamic role in the growth of the financial sector of India.
The growth of financial sector in India was due to the development in sectors
Growth of the banking sector in India
The banking system in India is the most extensive. The total asset value of the entire
banking sector in India is nearly US$ 270 billion. The total deposits is nearly US$ 220
billion. Banking sector in India has been transformed completely. Presently the latest
inclusions such as Internet banking and Core banking have made banking operations
more user friendly and easy.
Growth of the Capital Market in India
The ratio of the transaction was increased with the share ratio and deposit system
The removal of the pliable but ill-used forward trading mechanism
The introduction of infotech systems in the National Stock Exchange (NSE) in order to
cater to the various investors in different locations
Privatization of stock exchanges
Growth in the Insurance sector in India
With the opening of the market, foreign and private Indian players are keen to convert
untapped market potential into opportunities by providing tailor-made products.
The insurance market is filled up with new players which has led to the introduction of
several innovative insurance based products, value add-ons, and services. Many foreign
companies have also entered the arena such as Tokio Marine, Aviva, Allianz, Lombard
General, AMP, New York Life, Standard Life, AIG, and Sun Life.
27

The competition among the companies has led to aggressive marketing, and distribution
techniques.
The active part of the Insurance Regulatory and Development Authority (IRDA) as a
regulatory body has provided to the development of the sector.
Growth of the Venture Capital market in India
The venture capital sector in India is one of the most active in the financial sector inspite
of the hindrances by the external set up.
Presently in India there are around 34 national and 2 international SEBI registered
venture capital funds
FINANCIAL SYSTEM AND ECONOMIC DEVELOPMENT THE LINKAGE

Theoretical models show that financial instruments, markets, and institutions may arise to
mitigate the effects of information and transaction costs. In emerging to ameliorate
market frictions, financial arrangements change the incentives and constraints facing
economic agents. Thus, financial system may influence saving rates, investment
decisions, technological innovation, and hence long-run growth rates. A comparatively
less well-developed theoretical literature examines the dynamic interactions between
finance and growth by developing models where the financial system influences growth,
and growth transforms the operation of the financial system. Furthermore, an extensive
theoretical literature debates the relative merits of different types of financial systems.
Some models stress the advantages of bank-based financial system, while others highlight
the benefits of financial system that rely more on securities markets. Finally, some new
theoretical models focus on the interactions between finance, aggregate growth, income
distribution, and poverty alleviation. In all of these models, the financial sector provides
real services, i.e., it ameliorates information and transactions costs. Thus, these models
lift the veil that sometimes rises between the so-called real and financial sectors.
The financial system interacts with real economic activity through its various functions
by which it facilitates economic exchange. First, the financial system facilitates trade of
goods and services. An efficient financial system reduces information and transaction
costs in trade and helps the payments mechanism. Second, it increases saving
mobilization by an improvement of the savers confidence. By facilitating portfolio
diversification, financial intermediaries allow savers to maximize returns to their assets
and to reduce risk. Third, it plays an important role in mobilizing funds and transforming
them into assets that can better meet the needs of investors either by direct, market-based
financing or by indirect, bank-based finance. Financial intermediaries transfer resources
across time and space, thus allowing investors and consumers to borrow against future
28

income and meet current needs. This enables deficit units (those whose current
expenditures exceed current income) to overcome financing constraints and the
difficulties arising from mismatches between income and expenditure flows. Fourth,
financial institutions play an important role in easing the tension between savers
preference for liquidity and entrepreneurs need for long-term finance. Therefore, at any
given level of saving, an efficient financial system will allow for a higher level of
investment by maximizing the proportion of saving that actually finances investment
(Pagano, 1993). With an efficient financial system, resources will also be utilized more
efficiently due to the ability of financial intermediaries to identify the most productive
investment opportunities.
Fifth, financial system plays an important role in creating a pricing information
mechanism. By providing a mechanism for appraisal of the value of firms, financial
system allows investors to make informed decisions about the allocation of their funds.
Financial intermediaries can also mitigate information asymmetries that characterize
market exchange. One party to a transaction often has valuable information that the other
party does not have. In such circumstances, there may be unexploited exchange
opportunities. In the case of a firm, information imperfections can result in sub-optimal
investment. When a manager cannot fully and credibly reveal information about a worthy
investment project to outside investors and lenders, the firm may not be able to raise the
outside funds necessary to undertake such a project (Myers and Majluf, 1984). A market
plagued by information imperfections, the equilibrium quantity and quality of investment
will fall short of the economys potential. Financial intermediaries can mitigate such
problems by collecting information about prospective borrowers.
Sixth, the financial system can enhance efficiency in the corporate sector by monitoring
management and exerting corporate control (Stiglitz, 1985). Savers cannot effectively
verify the quality of investment projects or the efficiency of the management. Financial
intermediaries can monitor the behavior of corporate managers and foster efficient use of
borrowed funds better than savers acting individually. Financial intermediaries thus fulfill
the function of delegated monitoring by representing the interests of savers (Diamond,
1984). Financial markets also can improve managerial efficiency by promoting
competition through effective takeover or threat of takeover (Jensen and Meckling,
1976).
Both market and bank-based financial systems have their own comparative advantages.
The choice of a bank-based or market-based financial system emerges from firmfinancing preferences, and efficiency of financial and legal systems (Chakraborty and
Ray, 2005). For some industries at certain times of their development, market-based
financing is advantageous. For example, financing through stock markets is optimal for
industries where there are continuous technological advances and where there is little
consensus on how firms should be managed. The stock market checks whether the
manager's view of the firm's production is a sensible one. On the other hand, bank-based
financing is preferable for industries which face strong information asymmetries.
Financing through financial intermediaries is an effective solution to adverse selection
and moral hazard problems that exist between lenders and borrowers (Holmstrom and
Tirole, 1997). Banks, in particular, reduce costs of acquiring and processing information
29

about firms and their managers and thereby reduce agency costs as they have developed
expertise to distinguish between good and bad borrowers (Boyd and Prescott, 1986;
Diamond, 1984). Furthermore, Boot and Thakor (1997) argue that bank lending is likely
to be important when investors face ex post moral hazard problems, with firms of higher
observable qualities borrowing from the capital market. In contrast, Allard and Blavy
(2011) find that market-based economies experience significantly and durably stronger
rebounds than the bank-based ones. Lee (2012) finds that in the US, the UK and Japan,
the stock market played an important role in financing economic growth, whereas the
banking sector played a more important role in Germany, France, and Korea.
Furthermore, the banking sector and the stock market in each country were
complementary to each other in the process of economic growth except for the US, where
the two sectors were mildly substitutable.
The abovementioned argument points out that bank-based finance system outperforms
the market-based one for economies with underdeveloped capital market. However,
economies that have both well-developed banking sector and capital market have an
advantage of following any of the intermediation process. Furthermore, in times of crisis
in either system, the other system can perform the function of the famous spare wheel
FINANCIAL SYSTEM IN INDIA STYLIZED FACTS

Until the early 1990s, the role of the financial system in India was primarily restricted to
the function of channeling resources from the surplus to deficit sectors. Whereas the
financial system performed this role reasonably well, its operations came to be marked by
some serious deficiencies over the years. The banking sector suffered from lack of
competition, low capital base, low productivity and high intermediation cost. After the
nationalization of large banks in 1969 and 1980, public ownership dominated the banking
sector. The role of technology was minimal and the quality of service was not given
adequate importance. Banks also did not follow proper risk management system and the
prudential standards were weak. All these resulted in poor asset quality and low
profitability. Among non-banking financial intermediaries, development finance
institutions (DFIs) operated in an over-protected environment with most of the funding
coming from assured sources at concessional terms. 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 no regulation 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. Apart from inhibiting the development
of the markets, this also affected their efficiency (RBI, 2003, 2004).
Against this backdrop, wide-ranging financial sector reforms in India were introduced as
an integral part of the economic reforms initiated in the early 1990s. Financial sector
reforms in India were grounded in the belief that competitive efficiency in the real sectors
of the economy will not be realized to its full potential unless the financial sector was
reformed as well. Thus, the principal objective of financial sector reforms was to improve
the allocative efficiency of resources and accelerate the growth process of the real sector
30

by removing structural deficiencies affecting the performance of financial institutions and
financial markets.
The main thrust of reforms in the financial sector was on the creation of efficient and
stable financial institutions and markets. Reforms in respect of the banking as well as
non-banking financial institutions focused on creating a deregulated environment and
enabling free play of market forces while at the same time strengthening the prudential
norms and the supervisory system. In the banking sector, the focus was on imparting
operational flexibility and functional autonomy with a view to enhancing efficiency,
productivity and profitability, imparting strength to the system and ensuring
accountability and financial soundness. The restrictions on activities undertaken by the
existing institutions were gradually relaxed and barriers to entry in the banking sector
were removed. In the case of non-banking financial intermediaries, reforms focused on
removing sector-specific deficiencies. Thus, while reforms in respect of DFIs focused on
imparting market orientation to their operations by withdrawing assured sources of funds,
in the case of NBFCs, the reform measures brought their asset side also under the
regulation of the Reserve Bank. In the case of the insurance sector and mutual funds,
reforms attempted to create a competitive environment by allowing private sector
participation.
Reforms in financial markets focused on removal of structural bottlenecks, introduction
of new players/instruments, free pricing of financial assets, relaxation of quantitative
restrictions, improvement in trading, clearing and settlement practices, more
transparency, etc. Reforms encompassed regulatory and legal changes, building of
institutional infrastructure, refinement of market microstructure and technological
upgradation. In the various financial market segments, reforms aimed at creating liquidity
and depth and an efficient price discovery process.
Reforms in the commercial banking sector had two distinct phases. The first phase of
reforms, introduced subsequent to the release of the Report of the Committee on
Financial System, 1992 (Chairman: Shri M. Narasimham), focused mainly on enabling
and strengthening measures. The second phase of reforms, introduced subsequent to the
recommendations of the Committee on Banking Sector Reforms, 1998 (Chairman: Shri
M. Narasimham) placed greater emphasis on structural measures and improvement in
standards of disclosure and levels of transparency in order to align the Indian standards
with international best practices.
During the last four decades, particularly after the first phase of nationalization of banks
in 1969, there have been distinct improvements in the banking activities which
strengthened the financial intermediation process. The total number of offices of public
sector banks which was merely at 8262 in June 1969 increased to 62,607 as of June 2011
(Table 1). Similarly, there have been many fold increases in aggregate deposits and credit
indicating existence of a vibrant bank-based financial system.
Some interesting insights could be drawn while examining various indicators of financial
development in India (Table 2). First, an important indicator of bank-based financial
deepening, i.e., private sector credit has expanded rapidly in the past five decades thereby
supporting the growth momentum. However, the domestic credit provided by the Indian
banks still remains at an abysmally low as compared with major emerging market and
developing economies (EDEs) and advanced economies (Table 3). Furthermore, the
level of credit disbursement is also far below the world average levels. Therefore, there is
31

scope for the Indian banks to expand their business to important productive sectors of the
economy.
Second, financial innovations have influenced velocity circulation of money by both
reducing the transaction costs and enhancing the liquidity of financial assets. A relatively
increasing value of velocity could be seen as a representative indicator of an efficient
financial sector. Increasing monetization of the economy, which would be particularly
relevant for EDEs, may imply falling money velocity. In Indian case, the velocity
circulation of broad money has fallen since 1970s partly reflecting the fact that, in the
midst of crisis, money injected to the system could not get distributed efficiently from the
banking system to non-banks. Sharper fall in the velocity of narrow money reflected
reluctance among banks as well as the public to part with liquidity (Pattanaik and
Subhadhra, 2011).
Third, the market-based indicator of financial deepening, i.e., market capitalization-toGDP ratio has increased very sharply in the past two decades implying for a vibrant
capital market in India (Table 2). Market capitalization as a ratio of GDP fell in 2008
reflecting the peak of the global financial market crisis during the year and sharp decline
in major stock indices (Table 4). After a period of broader stability in the global financial
markets for about two years, financial markets worldwide fell again in 2011 due to
heightened sovereign debt crisis in the euro area. As a result, leading stock markets
declined in 2011 and market capitalization fell. Various reform measures undertaken
since the early 1990s by the Securities and Exchange Board of India (SEBI) and the
Government of India have brought about a significant structural transformation in the
Indian capital market. Although the Indian equity market has become modern and
transparent, its role in capital formation continues to be limited. Unlike in some advanced
economies, the primary equity and debt markets in India have not yet fully developed.
The size of the public issue segment has remained small as corporates have tended to
prefer the international capital market and the private placement market. The private
corporate debt market is active mainly in the form of private placements.
A comparison of bank-based indicator reported in Table 3 and market-based indicator
in Table 4 provide some useful insights. In Table 3, it may be observed that credit
provided by the banking sector as a percentage of GDP has increased steadily over the
years from 37.0 percent in 1980 to 75.1percent in 2011. On the other hand, stock market
capitalization as a percentage of GDP increased from 11.8 percent in 1990 to 54.9 percent
in 2011 (Table 4). It may also be noticed that stock market capitalization as a percentage
of GDP increased sharply in 2009 and 2010. These sharp gains in market capitalization to
GDP ratio in 2009 could be attributed to valuation gains due to steep rise in share prices
from a very low level in 2008 as the global financial crisis heightened. Furthermore, yearwise comparison of ratios in Table 3 and Table 4 reveals that barring a few years, credit to
GDP ratio was higher than market capitalization to GDP ratio implying that financial
system in India is more biased towards bank-based.
32
RISK AND ITS SOLUTIONS :
The financial system is growing to be highly complex and opaquesometimes

making it difficult to assess the extent of exposures and potential spillovers. This
opacity magnified the shock to confidence as the recent crisis unfolded.
the financial system has a propensity to become over-leveraged and heavily

interconnected, leading to massive deleveraging and easily available propagation
channels, both domestically and globally.
liquidity risks, both the funding risks incurred by institutions and the associated
market liquidity risks of assets, are often much higher than recognized.
financial intermediation has increasingly shifted to the non - or less-regulated

shadow banking sector, in large part to avoid the more stringent requirements
imposed on banks.
there is a critical absence of effective mechanisms to deal with institutions that

were deemed too big to fail.
How do regulators meet the above challenges?
Central banks must take a long-term view of the economy and craft appropriate
policy responses. We must have the latitude to raise interest rates when others
want cheap credit and rein in risky financial practices when others want easy
profits. There has to be greater societal consensus on taking tough corrective
actions.
While progress on macro and micro-prudential regulations will be the key for
moving forward, some work is still needed from the regulators in providing
guidance to the market in instituting a mechanism in the area of managing not
only several known unknowns but also a number of unknown unknowns.
With the benefit of hindsight, low nominal interest rates, abundant liquidity and a
favorable macroeconomic environment encouraged the private sector to take on
ever-increasing risks. Financial institutions provided loans with inadequate checks
on borrowers ability to pay and developed new and highly complex financial
products in an attempt to extract ever higher returns. Meanwhile, many financial
regulators and supervisors were lulled into complacency and did not respond to
the building up of vulnerabilities. We have to develop more sensitivity in our
policy tools to capture and quickly correct our policy stance to control such covert
signs of overheating.
33
PRE-REFORM PHASE:
Until the early 1990s, the role of the financial system in India was primarily
restricted to the function of channeling resources from the surplus to deficit sectors.
Whereas the financial system performed this role reasonably well, its operations
came to be marked by some serious deficiencies over the years. The banking sector
suffered from lack of competition, low capital base, low Productivity and high
intermediation cost. After the nationalization of large banks in 1969 and 1980, the
Government-owned banks dominated the banking sector. The role of technology was
minimal and the quality of service was not given adequate importance. Banks also
did not follow proper risk management systems and the prudential standards were
weak. All these resulted in poor asset quality and low profitability. Among nonbanking financial intermediaries, development finance institutions (DFIs) operated in
an over-protected environment with most of the funding coming from assured
sources at concessional terms. 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 no regulation 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. This apart from inhibiting the
development
of
the
markets
also
affected
their
efficiency.
34
FINANCIAL SECTOR REFORMS IN INDIA

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 financial
institutions and markets. The approach to financial sector reforms in India was one
of gradual and non-disruptive progress through a consultative process. The Reserve
Bank has been consistently working towards setting an enabling regulatory
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. Persistent efforts have been made
towards adoption of international benchmarks as appropriate to Indian conditions.
While certain changes in the legal infrastructure are yet to be effected, the
developments so far have brought the Indian financial system closer to global
standards.
The reform of the interest regime constitutes an integral part of the financial sector
reform. With the onset of financial sector reforms, the interest rate regime has been
largely deregulated with a view towards better price discovery and efficient resource
allocation. Initially, steps were taken to develop the domestic money market and
freeing of the money market rates. The interest rates offered on Government
securities were progressively raised so that the Government borrowing could be
carried out at market-related rates. In respect of banks, a major effort was
undertaken to simplify the administered structure of interest rates. Banks now have
sufficient flexibility to decide their deposit and lending rate structures and manage
their assets and liabilities accordingly. At present, apart from savings account and
NRE deposit on the deposit side and export credit and small loans on the lending
side, all other interest rates are deregulated. Indian banking system operated for a
long time with high reserve requirements both in the form of Cash Reserve Ratio
(CRR) and Statutory Liquidity Ratio (SLR). This was a consequence of the high fiscal
deficit and a high degree of monetisation of fiscal deficit. The efforts in the recent
period have been to lower both the CRR and SLR. The statutory minimum of 25 per
cent for SLR has already been reached, and while the Reserve Bank continues to
pursue its medium-term objective of reducing the CRR to the statutory minimum
level of 3.0 per cent, the CRR of SCBs is currently placed at 5.0 per cent of NDTL.
As part of the reforms programme, due attention has been given to diversification of
ownership leading to greater market accountability and improved efficiency. Initially,
there was infusion of capital by the Government in public sector banks, which was
followed by expanding the capital base with equity participation by the private
investors. This was followed by a reduction in the Government shareholding in public
sector banks to 51 per cent. Consequently, the share of the public sector banks in
the aggregate assets of the banking sector has come down from 90 per cent in 1991
to around 75 per cent in2004. With a view to enhancing efficiency and productivity
through competition, guidelines were laid down for establishment of new banks in
the private sector and the foreign banks have been allowed more liberal entry. Since
1993, twelve new private sector banks have been set up. As a major step towards
enhancing competition in the banking sector, foreign direct investment in the private
sector banks is now allowed up to 74 per cent, subject to conformity with the
guidelines
issued
from
time
to
time.
35
CONCLUSION
In India money market is regulated by Reserve bank of India (www.rbi.org.in) and
Securities Exchange Board of India (SEBI) [www.sebi.gov.in ] regulates capital market.
Capital market consists of primary market and secondary market. All Initial Public
Offerings comes under the primary market and all secondary market transactions deals in
secondary market. Secondary market refers to a market where securities are traded after
being initially offered to the public in the primary market and/or listed on the Stock
Exchange. Secondary market comprises of equity markets and the debt markets. In the
secondary market transactions BSE and NSE plays a great role in exchange of capital
market instruments.
In the context of the ongoing financial crisis and falling growth momentum worldwide,
this paper made an attempt to revisit the role of financial structures in economic growth.
It empirically re-examined the relationship between financial depth and economic
development in the Indian context based on both banking and equity market indicators of
financial deepening. Preliminary analysis revealed that credit disbursement by Indian
banks has increased sharply in the past decades, although it is still far below the world
average level and even below its EDEs peers. However, the market capitalization of
Indian stock market is comparable with leading stock markets in the advanced economies
as well as in EDEs. The empirical estimation is based on the premise of the endogenous
growth theory which postulates that financial development improves the efficiency of
capital allocation leading higher long-term growth. The study finds one-way Granger
causality from bank-based financial depth to economic development supporting the
premise that growth is more of supply-driven. However, no evidence of causality
between market capitalization and economic development was found. A detailed analysis
based on cointegration method revealed that both the bank-based and market-based
indicators of financial depth have positive impact on economic development in India.
The empirical findings of the study provide important policy insights in the Indian
context. As the Indian financial sector is largely bank-centric, the performance of the
banking sector is crucial in the development process of the economy. Given the potential
of further credit disbursement by Indian banks, there is still scope for them to channelize
credit to the productive sectors of the economy. Therefore, Indian banks need to develop
strong linkages with the real sector to develop the ability to maintain high growth levels
over a sustained period of time which was one of the critical lessons emerged from the
global financial crisis.
The Indian financial system has undergone structural transformation over the past decade.
The financial sector has acquired strength, efficiency and stability by the combined effect
of competition, regulatory measures, and policy environment. While competition,
consolidation and convergence have been recognized as the key drivers of the banking
sector in the coming years
36

BIBILOGRAPHY
The Financial System of India by Gyan Chand.2000
Financial Markets and Services, Gordon, Natarajan, Himalaya
Publishing House, 4th revised edition, 2007.
WIBLIOGRAPHY.
http://mbaseminars.blogspot.com/2010/05/indian-financialsystem.html#ixzz2iBwN0B4t
http://www.agii.gr/repository/upload/Indian%20Capital%20markets%20and%20financial
%20system.pdf
http://www.bizresearchpapers.com
https://www.indianembassy.org/financial-system-in-india.php
http://mbaseminars.blogspot.in/2010/05/indian-financial-system.html
37

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Indian Financial System

Indian Financial System

Indian Financial System

INDIAN FINANCIAL SYSTEM

Financial System of any country consists of financial markets, financial intermediation

Indian Financial System

Indian Financial System

Financial System is an institutional framework existing in a country to enable financial

The economic development of a nation is reflected by the progress of the various

Indian Financial System

Indian Financial System

Indian Financial System

CONSITUENTS OF FINANCIAL SYSTEM:

Indian Financial System

Indian Financial System

Capital market consists of:

Indian Financial System

Industrial securities market:

Indian Financial System

3.FINANCIAL INSTRUMENT/ FINANCIAL ASSETS

Indian Financial System

2.Capital Market Instruments

Indian Financial System

Financial instruments can also be called financial securities. Financial

Indian Financial System

Features of financial system

Characteristic Features of Financial Instruments

These instruments facilitates future trading so as to cover risks due to price

These instruments involve less handling costs since expenses involved in

The return on these instruments is directly in proportion to the risk undertaken

These instruments may be short-term or medium term or long term depending

FUNCTIONS OF FINANCIAL SYSTEM

Indian Financial System

Good financial system search in the following ways :

6. Minimizes situations of Asymmetric information:

Indian Financial System

Indian Financial Markets: Fuelling the Growth of the Indian Economy

Indian Financial System

Bank-based financial sector of India

Indian Financial System

Indian Financial System

Indian Financial System

Developing a vibrant bond market

Indian Financial System

Indian Financial System

Foreign exchange market

Indian Financial System

Indian Financial System

Indian Financial System

Indian Financial System

GROWTH OF INDIAN FINANCIAL SYSTEM

Indian Financial System

FINANCIAL SYSTEM AND ECONOMIC DEVELOPMENT THE LINKAGE

Indian Financial System

Indian Financial System

FINANCIAL SYSTEM IN INDIA STYLIZED FACTS

Indian Financial System

Indian Financial System

Indian Financial System

RISK AND ITS SOLUTIONS :

The financial system is growing to be highly complex and opaquesometimes

the financial system has a propensity to become over-leveraged and heavily