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Unit-1: Working of Financial Institutions

The document discusses financial institutions and their role in the financial system and economic development. It describes the three main components of a financial system - financial assets, financial institutions, and financial markets. It also discusses the types of specialized financial institutions in India, including development banks, state-level institutions, and investment institutions. The importance of these specialized financial institutions is that they provide long-term financing needed by industry and help develop small businesses and backward areas of the economy.

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25 views

Unit-1: Working of Financial Institutions

The document discusses financial institutions and their role in the financial system and economic development. It describes the three main components of a financial system - financial assets, financial institutions, and financial markets. It also discusses the types of specialized financial institutions in India, including development banks, state-level institutions, and investment institutions. The importance of these specialized financial institutions is that they provide long-term financing needed by industry and help develop small businesses and backward areas of the economy.

Uploaded by

praguusharma
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Unit-1

Working of Financial
Institutions
Financial System

An institutional framework existing in a country to


enable financial transactions. It consist of three main
parts:

 Financial assets (loans, deposits, bonds, equities, etc.)


 Financial institutions (banks, mutual funds, insurance
companies, etc.)
 Financial markets (money market, capital market etc.)
Financial assets/instruments
 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
Financial Institutions
 Includes institutions and mechanisms which
1. Affect generation of savings by the community
2. Mobilization of savings
3. Effective distribution of savings
 Institutions are Banks, Insurance Companies,
Mutual funds- promote/mobilise savings
 Individual investors, industrial and trading
companies- borrowers
Financial Markets
 Money Market- for short-term funds (less than a
year)
1. Organized (Banks)
2. Unorganized (money lenders, chit funds, etc.)

 Capital Market- for long-term funds


1. Primary Issues Market
2. Stock Market
3. Bond Market
Management of Financial
Institutions

Dr. Pushapa Negi


Financial Institutions
The term ‘Financial Institution’ includes banking
institutions and non-banking financial institutions. The
banking institutions may have quite a few things in
common with the non-banking ones. However, the
distinction between the two has been highlighted by
Sayers, by characterizing the former as ‘creators’ of
credit, and the latter as mere ‘purveyors’ of credit. This
distinction arises from the fact that banks, which are part
of payment system, can create deposits and credit but the
non-banking institutions, which are not part of payment
system, can lend only out of the resources put at their
disposal by the savers.
Role of Financial Institutions in
the Development of Economy
1. It reduces the transaction cost of the economy
through provision of an efficient payment
mechanism.
2. Helps in pooling of risks and making
available long-term capital through maturity
transformation.
3. By making funds available for
entrepreneurial activity and through its
impact on economic efficiency and growth.
4. A well functioning financial sector also helps
alleviate poverty both directly and indirectly
Specialized Financial Institutions
SFIs are institutions set up mainly by the government
for providing medium and long-term financial
assistance to industry. As these institutions provide
developmental finance, that is, finance for investment in
fixed assets, they are also known as ‘development banks’
or ‘development financial institutions’.

These institutions receive funds for their financing


operations primarily from the government or other
public institutions. These institutions also raise funds
from the capital market.
Types of Specialized Financial Institutions

(a) All India Development Banks

(b) State-level Institutions

(c) Investment institutions


a) All India Development Banks

1. Industrial Development Bank of India (IDBI)


2. Small Industries Development Bank of India
(SIDBI)
3. Industrial Finance Corporation of India (IFCI)
4. Industrial credit and Investment corporation of
India (ICICI)
5. National Bank for Agriculture and Rural
Development (NABARD)
6. Industrial Investment Bank of India Ltd.
(previously, Industrial Reconstruction Bank of
India)
(b) State-level Institutions

1. State Financial Corporation’s (SFCs)

2. State Industrial Development Corporations (SIDC)

3. State Industrial Investment Corporations (SIIC)


c) Investment institutions

1. Unit Trust of India (UTI)

2. Life Insurance Corporation of India (LIC)

3. General Insurance Corporation (GIC)


Need for Specialized Financial
Institutions

The need for establishing SFIs arose mainly because of the


following reasons:-

1.It was difficult for industry in general to procure sufficient


long term funds in the capital markets. There were no other
institutions to supply long-term finance to industry.
Traditionally, only short term finance could be availed from
commercial banks. SFIs were established to ensure that
industry get sufficient long-term funds and in the desired
sectors in accordance with planned priorities.
2. Certain particular sections of the industry faced greater
difficulties than others in procuring long-term finance.
These included (a) Small and medium sized concerns, (b)
new concerns set up by new entrepreneurial groups, (c)
specific industries, such as cotton and jute, which required
funds for modernization, (d) concerns involved in
innovation and new technological developments, (e)
concerns requiring extra-ordinarily large amounts of
finance with a long gestation period, (f) concerns in
backward regions.

In general it can be said that the gap between the demand for and
supply of industrial finance is sought to be filled through term
loans by development financial institutions. Due to this role,
they have been called gap-fillers.
Importance of Specialized
Financial Institutions
1. They constitute an important source of long-term finance to
industry. Over a period of time, there has been a steady
growth in the number of industrial units assisted, and in the
amount of loan sanctioned and distributed by SFIs.
2. SFIs have played an important role in the development of (a)
Small scale industry, and (b) Projects in backward areas.
3. They have helped new and small entrepreneurs in setting up
industry.
4. Through their operations involving underwriting of and
direct subscription to the issue of shares and debentures,
they have been important players in the capital market.
These operations have a favorable impact on the ability of
industrial concerns to raise funds from capital market.
5. These institutions have improved the allocation of funds to
industry and thus, have aided in better use of the available
resources for the economic development of the country.

6. SFIs have been a source of technical and managerial advice


to the industry. They have also helped in identification,
evaluation and execution of new investment projects.

7. These institutions have been helpful in the establishment of


concerns which required extra-ordinarily large amounts of
finance for their projects with a long gestation period.

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