UNIT I FINANCIAL SYSTEM

NATURE OR FEATURES OF FINANCIAL SYSTEM:

The financial system has several key features that contribute to its functionality
and effectiveness in the economy:

1. Intermediation: The financial system acts as an intermediary between

savers and borrowers, facilitating the flow of funds from those who have
excess capital to those who need it for investment.
2. Liquidity: It provides liquidity, allowing assets to be easily converted
into cash. This is essential for businesses and individuals to meet their
short-term financial obligations.
3. Variety of Instruments: The system offers a wide range of financial
instruments, such as stocks, bonds, mutual funds, and derivatives,
catering to different risk preferences and investment needs.
4. Risk Management: Through various products like insurance and
derivatives, the financial system helps individuals and businesses manage
financial risks.
5. Price Discovery: The system enables the determination of prices for
financial assets through supply and demand dynamics in financial
markets, helping investors make informed decisions.
6. Information Efficiency: It plays a crucial role in gathering, processing,
and disseminating information about financial assets and market
conditions, which aids in decision-making.
7. Regulation and Oversight: A robust regulatory framework ensures the
stability, transparency, and integrity of the financial system, protecting
investors and maintaining public confidence.
8. Global Integration: Modern financial systems are increasingly
interconnected globally, allowing for cross-border investment and
lending, which enhances capital mobility.
9. Innovation: The financial system is a hub for financial innovation,
leading to the development of new products and services that meet
changing consumer and business needs.
10.Support for Economic Growth: By efficiently allocating resources and
providing funding for businesses and infrastructure, the financial system
supports overall economic growth and development.

ROLES:

The financial system plays several crucial roles in the economy, facilitating
growth, stability, and efficient resource allocation. Here are its primary
functions:

1. Mobilizing Savings: It channels individual and institutional savings into

productive investments, enabling capital formation and economic
development.
 2. Providing Credit: The system offers loans and credit facilities, allowing
businesses and consumers to finance purchases, investments, and
expansion, which stimulates economic activity.
3. Facilitating Investment: By providing access to various financial
instruments, the system encourages both domestic and foreign
investments, contributing to infrastructure development and innovation.
4. Ensuring Liquidity: It provides mechanisms for converting assets into
cash quickly, ensuring that businesses and individuals can meet their
short-term financial obligations.
5. Risk Management: The financial system offers tools and instruments
(like insurance and derivatives) that help individuals and businesses
manage various financial risks, such as market fluctuations and
unforeseen events.
6. Price Discovery: It facilitates the determination of asset prices through
market interactions, helping investors assess value and make informed
decisions.
7. Enhancing Efficiency: By improving information flow and reducing
transaction costs, the financial system increases the efficiency of resource
allocation in the economy.
8. Promoting Economic Stability: A well-regulated financial system
contributes to economic stability by preventing excessive risk-taking and
promoting sound financial practices.
9. Facilitating International Trade: The financial system supports cross-
border transactions and investments, enhancing global trade and
economic integration.
10.Fostering Economic Growth: By efficiently allocating resources and
providing access to capital, the financial system plays a vital role in
driving overall economic growth and improving living standards.

OVERVIEW ON INDIAN FINANCIAL SYSTEMS:

The Indian financial system is a complex and evolving framework that plays a
crucial role in the country’s economic development. It consists of various
institutions, markets, instruments, and regulatory mechanisms. Here’s an
overview:

Key Components

1. Financial Institutions:
o Commercial Banks: These are the backbone of the financial
system, providing a range of services, including savings accounts,
loans, and investment products.
o Non-Banking Financial Companies (NBFCs): These provide
similar financial services but are not licensed as banks. They play a
vital role in extending credit, particularly to sectors underserved by
traditional banks.
 Insurance Companies: They provide risk management through
o
life, health, and property insurance.
o Mutual Funds: These pool money from investors to invest in a
diversified portfolio of stocks, bonds, or other securities.
o Development Financial Institutions (DFIs): They provide long-
term financing for economic development projects.
2. Financial Markets:
o Capital Market: Includes stock exchanges like the Bombay Stock
Exchange (BSE) and National Stock Exchange (NSE) where
equities and corporate bonds are traded.
o Money Market: Deals with short-term borrowing and lending,
including treasury bills and commercial paper.
o Foreign Exchange Market: Facilitates the trading of currencies,
crucial for international trade and investment.
3. Financial Instruments:
o Equity Shares: Represent ownership in a company.
o Debt Instruments: Include bonds, debentures, and government
securities, used for borrowing funds.
o Derivatives: Financial contracts whose value is derived from
underlying assets, used for hedging and speculation.
4. Regulatory Framework:
o Reserve Bank of India (RBI): The central bank that regulates the
monetary policy, manages currency, and oversees the banking
sector.
o Securities and Exchange Board of India (SEBI): Regulates the
securities market, ensuring investor protection and market
integrity.
o Insurance Regulatory and Development Authority of India
(IRDAI): Regulates the insurance sector.

Features

 Diversity: The Indian financial system includes a mix of formal and

informal institutions catering to various segments of the population.
 Growth-Oriented: It supports economic growth through investment in
infrastructure and development projects.
 Increasing Financial Inclusion: Initiatives like Jan Dhan Yojana aim to
provide banking services to the unbanked population, promoting broader
access to financial services.
 Technological Advancements: The rise of fintech has transformed the
financial landscape, enabling digital payments, mobile banking, and
online lending.

Challenges

 Regulatory Complexity: Multiple regulators and regulations can lead to

confusion and inefficiencies.
  Non-Performing Assets (NPAs): High levels of NPAs in the banking
sector pose risks to financial stability.
 Financial Literacy: Limited awareness and understanding of financial
products among the general population hinder effective participation in
the financial system.

Conclusion

The Indian financial system is crucial for supporting economic growth and
development. While it has made significant progress, ongoing reforms and
improvements are needed to enhance efficiency, stability, and inclusivity.

FINANCIAL SECTOR REFORMS:

Financial sector reforms are crucial for enhancing the efficiency, stability, and
inclusiveness of a country's financial system. In India, several key reforms have
been undertaken, particularly since the early 1990s. Here’s an overview of the
major financial sector reforms in India:

1. Liberalization of the Financial Sector

 Economic Reforms of 1991: Marked the beginning of significant

changes, moving from a regulated economy to a more market-oriented
approach. This included the deregulation of interest rates and removal of
restrictions on bank lending.

2. Banking Sector Reforms

 Nationalization to Privatization: Initially, banks were nationalized to

increase access to banking services. Later, reforms allowed for the entry
of private and foreign banks, enhancing competition.
 Capital Adequacy Norms: Introduction of norms based on Basel I and II
standards to ensure banks maintain sufficient capital buffers.
 Asset Reconstruction Companies (ARCs): Established to manage and
recover non-performing assets (NPAs), improving the health of banks.

3. Development of Financial Markets

 Establishment of Stock Exchanges: The Bombay Stock Exchange

(BSE) and National Stock Exchange (NSE) were modernized, with
electronic trading systems to improve efficiency.
 Regulatory Framework: Strengthening the role of the Securities and
Exchange Board of India (SEBI) to enhance transparency, investor
protection, and market integrity.
4. Enhancement of the Role of Non-Banking Financial Companies (NBFCs)

 Regulation and Licensing: Increased scrutiny and regulation of NBFCs

to ensure stability while allowing them to play a vital role in credit
delivery, especially in underserved sectors.

5. Insurance Sector Reforms

 Liberalization: The entry of private players and foreign investment in the

insurance sector was permitted, leading to increased competition and
product offerings.
 Insurance Regulatory and Development Authority of India (IRDAI):
Established to regulate and promote the insurance industry.

6. Promoting Financial Inclusion

 Microfinance Institutions (MFIs): Support for MFIs to provide credit to

low-income groups and small enterprises.
 Jan Dhan Yojana: Aimed at ensuring access to banking facilities for all
citizens, promoting savings and financial literacy.

7. Digital Transformation

 Introduction of Digital Payment Systems: Initiatives like the Unified

Payments Interface (UPI), National Payments Corporation of India
(NPCI), and mobile banking have revolutionized transactions.
 Fintech Innovation: Encouragement of fintech startups to enhance
service delivery, reach underserved populations, and increase efficiency.

8. Regulatory Reforms

 Strengthening Regulatory Frameworks: Ongoing efforts to improve

governance and oversight, ensuring stability in the financial system.
 Banking Ombudsman Scheme: Introduced to address customer
grievances and enhance trust in the banking sector.

9. Corporate Governance and Transparency

 Improved Disclosure Norms: Enhanced requirements for corporate

governance and financial disclosures to protect investor interests.

Conclusion

Financial sector reforms in India have significantly transformed the landscape,

promoting growth, stability, and accessibility. While considerable progress has
been made, ongoing reforms and adaptations are essential to address emerging
challenges and ensure a resilient financial system.
RBI:

The Reserve Bank of India (RBI) is the central bank of India and plays a critical
role in the country’s financial system and economic stability. Here’s an
overview of its functions, structure, and significance:

Key Functions of RBI

1. Monetary Policy:
o The RBI formulates and implements monetary policy to manage
inflation and stabilize the currency. It uses tools like the repo rate,
reverse repo rate, and cash reserve ratio (CRR) to influence money
supply and interest rates.
2. Regulation and Supervision of Banks:
o The RBI oversees commercial banks, ensuring their financial
health and compliance with regulatory norms. It establishes
guidelines for bank operations and conducts inspections.
3. Currency Issuance:
o The RBI has the exclusive authority to issue currency notes (except
one-rupee notes and coins), managing the country’s money supply
and ensuring the integrity of the currency.
4. Foreign Exchange Management:
o The RBI manages the Foreign Exchange Management Act
(FEMA) to facilitate external trade and payments while promoting
orderly development and maintenance of the foreign exchange
market in India.
5. Banker to the Government:
o It acts as the banker and financial advisor to the government,
managing its accounts and public debt. The RBI also facilitates
government transactions.
6. Developmental Role:
o The RBI promotes financial inclusion and supports the
development of financial markets. It also encourages the growth of
rural banking and small-scale industries.
7. Payment and Settlement Systems:
o The RBI regulates and oversees payment systems in India,
ensuring their efficiency, security, and accessibility. Initiatives like
the National Payments Corporation of India (NPCI) fall under its
purview.
8. Research and Data Collection:
o The RBI conducts research and analysis on various economic and
financial issues, providing data and insights that inform policy
decisions.
Structure of RBI

 Governor: The RBI is headed by a Governor, supported by a team of

Deputy Governors and other officials. The Governor is appointed by the
Government of India.
 Central Board of Directors: Comprising members from various sectors,
it guides the overall functioning of the RBI.

Significance of RBI

1. Economic Stability: The RBI’s monetary policy plays a crucial role in

maintaining economic stability and controlling inflation, which is vital
for sustainable growth.
2. Banking System Safety: Through regulation and supervision, the RBI
ensures the safety and soundness of the banking system, protecting
depositors’ interests.
3. Financial Inclusion: The RBI promotes access to financial services for
all sections of society, contributing to inclusive economic growth.
4. Crisis Management: The RBI acts as a lender of last resort, providing
liquidity to banks during times of financial distress to maintain
confidence in the banking system.

Recent Initiatives

 Digital Payments: The RBI has actively promoted digital payment

systems, enhancing the efficiency and security of financial transactions.
 Financial Literacy: The RBI has launched initiatives to improve
financial literacy among the population, empowering individuals to make
informed financial decisions.

Conclusion

The Reserve Bank of India plays a pivotal role in shaping the country's
economic landscape. Through its diverse functions and regulatory framework,
the RBI fosters stability, growth, and inclusivity in the financial system.

SEBI:

The Securities and Exchange Board of India (SEBI) is the primary regulatory
authority for the securities and capital markets in India. Established in 1992,
SEBI’s main objective is to protect investors' interests, promote the
development of the securities market, and regulate its operations. Here’s an
overview of SEBI's functions, powers, and significance:
Key Functions of SEBI

1. Regulation of Stock Exchanges:

o SEBI regulates the functioning of stock exchanges and oversees the
trading of securities to ensure fair practices and transparency.
2. Investor Protection:
o It works to protect the interests of investors by promoting
awareness and education about securities markets, ensuring that
investors have access to relevant information.
3. Market Regulation:
o SEBI monitors market activities to prevent fraudulent and unfair
trade practices, such as insider trading and price manipulation.
4. Registration and Regulation of Market Intermediaries:
o It registers and regulates various market intermediaries, including
brokers, mutual funds, and portfolio managers, ensuring they
adhere to regulatory standards.
5. Regulation of Mutual Funds and Collective Investment Schemes:
o SEBI establishes guidelines for the functioning of mutual funds
and ensures compliance with regulations to safeguard investor
interests.
6. Approval of Prospectuses and New Issues:
o It reviews and approves offer documents and prospectuses for
public offerings, ensuring transparency and the accuracy of
information provided to investors.
7. Enforcement and Penalties:
o SEBI has the authority to impose penalties for violations of
securities laws, conduct investigations, and take legal action
against offenders.
8. Promoting Research and Development:
o SEBI encourages research and development in the securities
market to enhance efficiency and innovation.

Powers of SEBI

 Regulatory Authority: SEBI has the power to frame regulations and

guidelines to govern the functioning of the securities market.
 Inspection and Investigation: It can conduct inspections and
investigations of registered entities and market participants to ensure
compliance with laws.
 Imposition of Fines and Penalties: SEBI can impose fines, issue cease-
and-desist orders, and take legal action against violators of securities
regulations.
Structure of SEBI

 Chairman: The organization is headed by a chairman, appointed by the

Government of India.
 Board Members: SEBI's board consists of full-time and part-time
members, including representatives from various sectors like finance,
economics, and law.

Significance of SEBI

1. Market Integrity: SEBI plays a crucial role in maintaining the integrity

and transparency of the securities market, fostering investor confidence.
2. Investor Education: By promoting financial literacy and awareness,
SEBI helps investors make informed decisions.
3. Market Development: SEBI's initiatives contribute to the overall
development and modernization of the securities market in India.
4. Crisis Management: SEBI acts swiftly to address market irregularities,
helping to stabilize the market during periods of volatility.

Recent Initiatives

 Strengthening Regulations: SEBI has introduced various measures to

enhance corporate governance, improve disclosure norms, and promote
ethical practices in the market.
 Technological Advancements: Initiatives to leverage technology for
better monitoring, trading, and investor services, including the
introduction of the electronic KYC process.
 Financial Inclusion: SEBI has promoted mutual funds and other
investment avenues to encourage participation from retail investors.

Conclusion

The Securities and Exchange Board of India plays a vital role in regulating and
promoting the securities market, ensuring investor protection, and fostering
market development. Through its various functions and initiatives, SEBI aims to
create a fair and transparent environment for all market participants.