What Is a Financial System?

A financial system is a set of institutions, such as banks, insurance companies, and stock exchanges, which
permit the exchange of funds. Financial systems exist on firm, regional, and global levels.

A financial system is a set of institutions and practices that facilitate and

allow for the exchange of funds between borrowers, lenders and
investors. Financial systems exist on firm-specific, regional and global
levels. They include institutions like:
 Banks
 Government treasuries
 Insurance companies
 Loan companies
 Mutual funds
 Stock exchanges

Objectives And Needs Of The Financial System

The financial system plays a crucial role in the functioning of modern economies, serving as a critical
infrastructure that facilitates the flow of money, capital, and resources. The primary objectives and needs
of the financial system can be outlined as follows:

 Resource Allocation:
Capital Formation: The financial system helps in the accumulation and mobilization of savings from
individuals and institutions, channeling these funds to businesses and government entities for
productive activities. This process supports the formation of capital, which is essential for economic
development and growth.

 Risk Management:
Diversification of Risk: Financial institutions provide various tools and instruments (e.g., insurance,
derivatives) that allow individuals and businesses to manage and mitigate financial risks. This helps in
stabilizing the economy and protecting stakeholders from unexpected events.

 Facilitating Transactions:
Payment Systems: The financial system provides efficient means for the exchange of goods and services
by offering payment systems such as checks, electronic funds transfers, and credit/debit cards. This
enhances the ease of transactions, reducing the need for cumbersome barter systems.

 Time Value of Money:

Interest Rate Mechanism: Through the financial system, interest rates are determined, reflecting the
time value of money. This helps allocate resources efficiently by rewarding savers and investors for
postponing consumption and taking on risk.

 Liquidity:
Market Liquidity: Financial markets provide a platform for buying and selling financial instruments. This
liquidity ensures that investors can convert their assets into cash relatively quickly, contributing to the
smooth functioning of the economy.

 Efficient Capital Markets:

Price Discovery: Financial markets play a vital role in establishing fair prices for financial assets. This
helps in the efficient allocation of resources by directing funds to areas where they are most needed
and can generate the highest returns.
  Promoting Economic Growth:
Investment and Innovation: By facilitating the flow of funds to productive sectors, the financial system
supports investment and innovation. This, in turn, contributes to economic growth and job creation.

 Wealth Distribution:
Income Redistribution: Financial institutions play a role in redistributing income through various
financial products and services, contributing to a more equitable distribution of wealth within society.

 Government Finance:
Funding Government Activities: The financial system enables governments to raise funds through the
issuance of bonds and other financial instruments. This is crucial for financing public infrastructure
projects, social programs, and other government activities.

Indian Financial System

The Indian financial system is a complex network of financial institutions, markets, instruments, and
services that facilitate the flow of funds between savers and investors. It comprises various entities such as
banks, non-banking financial companies (NBFCs), insurance companies, stock exchanges, mutual funds,
pension funds, and other financial intermediaries.

The Indian Financial System plays a crucial role in mobilizing savings, allocating capital, and facilitating
economic growth and development in the country.

Features of Indian Financial System

The Indian financial system is a complex and interconnected network of institutions, markets, and
instruments that facilitate the flow of funds between savers and borrowers. It plays a vital role in the
economic development of the country by mobilizing savings and allocating them to productive
investments. The Indian financial system is characterized by the following features:

 Dual structure system consisting of a formal sector and an informal sector.

 Intermediated, meaning that financial institutions play a key role in mobilizing savings and
allocating them to borrowers
 Increasingly market-based
 Regulated by the government through a number of regulatory bodies
 Promote financial inclusion, through the Pradhan Mantri Jan Dhan Yojana and the Pradhan Mantri
Mudra Yojana etc.
 Promoting economic growth.

Indian Financial System Structure

The Indian Financial System is made up of various components that work together to facilitate the flow of
funds between savers and investors. The structure of the Indian financial system can be broadly divided
into two parts: the organized sector and the unorganized sector.

The organized sector includes formal financial institutions such as banks, insurance companies, NBFCs,
mutual funds, stock exchanges, and pension funds. These institutions are regulated by the Reserve Bank of
India (RBI) and other regulatory bodies such as the Securities and Exchange Board of India (SEBI), the
Insurance Regulatory and Development Authority of India (IRDAI), and the Pension Fund Regulatory and
Development Authority (PFRDA).

The unorganized sector, on the other hand, includes informal financial intermediaries such as
moneylenders, chit funds, and other unregulated entities that cater to the financial needs of the unbanked
and underserved sections of society.

What Is Financial Sector Reforms?

Financial sector reforms are the changes and developments in the Indian financial system. These steps can
be for the banks, insurance market, capital market, stock exchanges, etc. These reforms help keep up with
the changing financial needs.

 The financial sector consists of all institutions dealing with financial products. They provide financial
services to citizens or businesses.
 The financial sector reforms bring changes to this sector. It can be anything from operation guidelines
to the entry of foreign entities.
 The financial sector covers banks, insurance businesses, investment funds, NBFCs, etc. These
companies can be government-owned or private.
 These entities have regulatory bodies. For example, Indian banks have the RBI. The securities market
has SEBI. These bodies are the ones bringing in the reforms.
 They also form rules for their functioning. All companies present in the financial sector must keep up
with the changing guidelines.
 The financial sector is responsible for adequate money flow. They allow money from savers to reach
borrowers.
 For example, banks and stock exchanges allow people to invest or save money. They further use these
deposits to fund companies or individuals.
 It helps in a smooth cash flow where everyone gets what they need. A disruptive financial sector can
hamper the entire economy. There would be no or very less economic development. It is due to the
absence of credit. People wouldn't have instruments to save or invest. The companies wouldn't have
the resources to grow.
 Thus, the financial sector reforms bring modernity and changes. They are per the changing needs.

The financial sector reforms become necessary as the market grows. Indian market is vast. Players are
entering different markets from other countries. Flexibility ensures that new businesses can easily operate
in the market. It helps in holistic economic development.

Objectives of Financial Sector Reforms

The objectives of financial sector reforms in India were to improve the economy. They were often made
during the financial crisis. These reforms help accommodate the financial conditions. Read below the
objectives.

 Financial stability: The financial sector reforms aimed to make the system stable. It should remain solid
even in a financial crisis.
 Resource allocation: Financial sector reforms help in effective resource allocation. It helps businesses
and individuals get the necessary funding.
 Financial health: These reforms also made the financial health of different institutions better. Banks,
insurance companies, and other businesses shall be stable and register profits.
 Accessibility: Financial reforms ensure that the services reach every. People in remote locations should
also have financial facilities.
 Competitiveness: Financial sector reforms help make businesses competitive. They ensure that Indian
financial companies can cope with international standards.

These significant objectives are realized with different banking sector reforms. They help make the
economy more stable and ensure better services.

Need For Financial Sector Reforms

The financial sector reforms became necessary as the previous financial system had faults. It was an
inherited one with fundamental defaults after independence.
 The colonial financial system had social and economic deprivation. This previous system was not
focused on development. It instead was for the benefit of the Britishers.
 The Mahalanobis economic strategy was present. However, it had a few limitations that came up in the
1980s.
 The government planned to increase borrowings for higher financial activities. It provided these
borrowings at concessional rates. But, this step further led to a weakened market. The interest
earnings were low, and there were several non-recoverable debts.
 The banks further came under government control as they were nationalized. It significantly lowered
the market force's role.
 The higher government control also led to a bureaucratic structure. There were red tape issues. Also, it
increased the non-performing assets for the banks.
 There were some major events like the USSR end and the Middle East war. Such conditions also
affected the foreign reserve.

The bad decisions and an inherited colonial system led to the need for financial sector reforms. They
became necessary if India wanted to perform better globally and become a competitive financial market.

Financial Sector Reforms in India

Reforms in the Banking Sector
 Reduction in CRR and SLR has given banks more financial resources for lending to the agriculture,
industry and other sectors of the economy.
 The system of administered interest rate structure has been done away with an RBI no longer
decides interest rates on deposits paid by the banks.
 Allowing domestic and international private sector banks to open branches in India, for example,
HDFC Bank, ICICI Bank, Bank of America, Citibank, American Express, etc.
 Issues pertaining to non-performing assets were resolved through Lok adalats, civil courts,
Tribunals, The Securitisation And Reconstruction of Financial Assets and the Enforcement of
Security Interest (SARFAESI) Act.
 The system of selective credit control that had increased the dominance of RBI was removed so
that banks can provide greater freedom in giving credit to their customers.

Reforms in the Debt Market

 The 1997 policy of the government that included automatic monetization of the fiscal deficit was
removed resulting in the government borrowing money from the market through the auction of
government securities.
 Borrowing by the government occurs at market-determined interest rates which have made the
government cautious about its fiscal deficits.
 Introduction of treasury bills by the government for 91 days for ensuring liquidity and meeting
short-term financial needs and for benchmarking.
 To ensure transparency the government introduced a system of delivery versus payment
settlement.

Reforms in the Foreign Exchange Market

 Market-based exchange rates and the current account convertibility was adopted in 1993.
 The government permitted the commercial banks to undertake operations in foreign exchange.
 Participation of newer players allowed in rupee foreign currency swap market to undertake
currency swap transactions subject to certain limitations.
 Replacement of foreign exchange regulation act (FERA), 1973 was replaced by the foreign
exchange management act (FEMA), 1999 for providing greater freedom to the exchange markets.
 Trading in exchange-traded derivatives contracts was permitted for foreign institutional investors
and non-resident Indians subject to certain regulations and limitations.
What Is Deregulation?
Deregulation is the reduction or elimination of government power in a particular industry, usually enacted
to create more competition within the industry.

Deregulation is the elimination or removal of government controls over a particular industry or sector.
Deregulation opens up the industry to more players and makes it more competitive.

Deregulation improves the quality of the goods and services for the end consumers. The US has established
the Securities and Exchange Commission to regulate and streamline the financial securities market.
Similarly, in India, the Securities and Exchange Board of India (SEBI) regulates financial markets.

What Is Capital requirement

A capital requirement (also known as regulatory capital, capital adequacy or capital base) is the amount of
capital a bank or other financial institution has to have as required by its financial regulator. This is usually
expressed as a capital adequacy ratio of equity as a percentage of risk-weighted assets. These
requirements are put into place to ensure that these institutions do not take on excess leverage and risk
becoming insolvent.

The capital requirement for both specific risk and general market risk will be 9 per cent each of the core
capital of the bank and the exposure to the specified instruments. These capital charges will also be
applicable to all trading book exposures, which are exempted from capital market exposure ceilings for
direct investments.
What is NBFC?
A Non-Banking Financial Corporation (NBFC) is a company that is registered under the Companies Act,
1956 and is involved in the lending business, hire-purchase, leasing, insurance business, receiving deposits
in some cases, chit funds, stocks, and shares acquisition, etc.

The functions of the NBFCs are managed by both the Ministry of Corporate Affairs and the Reserve Bank of
India A non-banking financial institution (NBFI) or non-bank financial company (NBFC) is a financial
institution that is not legally a bank; it does not have a full banking license or is not supervised by a national
or international banking regulatory agency. NBFC facilitate bank-related financial services, such
as investment, risk pooling, contractual savings, and market brokering.

Nonbank financial companies (NBFCs), also known as nonbank financial institutions (NBFIs) are entities
that provide certain bank-like financial services but do not hold a banking license.

Examples of NBFC in India

Some of the examples of Non-Banking Financial Company in India that offer investment options, loans,
fund transfer services, leasing, and hire-purchase options are Bajaj Finserv, Power Finance Corporation
Limited, Mahindra & Mahindra Financial Service, Shriram Transport Finance Company, Muthoot Finance
Ltd, etc.

Different Types Of NBFCs

Based on their activity, the deposits they hold, and the different types of loans they give, NBFCs can be
divided into different categories.

Loan Company - Any lender engaged in the provision of funds, whether through the granting of loans or
advances or in another way, for any activity other than its own is referred to as a loan company. It collects
funds from the general public and loans them to ultimate consumers, such as small-scale businesses and
other traders, who require financial support. These lenders offer streamlined processes for granting credit
facilities in a clear, prompt, and efficient manner.

Microfinance Institution - People in India's urban, semi-urban, and rural areas demand financial assistance
to launch their businesses and meet other necessities. The microfinance company steps forward to help
these underprivileged individuals financially. These businesses offer small-scale financial services to the
unbanked in rural and semi-urban areas in the form of credit or savings.

Asset Finance Company - It is a financial institution that allows people and businesses to get finance for a
variety of assets, including enormous power generators, heavy industrial machines, and farm and
production equipment. Asset finance companies must register with the RBI and are subject to the same
regulations as lending firms. Additionally, they adhere to the prudential rules established by the RBI with
regard to capital sufficiency, credit and investment norms, asset-liability management, income recognition,
accounting standards, asset classification, and other disclosure requirements.

Investment Company - A financial institution called an investment company (IC) engages in the acquisition
of securities as its primary business. It does this by taking money from the general population and investing
it in different securities and financial products. After deducting operating expenses from profits, the
business distributes the remaining funds to its owners.

Systemically Important Core Investment Company (CIC-ND-SI): These are NBFCs that hold not less than
90% of their total assets in the form of investment in equity shares, preference shares, bonds, debentures,
debt, loans, and other marketable securities.
 Aspect Banks NBFCs
Regulated by the RBI under the Banking Regulations Regulated by the RBI under
Regulatory Act
Act, 1949 the Companies Act, 1956
Engage in lending and
Functions Offer a wide range of banking services.
investment activities.
Do not accept demand
Deposit
Accept deposits from the public. deposits from the general
Acceptance
public.
Cannot issue or accept
Issue of Cheques Issue and accept cheques.
cheques.
Do not require a banking
Banking License Require a banking license to operate.
license to operate.
Have the power to create credit through fractional Cannot create credit like
Credit Creation
reserve banking. banks.
Clearing House No clearing house
Are members of the clearing house.
Membership membership.
Government Government insurance schemes may guarantee No government guarantee on
Guarantee deposits. deposits.
Access to RBI Access to various facilities the RBI provides, such as
No access to such facilities.
Facilities borrowing money and access to payment systems.
Mandated to allocate a certain percentage of their
Priority Sector Not mandated to follow
lending to priority sectors as per regulatory
Lending priority sector lending norms.
requirements.

Salient provisions
The Banking Regulation Act, 1949, and the Reserve Bank of India (RBI) Act, 1934, are two significant pieces
of legislation that regulate the banking sector in India. Here are the salient provisions of these acts:

Banking Regulation Act, 1949:

 Licensing of Banks (Section 22) :- The act empowers the Reserve Bank of India (RBI) to issue licenses for the
establishment of new banks and the opening of new branches.
 Regulation of Banking Business (Section 5B):- Defines the business of banking and specifies the types of
business that a banking company can engage in.
 Management and Control (Section 10A) :- Provides for the regulation of the management and control of
banking companies, including the appointment of directors.
 Prohibition of Insider Trading (Section 10B) :- Prohibits directors and officers of a banking company from
dealing in the bank's securities on the basis of unpublished price-sensitive information.
 Maintenance of Cash Reserves (Section 42):- Requires scheduled banks to maintain cash reserves with the
RBI.
 Audit and Inspection (Section 35A) :- Grants powers to the RBI to inspect the accounts of banking companies
and appoint auditors.
 Branch Licensing (Section 23) :- Governs the opening and closing of bank branches.

Reserve Bank of India (RBI) Act, 1934

 Constitution and Functions of RBI (Section 3):- Specifies the constitution and functions of the Reserve Bank of
India, including its role as the central bank.
 Issue of Bank Notes (Section 22) :-Empowers the RBI to issue currency notes.
 Monetary Policy (Section 45ZB) :- Gives the RBI authority to formulate and implement monetary policy in
India.
 Foreign Exchange Management (Section 10) :- Provides powers to the RBI to regulate the country's foreign
exchange and financial system.
 Banker to the Government (Section 20):- Designates the RBI as the banker to the Central and State
Governments.
 Banking Regulation Powers (Section 35A) :- Grants powers to the RBI to regulate and supervise banks.
 Regulation of Credit (Section 21) :- Authorizes the RBI to regulate the credit system in the best interests of
the national economy.
 Appointment of Banking Ombudsman (Section 35A) :- Allows the RBI to appoint Banking Ombudsmen to
resolve customer complaints against banks.
 Supervision and Inspection of Banks (Section 35) :- Empowers the RBI to inspect and supervise the
functioning of banks.

Reserve Bank of India (RBI)

Reserve Bank of India (RBI) is the Central Bank of India. RBI was established on 1 April 1935 by the RBI Act
1934. It controls the monetary policy concerning the national currency, the Indian rupee. The basic
functions of the RBI are the issuance of currency, sustaining monetary stability in India, operating the
currency, and maintaining the country’s credit system.

Main functions are those functions which every central bank of each nation performs all over the world.
Basically, these functions are in line with the objectives with which the bank is set up. It includes
fundamental functions of the Central Bank. They comprise the following tasks

1. Issue of Currency Notes:

The RBI has the sole right or authority or monopoly of issuing currency notes except one rupee note and
coins of smaller denomination. These currency notes are legal tender issued by the RBI. Currently it is in
denominations of Rs. 2, 5, 10, 20, 50, 100, 200, and 500. The RBI has powers not only to issue and
withdraw but even to exchange these currency notes for other denominations. It issues these notes
against the security of gold bullion, foreign securities, rupee coins, exchange bills and promissory notes and
government of India bonds.

2. Banker to other Banks:

The RBI being an apex monitory institution has obligatory powers to guide, help and direct other
commercial banks in the country. The RBI can control the volumes of banks reserves and allow other banks
to create credit in that proportion. Every commercial bank has to maintain a part of their reserves with its
parent's viz. the RBI. Similarly, in need or in urgency these banks approach the RBI for fund. Thus, it is
called as the lender of the last resort.

3. Banker to the Government:

The RBI being the apex monitory body has to work as an agent of the central and state governments. It
performs various banking function such as to accept deposits, taxes and make payments on behalf of the
government. It works as a representative of the government even at the international level. It maintains
government accounts, provides financial advice to the government. It manages government public debts
and maintains foreign exchange reserves on behalf of the government. It provides overdraft facility to the
government when it faces financial crunch.

4. Exchange Rate Management:

It is an essential function of the RBI. In order to maintain stability in the external value of rupee, it has to
prepare domestic policies in that direction. Also, it needs to prepare and implement the foreign exchange
rate policy which will help in attaining the exchange rate stability. In order to maintain the exchange rate
stability, it has to bring demand and supply of the foreign currency (U.S Dollar) close to each other.
5. Credit Control Function:
Commercial bank in the country creates credit according to the demand in the economy. But if this credit
creation is unchecked or unregulated then it leads the economy into inflationary cycles. On the other credit
creation is below the required limit then it harms the growth of the economy. As a central bank of the
nation the RBI has to look for growth with price stability. Thus, it regulates the credit creation capacity of
commercial banks by using various credit control tools.

6. Supervisory Function:
The RBI has been endowed with vast powers for supervising the banking system in the country. It has
powers to issue license for setting up new banks, to open new branches, to decide minimum reserves, to
inspect functioning of commercial banks in India and abroad, and to guide and direct the commercial banks
in India. It can have periodical inspections an audit of the commercial banks in India.
What is Core Banking?
Core banking is a centralized system that allows customers or business bodies to carry on business operations
regardless of the bank’s branch.
The main objective of core banking solutions is to offer tailor-made offerings to customers at their convenience.
These solutions differ in nature and are dependent a lot on the customer base. CBS refers to the networking of
different bank branches that enables customers to opt for varied banking facilities from different corners of the
world. The entire banking application is based on a centralized server and can be used via the internet.
Different functions of core banking encompass transactions, payments, loans and more. Internet banking, ATMs
(Automated Teller Machines), Phone banking, Fund transfer remotely and instantly (IMPS, NEFT, RTGS and
more), interest computation on loans and deposits etc., are some of the core banking solutions types.
While customers or business bodies reap the benefits of carrying out transactions freely, financial institutions
via core banking solutions benefit from lesser time and can save upon resources that are used for repetitive
business activities.

Some of the features of core banking solutions are:

 Transaction management
 Customer relationship management activities
 Accounts, loans and disbursal management
 Customer onboarding
 Deposits and withdrawal management etc.

What is RTGS and its Full Form?

RTGS full form is “Real-Time Gross Settlement,” and it is a specialized electronic funds transfer system used
by banks and financial institutions for high-value and time-sensitive transactions. In an RTGS system, funds
are transferred from one bank to another in real-time, meaning the transaction is processed immediately,
typically within seconds or minutes. The term “gross” in RTGS signifies that each transaction is settled
individually and in full, without netting or offsetting against other transactions. This ensures that the funds
are transferred securely and without any dependence on other transactions, minimizing counterparty risk.
Real-time gross settlement systems are often operated and overseen by central banks or financial
authorities to ensure the stability and integrity of the financial system.

Features and Benefits of RTGS

 Safety and Security
 No Maximum limit
 Real-time transfer
 Seven days a week
 No physical instruments
 Convenience of internet banking
 No fees or charges
 Legal backing

What is Internet Banking?

Internet banking, also known as online banking or e-banking or Net Banking is a facility offered by banks
and financial institutions that allow customers to use banking services over the internet. Customers need
not visit their bank’s branch office to avail each and every small service. Not all account holders get access
to internet banking. If you would like to use internet banking services, you must register for the facility
while opening the account or later. You have to use the registered customer ID and password to log into
your internet banking account.
Features of Online Banking
 Check the account statement online.
 Open a fixed deposit account.
 Make merchant payments.
 Transfer funds.
 Easy to Operate
 Convenience
 Time Efficient
 Activity Tracking