Financial finance from the persons who have surplus

 

Financial Systems

Introduction

In its simple meaning
the term ‘finance’ refers to monetary resources & the term ‘financing’
refers to the activity of providing required monetary resources to the needy
persons and institutions. The term ‘financial system’ refers to a system that
is concerned with the mobilization of the savings of the public and providing
of necessary funds to the needy persons and institutions for enabling the
production of goods and/or for provision of services. Thus, a financial system
can be understood as a system that allows the exchange of funds between
lenders, investors, and borrowers. In other words, the system that facilitates
the movement of finance from the persons who have surplus funds to the persons
who need it is called as financial system. It consists of complex, closely
related services, markets, and institutions used to provide an efficient and
regular linkage between investors and depositors. Financial systems operate at
national, global, and firm-specific levels.

It includes the public,
private and government spaces and financial instruments which can relate to
countless assets and liabilities.

 

Components
of Financial System

1. Financial Assets

2. Financial
Intermediaries/Financial Institutions

3. Financial Markets

4. Financial Rates of
Return

5. Financial
Instruments

 

 

 

 

Functions
of Financial System

 1. Provision of liquidity

 2. Mobilization of savings

3. Size
transformation/Capital formation

4. Maturity
transformation

5. Risk transformation

6. Lowering of cost of
transaction

7. Payment mechanism

8. Assisting new
projects

9. Enable better
decision making

10. Meet short and long
term financial needs

11. Provide necessary
finance to the Government

12. Accelerate the
process of economic growth of the country

 

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.

 

FINANCIAL
ASSETS

Financial assets refer
to the cash or cash equivalents that are used for production or consumption or
for further creation of assets. Cash, Bank Deposits, Shares, Debentures,
Investment in Gold, Land & Buildings, Contractual right to receive cash or
another financial asset, etc., are called as financial assets.

Classification
of Financial

Assets Financial assets
are classified in two ways

1. On the basis of
marketability

2. On the basis of
nature Classification of Financial Assets

 

On the basis of
marketability

1. Marketable – The
financial assets that can be bought and sold are called as marketable financial
assets. They include Shares, Government Securities, Bonds, Mutual Funds, Units
of UTI, Bearer Debentures

2. Non-marketable – The
financial assets that cannot be bought and sold are called as nonmarketable
finance assets. They include Bank Deposits, Provident Funds, LIC Policies,
Company Deposits, Post Office Certificates

Classification of
Financial Assets on the basis of nature

1. Money or Cash Asset
– Coins, Currency Notes, Bank Deposits

2. Debt Asset –
Debenture & Bonds

3. Stock Asset – Equity
Shares & Preference Shares

 

 

 

FINANCIAL
INTERMEDIARIES/FINANCIAL INSTITUTIONS

Different kinds of
organizations/institutions which intermediate and facilitate financial
transactions of both individual and corporate customers are called as financial
intermediaries or financial institutions.

Basically they are
classified into two types:

1. Unorganized Sector

2. Organized Sector

Unorganized
Sector

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. This
sector consists of the individuals and institutions like Local money lenders,
Pawn brokers, Traders, Landlords, Indigenous bankers, etc., who lend money to
needy persons and institutions.

Organized
Sector

The sector that is
governed by some statutory or legal authority is known as organized sector.
This sector consists of the institutions like Commercial Banks, Non Banking
Financial Institutions, etc. They are further classified into two:

1. Capital Market
Intermediaries

2. Money Market
Intermediaries

Capital
Market Intermediaries

Capital Market refers
to the market for long term finance. The intermediaries provide long term
finance to individuals and corporate customers. IDBI, SFCs, LIC, GIC, UTI, MFs,
EXIM BANK, NABARD, NHB, NBFCs (Hire Purchasing, Leasing, Investment and Finance
Companies) Government (PF, NSC) etc., are in the organized sector providing
long term finance.

 

 

Money
Market Intermediaries

Money Market refers to
the market for short term finance. The intermediaries provide short term
finance to individuals and corporate customers. RBI, Commercial Banks,
Co-operative Banks, Post Office Savings Banks, Government (Treasury Bills) are
in the organized sector providing short term finance.

 

FINANCIAL
MARKETS

The group of
individuals and corporate institutions dealing in financial transactions are
termed as financial markets. Financial markets facilitates flow of investments.
It provides monetary support for the growth of economy. Financial markets deals
with financial securities and financial services. Where ever financial
transactions exist financial markets exists. Issue of equity stock by a
company, deposit of money in banks, purchase of bonds on secondary markets are
few examples of financial transactions.

Functions Financial
Markets:

1.    
Create and allocate credit and liquidity

2.    
Intermediary for mobilization of savings

3.    
Provide financial support conveniently

4.    
Help in process of balanced economic
growth

5.    
Provide information and transactions at
low cost

6.    
Cater various credit requirements of
business organizations.

Classification of
Financial Markets:

1.    
Classification based on types of
financial claim:

·       Debt
Market: Transaction of fixed claims like debt instruments

·       Equity
Markets: Transaction of residual claims like equity instruments

 

2.    
Classification based on seasoning of
claims:

·       Primary
Market: These markets deals with new securities. They are also known as new
issue markets. These are the markets where securities are issued for the first
time. In these markets securities are issued directly by the company. Primary
markets are for mobilizing fresh capital in form of shares and debentures.

·       Secondary
Markets: This market deals with existing securities. Existing securities are
already issued and outstanding. It consists of stock markets which is self-regulated
under purview of SEBI.

3.    
  Classification based on structure:

·       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 two:

                       
I.        
Capital Market :  This market is for long term funds. It deals
with securities and stocks with a maturity period of more than 1 year, long
term claims. In this market capital is raised and made available for industrial
purposes. Examples of capital market are: stock market, government markets and
derivative markets.

                     
II.        
Money Market : This market where short
term funds are borrowed and lend. This type of market deals with short term
monetary assets with maturity less than 1 year. Liquid funds and highly liquid
securities are traded here. Examples of this market are Treasury bill market,
call money market, etc. Main participants are Banks, Financial Institutions and
government.  

                   
III.        
Foreign Exchange Market: Foreign
exchange market is simply defined as a market in which one country’s currency
is traded for another country’s currency. It is a market for the purchase and
sale of foreign currencies.

 

4.    
Classification based on timing of
delivery:

·       Cash/Spot
Market:  Buying and selling of
commodities, stocks are sold for cash and delivered immediately after purchase
or sale.

·       Forward/Future
Market: In this market participants buy and sell stocks or commodities,
contracts and the delivery of commodities or securities at a pre-determined
time in future.

5.    
Other financial markets:

·       Derivatives
Markets: Derivatives are financial instruments for hedging risks. The
individuals and firms who wish to avoid or reduce risk can deal with the others
who are willing to accept the risk for a price. The important types of
derivatives are forwards, futures, options, swaps, etc.

 

FINANCIAL
INSTRUMENTS

 Financial instruments refer to the documents
that represent financial claim. A financial claim is claim to the repayment of
a certain amount of money at the end of a specified period along with interest
or dividend. Shares, Government Securities, Bonds, Mutual Funds, Units of UTI,
Debentures, Bank Deposits, Provident Funds, LIC Policies, Company Deposits,
Post Office Certificates, etc., are some of the examples of financial instruments.

These instruments are
classified into two types, viz., Primary securities and Secondary securities.

Primary Securities –
These are the financial instruments that are issued directly to the savers by
the users of the funds. For example, shares or debentures issued by a joint
stock company directly to the public and institutions are called as primary
securities.

Secondary Securities –
These are the financial instruments that are issued to the savers by some
intermediaries. For example, units issued by Unit Trust of India and other
Mutual Fund Organizations are called as secondary securities

 

 

FINANCIAL
SERVICES

Financial services
refer to the activities of channelizing the flow of funds from the savers to
the users. It involves the mobilization of savings of the persons and
institutions who have surplus funds and allocating or lending them to the
persons and institutions who are in need of such funds.

The financial services are
categorized into two groups, viz., Traditional services and Modern services

1. Traditional services
refer to the services that the financial institutions are rendering from a very
long time.

They are further
classified into two viz.,

a) Fund based services
and

b) Non-fund or Fee
based services.

2. Modern services
refer to the services that the financial institutions are rendering in the
recent years.

 

Growth
of Financial Systems in India

1.    
Nationalized Financial Institutions :
After Independence government started creating new financial institutions for
the supply if finance for industrial and agriculture purpose. For this reason
important financial institutions were nationalized.

·       1948
: Reserve Bank of India (RBI) was nationalized.

·       1955:
Imperial Bank of India was nationalized and name changed to State Bank of India
(SBI)

·       1956:
245 life insurance business entities were merged and nationalized to form Life Insurance
Corporation of India  ( LIC)

·       1969:
14 commercial banks were nationalized

·       1972:
107 General Business Entities were nationalized and merged to form General
Insurance Corporation of India

·       1980:
6 Commercial Banks were nationalized.

 

2.    
Establishment of Unit Trust of India: It
was established in year 1964 to strengthen Indian Financial System and provide
credit to industries. It mobilized savings from public and provision of credit
facility to institutions.

 

3.    
Establishment of Development Banks:
Provides medium and long term finance for agriculture and industrial
development purposes.

 

·       1948:
Industrial Finance Corporation of India (IFCI) was established at central
level.

·       1951:
State Financial Corporation (SFCs) at the state level established

·       1955:
Industrial Credit and Investment Corporation of India (ICICI) established

·       1958:
Refinance Corporation of India (RCI) established

·       1964:
Industrial Development Bank of India (IDBI) established

·       1990:
State Industrial Development Corporation (SIDBI) was established

 

4.    
Establishment of Institutions for
Agriculture Development: In 1963 RBI set up Agricultural Refinance and
Development Corporation (ARDC) to provide refinance to banks to finance major
developmental projects. In 1982 National Bank for Agriculture and Rural
Development (NABARD)  was established.

 

5.    
Establishment of institution for housing
finance: The National Housing Bank (NHB) has been set up in July 1988 as an
apex institution to mobilise resources for the housing sector and to promote
housing finance institutions

Limitations of Indian
Financial Systems:

1.
Lack of coordination between different financial institutions

2.
Monopolistic market structures

3.
Dominance of development banks in industrial financing

4.
Inactive and erratic capital market

5.
Imprudent & immoral financial practice.

 

Written by