What Is a Financial System

A financial system is a set of institutions, such as banks,

insurance companies, and stock exchanges, that permit the
exchange of funds. Financial systems exist on firm, regional, and
global levels.

A financial system is a monetary machine comprising a

community that connects individuals, corporations, and
governments through various financial institutions, markets, and
contraptions. It allows the green allocation of capital by
channeling funds from savers and buyers to borrowers,
corporations, and governments that require financial resources.
This machine performs an essential role in furthering economic
activities, thus ensuring overall financial stability.

Key Components of the Financial System

●​ Financial Institutions: Organizations which include banks,

insurance organizations, and funding corporations that
provide essential financial offerings, such as savings, loans,
investments, and risk control.
●​ Financial Markets: A financial institution wherein monetary
belongings, shares, bonds, and commodities are traded for
financial gain. These markets allow businesses and
governments to raise capital and provide investors with
opportunities for wealth advent.
●​ Financial Instruments: Various economic products, together
with loans, stocks, bonds, and coverage rules, that facilitate
investment, capital elevating, and risk control.
 ●​ Regulatory Framework: A set of presidency-imposed
regulations and rules designed to ensure transparency,
equity, and stability inside the financial machine, stopping
fraud and economic crises.

functions of the financial system

Financial systems act as intermediaries between

1. Intermediation
savers and borrowers, channeling funds from those who have
excess funds (savers) to those who need funds (borrowers).

2. Mobilization of savings Financial

systems provide a mechanism for
individuals and businesses to save money and earn a return on
their savings. Through banks, investment funds, and other
financial institutions, savings are pooled together and made
available for productive investments.

They provide various investment

3. Facilitation of investments
options such as stocks, bonds, and venture capital, allowing
entities to raise funds to expand operations, launch new projects,
or develop infrastructure.

4. Risk management Financialsystems offer a range of risk

management tools and instruments, such as insurance,
derivatives, and hedging strategies.

5. Price discovery Financial

markets provide a platform for trading
financial instruments, allowing buyers and sellers to determine fair
prices based on supply and demand dynamics. This price
discovery process ensures transparency and efficiency in the
valuation of assets and facilitates the efficient allocation of
resources.
6. Facilitation of payments Financial
systems enable the smooth and
secure transfer of funds between individuals, businesses, and
institutions. They provide payment systems, such as electronic
funds transfer, credit cards, and digital wallets, which facilitate the
settlement of transactions and support economic activities.

7. Capital Formation Financialsystems play a crucial role in capital

accumulation within an economy. By mobilizing savings,
facilitating investments, and promoting efficient allocation of
capital, they contribute to capital stock growth, which is essential
for long-term economic development.

What is SEBI?

SEBI, or the Securities and Exchange Board of India, is the

primary regulatory authority for India's stock market and
investment sector. It started as an administrative entity on April
12, 1988, and became officially recognised by law on January 30,
1992, under the SEBI Act. Think of SEBI as the guardian that
ensures your investments are protected and the markets function
fairly and transparently. Before SEBI's creation, there weren't
enough rules to protect investors, which led to many unfair
practices..

●​ Established: April 12, 1988 (administrative entity); January

30, 1992 (official status)
●​ Main office: Mumbai, Maharashtra
●​ Reports to: Ministry of Finance, Government of India
●​ Other offices: Found in major cities like Delhi, Kolkata,
Ahmedabad, and Chennai
 ●​ Leadership: Run by a board with a chairman (chosen by the
government), members from the Finance Ministry, Reserve
Bank of India (RBI), and other government-appointed
experts
ROLE OF SEBI
Regulatory Role: The role of Securities and Exchange Board of
India in regulating the Indian capital market is very important
because the government of India can only open or take decisions
to open new stock exchanges in India after getting advice from
SEBI. IF SEBI thinks that it will be against its rules and
regulations, SEBI can ban any stock exchange to trade in
securities. SEBI regulates the capital market by using its powers
as under:
(i) SEBI has power to make rules for controlling stock exchanges
in India. For example, SEBI fixed the time of trading 9 AM and 5
PM in the stock market.
(ii) SEBI has the power to give licenses to dealers and brokers of
the capital market.
. Role in Primary Market Reforms:
(i) The control over price and premium of shares has been
removed. Companies are now free to fix the prices and premia of
shares and debentures after clearance from the SEBI. Vetting of
offer documents is not done by the SEBI.
(iii) The minimum percentage of securities to be issued to the
public has been fixed at 25 percent.
3. Role in Secondary Market Reforms: The SEBI has also
introduced a number of regulatory and supervisory measures for
intermediaries in the secondary market. Specific rules and
regulations have been laid down for intermediaries in the
secondary market.
Role in Investor Protection:
(i) In order to bring awareness among the issuers and
intermediaries, the SEBI is publishing the names of those
companies against whom maximum number of complaints have
been received.
(iii) SEBI supervises the allotment process in order to stop
malpractices in allotment of shares.

Regulation of Capital Market in India

Regulatory Management SEBI regulates the various segments of the

security market viz. Equity, Debentures, Derivatives, and Mutual
Funds. It administers stock exchanges, intermediaries like
brokers, merchant bankers, mutual funds, and other market
participants to ensure that they remain within the ambit of laws,
rules, and regulations.

Protection of Investors Theinherent function of SEBI is to protect the

interest of investors. This includes fair treatment of investors,
transparency in the operation of the market, and availability of
accurate information. It promotes investor education and
awareness through campaigns, workshops, and internet
resources to make the investor empower decisions.

Market DevelopmentThe contribution of SEBI becomes very

important in developing and enhancing the efficiency of the
securities market.

Regulation of Securities Offerings Public

offerings for securities with
respect to IPOs, rights issues, and follow-on public offers are
regulated by SEBI. It puts in place the mandatory requirements
related to disclosure norms, pricing guidelines, allotment
processes, and the like, all aimed at protecting investor interest
and ensuring best practice-based issuance of securities.

Surveillance and Enforcement SEBI is involved in surveillance on

market activity to weed out and prevent market manipulation,
insider trading, etc. It has enforcement powers to investigate
violations of securities laws and appropriate legal actions against
offenders.

Capital Market
A capital market is a financial market in which investors buy and
sell financial securities, such as stocks and bonds. These
transactions take place through various exchanges. A stock
market, for example, is an exchange where stock brokers and
traders buy and sell stocks of public companies. A bond market is
an exchange where traders buy and sell bonds issued by
corporations, governments, or other entities.
The primary function of the capital market is to bring together
investors who buy securities with those who sell them. The three
main participants of the capital markets are savers (also known as
investors), borrowers, and stockholders.
The term capital market includes the stock market, bond market,
and related markets. The term is frequently used with reference to
banks and banking in both a narrow and broad sense. In the
United States, the term is sometimes used to include markets for
saving and loans as well as bonds. The units invested may be of
any country.

Capital Market Instruments

Equities

As capital market instruments, equities enable companies to raise

capital by selling ownership stakes. They are traded on stock
markets, allowing investors to buy and sell shares, with their value
influenced by the company's performance and market dynamics.

Equity Share An equity share represents a portion of ownership in

a company. When you buy equity shares, you become a
part-owner of that company. As a shareholder, you may get voting
rights in major company decisions and a share of the profits,
known as dividends..

Preference Share Preference shares are a type of stock in a

company that gives shareholders certain advantages over
common stockholders. Typically, preference shareholders receive
dividends before common shareholders, and these dividends are
often fixed.

Debt Instruments Debt instruments, like bonds and debentures,

are essentially loans that investors give to companies or
governments.

Bonds are like loans given by investors to companies or

governments. You're lending money to the bond issuer when you
buy a bond. In return, they promise to pay you back the principal
amount on a future date and make regular interest payments,
known as coupon payments.
Debentures Debt instruments, like bonds and debentures, are
essentially loans that investors give to companies or
governments. When you invest in these, you're lending money,
and in return, you receive interest payments over a specified
period.

Derivative Instruments Derivative instruments are financial

contracts whose value is derived from an underlying asset, like
stocks, commodities, or interest rates.

Forward: Future:.Options: Interest Rate Swap:

Exchange-Traded Funds Exchange-traded funds (ETFs) are capital

market instruments that track indexes, commodities, bonds, or a
basket of assets like an index fund but trade like stocks on an
exchange. Each ETF share represents a portion of the fund's
portfolio, giving investors access to a diversified set of assets or a
specific market segment.

Foreign Exchange Instruments Foreign Exchange Instruments in

the capital market are tools for trading currencies between
countries. These include currency pairs like the US Dollar against
the Euro. Investors and companies use them to exchange one
currency for another, essential for international trade, travel, or
investment.

Functions of the Capital Market

●​ Enhance trading of securities

●​ Provides a common platform to both investors and savers
●​ Accumulation of capital for companies that need them
 ●​ Stimulates economic growth
●​ It improves the process of allocation of capital
●​ Prepares for continuity of funds availability
●​ It reduces information and transaction charges significantly.
●​ Faster valuation of securities.
●​ Provides proper channeling of funds to be used productively.
Types of Capital Market?

Primary Market Herein, the trading takes place for new securities.
Companies go public for the first time in this market allows entities
outside the locus of an organization to purchase their shares. This
phenomenon is called Initial Public Offering or IPO.

Secondary Market Between the types of capital markets, it deals

with securities that have already been traded in the primary
market. New York Stock Exchange (NYSE), Bombay Stock
Exchange (BSE), National Stock Exchange (NSE), etc. are
secondary markets.
​

Money Market?
●​ Money Market refers to that part of the broader Financial
Market in which highly liquid and short-term financial
assets with maturity upto 1 year are traded.
○​ Thus, it caters to the short-term borrowing needs of
working capital.
●​ Because of the short maturity period, it offers high liquidity
of securities, and hence money market investments are
also called cash investments.Financial Market is a broad
term, referring to any center or arrangement where buyers
 and sellers participate in the trade of financial claims such as
equities, bonds, currencies, and derivatives.
●​ – The Financial Market is classified into two categories.
●​ a. Money Market– Market for trading short-term financial assets
with a maturity of upto 1 year
●​ b. Capital Market – Market for borrowing and lending of medium
and long-term funds, above 1 year.

Organized Money Market

●​ This sector of the money market in India is characterized by

registration, approval, and license from market regulators.
●​ It is called organized because it is systematically coordinated by
the RBI and other market regulators.
●​ Major participants in the Organized Money Market in India
include – the RBI, Banks, NBFCs, Mutual Funds, Insurance
Companies, etc.

Unorganized Money Market

●​ This sector of the money market in India refers to the one that is
not registered and not regulated.
●​ It is called unorganized because it is not systematically
coordinated by the RBI or any other market regulator.
●​ Major participants in the Unorganized Money Market in India
include – Local Moneylenders, Chit Funds, etc.

Instruments of Money Market

Various types of Money Market Instruments are used in India, each

catering to specific needs and participants. Some of the major
instruments of Money Market in India are discussed in detail in the
sections that follow.
Call Money or Money at Call

●​ Call Money refers to interbank borrowing and lending for a very

short period, typically overnight to upto 14 days.
●​ The Call Money or Money at Call enables banks and financial
institutions to manage their short-term liquidity requirements.

Treasury Bills (T-Bills)Treasury Bills or T-Bills refer to short-term

securities issued by the RBI on behalf of the Central Government.

●​ They act as short-term fundraising tools for the government.

●​ Treasury Bills (T-Bills) are one of the two types of Government
Securities (G-Secs).

Cash Management Bills (CMBs)Similar to T-Bills, CMBs are also

short-term securities sold by the RBI on behalf of the Central
Government, but with a maturity period of less than 91 days.

●​ It is also aimed at meeting the short-term cash flow mismatches

of the Government of India.
●​ Banks are allowed to keep CMBs to meet their SLR
requirements.

Ways and Means Advances (WMAs)Way and Means Advances

(WMAs) are temporary loans or overdraft facilities extended by the
RBI to the Governments.

●​ This facility is available to both Central Government as well as

State Governments.

Certificate of Deposit (CD)Certificate of Deposit (CD) is a security

issued by the Scheduled Commercial Banks (SCBs) and some other
Financial Institutions (FIs) that have been permitted by the RBI to
raise short-term funds.
 ●​ Their maturity period is, usually, more than 7 days and less than
1 year.
●​ Withdrawal of a CD before the maturity date results in a penalty.
●​ Banks are not allowed to provide loans against the CDs.

Commercial Paper (CP)Commercial Paper (CP) is a type of

unsecured, short-term debt instrument issued by large Corporations,
Primary Dealers, and Financial Institutions (FIs).

●​ The eligible institutions may issue Commercial Papers (CPs) to

finance their short-term needs, such as inventory management,
meeting payroll expenses, funding new projects, etc.

Reserve Bank of India

The Reserve Bank of India (RBI) is India’s central bank and

regulatory organisation in charge of banking regulation. It belongs
to the Indian government’s Ministry of Finance. The Indian rupee
is issued and distributed by it. It also oversees the country’s major
payment networks and aims to further the country’s economic
growth. The RBI’s Bharatiya Reserve Bank Note Mudran division
prints and mints Indian banknotes and coins. To regulate India’s
payment and settlement systems, the RBI formed the National
Payments Corporation of India as one of its specialised divisions.
The Reserve Bank of India formed the Deposit Insurance and
Credit Guarantee Corporation as a specialised division to provide
deposit insurance and credit guarantee to all Indian banks.
Role of Reserve Bank of India (RBI)

1.​Monetary Management – The formulation and seamless

execution of monetary policy are one of the Reserve Bank of
India’s main responsibilities. Various policy instruments are
used by monetary policy to impact the cost and availability of
money in the economy.
2.​The issuer of Currency – Currency management and issuance
are critical central banking functions. The Reserve Bank of
India (RBI) is in charge of the country’s currency design,
manufacture, distribution, and overall management.
3.​Banker and debt manager of the Government – The Reserve
Bank of India (RBI) is in charge of the government’s banking
transactions. The Reserve Bank of India also holds the cash
holdings of the Indian government. It can also serve as a
lender to state governments.
4.​Banker to Banks – The RBI is also responsible for the
settlement of interbank transactions. This is normally
accomplished through the employment of a “clearing house,”
which allows banks to present cheques and other similar
instruments for clearing.
5.​Financial Regulation and Supervision- The regulatory and
supervisory powers of the RBI are extensive. Through a
variety of policy initiatives, it aims to ensure general financial
stability. Its goal is to ensure the orderly development and
conduct of banking activities, as well as bank liquidity and
solvency.
6.​Developmental Role – The Reserve Bank of India (RBI)
actively supports and enhances development efforts in the
country. It guarantees that the productive sectors of the
economy have access to sufficient credit and establishes
 organisations to support the development of financial
infrastructure.
7.​Overseas Market Operations – The Central Bank implements
its monetary policy through government securities, foreign
exchange, and money market operations. It also regulates
and develops market instruments such as the term money
market, repo market, and others.
8.​Foreign Exchange Management – The foreign exchange
market is regulated by the Reserve Bank of India (RBI). It
has also opened practically all areas to international
investment.

Meaning of Financial Markets

A Financial Market is referred to space, where selling and buying

of financial assets and securities take place. It allocates limited
resources in the nation’s economy. It serves as an agent between
the investors and collector by mobilising capital between them.

In a financial market, the stock market allows investors to

purchase and trade publicly companies share. The issue of new
stocks are first offered in the primary stock market, and stock
securities trading happens in the secondary market.

Role of Financial Market

Mobilization of Capital: They efficiently channel savings and

investments towards businesses that need funding to grow and
create jobs.
Maintaining Liquidity: Markets provide liquidity by enabling buyers
and sellers to quickly transact without causing significant price
changes. This liquidity is crucial for economic stability and growth,
as it allows investors to convert assets into cash swiftly.

Risk Management: Some financial instruments like derivatives

allow businesses and investors to hedge against risks, like
sudden currency fluctuations.

Price Discovery: Financial markets provide a platform where the

prices of securities are determined by the forces of supply and
demand. This pricing mechanism helps in allocating resources
and coordinating economic activity efficiently.

Information Aggregation and Coordination: Markets reflect

information in the prices of securities, helping to coordinate
economic activity. The prices at which trades occur can reflect the
collective sentiment about the present and future economic
conditions.
Financial Instruments:

●​ Definition: Any asset that can be traded in a financial market

and represents a financial value.
Regulations:

Definition: Rules and guidelines that govern the operation of

financial markets and financial institutions.

Examples: Shares, bonds, stocks, derivatives (futures, options),

and commodities.
Types: Cash instruments (easily transferred), derivative
instruments (value derived from an underlying asset), and foreign
exchange instruments.
Purpose: To protect investors, maintain stability, and prevent
fraud.
Examples: Regulations set by regulatory bodies like the Securities
and Exchange Commission (SEC).

Mutual funds
are investment vehicles that pool money from multiple investors to
invest in a diversified portfolio of securities like stocks, bonds, and
other instruments. They offer professional management and
potential diversification, allowing investors to access a wider
range of investments than they could individually. Types of mutual
funds include equity, debt, hybrid, and money market funds, each
with different investment objectives and risk profiles.

Types of Mutual Funds:

Equity Funds:​
Invest primarily in stocks, offering the potential for higher returns
but also higher risk.

Debt Funds: Invest in fixed-income securities like bonds, providing

a more stable income stream and lower risk compared to equity
funds.
Hybrid Funds: Combine investments in both stocks and bonds,
aiming for a balance of risk and return.
Money Market Funds: Invest in short-term, low-risk debt
instruments like treasury bills and commercial paper.

Other Types:

Index Funds: Aim to replicate the performance of a specific market

index, such as the S&P 500.

Balanced Funds:Invest in a mix of stocks, bonds, and other asset

classes to balance risk and potential returns.

Liquid Funds:Invest in short-term, highly liquid instruments like

treasury bills and commercial paper, allowing investors to access
their funds quickly.

ELSS (Equity-Linked Savings Scheme) Funds:Offer tax benefits

while investing primarily in equities, combining tax savings with
potential capital appreciation.

Target Date Funds:Automatically adjust their asset allocation as

investors approach their retirement date, offering a simplified
approach to retirement savings.

International Funds Invest in securities outside of the investor's

home country, offering diversification and potential exposure to
global markets.

Closed-ended Funds: Offer a limited number of shares for sale at

the time of their initial launch, and then their shares are traded on
the stock exchange. ​