Student Name:

Financial Institutions and Markets

NEP
V S em B.Com - 2023

Prepared by,

Asst Prof Gurulingu P

Youtube Channel: Gurulingu Tutors

https://www.youtube.com/@gltutors9171

Podcast: https://anchor.fm/gurulingu-p
Mob: 8880007842

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 Module No.1: Financial System in India
Introduction – Meaning of Financial System– Financial concepts - Constituents of Financial System
– Structure of Financial Syste m – Role of Financial system- Functions of Financial Syste m –
Development of Financial Syste m in India. Financial Sector Reforms - Financial Syste m and
Economic Development – We ak ness of Indian financial system.

Meaning of Financial System:

A financial system is a complex network of institutions, markets, and intermediaries that

facilitate the flow of funds and capital between individuals, businesses, and governments. It
plays a crucial role in the functioning of an economy by providing the infrastructure for financial
transactions and the allocation of resources.

A financial system is a critical component of any modern economy, serving as the backbone for
economic activity by facilitating the efficient allocation of capital and resources while managing
financial risks and supporting economic growth.

According to Robinson, the primary function of a financial system is “to provide a link
between savings and investment for creation of wealth and to permit portfolio adjustment in the
composition of existing wealth”

A Financial System consists of various financial Institutions, Financial Markets, Financial

Transactions, rules and regulations, liabilities and claims etc.

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. Borrowers, lenders, and investors exchange current funds to finance projects,
either for consumption or productive investments, and to pursue a return on their financial
assets. The financial system also includes sets of rules and practices that borrowers and
lenders use to decide which projects get financed, who finances projects, and terms of financial
deals.

Financial systems are crucial for economies as they promote economic growth. They enable
individuals and institutions to save, invest, manage risks, and conduct transactions efficiently.
Financial systems also play a role in price discovery, ensuring fair prices for assets and
commodities.
They contribute to economic stability, support monetary policy, and help regulate financial
activities. Overall, financial systems are vital for the functioning and development of economies.

Features/Characteristics of Financial System:

1. Financial system acts as a bridge between savers and borrowers
2. It consists of a set of inter-related activities and services
3.It consists of both formal and informal financial sectors. The existence of both formal
and informal system is also called as financial dualism.
4. It formulates capital, investment and profit generation
5. It is universally applicable at firm level, regional level, national level and international level
6.It consists of financial institutions, financial markets, financial services, financial
instruments, financial practices and financial transactions.

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Components/Constituents/Elements/Parts of Financial System
/Structure of Indian Financial System:
The structure of the Indian financial system is a well-organized and diverse network of
institutions, markets, regulators, and intermediaries that collectively facilitate the flow of funds,
support economic activities, and ensure financial stability. The structure of the Indian financial
system can be broadly categorized into the following components

The financial system of a country is an important tool for economic development of the country,
as it helps in creation of wealth by linking savings with investments. It facilitates the flow of
funds form the households (savers) to business firms (investors) to aid in wealth creation and
development of both the parties.

The financial system of a country is concerned with:

 Allocation and Mobilization of savings

 Provision of funds
 Facilitating the Financial Transactions
 Developing financial markets
 Provision of legal financial framework
 Provision of financial and advisory services

1. Financial Institutions:

Commercial Banks: These are the backbone of India's financial system, including both public
sector and private sector banks. They offer a wide range of financial services, such as deposit-
taking, lending, and payment services.

Cooperative Banks: These banks are owned and operated by cooperative societies. They serve
rural and urban areas and offer banking and financial services to their members.

Development Banks: Institutions like the National Ba nk for Agriculture and Rural Development
(NABARD) and the Small Industries Development Ba nk of India (SIDBI) focus on specific sectors
and provide financial assistance and support.

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Non-Banking Financial Companies (NBFCs): N B FC s play a critical role in lending and providing
financial services, including microfinance, housing finance, and consumer finance.

Insurance Companies: Life and general insurance companies offer a range of insurance
products to protect individuals and businesses from various risks.

Pension Funds: Entities such as the Employees' Provident Fund Organization (EPFO) and the
National Pension System (NPS) manage retirement savings for employees.

Asset Management Companies (AMCs): AMCs manage mutual funds and other investment
vehicles, offering investors opportunities to invest in a diversified portfolio of assets.

2. Financial Markets:

Stock Markets: India has two major stock exchanges, the National Stock Exchange (NSE) and
the Bombay Stock Exchange (BSE), where companies list their stocks for trading.

Bond Markets: Debt securities are traded on various platforms, including the Wholesale Debt
Market (WDM) segment of N S E and B S E , along with Over-the-Counter (OTC) markets.

Commodity Markets: The Multi Commodity Exchange (MCX) and the National Commodity and
Derivatives Exchange (NCDEX) are major commodity exchanges.

Currency and Forex Markets: These markets facilitate foreign exchange trading and are
regulated by the Reserve Ba nk of India (RBI).

3. Regulators and Supervisory Authorities:

Reserve Bank of India (RBI): The central bank of India is responsible for monetary policy,
regulation of banks and financial institutions, and maintaining financial stability.

Securities and Exchange Board of India (SEBI): S E B I regulates securities markets and protects
the interests of investors.

Insurance Regulatory and Development Authority of India (IRDAI): IRDAI oversees and
regulates the insurance industry in India.

Pension Fund Regulatory and Development Authority (PFRDA): PFRDA regulates and
promotes pension-related activities, including the National Pension System (NPS).

Ministry of Finance: The Ministry of Finance plays a role in formulating financial policies,
budgeting, and economic planning.

4. Payment and Settlement Systems:

National Payments Corporation of India (NPCI): NPCI oversees various retail payment systems,
including the Unified Payments Interface (UPI) and Immediate Payment Service (IMPS).

Real-Time Gross Settlement (RTGS) and National Electronic Funds Transfer (NEFT): These
systems enable large-value and retail fund transfers, respectively.

5. Financial Instruments and Products:

Indian Rupee (INR): The national currency used for transactions and investments.

Government Securities: Issued by the central and state governments, they are considered risk-
free and are traded in the bond market.

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Equities: Stocks of publicly listed companies traded on stock exchanges.

Mutual Funds: Managed by asset management companies, mutual funds offer diversified
investment options.

Derivatives: Futures and options contracts are traded on stock and commodity exchanges.

Insurance Policies: Life, health, and general insurance products provide risk coverage.

The Indian financial system is highly regulated and has undergone significant reforms in recent
years to promote financial inclusion, increase transparency, and strengthen the regulatory
framework. It continues to evolve to meet the changing needs of the Indian economy and its
diverse population.

Role of Financial system:

The financial system plays a critical and multifaceted role in an economy, serving as a backbone
for economic activities, investment, and the allocation of resources. Its primary functions and
roles include:

1.Intermediation: One of the core functions of the financial system is intermediation.

Financial institutions, such as banks and non-banking financial companies (NBFCs), act as
intermediaries between savers and borrowers. They accept deposits from individuals and
businesses and provide loans to those in need of funds. This intermediation process facilitates
the flow of money from those who have surplus funds to those who require capital for
investments, consumption, or other financial needs.

2.Payment System: The financial system includes payment mechanisms and systems
that enable the exchange of goods and services. This includes traditional methods like cash,
checks, and credit cards, as well as modern electronic payment systems, digital wallets, and
online banking. Efficient payment systems are essential for conducting daily economic
transactions.

3.Risk Management: The financial system provides tools and products to manage and
mitigate financial risks. This includes insurance policies to protect against various risks
(e.g., life insurance, health insurance, property insurance) and financial derivatives (e.g., options,
futures) that allow businesses to hedge against fluctuations in interest rates, exchange
rates, and commodity prices.

4.Capital Allocation: Financial markets, such as stock exchanges and bond markets, provide
a platform for businesses and governments to raise capital by issuing equity (stocks) and
debt securities (bonds). Investors allocate their funds to these assets, enabling companies to
expand, innovate, and finance various projects and initiatives.

5.Price Discovery: Financial markets offer a platform for determining the prices of
financial instruments based on supply and demand dynamics. This price discovery
process helps investors and businesses assess the value of assets and make informed investment
decisions.

6.Resource Mobilization: A well-functioning financial system facilitates the mobilization

of savings and investments, channeling them into productive economic activities. This process
is essential for economic development and growth.

7.Monetary Policy Transmission: Central banks use the financial system to

implement monetary policy. They influence interest rates, the money supply, and economic
conditions by regulating the banking system and influencing financial markets. The financial
system plays a crucial role in transmitting these policy changes to the broader economy.
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 8.Financial Stability: Regulatory authorities and supervisory bodies oversee the
financial system to ensure its stability and protect consumers and investors. They establish
rules and regulations to prevent financial crises and maintain confidence in the system.

9.Savings and Investment: The financial system encourages individuals and businesses
to save and invest their money. It provides a range of investment options, such as stocks,
bonds, mutual funds, and retirement accounts, allowing individuals to build wealth and
secure their financial future.

10.Facilitating Economic Growth: By efficiently allocating capital, facilitating

investments, and managing risk, the financial system contributes to overall economic
growth and development. It plays a pivotal role in financing infrastructure projects,
supporting entrepreneurship, and fostering innovation.

In summary, the financial system is an essential component of any modern economy, playing a
pivotal role in connecting savers and borrowers, facilitating economic transactions, managing
financial risks, and promoting economic growth and stability. It serves as a vital infrastructure
for the functioning of markets and the allocation of resources, benefiting individuals, businesses,
and governments alike.

Role of Financial system (In Simple)

 It accelerates the rate and volume of savings through provision of various financial
instruments and efficient mobilization of savings
 It aids in increasing the national output of the country by providing funds to corporate
customers to expand their respective business
 It protects the interests of investors and ensures smooth financial transactions through
regulatory bodies such as RBI, S E B I etc.
 It helps economic development and raising the standard of living of people
 It helps to promote the development of weaker section of the society through rural
development banks and co-operative societies
 It helps corporate customers to make better financial decisions by providing effective
financial as well as advisory services
 It aids in Financial Deepening and Broadening:

Functions of a Financial System:

1) The Savings Function

As already stated, public savings find their way into the hands of those in production through
the financial system. Financial claims are issued in the money and capital markets, which
promise future income flows. The funds are in the hands of the producers, resulting in better
goods and services and an increase in society's living standards. When savings flow declines,
however, investment and living standards growth begins to fall.

2) Liquidity Function

Money in the form of deposits offers the least risk of all financial instruments. But its value is
mainly eroded by inflation. That is why one always prefers to store funds in financial
instruments like stocks, bonds, debentures, etc. However, in such investments, (i) a greater level
of risk is involved, (ii) and the degree of liquidity (i.e., conversion of the claims into money) is;
moreover, The financial markets provide the investor with the opportunity to liquidate their
investments.

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3) Payment Function

The financial systems offer a very convenient mode of payment for goods and services. The check
system, credit card systems, et al. are the easiest methods of charge in the economy; they also
drastically reduce the cost and time of transactions.

4) Risk Function

The financial markets provide protection against life, health, and income risks. These are
accomplished through the sale of life, health, and property insurance policies. Overall, they
provide immense opportunities for the investor to hedge himself/herself against or reduce the
possible risk involved in various instruments.

5) Policy Function

Most governments intervene in the financial system to influence macroeconomic variables like
interest rates or inflation. S o, for example, the federal or central bank indulges in several cuts in
C R R and tries to decrease the interest rates and increase the availability of credit at cheaper
rates to the corporates.

Functions of Financial system (In Short):

 It bridges the gap between savings and investment through efficient mobilization and
allocation of surplus funds
 It helps a business in capital formation
 It helps in minimising risk and allocating risk efficiently
 It helps a business to liquidate tied up funds
 It facilitates financial transactions through provision of various financial instruments
 It facilitate trading of financial assets/instruments by developing and regulating financial
markets

Development of Financial System in India:

The development of the financial system in India has been a dynamic and evolving process over
the years. India's financial system has undergone significant transformations to meet the
changing needs of its growing economy and to align with global financial standards. Here is an
overview of the development of the financial system in India:

1. Pre-Independence Era (Prior to 1947):

India's financial system during the colonial era was primarily structured to serve the interests
of the British colonial administration.

The Reserve Ba nk of India (RBI) was established in 1935, which laid the foundation for the
modern central banking system in India.

Limited financial infrastructure and services were available to the general population, with
banking primarily concentrated in urban areas.

2. Post-Independence and Planning Era (1950s-1980s):

In the post-independence period, India adopted a planned economic model that involved a
high degree of government intervention and regulation in the financial sector.

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 Nationalization of Banks: In 1969 and 1980, major banks were nationalized to promote
financial inclusion and spread banking services to rural and underserved areas.

Financial Institutions: Various specialized financial institutions were established to cater to

specific sectors, such as the Industrial Development Ba nk of India (IDBI), National Bank for
Agriculture and Rural Development (NABARD), and the Industrial Finance Corporation of India
(IFCI).

Limited Market-Based Activities: The capital markets were underdeveloped, and there were few
investment opportunities beyond traditional bank deposits.

3. Economic Liberalization (1991 Onward):

In 1991, India initiated economic liberalization and financial sector reforms to dismantle
regulatory controls and open up the economy to foreign investment and competition.

Banking Sector Reforms: The banking sector saw a shift towards a more market-oriented
approach, with greater autonomy given to public sector banks and the entry of private and
foreign banks.

Capital Market Reforms: The establishment of the National Stock Exchange (NSE) and the
Securities and Exchange Board of India (SEBI) strengthened the capital markets, enhancing
transparency and investor protection.

Introduction of Derivatives: Derivative products and futures and options trading were
introduced, broadening investment opportunities.

Foreign Exchange Reforms: India gradually liberalized its foreign exchange regulations,
allowing greater foreign direct investment and easing restrictions on currency convertibility.

Infrastructure Development: Various financial infrastructure institutions, such as the National

Securities Depository Limited (NSDL) and the Central Depository Services Limited (CDSL), were
established to modernize and streamline trading and settlement processes.

4. Digitalization and Financial Inclusion (2000s Onward):

The 2000s saw a significant focus on technology adoption, leading to the development of
digital payment systems, mobile banking, and online trading platforms.

The launch of the Pradhan Mantri J a n D h a n Yojana (PMJDY) in 2014 aimed to enhance
financial inclusion by providing access to banking services to all households.

Initiatives like the Unified Payments Interface (UPI) and Aadhar-based eKYC (electronic Know
Your Customer) have revolutionized payment and identity verification systems.

5. On-going Reforms and Global Integration:

India continues to implement reforms to promote financial stability, enhance transparency,

and align with international standards.

Steps are being taken to promote fintech, attract foreign investment, and deepen the corporate
bond market.

Regulatory changes to encourage investment in infrastructure and the development of a

vibrant corporate bond market are ongoing.

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The development of India's financial system reflects the country's transition from a closed and
heavily regulated economy to an open, market-oriented one. These changes have contributed to
India's economic growth and increased its prominence in the global financial landscape.
However, challenges remain, particularly in addressing issues of financial inclusion, improving
regulatory frameworks, and strengthening risk management.

Recent developments in Indian financial systems:

1. Digital Payment and Fintech Innovations:

India has seen a surge in digital payments and fintech innovations. The Unified Payments
Interface (UPI) has become the backbone of digital transactions in India, enabling fast and
convenient peer-to-peer and merchant payments.

2. Inclusive Banking Initiatives:

The government's financial inclusion programs, s uc h as the Pradhan Mantri J a n D h a n Yojana

(PMJDY), have made significant progress in bringing underserved populations into the formal
banking system.

3. Credit Growth and Non-Performing Assets (NPA) Resolution:

The banking sector has been working on addressing the issue of non-performing assets
through mechanisms like the Insolvency and Bankruptcy Code (IBC). Efforts to enhance credit
growth and credit quality continue.

4. Regulatory Reforms:

Regulatory bodies, such as the Reserve Bank of India (RBI) and the Securities and Exchange
Board of India (SEBI), have been introducing measures to enhance transparency, investor
protection, and regulatory compliance.

5. Economic Recovery Post-Pandemic:

The financial system has been pivotal in supporting economic recovery efforts following the
COV I D - 19 pandemic. Measures like loan moratoriums and government stimulus packages have
been implemented to mitigate the economic impact.

6. Corporate Bond Market Development:

India has been working to deepen its corporate bond market to provide diversified funding
sources for businesses and reduce dependence on bank loans.

7. Foreign Investment Inflows:

Foreign investors have shown increasing interest in the Indian financial markets, particularly
in equities and government bonds. Regulatory changes have eased investment processes for
foreign investors.

8. Consolidation in the Banking Sector:

Several public sector banks have undergone mergers to strengthen their balance sheets and
improve efficiency. This consolidation aims to create more robust and globally competitive
banking entities.

9. Infrastructure Investment Trusts (InvITs) and Real Estate Investment Trusts (REITs):

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 The Indian market has witnessed the emergence of InvITs and REITs, offering new investment
avenues for infrastructure and real estate assets, respectively.

10. Financial Literacy and Investor Education:

Efforts to enhance financial literacy and investor education have been ongoing to empower
individuals to make informed financial decisions.

11. Sustainable Finance and E S G Considerations:

There is a growing focus on sustainable finance and environmental, social, and governance
(ESG) factors in investment decisions. Regulatory bodies are working on E S G disclosure norms.

12. Insurance Sector Reforms:

The insurance sector has seen various regulatory changes to boost penetration and
digitalization, including the introduction of standardized insurance products and increased
foreign direct investment limits.

Financial Sector Reforms:

Financial Sector Reforms are the steps taken to change the banking system, capital market,
government debt market, foreign exchange market, etc. An efficient financial sector enables
the mobilization of household savings and ensures their proper utilization in productive
sectors.

What is the Financial Sector?

 The financial sector constitutes the commercial banks, non-banking financial companies,
investment funds, money market, insurance and pension companies, real estate etc.

 It forms the core of an economy which facilitates the mobilization and distribution of
financial resources.

 It is engaged in providing financial services to the customers of the commercial and retail
segments.

Need for Financial Sector Reforms

 After independence India inherited a colonial legacy that was full of various social and
economic deprivations.

 The planned economic development strategy adopted based on the Mahalanobis model had its
limitations that started showing in the 1980s.

 In order to achieve various economic goals, the government resorted to increased borrowings
at concessional rates which lead to weak and underdeveloped financial markets in India.

 The nationalization of banks increased government control and decreased the role of market
forces in the financial sector.

 Increased bureaucratic control, issues of red-tapism increased the non-performing assets.

 Turbulent international events such as the war in the Middle East and the fall of the U S S R
increased the pressure on the Foreign Exchange Reserves of India.

Narasimham Committee report (1991)

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  It was established to give reforms pertaining to the financial sector of India including the
capital market and banking sector.

 Some of its major recommendations have been mentioned below:

o It recommended reducing the cash reserve ratio (CRR) to 10% and the statutory
liquidity ratio (SLR) to 25% over the period of time.

o It suggested fixing at least 10% of the credit for priority sector lending to marginal
farmers, small businesses, cottage industries, etc.

o In order to provide required independence to the banks for setting the interest rates
themselves for the customers, it recommended de-regulating the interest rates.

Financial Sector Reforms in India

Reforms in the Banking Sector
 Reduction in C R R and S L R 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 and 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, H D F C Ba nk , ICICI Ba nk , Ba nk 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.

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 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.

Impact of Various Reforms in the Financial Sector

 It increased the resilience, stability and growth rate of the Indian economy from around
3.5 % to more than 6% per annum.

 A resilient banking system helped the country deal with the Asian economic crisis of
1977-98 and the Global subprime crisis.

 The emergence of private sector banks and foreign banks increased competition in the
banking sector which has improved its efficiency and capability.

 Better performance by stock exchanges of the country and adoption of international best
practices.

 Better budget management, fiscal deficit, and public debt condition have improved after the
financial sector reforms.

Financial System and Economic Development:

Financial institutions and markets are together called the financial system. This
financial system is the backbone of the national economy. This is because the efficiency
with which the financial system works plays a very important role in the economic
development of a nation.

The role of the financial system may not be apparent since we assume its existence to be
a given. However, when we do start paying attention to the financial system, it is easy to
see why it plays a foundational role in the economic development of a country.

This article lists down certain examples that explain how financial systems play an
important role in the economic development of a nation.

Interest Rates Stabilization: The financial system ensures that all the organizations
and institutions which it is composed of, behave as one unified system. Generally,
healthy competition is promoted between the members of the system. This means that
members have to compete with each other by lowering their costs. As a result, the
benefits of lower interest rates are passed on to the consumers.

It is the existence of the financial system, which ensures that interest rates
remain stable across the country. The banking system led by a central bank makes
this possible. In the absence of a financial system, each region would have its own
interest rate based on the availability of capital. However, with the financial system in
place, interest rates remain the same across the entire country. As a result,
businessmen and entrepreneurs throughout the country are on an equal footing.

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Aids Trade and Commerce: Credit risk has always been the main factor that inhibits
trade and commerce. If a seller is not sure about whether they will get paid for the goods
which they sold, then they will not sell more goods till the earlier payment has been
received. This reduces inventory turnaround and leads to a decline in trade and
commerce. Financial systems ensure quick and timely payment.

With the advent of advanced technology, it is now possible to remit money to any part of
the world within a few seconds. Hence, financial markets and institutions aid in trade
and commerce and even improve the gross domestic product of a country.

Aids International Trade: The risks inherent in trade and commerce get multiplied
several times when it comes to international trade. This is because firstly, the seller and
buyer, are in different legal jurisdictions. Hence, the enforceability of contracts is
reduced.

Secondly, the quantity of goods involved in import and export transactions is extremely
large. Hence, the outstanding amounts also become large, and this ends up increasing
the overall risk in the transaction.

Financial systems play a very important role in the international trade process. This is
because importers and exporters generally use banks as an intermediary in the process.
The importer deposits money with the bank in the form of a letter of credit. This letter of
credit is then paid to the exporter by the bank when goods are received. As a result,
neither party has to rely on each other. Instead, both of them can rely on the bank,
which has a higher credit rating and therefore aids in the reduction of risk.

Similarly, countries have created special boards for export credit and promotion. These
boards provide important services like insurance and payment guarantees in
international trade. It would be fair to say that in the absence of financial markets and
systems, international trade would be negatively impacted.

Aids in Attracting Capital: Stable financial markets raise investor confidence. As a

result, investors from domestic as well as international markets start investing in the
capital markets. As a result, more capital becomes available to domestic companies.
They can then use this capital to increase economies of scale, which makes them more
competitive in the international market. If these financial institutions and markets were
not present, foreign investors would find it very difficult to locate investment
opportunities and follow through with them.

Aids Infrastructure Development: Financial markets play a vital role in infrastructure

development, as well. This is because the private sector may face great difficulties in
raising large amounts of funds for projects with a high gestation period.

It is the financial markets that provide the liquidity required by investors. Investors
can sell their securities and cash out whenever they want. It is not important for the
same investor to hold on to the security for the entire tenure of the loan. Key sectors like
power generation, oil, and gas, transport, telecommunication, and railways receive a lot
of funding at concessional rates thanks to the financial markets.

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Financial markets also allow governments to raise large sums of money. This enables
them to continue deficit spending. In the absence of financial markets, governments
would not be able to continue deficit spending, which is important to fund infrastructure
projects in the short run.

Help in Employment Creation: The financial system provides capital to entrepreneurs

who want to start a business. When these businesses come into existence, they, directly
and indirectly, require the services of a wide variety of personnel. As a result, a lot of
employment is generated in the economy.

In Short:

1.Help to form huge financial resources through mobilization of savings of the

public and corporate
2.Promote investment in agriculture, manufacturing and service industries by
providing the necessary finance for the cultivation of land, production of goods and
provision of
services
3.Transfer surplus funds from one part of the economy to another keeping in mind
the national priorities
4.Encourage people to divert their physical assets into financial assets and make
it available for balanced growth of trade, commerce, agriculture, manufacturing
and service industries
5. Provide mechanism to control the risk and uncertainties
6. Multiply the monetary resources by the process of credit creation
7.Provide a variety of financial assets to suit the different needs of investing public
and corporate
8. Encourage entrepreneurial skills among the public
9. Increase the growth rate of the economy

Weakness of Indian financial system:

In order to meet the growing requirements of the Government and the industries, many
innovative financial instruments have been introduced. Besides, there has been a mushroom
growth of financial intermediaries to meet the ever-growing financial requirements of different
types of customers. Hence, the Indian financial system is more developed and integrated today
than what it was 50 years ago. Yet, it suffers from some weaknesses as listed below:

1. Dominance of development banks in industrial finance:

The industrial financing in India today is largely through the financial institutions set up by the
government. They get most of their funds from their sponsors. They act as distributive agencies
only. Hence, they fail to mobilise the savings of the public. This stands in the way of growth of an
efficient financial system in the country.

2. Lack of co-ordination among financial institutions:

There are a large number of financial intermediaries. Most of the financial institutions are owned
by the government. At the same time, the government is also the controlling authority of these
institutions. As there is multiplicity of institutions in the Indian financial system, there is lack of
co-ordination in the working of these institutions.

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3. Unhealthy financial practices:

The dominance of development banks has developed unhealthy financial practices among
corporate customers. The development banks provide most of the funds in the form of term
loans. So there is a predominance of debt in the financial structure of corporate enterprises. This
predominance of debt capital has made the capital structure of the borrowing enterprises uneven
and lopsided. When these enterprises face financial crisis, the financial institutions permit a
greater use of debt than is warranted. This will make matters worse.

4. Inactive and erratic capital market:

In India, the corporate customers are able to raise finance through development banks. S o , they
need not go to capital market. Moreover, they do not resort to capital market because it is erratic
and inactive. Investors too prefer investments in physical assets to investments in financial
assets.

5. Monopolistic market structures:

In India some financial institutions are so large that they have created a monopolistic market
structures in the financial system. For instance, the entire life insurance business is in the
hands of LIC. The weakness of this large structure is that it could lead to inefficiency in their
working or mismanagement. Ultimately, it would retard the development of the financial system
of the country itself.

6. High Rate of Interest:

There is a possibility of the high-interest rate charged by several financial institutions in the
financial system of our country. Various institutions due to their monopolistic structure in the
market may charge high or unfair interest rates.

Other factors:

Apart from the above, there are some other factors which put obstacles to the growth of Indian
financial system. Examples are:

a. Banks and Financial Institutions have high level of NPA.

b. Government burdened with high level of domestic debt.
c. Cooperative banks are labelled with scams.
d. Investors’ confidence reduced in the public sector undertaking etc., financial illiteracy.

*****

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 Module No. 2: Capital Market & Money Market

Capital Market: Meaning – Structure, Importance – Functions – Players in the Capital

Market – Instruments of Capital Market – Components of Capital Market – Recent trends in
Capital Market. Money Market: Meaning - Structure, functions Importance – Functions –
Instrument of Money Market – Recent trends in Money Market.

FINANCIAL MARKETS:

Introduction: The group of individuals and corporate institutions dealing in financial

transactions are termed as financial markets. The centers or arrangements that facilitate buying
and selling of financial assets, claims and services are the constituents of financial market. In
economics, typically, the term market means the aggregate of possible buyers and sellers of a
certain good or service and the transactions between them.

Thus a financial market may be defined as a market in which people trade financial securities,
commodities, and other fungible items of value at low transaction costs and at prices that reflect
supply and demand. Financial securities include stocks and bonds, commodities include
precious metals or agricultural products and fungible items include something that can be
exchanged for something else of the same kind (for example, one gram of gold that is exchanged
for one gram of gold sometime later.) Basically they are classified into two categories:

1. Unorganized Market

2. Organized Market

3. Unorganized Market

The sector that is not governed by any statutory or legal authority is known as unorganized
sector. This sector consists of the individuals and institutions for whom there are no
standardized rules and regulations governing their financial dealings. They are not under the
supervision and control of RBI or any other regulatory body. Local money lenders, Pawn brokers,
Traders, Landlords, Indigenous bankers, etc., who lend money are in the unorganized sector.

Organized Market

The sector that is governed by some statutory or legal authority is known as organized sector.
This sector consists of the institutions for whom there are standardized rules and regulations
governing their financial dealings. They are under the supervision and control of RBI and other
statutory bodies. They are further classified into three:

1. Capital Market
2. Money Market
3. Foreign Exchange Market

4. Capital Market

Capital Market refers to the market for long term finance. Financial assets which have a long
or indefinite maturity period like Shares, Debentures, Bonds, etc., are dealt in this market. It
includes all the facilities and the institutional arrangements for borrowing long-term funds by
private sector industries and the government for the purpose of manufacturing and development
activities.

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Features:

The features of the capital market are as follows:

1. The link between investors and borrowers: The capital market links investors with the
borrowers of funds. It routes money from savers to entrepreneurial borrowers.

2. Deals in medium and Long-term investment: In the capital market, medium and long-term
financial instruments are traded. Through this market, corporates, industrial
organisations, financial institutions access long-term funds from both, domestic as
well as foreign markets.

3. Presence of Intermediaries: Capital market operates with the help of intermediaries. The
intermediaries like brokers, underwriters, merchant bankers, collection bankers, etc. play
an important role in the capital market.

4. Promotes capital formation: Capital market provides a platform for investors and borrowers of
long-term funds to engage in trade. This leads to capital formation in the economy as
it mobilises funds.

5. Regulated by government rules, regulations, and policies: Capital market operates freely.
However, it is regulated by government rules, regulations, and policies. E.g.: S E B I is
the regulator of Capital markets.

6. Deals in marketable and non-marketable securities: It trades in both, marketable and non-
marketable securities. Marketable securities are securities that can be transferred.
E.g.: shares, debentures, etc. Non-marketable securities are those which cannot be
transferred. E.g.: term deposits, loans, and advances.

7. Variety of Investors: It has a wide variety of investors including both, individuals (i.e. general
public) and institutional investors like mutual funds, insurance companies,
financial institutions, etc.

8. Risk: Risk is very high as the instruments have long maturity periods. But along with that, the
return on investments is also very high.

9. Instruments: Equity shares, preference shares, debentures, bonds, government securities and
public deposits are the main instruments in capital market.

10. Types: Capital market is mainly classified into two main types, government securities market
or gilt-edged market and industrial securities market. Industrial securities market is
further classified into the primary and secondary markets.

Structure of capital Market:

The capital market is a segment of the financial market where long-term financial instruments,
such as stocks, bonds, and other securities, are bought and sold. It plays a crucial role in
channeling funds from investors to businesses and governments for their capital and investment
needs. The structure of the capital market typically comprises several components:

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1. Primary Market:

 In the primary market, newly issued securities are offered to the public for the first time.
This process is known as the primary offering.

 Companies raise capital in the primary market through methods like initial public offerings
(IPOs) and rights issues.

 The primary market facilitates the issuance of new stocks and bonds.

2.Secondary Market:

 The secondary market, also known as the stock market or securities exchange, is where
previously issued securities are bought and sold among investors.

 Investors trade securities with one another, and the issuing company is not directly involved
in these transactions.

 Well-known secondary markets include stock exchanges like the N S E , B S E , New York Stock
Exchange (NYSE) and the NASDAQ.

3. Stock Exchanges:

 Stock exchanges provide a centralized platform for the trading of equities (stocks) and other
financial instruments.

 These exchanges facilitate transparency, liquidity, and price discovery for securities.

 They are regulated by financial authorities and have specific listing requirements for
companies to be traded on their platforms.

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4. Bond Markets:

 Bond markets allow for the issuance and trading of bonds, which represent debt obligations.
Bond markets can be divided into the government bond market and the corporate
bond market.

 Government bonds are issued by governments to raise funds, while corporate bonds are
issued by companies for the same purpose.

 Bond markets provide an important source of long-term financing for both public and private
sector entities.

5. Derivatives Markets:

 Derivatives markets deal in financial instruments whose values are derived from underlying
assets, such as stocks, bonds, commodities, or currency.

 Common derivatives include options, futures, and swaps. These instruments can be used for
hedging, speculation, and risk management.

6. Alternative Investment Markets:

 These markets offer opportunities for investments outside traditional stocks and bonds.
Examples include private equity, venture capital, real estate investment trusts (REITs),
and hedge funds.

 These markets are typically less regulated and suitable for sophisticated investors.

7.Commodity Markets:

 Commodity markets deal in the trading of physical goods such as oil, gold, agricultural
products, and metals.

 These markets are used for hedging, speculation, and procurement of raw materials for
industries.

8. Foreign Exchange (Forex) Market:

 The forex market is where currencies are traded, facilitating international trade and
investment.

 It is the largest and most liquid financial market globally.

9.Over-the-Counter (OTC) Market:

 The OTC market involves the trading of securities directly between parties, typically through
electronic trading platforms or dealer networks.

 OTC markets are used for securities that are not listed on formal exchanges.

10. Regulators and Regulatory Authorities:

 Regulatory bodies and authorities oversee the capital market to ensure transparency, fairness,
and investor protection.

 In the United States, for example, the U. S . Securities and Exchange Commission (SEC)
regulates the capital market.

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Importance of capital market:

These markets are important for several reasons:

1. Facilitate capital formation: Capital markets provide a platform for companies and
governments to raise capital by issuing securities.

2. Resource Allocation: Capital markets help to allocate capital to its most productive uses by
providing investors with a wide range of investment opportunities.

3. Price discovery: These markets play a crucial role in price discovery, determining the fair
value of securities.

4. Debt Management – Capital markets allow the issuance of debt, which is a more efficient and
less restrictive form of borrowing for corporations. These markets equalize borrowers and
investors regarding debt, acting as buffers during economic stress or market turmoil.

5. Liquidity: Capital markets provide liquidity to investors by allowing them to buy and sell
securities quickly and easily, thus freeing up capital for other investments.

6. Risk management: Capital markets offer a range of risk management tools, such as
derivatives, which allow investors to manage their exposure to various types of risks.

7. Building Wealth – These markets help people build wealth and invest in their future.
Investors can invest in many types of securities, including stocks, ETFs, mutual funds,
corporate bonds, etc. Individuals can use invested principal and any corresponding
appreciation to invest in their pension, buy their own home, or save for higher education.

8. Innovation – A capital market fuel companies or entrepreneurs to turn an idea or industrial

innovation into a real business or expansion for an existing company. This, in turn, creates
jobs and stimulates economic growth.

9. Economic Growth: A well-functioning capital market fosters economic development by

facilitating the allocation of capital to productive investments. It supports businesses' growth
initiatives, research and development, and infrastructure projects.

10. J o b Creation: As businesses expand and invest, they often hire more employees, leading
to job creation and lower unemployment rates. Economic growth driven by capital
market activities can have a positive impact on employment.

11. Alternative Financing: In addition to traditional bank loans, the capital market offers
companies alternative sources of financing. This diversification of funding options can
enhance financial flexibility.

12. Global Investment: Capital markets allow investors to participate in global

investment opportunities. They can invest in foreign stocks and bonds, diversifying their
portfolios across different regions.

Functions of Capital Market

13. Links Borrowers and Investors: Capital markets serve as an intermediary between people
with excess funds and those in need of funds.

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 2.Capital Formation: The capital market plays an important role in capital formation.
By timely providing sufficient funds, it meets the financial needs of different sectors of
the economy.

3.Regulate Security Prices: It contributes to securities' stability and systematic pricing.

The system monitors whole processes and ensures that no unproductive or speculative
activities occur. A standard or minimum interest rate is charged to the borrower. As a
result, the economy's security prices stabilize.

4.Provides Opportunities to Investors: The capital markets have enough

financial instruments to meet any investor's needs, regardless of the risk level. Capital
markets also provide investors with the opportunity to increase their capital yields. The interest
rate on most savings accounts is extremely low compared to the rate on equities. Therefore,
investors can earn a higher rate of return on the capital market, though some risks are involved
as well.

5.Minimises Transaction Cost And Time: Long-term securities are traded on the
capital market. The whole trading process is simplified and reduced in cost and time. A
system and program automate every aspect of the trading process, thus speeding up the entire
process.

6.Capital Liquidity: The financial markets allow people to invest their money. In
exchange, they receive ownership of a stock or bond. Bond certificates cannot be used to
purchase a car, food, or other assets, so they may need to be liquidated. Investors can sell their
assets for liquid funds to a third party on the capital markets.

Players in the Capital Market:

In the context of the capital market in India, the players are similar to those in the global capital
market but with specific entities and institutions relevant to the Indian financial system. Here
are the key players in the capital market of India:

7. Securities and Exchange Board of India (SEBI):

S E B I is the primary regulatory authority for the securities market in India. It regulates and
supervises stock exchanges, intermediaries, and market participants to ensure market integrity
and investor protection.

2. Stock Exchanges:

National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are the two major stock
exchanges in India. They provide platforms for trading equities, derivatives, and other financial
instruments.

3. Brokerage Firms and Stockbrokers:

Brokerage firms and stockbrokers facilitate securities trading on behalf of investors. They
execute buy and sell orders and provide research and advisory services.

4. Investors:

Individual retail investors, high-net-worth individuals, foreign institutional investors (FIIs), and
domestic institutional investors (DIIs) participate in the Indian capital market.

5. Mutual Funds:

Asset management companies in India manage mutual funds, which pool investments from
various investors and invest in diversified portfolios of stocks, bonds, and other securities.
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6. Insurance Companies:

Insurance companies invest in the capital market to generate returns on their investment
portfolios. They often hold significant stakes in listed companies.

7. Pension Funds:

Pension funds, including the Employees' Provident Fund Organization (EPFO) and the National
Pension System (NPS), invest in equities and debt instruments in the capital market to grow their
assets.

8. Banks and Financial Institutions:

Banks and financial institutions participate in the capital market by offering various financial
products, including bonds, fixed deposits, and wealth management services.

9. Clearing Corporations and Depositories:

The National Securities Depository Limited (NSDL) and the Central Depository Services Limited
(CDSL) are depositories responsible for holding and maintaining electronic records of securities.
Clearing corporations ensure the settlement and clearing of transactions.

10. Foreign Institutional Investors (FIIs):

FIIs are foreign entities that invest in the Indian capital market. They can invest in stocks,
bonds, and other financial instruments.

11. Credit Rating Agencies:

Credit rating agencies in India, such as CRISIL, ICRA, and C A R E , assess the creditworthiness
of issuers and their securities, providing credit ratings that help investors make informed
decisions.

12. Asset Reconstruction Companies (ARCs):

ARC s specialize in the acquisition and resolution of non-performing assets, especially

distressed loans. They play a role in managing bad debts in the banking system.

13. Venture Capital and Private Equity Firms:

Venture capital and private equity firms provide funding to startups and growth-stage
companies. They play a vital role in supporting entrepreneurship and innovation.

14. Public and Private Sector Companies:

Public and private sector companies issue equities and bonds in the capital market to raise
capital for their business operations, expansion, and projects.

15. Market Intermediaries:

Market intermediaries include sub-brokers, registrars, transfer agents, and investment

advisors who provide various services to investors and issuers.

16. Depository Participants:

These are entities that act as intermediaries between depositories and investors, facilitating
the holding and transfer of securities in electronic form.

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17. Market Regulators:

Apart from S E B I , other regulatory authorities like the Reserve Ba nk of India (RBI) and the
Insurance Regulatory and Development Authority of India (IRDAI) oversee specific segments of
the financial market, such as banking and insurance.

These are the main players in the capital market in India, and they collectively contribute to
the functioning and development of the market. Each player has a specific role in facilitating
capital formation, investment, and trading activities within the Indian capital market.

Instruments of Capital Market:

The Indian capital market offers a variety of financial instruments that investors can trade
or invest in. These instruments serve different purposes and cater to the diverse investment
needs of market participants. Here are some of the key instruments in the Indian capital market:

1. Equity Shares (Stocks):

Equity shares represent ownership in a company. Investors who hold these shares are known
as shareholders or stockholders. They have a claim on the company's assets and earnings.
Equity shares provide an opportunity for capital appreciation and dividends.

2. Preference Shares:

Preference shares combine features of both equity and debt. Preference shareholders have a
preference in receiving dividends and in the event of liquidation but do not have voting rights like
common shareholders.

3. Debentures and Bonds:

Debentures and bonds are debt instruments issued by corporations and government entities.
Holders of these instruments are creditors and receive periodic interest payments and the
principal amount at maturity.

4. Government Securities:

These are debt instruments issued by the Government of India. They include Treasury bills,
government bonds, and savings bonds. They are considered among the safest investments and
are used to finance government expenditures.

5. Mutual Funds:

Mutual funds pool money from various investors and invest in a diversified portfolio of stocks,
bonds, and other securities. They offer a convenient way to access a diversified investment
portfolio.

6. Exchange-Traded Funds (ETFs):

ETFs are investment funds that trade on stock exchanges like individual stocks. They aim to
replicate the performance of a specific index, commodity, or a basket of assets.

7. Real Estate Investment Trusts (REITs):

REITs are trusts that invest in income-generating real estate properties, such as office
buildings, shopping centers, and residential complexes. They provide a way for investors to gain
exposure to the real estate market.

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8. Initial Public Offerings (IPOs):

An IPO is the process by which a company offers its shares to the public for the first time.
Investors can participate in IPOs to become initial shareholders of the company.

9. Rights Issues:

Rights issues allow existing shareholders of a company to purchase additional shares at a

predetermined price. This can provide an opportunity to increase one's stake in the company.

10. Commercial Papers (CP):

Commercial papers are short-term debt instruments issued by corporations to raise funds for
working capital needs. They have a maturity of typically up to 1 year.

11. Medium-Term Notes (MTNs):

MTNs are debt instruments with maturities ranging from one to ten years. They are often used
by corporations to fund medium-term projects and obligations.

12. Fixed Deposits (FDs):

Fixed deposits are investment products offered by banks and non-banking financial
companies (NBFCs). They provide a fixed rate of interest and have various tenures.

13. Sovereign Gold Bonds:

These government-issued bonds allow investors to invest in gold without the need for physical
possession. They offer periodic interest payments and the option to convert to physical gold.

14. Preference Share Certificates (PSCs):

P S C s are a type of non-convertible preference share issued by companies. They offer fixed
dividends and have a specific redemption date.

15. Warrants:

Warrants are financial instruments that give the holder the right to buy a specific number of
shares of a company at a predetermined price. They are often issued along with other securities.

16. Participatory Notes (P-Notes):

P-Notes are financial instruments used by foreign investors to invest in Indian securities
without directly registering with S E B I . They provide a way for foreign investors to gain exposure
to the Indian market.

These are some of the major instruments available in the Indian capital market. Investors
can choose from these instruments based on their investment objectives, risk tolerance, and time
horizon. It's important to conduct thorough research and consult with financial professionals
before making investment decisions.

Components of Capital Market:

The capital market in India consists of various components that collectively
contribute to the functioning and development of the market. These components include
the following:

Page 24 of 36
1. Primary Market:

The primary market is where new securities are issued for the first time to raise
capital. It includes activities such as initial public offerings (IPOs), follow-on public
offerings (FPOs), and rights issues. Companies and the government use the primary
market to raise funds for expansion, debt repayment, or project financing.

2. Secondary Market:

The secondary market is where previously issued securities, such as stocks and
bonds, are bought and sold among investors. The major stock exchanges, like the
National Stock Exchange (NSE) and Bombay Stock Exchange (BSE), facilitate secondary
market trading.

3. Stock Exchanges:

Stock exchanges serve as the central platforms for trading equities (stocks), equity
derivatives, and other financial instruments. The N S E and B S E are the two primary
stock exchanges in India.

4. Bond Market:

The bond market is a component of the capital market where issuers, including the
government and corporations, raise capital by issuing bonds. It encompasses
government bonds, corporate bonds, municipal bonds, and various debt instruments.

5. Commodity Derivatives Market:

Page 25 of 36
 The commodity derivatives market allows the trading of commodity futures and options
contracts. It provides a platform for hedging and speculating on commodity prices.

6. Currency Derivatives Market:

The currency derivatives market deals with the trading of foreign exchange (forex)
derivatives, including currency futures and options. It enables participants to hedge
against currency fluctuations.

7. Equity Derivatives Market:

The equity derivatives market focuses on derivatives contracts linked to stocks and
stock indices. It includes products like stock futures and options.

8. Depositories:

The National Securities Depository Limited (NSDL) and the Central Depository Services
Limited (CDSL) are depository institutions responsible for holding and maintaining
electronic records of securities. They facilitate the dematerialization and transfer of
securities.

9. Clearing Corporations:

Clearing corporations are responsible for ensuring the efficient clearing and settlement
of trades in the capital market. They manage the counterparty risk and facilitate the
delivery of securities and funds.

10. Regulatory Authorities:

The Securities and Exchange Board of India (SEBI) is the primary regulatory authority
overseeing the securities market in India. It sets rules, regulations, and guidelines to
ensure market integrity and investor protection.

11. Intermediaries:

Intermediaries include brokerage firms, stockbrokers, merchant bankers, investment

advisors, and market makers who facilitate trading and provide various financial services
to investors and issuers.

12. Investors:

Investors in the capital market include individual retail investors, institutional

investors (mutual funds, insurance companies, pension funds), high-net-worth
individuals, and foreign institutional investors (FIIs).

13. Mutual Funds:

Mutual funds pool funds from multiple investors and invest in a diversified portfolio of
securities. They play a significant role in intermediating between retail investors and the
capital market.

14. Alternative Investment Funds (AIFs):

Page 26 of 36
 AIFs are a category of investment funds that pool capital from investors and invest in
various assets, including equities, real estate, and venture capital.

15. Insurance Companies:

Insurance companies invest in the capital market to generate returns on their

investment portfolios. They often hold significant stakes in listed companies.

16. Pension Funds:

Pension funds, such as the Employees' Provident Fund Organization (EPFO) and the
National Pension System (NPS), invest in equities and debt instruments in the capital
market to grow their assets.

17. Venture Capital and Private Equity Firms:

Venture capital and private equity firms provide funding to startups and growth-stage
companies, supporting entrepreneurship and innovation.

18. Market Analysts and Economists:

Market analysts and economists analyze market trends, economic indicators, and
macroeconomic factors to provide insights into the state of the economy and financial
markets.

These components work together to create a dynamic and diversified capital

market in India, offering various investment opportunities and avenues for capital
formation. Regulatory oversight ensures transparency, fairness, and investor protection,
making the Indian capital market an integral part of the nation's financial system.

Recent trends in Capital Market:

1. Increased Retail Participation: Retail investors in India were increasingly participating in the
stock market, driven by factors like easy access to online trading platforms, financial
literacy initiatives, and a desire for higher returns in a low-interest-rate environment.

2. IPO Boom: India witnessed a surge in Initial Public Offerings (IPOs), with many companies
going public to raise capital. This trend was driven by liquidity, a positive sentiment in
the equity markets, and government initiatives promoting economic growth.

3. Rise of Technology Stocks: Technology and IT-related stocks experienced significant growth
as the COV I D - 19 pandemic accelerated digital adoption. Companies in the IT sector and
related businesses benefitted from increased demand for digital services.

4. Regulatory Reforms: S E B I and the government continued to introduce regulatory reforms

aimed at enhancing transparency, investor protection, and market efficiency. These reforms
included changes in margin trading, risk management, and insider trading regulations.

5. Investor Education: There was a growing emphasis on investor education and awareness,
with initiatives aimed at improving financial literacy and educating retail investors about
the risks and opportunities in the capital market.

6. Impact of the Pandemic: The COV I D - 19 pandemic had both short-term and long-term
impacts on the Indian capital market. While markets experienced sharp volatility in the
early

Page 27 of 36
 stages of the pandemic, they rebounded strongly, driven by liquidity injections and
government stimulus measures.

7. Rise of E S G Investing: Environmental, Social, and Governance (ESG) investing gained

traction in India. Investors and companies increasingly focused on E S G
principles, considering sustainability and corporate responsibility in their investment
decisions.

8. Listing of Startups: Several Indian startups explored the possibility of going public, providing
investors with opportunities to invest in technology-driven companies. The introduction of
the Innovators Growth Platform (IGP) by stock exchanges aimed to support startup listings.

9. Foreign Institutional Investments: Foreign institutional investors (FIIs) continued to be

significant participants in the Indian capital market. Their investments played a role in
market movements and liquidity.

10. Commodity Market Reforms: Reforms in the commodity derivatives market aimed at
improving market integrity and facilitating participation by a broader range of
participants, including retail investors.

11. Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs):
The market saw the listing and growth of REITs and InvITs, providing investors with
opportunities to invest in real estate and infrastructure projects.

12. Digital Payment and Fintech: Companies in the digital payment and fintech sector saw
increased interest from investors as the digitalization of financial services continued
to expand.

Money Market
The money market is a segment of the financial market where short-term debt securities
and financial instruments with high liquidity and low risk are bought and sold. It serves as a
marketplace for the borrowing and lending of funds for short periods, typically one year or less.
The money market plays a vital role in the overall financial system by facilitating the efficient
allocation of short-term capital and the management of liquidity by financial institutions and
corporations.

The money market is a marketplace where participants engage in the borrowing, lending,
buying, and selling of short-term financial instruments, such as Treasury bills, commercial
paper, certificates of deposit, and repurchase agreements (repos). These instruments are highly
liquid and serve as a means for participants to manage their short-term cash needs and invest
excess funds.

The money market is primarily a market for short-term debt instruments that mature
within one year or less. It provides a platform for governments, financial institutions, and
corporations to raise short-term funds by issuing these debt securities.

Features of Money Market:

A few general money market features are:

 It is fund-term market funds.

 It’s maturity period up to one year.
 It trades with assets that can be transformed into cash easily.
 All the transactions take place through phone, email, text, etc.
 Broker not required for the transactions.
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  The components of a money market are the Commercial Banks , Non-banking financial
companies and Central Ba nk , etc.
 Instruments in Money market are TB, C D , C B , and Term deposits etc.,

Structure of the Money Market:

The structure of the money market in India is similar to the structure of money markets in other
countries and consists of various components that facilitate the borrowing and lending of short-
term funds and the trading of highly liquid, low-risk financial instruments. Here's an overview of
the structure of the money market in India:

1. Participants:

 Participants in the Indian money market include a wide range of entities, such as:
 Commercial banks
 Cooperative banks
 Regional rural banks
 Urban cooperative banks
 Non-banking financial companies (NBFCs)
 Microfinance institutions
 Primary dealers
 Mutual funds
 Insurance companies
 Pension funds
 Corporations
 State and central government bodies
 High-net-worth individuals (HNIs)

2. Short-Term Financial Instruments:

 The Indian money market features various short-term financial instruments, including:

 Treasury Bills (T-Bills): Short-term government securities with maturities of 91 days, 182
days, and 364 days. They are issued by the Reserve Ba nk of India (RBI) on behalf of the
government.

 Commercial Paper (CP): Unsecured short-term debt instruments issued by corporations to

meet their short-term funding requirements. Maturities can range from a few days to
one year.

 Certificates of Deposit (CDs): Time deposits offered by banks with fixed maturities, usually
ranging from 7 days to one year.

 Call Money and Notice Money: Short-term interbank lending and borrowing where funds
are lent or borrowed on a one-day to 14-day basis.

 Repurchase Agreements (Repos): Agreements where one party sells securities to another
with an agreement to repurchase them at a specified date and price. They are used for short-
term financing.

 Commercial Bills: Short-term debt instruments used in trade finance for financing trade
transactions.

3. Intermediaries:

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 Various intermediaries, such as commercial banks, primary dealers, and non-banking
financial companies (NBFCs), act as market makers, facilitating transactions and connecting
borrowers with lenders in the money market.

4. Regulatory Oversight:

The Reserve Ba nk of India (RBI) is the central regulatory authority overseeing the Indian
money market. It sets the regulatory framework, conducts monetary policy operations, and
regulates the issuance of T-Bills and other money market instruments.

5. Trading Platforms:

Money market instruments are traded on various platforms, including the Wholesale Debt
Market (WDM) and the Negotiated Dealing System (NDS). Electronic trading systems and
OTC markets are used for trading these instruments.

6. Money Market Funds:

Money market mutual funds (MMMFs) are offered by asset management companies in India.
These funds pool funds from investors and invest in a diversified portfolio of money market
instruments.

7. Credit Rating Agencies:

Credit rating agencies in India assess the creditworthiness of issuers and their short-term
debt instruments, providing credit ratings to help investors evaluate risk.

8. Non-Banking Financial Companies (NBFCs):

N B FC s in India are significant participants in the money market, both as borrowers and
lenders. They often issue commercial paper and certificates of deposit and provide short-term
financing solutions.

The Indian money market plays a critical role in monetary policy implementation, the efficient
allocation of short-term capital, and the management of liquidity by financial institutions and
corporations. It serves as a foundation for short-term financing and investment in the country.

Functions of Money Market:

The money market serves several important functions in the financial system and the broader
economy. These functions are designed to facilitate the efficient allocation of short-term funds,
provide liquidity management tools, and support monetary policy. Here are the key functions of
the money market:

9. Providing Short-Term Financing:

The money market allows borrowers, such as corporations and government entities, to raise
short-term funds to meet their working capital needs, finance projects, or address temporary
cash flow imbalances. For example, companies may issue commercial paper to raise funds for
day-to-day operations.

2. Investing Short-Term Surpluses:

Savers, including individuals, businesses, and institutional investors, can invest their short-
term surpluses in money market instruments to earn a return on their excess funds. This
provides a safe and liquid means of investing funds temporarily.

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3. Liquidity Management:

Financial institutions, including banks, use the money market to manage their daily liquidity
requirements. They can borrow or lend funds as needed to ensure they meet regulatory
liquidity ratios and address short-term cash flow fluctuations.

4. Supporting Central Bank Operations:

Central banks, such as the Federal Reserve in the United States or the Reserve Bank of India,
use the money market as a primary tool for implementing monetary policy. Central banks
conduct open market operations by buying or selling government securities in the money
market to influence the money supply, short-term interest rates, and economic conditions.

5. Price Discovery:

Money market instruments, such as Treasury bills, provide a benchmark for short-term
interest rates. The yields on these instruments reflect prevailing market conditions and serve
as a reference point for pricing other financial products.

6. Risk Management:

Market participants use money market instruments, such as repurchase agreements (repos),
as a tool for managing interest rate risk and credit risk. Repos allow investors to lend funds
secured by collateral, reducing the risk of default.

7. Financing Trade:

The money market supports international and domestic trade by facilitating the issuance of
commercial bills and the provision of trade finance. These instruments enable companies to
secure financing for imports and exports.

8. Low-Risk Investments:

Money market instruments are considered low-risk investments due to their short maturities
and typically high credit quality. Investors looking for safe and liquid options for their short-
term funds often turn to money market instruments.

9. Access to Short-Term Funds:

The money market provides a platform for financial institutions to access short-term funds at
competitive rates. They can borrow from other market participants to address temporary
liquidity needs.

10. Interbank Lending and Borrowing:

Banks use the money market for interbank lending and borrowing. Call money and notice
money markets enable banks to manage their liquidity requirements and maintain balances at
the central bank.

11. Facilitating Monetary Policy Transmission:

The money market plays a crucial role in transmitting changes in monetary policy initiated by
the central bank. When central banks adjust interest rates, these changes are reflected in
short-term money market rates, affecting lending and borrowing costs in the broader
economy.

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In summary, the money market is an integral part of the financial system, providing a range of
functions that support short-term financing, investment, liquidity management, and the
implementation of monetary policy. It plays a pivotal role in ensuring the efficient allocation of
short-term capital in the economy.

Importance of money market:

The money market in India holds particular importance within the country's financial system
and economy due to its crucial functions and contributions. Here are the key reasons
highlighting the importance of the money market in India:

1. Liquidity Management: The Indian money market plays a vital role in the efficient
management of liquidity for financial institutions, especially commercial banks. It enables
them to address daily liquidity needs, maintain regulatory requirements, and manage
short- term cash flow fluctuations.

2. Monetary Policy Transmission: The Reserve Ba nk of India (RBI), as the central bank, utilizes
the money market as a primary tool for implementing monetary policy. Open
market operations in the money market are used to influence the money supply,
interest rates, and overall economic conditions.

3. Short-Term Financing: The money market allows Indian corporations and government
entities to raise short-term funds to meet working capital requirements, finance projects,
and manage temporary cash flow imbalances. It provides them with a cost-
effective source of funds.

4. Investment Opportunities: Individual investors, businesses, and institutional investors in

India have access to the money market for investing their short-term surplus funds.
Money market instruments provide a safe and liquid option for earning returns on
excess cash without taking on significant risk.

5. Financial Stability: The money market helps maintain the stability of the Indian financial
system by ensuring that financial institutions have access to short-term funds as needed.
This stability is vital for overall economic health.

6. Price Discovery: Money market instruments, such as Treasury bills, provide benchmarks for
short-term interest rates in India. The yields on these instruments serve as reference
points for pricing other financial products, including loans and bonds.

7. Risk Management: Market participants in India use money market instruments, such as
repurchase agreements (repos), to manage interest rate risk and credit risk effectively.
Repos enable investors to lend funds with collateral security, reducing the risk of default.

8. Trade Finance: The Indian money market supports trade finance by facilitating the issuance
of commercial bills and other trade-related instruments. Companies involved in both
domestic and international trade can access financing through these channels.

9. Low-Risk Investments: Money market instruments in India are known for their low-risk
nature. They feature short maturities and often high credit quality, making them attractive
to investors looking for safe, stable options to preserve capital while earning modest returns.

10. Access to Short-Term Funds: Financial institutions in India, including banks and non-
banking financial companies (NBFCs), can efficiently access short-term funds in the
money market at competitive rates. This access is crucial for them to meet
temporary liquidity requirements and support their lending activities.

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 11.Monetary Policy Impact: Changes in interest rates initiated by the RBI have a direct impact
on short-term money market rates. These changes influence the cost of borrowing and lending
across the Indian economy, affecting consumer spending and business investment.

In summary, the Indian money market is of immense importance for liquidity management,
monetary policy implementation, short-term financing, and investment opportunities. It provides
stability to the financial system and plays a significant role in the functioning of India's broader
economy.

Instrument of Money Market:

1. Treasury Bills (T-Bills): These are short-term government securities issued by the Reserve
Ba nk of India (RBI) on behalf of the Indian government. T-Bills come in three maturities:
91 days, 182 days, and 364 days. They are used to manage government finances and serve
as benchmark instruments for short-term interest rates.

2. Commercial Paper (CP): Commercial paper is an unsecured, short-term debt instrument

issued by corporations, financial institutions, and primary dealers. It provides a cost-
effective way for companies to raise funds to meet their working capital needs
and short-term obligations.

3. Certificates of Deposit (CDs): Certificates of deposit are time deposits offered by banks and
financial institutions. They have fixed maturities and are often used by banks to raise
short- term funds. The maturities of C D s in India can vary from 7 days to one year.

4. Call Money and Notice Money: These are interbank lending and borrowing markets in India.
Call money is used for very short-term (typically one day) transactions, while notice
money involves a notice period before the lender can ask for repayment.

5. Repurchase Agreements (Repos): Repos are short-term agreements in which one party sells
securities to another with an agreement to repurchase them at a specified date and price.
They are commonly used for short-term financing and liquidity management.

6. Commercial Bills: Commercial bills, also known as trade bills, are used in trade finance. These
short-term instruments are used to facilitate transactions between buyers and sellers, with
the promise of payment at a future date.

7. Banker's Acceptances (BAs): Banker's acceptances are short-term financial instruments used
in trade finance and international transactions. They represent a bank's unconditional
promise to pay a specific amount at a future date.

8. Indian Depository Receipts (IDRs): IDRs are financial instruments representing the shares of
foreign companies listed on Indian stock exchanges. While not exclusive to the money
market, they are part of the broader Indian financial market and serve as an investment
option.

9. Treasury Income Plan (TIP): TIP is a money market mutual fund offered by mutual fund
companies in India. It provides individual and institutional investors with an opportunity
to invest in a diversified portfolio of money market instruments.

10. Money Market Mutual Funds (MMMFs): Mutual funds that pool money from investors and
invest in a diversified portfolio of money market instruments. They offer a convenient way
for individuals and institutions to access the money market.

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11. Short-Term Government and Corporate Bonds: These bonds have shorter maturities
compared to their longer-term counterparts and provide investors with an avenue to invest
in short-term debt securities.

Recent trends in Money Market:

1. Liquidity Management: The Reserve Ba nk of India (RBI) continued to use various liquidity
management tools, such as the Liquidity Adjustment Facility (LAF) and open market
operations (OMOs), to manage liquidity in the banking system and keep short-term
interest rates within the desired range.

2. Low Interest Rate Environment: The prevailing low-interest-rate environment globally,

including in India, had an impact on money market yields. Short-term interest rates
remained relatively low, affecting the returns on money market instruments.

3. Digitalization: The Indian money market saw increased digitalization, with more transactions
and trading taking place through electronic trading platforms. This digital shift
improved transparency and efficiency in money market operations.

4. T-Bill Auctions: The issuance of Treasury Bills (T-Bills) by the Indian government continued
to be an important part of the money market. T-Bill auctions were conducted
regularly to manage government finances and provide benchmark securities for the market.

5. Repo Market: The repo market remained a key component of the money market, facilitating
short-term borrowing and lending among financial institutions. The RBI actively used
repo operations to manage liquidity and influence market interest rates.

6. Corporate Fundraising: Corporations in India continued to rely on the money market for
short-term fundraising through instruments like commercial paper (CP). The C P
market witnessed fluctuations based on corporate funding requirements.

7. Monetary Policy Impact: Changes in the RBI's monetary policy, including adjustments to the
repo rate and reverse repo rate, had a direct influence on money market interest rates.

8. Regulatory Changes: Regulatory updates from the RBI and the Securities and Exchange
Board of India (SEBI) aimed at enhancing market transparency, improving risk
management, and ensuring investor protection.

9. Participation of Non-Banking Financial Companies (NBFCs): Non-banking financial

companies played a significant role in the money market as both borrowers and lenders.
They often issued commercial paper and participated in money market operations.

10. Retail Participation: With the increased focus on financial inclusion and digital access to the
money market, retail investors gained more opportunities to invest in money
market instruments through mutual funds and online platforms.

11. Government and Corporate Borrowing: Both government and corporate entities actively
used the money market to meet their short-term funding needs. Treasury Bills, C P,
and Certificates of Deposit (CDs) were common instruments for raising funds.

12. Risk Management: Market participants continued to use instruments like interest rate swaps
and credit default swaps to manage risks associated with interest rates and credit.

13. Innovation in Money Market Products: The Indian money market witnessed innovation in
financial products, with the introduction of new money market instruments and
derivatives to cater to specific needs of market participants.

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14. Improved Risk Management: Market participants, including banks and non-banking
financial companies (NBFCs), emphasized robust risk management practices in
response to regulatory requirements and a focus on preserving asset quality.

15. Foreign Institutional Investors (FIIs): FIIs continued to invest in Indian money market
instruments, particularly in short-term government securities, contributing to
increased foreign participation in the market.

16. Shift to Market-Linked Instruments: Investors seeking potentially higher returns in a low-
interest-rate environment considered moving towards market-linked instruments,
such as dynamic bond funds and liquid funds, which invest in money market
instruments with flexibility.

17. Revised Margin and Collateral Norms: Regulatory changes impacted the margin and
collateral norms in the repo market, affecting how financial institutions manage their
liquidity and collateral requirements.

18. Volatility Management: Market participants increasingly used money market instruments,
including short-term bond funds, as tools for managing market volatility and
adjusting investment portfolios based on changing economic conditions.

19. Green Finance Initiatives: There was growing interest in sustainable finance and green
bonds, with some issuers in India exploring the issuance of green commercial paper and
other money market instruments to fund environmentally friendly projects.

20. Retail Digital Investment Platforms: The emergence of retail-focused digital investment
platforms and apps made it easier for individual investors to access money market
mutual funds and other short-term investment options.

21. RBI's Regulatory Guidance: The Reserve Ba nk of India continued to provide regulatory
guidance to ensure the stability and efficiency of the money market, along with
measures aimed at addressing financial inclusion and enhancing transparency.

Difference between Money Market and Capital Market:

Basis for Comparison Money market Capital market

Definition The part of the financial The part of the financial
market where borrowing and market where borrowing and
lending are done in the short lending are done in the long
term. term.

Types of instruments Treasury bills, commercial Bonds, debentures, preference

involved paper, trade credit, certificate shares, equity shares, and
of deposit, etc. more.
Nature of Market Informal Formal
Liquidity of the Market Very liquid Not very liquid
Maturation period Up to a year. More than a year. However,
there is no fixed time frame.

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Types of Commercial banks, financial Individual investors,
investors/institutions banks, companies, central commercial banks,
banks, chit funds, etc. underwriters, mutual funds,
stockbrokers, etc.

Purpose Fulfills the short-term credit Fulfills the long-term credit

needs of companies and needs of companies and
businesses. businesses.
Risk Factor Low risk. High risk.
Return on investment Low. High.
Functional Merit The liquidity of funds in the Long-term savings help
economy is increased. stabilize the economy.

*****

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