FINANCIAL INSTITUTIONS AND MARKETS

Vinod Basupattad, JSS-DVH-IMSR

An individual has a surplus of Rs.1 lac, what he can do with it ? What does a bank do? Where all the insurance premium collected by Insurance company goes? How do government raise funds? A company is need of funds, what options it has got?

Financial System

An institutional framework existing in a country to enable financial transactions Three main parts

Financial assets (loans, deposits, bonds, equities, etc.) Financial institutions (banks, mutual funds, insurance companies, etc.) Financial markets (money market, capital market, forex market, etc.)

Regulation is another aspect of the financial system (RBI, SEBI, IRDA, FMC)

Requirement of efficient financial system

Regulatory system for governance Diversified instruments/assets Free market system with less intervention of government Developed capital and money markets Financial engineering Financial innovation

THE FINANCIAL SYSTEM

Funds Deposits/Shares
Financial Institutions
Commercial Banks Insurance Companies Mutual Funds Provident Funds Non-Banking Financial Companies

Funds Loans

Suppliers of Funds Individuals Businesses Governments

Demand of Funds
Individuals Businesses Governments

Financial Markets

Funds Securities

Money Market Capital Market

Funds Securities

Centre for Financial Management , Bangalore

Definitions
Financial Inst : FI are business organizations that act as mobilisers and depositories of savings and as purveyors of credit or finance. A typical FI deals in deposits, loans, securities etc Financial Market : A FM is an institution or arrangement that facilitates the exchange of financial instruments, including deposits and loans, corporate stocks and bonds, govt securities

Indian Financial System

Non- Organized Organized Money lenders Regulators Financial Institutions Financial Markets Financial services Local bankers Traders Landlords Pawn brokers Chit Funds

Evolution of Financial System

Barter Money Lender

Nidhi's/Chit Funds

Indigenous Banking

Cooperative Movement

Societies

Banks

Joint-Stock Banks

Consolidation Commercial Banks Nationalization

Investment Banks Development Financial Institutions

Investment/Insurance Companies Stock Exchanges Market Operations Specialized Financial Institutions

Merchant Banking
Universal Banking

Classification of Financial Institutions

Banking and Non Banking Institutions

Intermediaries and Non-intermediaries Eg : PSU Banks, Pvt Sector Banks, LIC, GIC, UTI

NABARD, NAFED, IFCI are non intermediaries

FINANCIAL INTERMEDIARIES/NON INTERMEDIARIES

Reserve Bank of India

Commercial banks

Developmental financial institutions

Insurance companies

Other public sector financial institutions

Mutual funds

Non-banking financial corporations

Public sector banks

All India institutions

Life Insurance Corporation of India

POSB

Unit Trust of India

Public sector firms

Private sector insurance companies

NABARD

Private sector banks

State level institutions

General Insurance Corporation of India

NHB & SIDBI NAFED

Other mutual funds

Private sector firms

Centre for Financial Management , Bangalore

Financial assets/instruments Classified as Marketable Assets/Non Marketable Assets

Enable channelizing funds from surplus units to deficit units There are instruments for savers such as deposits, equities, mutual fund units, etc. There are instruments for borrowers such as loans, overdrafts, etc. Like businesses, governments too raise funds through issuing of bonds, Treasury bills, etc. Instruments like PPF, KVP, etc. are available to savers who wish to lend money to the government Examples :

A 10-year bond issued by the GOI carrying an interest rate of 7 percent.

Equity shares issued by TCS to the general investing public through an initial public offering.
ESOP granted by WIPRO to its employees.

Characteristics of Financial Institutions

FI includes institutions and mechanisms which

Affect generation of savings by the community Mobilisation of savings Effective distribution of savings

Institutions are banks, insurance companies, mutual funds- promote/mobilise savings Individual investors, industrial and trading companies- borrowers

FUNCTIONS OF THE FINANCIAL SYSTEM

Payment and settlement System Depository financial intermediaries such as banks are the pivot of the payment system. Credit card companies play a supplementary role. Pooling of Funds(Mobilization of savings)

Financial markets and intermediaries facilitate the pooling of the household savings for financing business.
Transfer of Resources The financial system facilitates the efficient life-cycle allocations of household consumption, the efficient allocation of physical capital to its most productive use, and the efficient separation of ownership from management. Provision of Liquidity A well-developed financial system offers necessary liquidity to market to ensure that there is no shortage of financial resources for productive ventures Eg: RBI ensures liquidity in Indian Financial System

FUNCTIONS OF THE FINANCIAL SYSTEM

Risk Management
A well-developed financial system offers a variety of instruments that enable economic agents to pool, price, and exchange risk The three basic methods of managing risk are : hedging, diversification, and insurance Price Information for Decentralised Decision Making Interest rates and security prices are used by households in their consumption-saving-investment decisions and by firms in their investment and financing decisions

Financial System and Economic Development

1.

2.

3.

4. 5. 6.

7.
8.

Mobilizing Savings Promoting and encouraging investments in diversified financial assets Allocation on economical basis as well as on priority of national importance Creating credit Providing a spectrum of assets Financing trade and agriculture and priority sector Entrepreneurial development Equitable development of industry as well as regions(geographies)

Exercise

To assess various business/corporate or entities and understand how finance is sourced by them