Indian Financial System

Indian Financial System

Indian Financial System is a system in which People, Financial Institutions, Banks, Industrial Companies, and the Government demand funds, and the same is supplied to them.  

The Indian Financial System consists of two main components: the demand side and the supply side. The demand side includes individuals, businesses, and the government that seek funds, while the supply side comprises banks, insurance companies, mutual funds, and other financial institutions that provide these funds.

Broadly, the system is divided into the money market, which handles short-term funds, and the capital market, which deals with medium- and long-term funds.

This system plays a crucial role in India's economic growth by facilitating the saving-investment process, also known as capital formation.

The financial system is commonly classified into:

1. Industrial finance

2. Agricultural finance

3. Development finance

4. Government finance.

Devaluation refers to the official reduction in the value of a country's currency in terms of foreign currency or gold.

• The Balance of Payments (BoP) is a comprehensive record of a country’s economic transactions with the rest of the world, divided into the current and capital accounts.

• The Balance of Trade (BoT) reflects the difference between exports and imports of goods, excluding services.

Key developments

The introduction of the SEZ Scheme under the EXIM Policy 2000–01 and full current account convertibility of the Indian Rupee in 1994–95.  Fiscal policy governs government revenue and expenditure.

The Indian money market comprises the organised sector, which includes the RBI, commercial, co-operative, and foreign banks, and the unorganised sector, which consists of indigenous bankers and NBFCs.

The Reserve Bank of India, the apex financial institution, regulates the entire organised financial system.

Reserve Bank of India

• The Reserve Bank of India regulates and controls the money of the country.

• The RBI was established under the Reserve Bank of India Act, 1934 on 1st April, 1935 with a capital of Rs. 5 crore.

• It was nationalised on 1st January 1949, on the recommendation of the Parliamentary Committee in 1948. It is the Central Bank of India.

• The Reserve Bank of India is the supreme monetary and banking authority in the country and has the responsibility to control the banking system in the country.

• It keeps the reserves of all commercial banks and hence is known as the 'Reserve Bank'. Its financial year is from 1st July to 30th June.

The Indian Capital Market

The Indian capital market is the market for long-term capital (or loans); it refers to all the facilities and institutional arrangements for borrowing and lending 'term funds'— medium-term and long-term funds.

The Capital Market in India includes:

1. Government Securities (Gilt-edged market)

2. Industrial Securities Market

3. Development financial institutions like IFCI, IDBI, ICICI, SFCs, IIBI, UTI, etc

4. Financial Intermediaries like Merchant banks.

Individuals who invest directly in securities on their own are also suppliers of funds to the capital market. The trend in the capital market is affected by two important factors :

1. Operations of the institutional investors in the market and;

2. The excellent results flowing in from the corporate sector.

Important Share Price Index of the World

The capital market in India can be classified into:

(i) Gilt-edged market or market for Government and semi-government securities;

(ii) Industrial securities market;

(iii) Development of financial institutions

(iv) Non-banking financial companies.

The gilt-edged securities market is the market for Government and semi-government securities, which carry fixed interest rates.

The industrial securities market is the market for equities and debentures of companies of the corporate sector. This market is further classified into— 

a. New issue markets for raising fresh capital in the form of shares and debentures (commonly referred to as the primary market), and

b. Old issues market (or secondary market) for buying or selling shares and debentures of existing companies— this market is commonly referred to as the stock market or stock exchange.

If shares or debentures of private corporations, primary sureties of government companies, or new sureties and the issue of bonds of the public sector are sold or purchased in the capital market, then the market is called the Primary Capital Market.

Secondary Market includes transactions in the stock exchange and gilt-edged market.

Merchant Bank, Mutual Fund, Leasing Companies, Risk Capital Companies, etc., collect and invest public money into the capital market.

Unit Trust of India (UTI) is the biggest Mutual Fund Institution of India.

Stock Exchange

• The stock exchange is the market for buying and selling stocks, shares, securities, bonds, and debentures, etc.

• It increases the marketability of existing securities by providing a simple method for the public and others to buy and sell securities.

• The first organised stock exchange in India was started in Bombay (now Mumbai) when the "Native Share Brokers' Association", known as the Bombay Stock Exchange (BSE), was formed by the brokers in 1875. BSE is Asia's oldest stock exchange.

• In 1894, the Ahmedabad Stock Exchange was started to facilitate dealings in the shares of textile mills there.

• The Calcutta Stock Exchange was started in 1908 to provide a market for shares of plantations and jute mills. The number of stock exchanges rose from 7 in 1939 to 21 in 1945.

• Under the Securities Contract (Regulation) Act of 1956, the Government of India has so far recognised 23 stock exchanges. Bombay is the premier exchange in the country.

• With the setting up of the National Stock Exchange, all regional stock exchanges have lost relevance.

• The BSE transformed itself into a corporate entity from being a brokers' association from the middle of August 2005.

Regulator in India (As on 22.09.2022)

• As a public limited company, BSE (Bombay Stock Exchange) is obliged to dilute stock brokers' stake to 49%.

• To prevent excessive speculation and volatility in the stock market, the SEBI has introduced rolling settlements from July 2, 2001, under which settlement has to be made every day.

Some Important Share Price Indexes of India

• BSE SENSEX This is the most sensitive share index of the Mumbai Stock Exchange.

• This is the representative index of 30 main shares.

• Its base year is 1978-79.

• BSE is the oldest stock exchange of India, founded in 1875.

  • BSE 200: This represents 200 shares of the Mumbai Stock Exchange. Its base year is 1989-90.

  • DOLLEX: The Index of 200 BSE Dollar Value Index is called DOLLEX. Its base year is 1989-90.

  • NSE-50: From 28^th July, 1998, its name is S and P CNX Nifty. National Stock Exchange has launched a new share Price Index, NSE-50, in place of NSE-100 in April 1996. NSE-50 includes 50 companies' shares. This stock exchange was founded on the Ferwani Committee's recommendation in 1994.

• CRISIL, set up in 1988, is a credit rating agency. It undertakes the rating of fixed deposit programmes, convertible and non-convertible debentures, and also credit assessment of companies.

  • CRISIL 500 is the new share Price Index introduced by Credit Rating Agency, by the "Credit Rating Information Services of India Limited" (CRISIL) on January 18, 1996.

• The National Stock Exchange (NSE) has launched a new version of its online trading software called "National Exchange for Automatic Trading" (NEAT).

Ranking of India in Different Indexes (As on 22.09.2022)

1. In Edelman Trust Barometer-2021, India ranked 1st and China second.

2. Transparency International India (TII)-Global Corruption Perception Index-2021 India ranked 85th among 180 countries (Denmark, New Zealand Topped).

3. World Bank's 'Ease of Doing Business' Report (2020) - India ranked 63rd among the 190 countries (New Zealand at the top, followed by Singapore).

4. World Economic Forum's 2022 Gender Gap Index - India 135^th (Iceland top, Afghanistan last).

5. Global Hunger Index Report 2021 - India ranked 101st among 116 countries. (Yemen ranked 115^th, followed by Samolia 116th).

6. Human Development Index 2021-22 - India ranked 132 among in the list of 191 countries (Switzerland top).

7. World Press Freedom Index 2022 - India ranked 150 in the list of 180 countries (Norway top, North Korea last).

8. Global Peace Index 2022 - India ranked 135th out of 163 countries (Iceland top, Afghanistan is the least peaceful place).

9. Global Innovation Index 2021 - India ranked 46th, out of 131 countries (Switzerland top).

10. World Happiness Report 2022 - India ranked 136th out of 146 countries (Finland top and Afghanistan last).

Final Thoughts

The Indian Financial System serves as the backbone of the country’s economy by efficiently channeling funds from surplus units to deficit units.

Its two key components—the demand side, consisting of individuals, businesses, and the government, and the supply side, including banks, insurance companies, mutual funds, and other financial institutions—work together to maintain a balanced and functioning economy.

By facilitating short-term needs through the money market and long-term investments through the capital market, the system ensures smooth financial operations, encourages savings and investments, and contributes significantly to capital formation.

Overall, it plays a critical role in fostering economic development, financial inclusion, and long-term growth for the country.