Indian Financial System Overview

Indian Financial System Overview

Indian Financial System

There are two parts of the Indian Financial System: the first demand side, and the second supply side. The representative of the demand side can be Individual investors, Industrial and Business Companies, Government, etc., and the representative of the supply side will be Banks, Insurance Companies, Mutual funds, and other Financial Institutions.

The Indian financial system, which refers to the borrowing and lending of funds or to the demand for and supply of funds of all individuals, institutions, companies, and the Government, consists of two parts, viz., the Indian money market and the Indian capital market.

Indian Money Market and Capital Market

• The Indian money market is the market in which short-term funds are borrowed and lent.

• The capital market in India, on the other hand, is the market for medium-term and long-term funds.

Role in Economic Development

• The Indian financial system performs a crucial role ithe n the economic development of India through the saving-investment process, also known as capital formation.

Classification of Financial System

The financial system is commonly classified into:

1. Industrial finance

2. Agricultural finance

3. Development finance

4. Government finance

Important Financial Concepts

Devaluation

• A Devaluation means lowering the official value of the local money in terms of foreign currency or gold.

Balance of Payments (BoP)

A Balance of Payments (BoP) is a systematic record of all the economic transactions between one country and the rest of the world in a given period.

• BoP is divided into the current account and the capital account.

Balance of Trade (BoT)

Balance of Trade (BoT) is the difference between the value of goods exported and the value of goods imported per annum.

• Services not included in BoT.

Key Policies and Milestones

• EXIM Policy 2000-01 introduced the Special Economic Zones (SEZ) Scheme.

• In 1994-95, the Indian Rupee was made fully convertible on the current account.

Fiscal Policy

• Fiscal Policy is the policy relating to public revenue and public expenditure and allied matters.

Classification of the Indian Money Market

Organised and Unorganised Sectors

Usually, the Indian money market is classified into the organised sector and the unorganised sector.

• The unorganised sector consists of indigenous bankers, including the Non-Banking Financial Companies (NBFCs).

• Besides these two, there are many sub-markets in the Indian money market.

Organised Banking System in India

The organised banking system in India can be broadly divided into three categories, viz.:

1. The central bank of the country is known as the Reserve Bank of India

2. The commercial banks

3. The co-operative banks, which include private sector and public sector banks, and also foreign banks

The highest financial institution in the organized sector is the Reserve Bank of India, and in addition to this, of Public Sector Banks of Private Sector Banks, Foreign Banks, and other financial institutions are also part of the organized sector.

Reserve Bank of India

Establishment and History

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 1 April, 1935 with a capital of Rs. 5 crore.
It was nationalised on 1 January, 1949; on the recommendation of Parliamentary Committee in 1948.
It is the Central Bank of India.

Role and Functions

• 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 1 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.

Components of the Capital Market in India

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 on their own in securities are also suppliers of funds to the capital market.

Factors Affecting the Market

The trend in the capital market is basically affected by two important factors:

1. Operations of the institutional investors in the market

2. The excellent results flowing in from the corporate sector

Important Share Price Index of the World

Classification of the Capital Market in India

The capital market in India can be classified into:

1. Gilt-edged market or market for Government and semi-government securities

2. Industrial securities market

3. Development financial institutions and Non-banking financial companies

Gilt-edged Securities Market

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

Industrial Securities Market

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 Market (Primary Market) – for raising fresh capital in the form of shares and debentures.

(b) Old Issues Market (Secondary Market) – for buying or selling shares and debentures of existing companies, commonly referred to as the stock market or stock exchange.

Primary Capital Market

• If shares or debentures of private corporations, primary securities of government companies, or new securities and issues 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

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

Financial Intermediaries

• 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 in 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.

History in India

• The first organised stock exchange in India was started in Bombay (now Mumbai), when the "Native Share Exchange (BSE)" was formed by the brokers in 1875.

• BSE Brokers' Association, known as the Bombay Stock Exchange (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 (NSE), all regional stock exchanges have lost relevance.

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

Credit Rating Agencies in India & the World

Registered intermediaries as on 13 July 2023. The Indian credit rating industry mainly comprises:

• CRISIL – Headquarters: Mumbai

• ICRA (Investment Information and Credit Rating Agency) – Headquarters: Gurgaon

• CARE (Credit Analysis and Research) – Headquarters: Mumbai

• ONICRA

• FITCH (India Ratings & Research) Headquarters: Mumbai

• SMERA (SOLITE Ratings & Research Ltd) – Headquarters: Mumbai

• Brickwork Ratings India Pvt. Ltd – Headquarter: Bangalore

• NOOMERICS Valuation and Rating Pvt. Ltd – Headquarter: New Delhi

Global Credit Rating Agencies

• Standard & Poor's (S&P) –Headquarters: New York, US

• Moody's Headquarters: New York, US

• Fitch Ratings Headquarters: New York, US

Market Position

• CRISIL is the largest credit rating agency in India, with a market share of greater than 60%. [Source: SEBI]

Final Thoughts

The Indian Financial System acts as the backbone of the country’s economy by connecting the demand and supply of funds. It ensures smooth functioning of both the money market and the capital market, providing short-term as well as long-term finance to individuals, businesses, and the government.

Institutions like the Reserve Bank of India (RBI), commercial banks, co-operative banks, and financial intermediaries play a vital role in maintaining stability. The system also evolves with policies like Fiscal Policy, EXIM Policy, and the introduction of SEZs, which promote growth and trade.

Moreover, the presence of stock exchanges and credit rating agencies ensures transparency, investor confidence, and efficient capital flow in the economy.