Components/Constituents of Indian Financial System

The following are the four major components that comprise the Indian Financial System:

1. Financial Institutions
2. Financial Markets
3. Financial Instruments/Assets/Securities
4. Financial Services.

Financial Institutions:
Financial institutions are the intermediaries who facilitate smooth functioning of the financial system by  making investors and borrowers meet. They mobilize savings of the surplus units and allocate them in production activities promising a better rate of return. Financial institutions also provide services to entities (individual, business,  government) seeking advice on various issues ranging from restructing diversification plans. They provide whole range of services to the entities who want to raise funds from the market or elsewhere.
      Financial institutions are also termed as financial intermediaries because they act as middlemen between the savers (by accumulating funds from them) and borrowers (by lending these funds). Bank also act as intermediaries because they accept deposits from a set of customers (savers) and lend these funds to another set of customers (borrowers). Like-wise investing institutions such as GIC, LIC, mutual funds etc. also accumulate savings and lend these to borrowers,  thus performing  the role of financial intermediaries.
      Financial institutions role as intermediaries differs from that of a broker who acts as an agent between buyer and seller of a financial instrument (equity shares, preference, debt); thus facilitating the transaction but does not personally issue a financial instrument. Whereas, financial intermediaries mobilise savings of the surplus units and lend them to the borrowers in the form of loans and advances (i.e. by  creating a financial assets). They earn profit from the difference between rate of interest charged on loans and rate of interest paid on deposits (savings). In short, they repackage the depositor's savings into loans to the borrower. As financial intermediaries, they meet the short-term as well as long-term needs of the borrowers and provide liquidity to the savers. Deposits are payable on demand by the customers. Banks are in a position to avoid the situation of illiquidity while borrowing for short periods and lending for long term by mobilising savings from diversified set of depositors. RBI also has made it mandatory for the banks to keep a certain percentage of deposits as cash reserves with itself to avoid the situation of ill- liquidity.

Financial Markets :
     Finance is the pre-requisite for modern business and financial institutions play a vital role in the economic system. It is through financial markets and institutions that the financial system of an economy  works. Financial markets refer to the institutional arrangements for dealing in financial assets and credit instruments of different  types such as currency, cheques, bank deposits,  Bills, bonds, etc.
      Financial markets may be broadly classified as negotiated loan markets and open markets. The negotiated loan market is a market in which the lender and the borrower personally negotiate the terms of the loan agreement, e.g. a businessman borrowing from a bank or from a small loan company. On the other hand, the open market is an impersonal market in which standardized securities are treated in large volumes. The stock market is an example of an open market. The financial markets, in a nutshell, are the credit markets catering to the various credit needs of the individuals, films and institutions. Credit is supplied both on a short as well as a long term basis.

      Another important constituent of financial system is financial assets / instruments. They represent a claim against the future income and wealth of others. In other words, a financial instrument is a claim, against a person or an institution, for the payment of a sum of money and/or a periodic payment in the form of interest  or dividend, at a specified future date. In financial markets, a variety of investors operate. To suit their requirements, different types of securities are issued by the companies and financial instruments. In other words, financial markets/system promotes development of innovative financial products suited to the investment requirements of heterogeneous investors.
      Financial security's may be classified under two board categories :
      1. Primary securities. These are also termed as 'direct securities' as these are issued directly by the ultimate borrowers of funds to the ultimate savers or investors. Primary securities include equity shares, preference shares and debentures.
       2. secondary securities. These securities are also termed as 'indirect securities' as these are not issued directly by the ultimate borrowers, rather, these are issued by financial intermediaries to ultimate savers. Insurance policies, units of the mutual funds, bank deposits etc. are the examples of secondary securities.
       Financial instruments perform a significant role in transfering funds from lenders to borrowers through financial markets and financial intermediaries. Each instruments differs from reach other in terms of its marketability, risk, return, liquidity and transaction costs.
      There has been tremendous growth in new financial instruments since 1990's, issued by both the corporate and financial instruments. The following are the some of the new innovative financial instruments devised for raising funds :
             (1) Equity Warrants
             (2) Secured premium notes
             (3) Collable Bond
             (4) Floating/variable or adjustable rate bonds
             (5) Deep Discount bonds (DDBs)
             (6) Inflation Adjusted Bonds (IABs)
             (7) Easy Exit Bond with a Floating Interest Rate
             (8) Regular Income Bonds
             (9) Retirement Bonds
             (10) Index Bonds
             (11) Encash Bonds
             (12) Growth Bonds
             (13) Capital Bonds, etc.

          Efficiency of emerging financial system largely depends upon the quality and variety of financial services provided by financial intermediaries. Financial services organisation render services to industrial enterprises  and ultimate consumer markets. Within the financial services industry the main sectors are banks, financial institutions and non-banking financial companies. Financial services provided 3various financial institutions, commercial banks and merchant bankers are broadly classified into two categories  (1) Asset based/fund based services  (2) Fee based/advisory services. Asset based services include equipment leasing/finance, hire purchase and consumer credit, bill discounting, venture capital, housing finance, insurance services, factoring etc. Whereas fee based services include issue management, portfolio management, corporate counseling, loan syndication, merger and acquisition, credit-rating etc.


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