Indian Financial Sysytem

The financial system in any country is comprised of the financial institutions, financial markets, financial instruments and financial services.

Organisation of Financial System in India

 The Structure of the Financial System

Indian financial system refers to the system of borrowing and lending of funds or the demand for and the supply of funds of all individuals, institutions, companies and government. Broadly, the financial system is classified into:

• industrial finance: funds required for the conduct of industry and trade;
• agricultural finance: funds needed and released for the conduct and agricultural and allied activity;
• development finance: funds required for the development of the country; it indeed includes all the above finances; and
• government finance: relates  to the demand for and supply of funds to meet Government expenditure.

The Function of the Indian financial system:

• transferring resources across time and space: Loans help move resources from the future to today, and savings products do the opposite, but the underlying function for these two seemingly different products is the same. Student loans, borrowing to buy a house and saving for retirement are all that shift resources from one place to another. So, when a person sends money to a family member in a different location, the basic function the movement of resources to him to the recipient.

• Managing Risk: Through financial securities  and through private sector and government intermediaries, the financial system provides risk pooling and risk sharing opportunities, for both households and business firms. For example, suppose you want 100,000 to start a business. You get 70,000 from a private investor in equity capital in exchange for 75% share of the profits of the business, and you get 30,000 loan from the bank at 6% interest rate per year. Suppose the bank requires that you get other members of your family to guarantee the loan, thereby transferring the risk of default from the bank to your relatives. Thus the bank is now providing you with the money with minimal risk to itself and the risk of the loan is transferred to your relatives. Just as funds are transferred through the financial system, so are risks. For example, Insurance companies are financial intermediaries that offer the transfer the risk from the customers to the investors in exchange for some premium.

• clearing and settling payments: An important function of the financial system is to provide an efficient way for people and business to make payments for the good services they wish to buy. Depository financial intermediaries serve this function with wire transfers, checking accounts, and credit/cash cards. Other intermediaries such as money market, mutual funds offer transaction-draft accounts and firms whose principal business is not financial, such as General Electric, offer general credit cards. The key elements for managing costs and risks associated with the process of clearing and settling payments include netting arrangements, efficient use of collateral, delivery-versus payment, immobilization of securities, and extension of credit.

• pooling resources and subdividing shares: The financial system provides a mechanism for  the pooling of funds to undertake large-scale indivisible enterprise and for the subdividing of shares in enterprises to facilitate diversification. Suppose you wish to invest in a business that costs 100,000, but you only have 10,000 to invest. Since you cannot possibly divide the business to buy a part of it, you will not be able to make this investment. A financial system corrects this problem by bringing together a bunch of investors and distributing shares to them, there by dividing the sum of investment 100,000 into smaller economic pieces. Any money the business earns from the race will be distributed among the shareholders.

• providing information and security: The financial system provides the price information that helps coordinate decentralized decision-making in various sectors of the economy. The clear function of financial markets is to allow individuals and business to trade financial assets. An additional function of the capital market is to provide information the assists in decision-making. For example Interest rates and security prices are information that households use in making their consumption-saving decisions. The financial market provides security to dealings in financial assets.