Structure of Indian Financial System.

Structure of Indian Financial System. There are four segments or components of the Indian financial system. These are financial institutions, financial markets, financial instruments, and financial services. The structure of the financial system in an economy is shown in the figure below.

structure of the Indian financial system

1) Indian financial Institutions

Indian financial institutions. Different kinds of organizations that act as intermediaries and facilitators in financial transactions at the individual and corporate levels are included in the term financial institutions. Thus, it covers both the institutions providing finance and the investing institutions. They are the ones who channelize the saving and allocate the funds in the most optimum manner.

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2) Indian Financial Markets

There does not exist a physical or geographical location that can be termed as a financial market but all the financial transactions are deemed to occur in the financial market. So, it can be said that as financial transactions are pervasive in nature, financial markets are also pervasive,. Basically , a financial market is a a common place where the buyers and sellers of financial instruments meet and exchange products. Stock exchange may be termed as a place where these transactions take place and a location for the financial market.

In India financial markets are classified as follows :

1) Unorganised Market :

Under the unorganised market, there exists a large number of indigenous bankers, money lenders, tradersn etc., who lends the money to the public at large through informal source.

The indigenous bankers are responsible for collecting deposits while the others may lend. Some other forms like private financing companies, Nidhi’s, chit funds are also available and are engaged in the same line of activity. Presently, they are not monitored by RBI, but recently RBI is making efforts to convert the same into an organised sector.

   2) Organised Markets:

Under this, standardised regulations and norms are framed that governs financial trading. RBI exercises strict supervision and control on the financial transactions taking place under this type of market.

This market is further classified in two types of market:

a) Capital Market:

It is a market where the securities are usually held for long-term basis, i e., more than one year. They do not have a fixed maturity or expiry date. The buyer can hold the same, till the time he wishes to do so.

i) Equity Market:

It comprises of the equity shares of the company. Equity shares are further classified in Two categories:

  • Primary Market: Where the shares are being sold for the very first time, i.e., Initial Public Offer (IPO) and Right Issues.
  • Secondary Market: Where the existing shares are bought or sold, after they were originally issued to the public. These shares are listed on stock exchange through which they can be traded.
ii) Debt Market:

It is the financial market in which debt securities are bought and sold by the investors. These securities are in the nature of bonds or debentures and carry a fixed rate of return. Therefore, they are fixed income bearing securities that are issued by the Central and State Governments, municipal corporations, other government bodies, and commercial entities like financial institutions, banks, PSU, public limited companies, etc.

Money Market:

It means a ready market or a short-term market where securities are bought or sold only for a very short duration. The tenure usually does not exceed one year thus is considered to be an equivalent to cash only. The securities are highly liquid in nature and can be readily converted to the cash. The transaction cost is also the minimum.

3) Indian Financial Assets and Instruments

A financial instrument is an acknowledgement for a person entitling him against the claim that is receivable from another person or institution, while the person is in regular receipt of interest or dividend. These financial instruments assist the market in routing the funds from the lender to the borrower in consideration of interest. There are number of products that are available and they vary in terms of return, liquidity, marketability, reversibility, types of assets, risk and the transaction cost.

Following are the Three major forms of the Indian financial instruments and assets:

1) Money Market Instruments:

It is a component of the financial market for assets involved in short-term borrowing, lending, buying and selling with original maturities of one year or less. Some of the types of money market instruments are as follows:

i) Call and Notice Money Market: Call money market is a place where borrowings and lending take place for a very short period, ranging between overnight and fortnight

ii) Commercial Paper: It is a short duration instrument. They can be purchased directly from the market or through the intermediary and the amount is repayable on a certain future date.

iii) Treasury Bills: They are short-term (till 91 days) money market instrument, issued by the Government to meet its short-term deficiency of funds.

iv ) Bill of Exchange: Bill of exchange is also a money market instniment, which is in the form of an order in writing by the drawer of the bill to the drawee for the payment of money to the payee.

v)Certificates of Deposits (CDs): They are unsecured, negotiable and short-term in nature, which are “ payable to the bearer.

vi) Money Market Mutual Funds (MMMFs): They constitute a category of open-ended mutual funds, which specializes in channelizing investors’ funds to the short-term money market instruments.

2) Capital Market Instruments:

Capital market instruments are long-term financial instruments in the form of debt or equity that are traded either on a securities exchange or directly between investors and borrowers. Some of the instruments of capital market are as follows:

i) Equity Shares:

They represent the ownership of the company. They have the voting rights and part of decision-making process on major issues relating to the affairs of the company.

ii) Preference Shares:

Preference shareholders enjoy a fixed rate of dividend even though the company does not make profit in a year. The rate of return is fixed and is not dependent on the volume of the profits earned and they get preference over the equity in terms of dividend.

iii) Debentures:

They are the kinds of bonds that are issued by companies carrying a fixed coupon rate which is nounally payable half-yearly on pre-determined dates and the principal amount is repayable at the time of redemption. Usually the debenture holders carry some kind of charge on the debentures held by them.

iv) Bond:

It is a certificate of the indebtedness of the firm and normally does not cafry any security. unusually they are issued by a company, municipality or government agency. An investor in this case, lends out money to the issuer iii /re« of regular payment of interest and principal payment on thespecified maturity date. The interest is paid during the entire life span of the bond.

v) Rights Issue or Rights Shares:

They are issued to the existing shareholders in a pre-determined ratio of their holding.

vi) Bonus Shares:

These are issued by companies for free to their shareholders by capitalising the eserves. They are declared out of the profits of the previous years.

vii ) Government Securities:

They are also termed as G-Secs. They are sovereign (risk-free credit) interest bearing instruments issued by RBI on behalf of the Government to comply with the Central Government’s market borrow ing programme. The securities issued canry a fixed interest rate payable on pre-determined rates semi-annually basis.

3 ) Derivatives:

A derivative instrument is a financial intrument which derives its value from the underlying asset. Following are the types of derivatives:

i) Forwards:

This type of contract is a tailor-made contract, catering the need of the two parties. Under this, the contract is settled at a certain future date at a predetermined price.

  ii) Futures:

This is an arrangement between two parties, where they agree to purchase or sell a particular asset on a predetermined time in future on a specific price. They are just like the forward concocts, the only difference being that the forwards contracts are standardised and dealt on the stock exchange.

iii) Options:

An option buyer acquires the right to buy or sell a specified amount of currency for another currency at a specific rate.

iv) Swaps:

They are private contracts among two persons for exchange of cashflows at a future date on pre-decided terms. They may also be termed as the portfolios of forward contracts.

4) Indian Financial Services

Important financial services like that of leasing, credit rating, hire purchase, merchant banking, etc., are rendered by these financial intermediaries. These services are crucial in reducing the gap resulting out of ignorance and unavailability of information among the investors and the rising complexity in financial instruments and the markets.

These financial services play a crucial role in the creation of the firms, expansion of the industry and thus leading to the economic growth. The financial services are classified further in two Categories.

1) Assest and Fund-Based Financial Services:

Asset based finance is termed as funding against a range of corporate assets including accounts receivable, inventory, plant and machinery, real estate and sometimes even intellectual property and brands. It is the method of making a loan secured by an asset. It includes the following:

a) Lease Financing:

It is a financial contractual arrangement where one party having ownership of an asset lends the same to another for usage for certain duration in lieu or regular and periodic payments known as rent. At the expiry of the lease period the assets comes back to the original owner known as the lessor from the lessee. However, the parties may further renew the agreement.

b) Hire Purchase:

It refers to hiring of an asset for a certain period and after the expiry of the period acquiring the same asset. The concept of ttme sharing is followed in this case. The person who hires the asset eventually ends up purchasing it. It is used as a tool in financing capital goods like industrial finance, consumer goods.

c) Factoring:

The term ‘factoring’ is originated from Latin word ‘Factor’ which means ‘doer’. The Webster’s New Collegiate Dictionary has defined a factor as ‘one that lends money to producers and dealers on the security of accounts receivables’.

d) Forfaiting:

Forfaiting is a form of financing of receivables arising in the course of overseas trade. It refers to the purchasing of trade bills or promissory notes issued by the banks or the financial institutions without recourse to seller. Finance is carried out by discounting the instruments and taking over the entire risk involved in case of default payment.

e) Mutual Fund:

Under this the investment made by the investors are pooled together and the same is invested in securities like stock, bonds and money market instrument and other allied assets.

f) Exchange Traded Fund:

It is just like other investment funds that are traded on the stock exchange. Assets like stock, commodities, bonds, etc., are traded close to their NAV during the daily trading. Majority of these funds track an index like stock or the bond index.

g)  Consumer Credit or Consumer Finance:

It is the phenomenon of providing credit to the consumers for the purchase of consumer durable goods for everyday use. There are other names for the same concept like deferred payments, credit merchandising, instalment buying, pay as you earn scheme, pay out of income scheme, hire purchase, easy payment, instalment credit plan, credit buying, etc.

h) Bill Discounting:

It denotes a short-term money market instrument and assists in financing credit trade related transactions. Normally, bills are discounted with the bank in the ordinary course of the trading activity.

i) Housing Finance:

It is a set of financial arrangements which are rendered by the Housing Finance Companies to finance the need of funds for the construction and the purchase of house.

j) Venture Capital:

It consists of two words that are, ‘venture’ and ‘capital’. The first term venture means a course or a proceeding where the result is uncertain but the risk of loss arising exists. While the other term capital means the funds required to initiate the venture.

4) Fee-Based Financial Services:

Fee-based financial services do not create funds on the outset, rather, they ensure that the funds are created via their services for which a fee is charged by them. It comprises of:

  • Merchant Banking: It may be an institution or an individual who may be an agent for the corporation and the municipalities issuing securities. Further, broker or dealer operations are also maintained by them alongside and they also trade in existing issued securities. They also offer advice related to the investments to the investors in general.
  • Credit Rating: It is the process of allocating symbols having unique reference to the different instruments being rated, that indicate the opinion of the issuer to issue debt-related instruments on the ability to pay off the debt in timely manner is known as credit rating.
  • Stock Broking: The mechanism under which the buyer and the seller of the securities come to a particular place like stock exchange for transaction dealing is termed as stock broking.
( Indian Financial System )
  • Debt Securitisation: It is the process by which assets like auto loan receivables, cash credit receivables, mortgage loans are converted into tradable investment.
  • Letters of Credit: It is commonly referred as LC. It is a written document which is issued by the buyers bank to the sellers bank to reimburse the cost of goods and services that are supplied by the seller to the buyer when the documents are submitted within the particular timeframe at a specified time and specified place, upto a certain amount and to a particular bank on the condition that the documents are submitted in accordance with terms and the conditions implied.
  • Bank Guarantees: It is the contract between the client and the issuing bank where the bank assumes the responsibility to settle the claims of the client for the customer for which the guarantee was given.

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