Financial System: The economic development of a nation is reflected by the progress of the various economic units, broadly classified

d into corporate sector government and Household sector.

While performing their activities these units will be placed in a surplus/deficit/balanced budgetary situations. Means - 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. It plays a vital role in growth of the economy of a country by mobilizing the scarce resources of a country and allocating them to required use It is a complex, well-integrated set of subsystems of financial institutions, markets, instruments, services which facilitates the transfer and allocation of funds efficiently and effectively

Financial system is characterized by the co-existence of the Formal and informal financial sectors commonly referred to as Financial Dualism o Formal Financial System well organized, institutional and regulated system catering to the modern spheres of economy o Informal Financial System unorganized, un-institutional and non-regulated system developed due to financial repressions and certain deprived sections of the society from accessing funds Characterized by the Flexibility of operations, depending on the relationships between the lender and seeker, exploitation

Indian Financial System: Broadly classified into formal and informal financial system Informal System Mainly Consists of o Individual money lenders (friends, landlords, neighbors, traders etc) o Group of persons operating as funds or association o Partnership firms consisting of local brokers and NBFCs like investment companies, chit fund companies etc. Formal System o Comes under the purview of Ministry of Finance, Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI) and other regulatory bodies like IRDA, AMFI etc o Mainly composed of Financial Institutions These are intermediaries that affects generation of savings, mobilizes these savings and facilitates the allocation of funds in an efficient manner Can be classified as Banking and Non Banking Banking institutions creates and supplies the credit whereas the non banking only supplies the credit The main Non-Banking institutions are DFIs (Development Financial Institutions), NBFCc (Non-Banking Financial Institutions), HFCs (Housing Finance Institutions) They can be specialized finance institutions such as SIDBI, NABARD, IDBI, ICICI They can be investment institutions like LIC, GIC, UTI etc They can be state level or national level Financial Markets Imaginary marketplace bringing the seeker and supplier of funds together and provides a platform to deal in financial claims Also provide the facility to set the price (interest rate) for such claims Of two types o Capital Market dealing in long- term instruments and financial claims ( more than one year) o Money Market dealing in short -term instruments (less than one year) Can be classified into o Primary deals with new issues (first time issued securities IPOs) o Secondary deals in outstanding securities Financial Instruments Are the outstanding financial claims against a person or institution for payment at a future date of a sum of money eg shares, bonds, debentures, notes Enable channelizing funds from surplus units to deficit units They are freely marketable in the organized markets and thus reduces the risk of investors They are negotiable and tradable and hence they ensure the financial liquidity Are of two types

Primary Instruments Also called as direct securities. These securities are directly issues by the ultimate borrowers to the ultimate lenders/savers. Eg IPOs, FPOs o Secondary Instruments - these are indirect securities as they are issued by the intermediaries to the ultimate savers. Eg. Bank deposits, Mutual Funds, insurance policies, shares Financial Services These are those services that help in borrowing and funding, lending and investing, buying, selling, enabling and making payments and managing risk exposures in financial market. They also bridge the gap between the lack of knowledge on the part of investor and increasing complex instruments They enable quick, safe and convenient transfer of funds and settlements of transactions. Various financial services are merchant banking, leasing, hire-purchase, credit rating, bill discounting, venture capital etc Are of two types o Fund based Asset based. Services that involves lending money o Fee Based - Advisory services. Services that involves advice/non fund activities

Financial System

Formal

Informal

Financial Market

Financial Intermediaries

Financial Instruments

Financial Services

Primary Market

Secondary Market

Banking

Non Banking (NBFC's)

Primary Instruments

Secondary Instruments

Fund BAsed

Fee Based

Capital Market

Money Market

Long Term

Short Term

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Financial Markets Financial Intermediaries

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Ultimate Lenders

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Ultimate Borrowers

Financial Instruments/Claims Financial System

Capital Formation

Economic Growth

Functions of Financial System: To link savers and seekers of fund and thus help in mobilizing and allocating the savings efficiently and effectively It not only fund the projects but also monitors the performance of the investment through corporate monitoring and control Provides for payment mechanism for the exchange of goods and services in a safe, quick and timely manner Transfer economic resources across time, place and parties and thereby enable financial transactions Helps in pooling and trading the risk involved in mobilizing savings and aims at limiting risk at acceptable limits. This is done by o Laying down the rules and regulations governing the operation of system o By holding diversified portfolios and screening of borrowers o By providing protection from unexpected losses Makes available the price-related and other financial information to those who need to make financial decision regarding investment, divestment, re-investment. It also make sure that this information is available on unbiased and non-preferential basis so that some should not take advantage of such information over others. It also reduces the cost of such gathering and analyzing such information. It provides a ready market for securities to buy/sell wide variety of financial assets in a cheap, quick and reliable way and thereby enhancing the liquidity of the portfolio Helps in reducing the cost of financial transaction by providing a structure that enables such transactions in a cheap, faster, effective and efficient way Helps in

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financial deepening refers to the increase in financial assets as the percentage of GDP Financial Broadening refers to building increasing number of participants and variety of instruments