FINANCIAL INSTITUTIONS AND MARKETS

Subject code : EL15FN505

BOOKS FOR REFERENCE

• Khan, M Y. (2020). Indian Financial System .Eleventh Edition . McGraw Hill Higher Education

• Machiraju ,H. R. (2019). Indian Financial System , Fifth Edition .Vikas publishing House.

• LM Bhole. Financial Institutions and Markets

• Shahani, Rakesh( 2011). Financial Markets in India: A Research Initiative. Anamica

Publications

• Venkatesh T R: Indian Financial Market an Introduction

• Saunders, Anthony & Cornett, Marcia Million (2007). Financial Markets and Institutions (3rd
ed.). Tata McGraw Hill
Module 1 : Indian Financial System

Evolution of Indian Financial System – Structure (Sub-

systems) of Indian Financial System : Introduction to
Markets, Instruments, and Institutions & Services.
Money
• It is a medium of exchange; it allows people to obtain what they need
to live
• A unit of account; a store of value; and, occasionally, a standard of
deferred payment
Importance
• It enables you to give back to your community, to pick the charities
and causes you to believe in and support them. 
Economies
• It is rely on the exchange of money for products and services.
• Where it comes from, and what it's worth.

Characteristics –

money are durability, 

portability, 

divisibility,

uniformity, limited supply and

acceptability.
Four Different Types of Money

• Commodity money – It relies on intrinsically valuable commodities that act as a medium

of exchange

• Fiat money - its value from a government order . (the government declares fiat money)
to be legal tender, which requires all people and firms within the country to accept it as
a means of payment. (supply and demand)

• Fiduciary money - Its value on the confidence that it will be generally accepted as a
medium of exchange. (cheques, banknotes, or drafts)

• Commercial bank money – It is debt generated by commercial banks that can be

exchanged for “real” money or to buy goods and services.
Finance

• It is a management of money and other valuables, which can be easily

converted into cash. 

• It is concerned with the maintenance and creation of economic value

or wealth.

• Encompasses - banking, leverage or debt, credit, capital markets,

money, investments, and the creation and oversight
of financial systems. 
Three areas of finance
• money and credit markets, which deals with the securities markets
and financial institutions;

• investments- focuses on the decisions made by both individuals and institutional

investors

• financial management- involves decisions made within the firm regarding the
acquisition and use of funds.

• Areas - Corporate finance, Investments, Financial institutions, International finance.

• Purpose of finance - people save, manage, and raise money.

Father of modern finance

Dr.Eugene Fama - the “father of modern finance” and who

was awarded the Nobel Prize for Economics.
Dr Fama is a professor at the University of Chicago and
founding board member of Dimensional Fund Advisers.
Dr Fama developed a theory known as the Efficient Market
Hypothesis.
the theory - market prices react quickly to new and
previously unknown information implying that it’s not possible
for an individual investor to outperform the market in the
long term.

Source: https://www.quora.com/Who-is-the-father-of-finance
Financial system

• It aims at establishing and providing a regular, smooth, efficient and cost effective
linkage between depositors and investors is known as financial system

• Set of institutions - such as banks, insurance companies, and stock exchanges, that
permit the exchange of funds.

• Exist on firm - regional, and global levels.

• Borrowers, lenders, and investors exchange current funds to finance projects,

either for consumption or productive investments, and to pursue a return on their
financial assets. 
Financial system
• financial institutions, financial intermediaries, financial markets and financial
instruments
Nature

• Transfer Funds - Transferring of financial resources from one person to another person. (system -
financial markets, financial intermediaries, financial assets and services which facilitates fund
movements in an economy ).

• Mobilizes Saving - It helps in allocating ideal lying resources with peoples into productive means.

• Risk Allocation -. Financial system allocates people’s funds in various sources due to which risk is
diversified. 

• Facilitates Investment - It provides various income-generating investment options to peoples for

investing their savings.

• Enhances Liquidity – It helps in maintaining optimum liquidity in an economy. It facilities free

movement of funds from households (savers) to corporates (investors) which ensures sufficient
availability of funds. 
Stock Exchange in India

• https://www.nseindia.com/ - NSE
• https://www.bseindia.com/ - BSE

Financial Products
 AMC - 44 companies

 57 insurance companies of which 24 are in

life insurance business and 33 are non-life insurers.
 World’s Stock Exchanges

Source : http://money.visualcapitalist.com/all-of-the-worlds-stock-exchanges-by-size/
Source : http://money.visualcapitalist.com/all-of-the-worlds-stock-exchanges-by-size/
Source : http://money.visualcapitalist.com/all-of-the-worlds-stock-exchanges-by-size/
Source : http://money.visualcapitalist.com/all-of-the-worlds-stock-exchanges-by-size/
Source : http://money.visualcapitalist.com/all-of-the-worlds-stock-exchanges-by-size/
Source : http://money.visualcapitalist.com/all-of-the-worlds-stock-exchanges-by-size/
The Global Financial System (GFS) is a financial system consisting of institutions

and regulations that act on the international level, as opposed to those that act on a

national or regional level.

The main players are the global institutions, such as

International Monetary Fund and Bank for International Settlements, national

agencies and government departments, e.g., central banks and finance ministries,

and private institutions acting on the global scale, e.g., banks and hedge funds.
Role of Financial system in Economic development

• Saving – Investment Relationship : It helps efficiently direct the flow of savings

and investments in the economy . (E.g., Banks)

• Growth of Capital Markets : Raise funds for both short term and long term
requirements in business . ( Working and fixed capital in the business entities)

• Foreign Exchange markets : It helps exporters and importers raise and receive
funds for settling transactions. ( Banks borrow money and provides funds to
different types of customers in various foreign currencies)
Role of Financial system in Economic development

• Government securities : Government can raise short term and long term
funds from the government securities market. ( Bills and bonds)

• Infrastructure and Growth : Economic growth , financial infrastructure

signifies the financial assets, the financial market and financial
intermediaries. Financial services – providing funds for the growth of
infrastructure and industry. Financial market – the mechanism for trade in
financial assets through financial intermediaries ( link between savers and
investors )
Role of Financial system in Economic development

• Trade development : Financial system -Both domestic and foreign trade

(industry and commerce). It facilitates the exchange of documents between
sellers and buyers through banks . Financial Institutions – Provides funds to
traders through the financial market (Instrument like treasury bills and
commercial papers , letter of credit (LCs) issued in favor of importers by
commercial banks).

• Employment growth : Financial system helps provide funds to the growing

houses and industries which results in an increases in production.
Role of Financial system in Economic development

• Venture capital : More financial institutions contributed a part

of their funds for the promotion of new ventures. ( Startups)

• Balances Economic Growth : The financial system helps

channelizes available funds (productive use of money by
distributing it across sectors and that there is balanced
growth industries , agriculture and service sector).
Indian Financial System (IFS) refers to a set of institutional
arrangement through which financial surplus of our economy are mobilised
from surplus units and transferred to the deficit units.
This institutional arrangements includes -
The conditions and mechanisms governing the production, distribution,
exchange and holding of financial assets or instruments, Working of
financial markets, and Organisation and operation of financial institutions.
Structure of Indian Financial System

Structure of Indian Financial System is divided into four components

which are

 Financial Services

 Financial Markets

 Financial Instruments

 Financial Institutions
 Organisation of the Financial System

Financial Financial Assets/

Financial Markets
Intermediaries Instruments
Financial Intermediaries

 Banks
 Asset Finance Companies
 Housing Finance Companies
 NBFCs  Venture capital Funds
 Alternative Investment Funds
 Mutual Funds  Merchant Banking Organisations
 Credit Rating Agencies
 Insurance Organisations  Factoring and Forfaiting
 Organisation
 Stockbroking Firms
 Depositories
 Custodial Services
 Credit Information companies
 Mortgage Guarantee Companies
 Core Investment Companies
Financial Markets
• Call market

 Money Market • T-Bills Market

• Bills Market
• CP Market
• CD Market
• Repo Market

 Capital/ Securities Market

• Primary / New Issue market
• Secondary / Stock Market / Exchange
Financial Assets / Instruments

Primary / Direct Indirect Derivatives

 Equity / Ordinary
 Shares  Convertible Debentures
 Non-convertible Debentures
 Preference Shares  Secured premium Notes
 Debentures  Warrants

 Innovative Debt Instruments

Financial Assets / Instruments

Primary / Direct Indirect Derivatives

 Mutual Fund Units

 Security Receipts
 Securitised Debt Instruments
Financial Assets / Instruments

Primary / Direct Indirect Derivatives

 Forward
 Futures
 Options
Financial Services
The services provided by the Financial Institutions. These services generally include the banking

services, Foreign exchange services, investment services, insurance services and few others. 
• Banking Services –deposit and withdrawal of money to the issue of loans, credit
cards etc.
• Foreign Exchange services –currency exchange, foreign exchange banking or the
wire transfer
• Investment Services  the asset management, hedge fund management and the
custody services
• Insurance Services –the selling of insurance policies, brokerages, insurance
underwriting or the reinsurance
• Some of the other services include the advisory services, venture capital, angel
investment etc.
Financial Intermediaries
• To channel funds from people who have extra inflow of money 

• Example of an intermediary can be a bank which transforms the bank deposits to

bank loans.

Functions of Financial Intermediaries

• Maturity transformation – Deals with the conversion of short-term liabilities to

long term assets.

• Risk transformation – Conversion of risky investments into relatively risk-free ones.

• Convenience denomination – Way of making the unmatched matching which is

matching small deposits with large loans and large deposits with small loans. (Eg.,
liquidity for entrepreneurs,)
Financial Instrument

• It is a trade-able asset which can be in terms of cash, agreement,

evidence of an ownership in an entity; or a contractual right which has
the right to deliver cash or any kind of asset.

• Examples – bill of exchange, promissory note, treasury bill, government

bond, deposit receipt, share, debenture, etc.

• Financial securities – Primary/ direct – shares and debentures issued

directly to the public (ultimate investors to the ultimate savers)
• Secondary securities – Unit Trust of India and Mutual fund ( financial intermediaries
to the ultimate savers) . Short/Medium/ Long term securities (basis of duration).
Financial Market

• It is a mechanism that allows people to indulge themselves in the

buying and selling i.e. trade of financial securities (for example stocks
and bonds), commodities (for example precious metals) at prices that
reflect the market’s effectiveness.
Financial Market

• Capital Market – business enterprises or government entities raise fund for long term using
the weapon of securities or debts. It includes the Stock market (equities) and Bond Market
(debt) for fund raising.
• Commodity Market – the market where such goods are traded.
Money Market – Deals with the assets involved in short-term borrowing and lending with
original maturities ranging from a period of one year or even lesser time frames.
• Derivative Market – The financial instruments like the futures contracts or options, which are
derived from other forms of assets, are traded in these markets.
Insurance Market – Deals with the trading of insurance policies.
•  Futures Market – where people can trade standardized futures contracts which is a contract
to buy specific number of quantities of a commodity or financial instrument at a specified
price with the delivery of the commodity or financial instrument set at a specified time in the
future.
Foreign Exchange Market – Also known as Forex is a global, worldwide decentralized financial
market meant only for the trading of currencies.
Evolution of Indian Financial System

Three Distinct phases

• Up to 1951, Corresponding to the post-independence scenario, on the

eve of the initiation of planned economic development

• Between 1951 and the mid-eighties reflecting the imperatives of

planned economic growth

• After the early nineties responding to the requirements of

liberalised/ deregualted / globalised economic environment
PHASE I : PRE-1951 Organisation
• Close resemblance with the theoretical model of a financial organisation in a
traditional economy (the per capital output is low and constant – R.L.,Bennett)
PHASE II : 1951 TO MID-EIGHTIES Organisation
The system to supply finance and credit to varied enterprises in diverse forms was
greatly strengthened .

The imperatives of planned economic development and distribution of resources by the

financial system (Five year plans)

With the adoption of mixed economy as the pattern of industrial development- Public
& private sectors.
PHASE II : 1951 TO MID-EIGHTIES Organisation

• The financial organisation in planned economic development consists of four board

groups.

• Public/ Government ownership of financial institutions

• Fortification of the institutional structure

• Protection to investors

• Participation of financial institutions in corporate management

 Phase II: Organisation of Indian Financial System

Public/ government
Fortification of Investor
ownership of Financial
Institutional Structure Protection
Institutions
 Public / Government Ownership of Financial
Institution
 Nationalisation  New Institutions
 RBI  DFIs
SBI  UTI
LIC
Banks
GIC
Fortification of Institutional Structure
• IFCI
• SFCs

 DFIs • ICICI
• IDBI
• SIDCs
• SIICs
• IIBI
 LIC
 UTI

 Banks
• Diversification of forms of Financing
• Enlargement of Functional coverage
• Innovative Banking
Investor Protection
Companies Act Capital Issues (Control) Act Securities Contracts
(Regulation Act )

Monopolies and Restrictive Trade

Practices Act

Foreign Exchange Regulation Act

& Participation by Financial
Institutions in Corporate Management
Phase III: Post- Nineties organisation

• The new economic policy in 1991

• Market Economics and the consequent liberalisation/ deregulation/ globalisation of the

economy

• Major Economic policy changes such as macro-economic stabilisation, delicensing of

industries, trade liberlisation, currency reforms, reduction in subsides, financial sector,
Capital market, banking reforms, privatisation, disinvestment, tax reforms and company law
reforms.

• Indian Financial system phase reference to i) privatisation ii) reorganisation of institutional

structure and iii) investor protection.
Phase III: Post -1991 Phase Organisation of the Indian Financial System

Reorganisation of Financial
Privatisation of
structure Markets
Financial Institutions:
 Banks
 Mutual funds
 Insurance
Companies
Reorganisation of Structure
DFIs/ PFIs Banks Mutual Funds

NBFCs

Prudential Norms Management of Non- Risk Management

Performing Assets
 Asset Liability Mgmt
 Credit/ Advance  Debt Recovery  Credit Risk
Portfolio Tribunals management
 Investment  Corporate Debt  Operational Risk Mgmt
Portfolio Restructuring
 Securitisation ,
 Capital Adequacy Reconstruction of
Financial asset
Major Reforms in the Primary Market

• Merit based Regime to disclosure based regime

• Disclosure & Investor Protection (DIP) Guidelines issued
• Pricing of public issues determined by the market
• A system of proportional allotment to raise funds from the primary
market
• Banks, FIs and PSUs allowed to raise funds from the primary market
• Accounting standards are close to the International standard
• Corporate Governance Guidelines issued
• Discretionary allotment system to QIB withdrawn
• FIIs allowed to invest in primary issues within the sect oral limits

• Mutual funds are encouraged, both in public and private sectors, and they have been

• Guidelines for private placements of debt issued

• SEBI promoted Self –Regulatory Organisation (SROs)

• Allocation to retail investors increased from 25 per cent to 35 per cent.

• Separate allocation of 5 per cent to domestic mutual funds within the QIB category.
(qualified institutional buyer)
• Freedom to fix face value of shares below rs 10 per share
only in cases where the issue price is rs 50

• Shares allotted on a preferential basis as well as the pre-

allotment holding are subject to a lock-in period of six
months to prevent sale of shares
Major Reforms in the secondary market

• Mandatory registration of market intermediaries

• Capital adequacy norms specified for the brokers, sub-brokers of stock

exchanges

• Guidelines issued on listing agreement between stock exchanges and corporates

• Shortening of settlement cycle to T+2.

• Regular inspection of stock exchanges and other intermediaries including

mutual funds put in place.
• Regulation of Substantial Acquisition of Shares and Takeovers

• FIIs allowed to invest in Indian Capital since, 1992

• Order driven, fully automatic , anonymous , screen based trading introduced

• Depositories Act enacted

• Guidelines on Corporate Governance issued

• SEBI has prohibited fraudulent and unfair trade practices, including insider
trading.
• Straight Through Processing introduced and made mandatory for
institutional trades

• Margin trading, short selling and securities lending and borrowing

schemes introduced.

• Separate, trading platform, namely, Indonext for SME sector

launched

• Corporatisation and demutualisation of stock exchanges notified.

• Settlement and Trade Guarantee Fund/ Investor Protection
Fund setup.

• Comprehensive surveillance system(CSS)

• Securities Appellate Tribunal (SAT) setup

• Introduction of exchange traded derivatives.

• Mutual funds and FIIs to enter the Unique Client Code (UCC)
• IFCI – Industrial Finance Corporation of Indian -1948

• SFCs- State Financial Corporations -1951

• NIDC – National Industrial Development Corporation - 1954

• ICICI- Industrial Credit and Investment Corporation of India -1955

• RCI – Refinance Corporation of Industry – 1964

• RBI – Reserve Bank of India - 1976

• SIDCs – State Industrial Development Corporations – 1971

• SIICs – State Industrial Investment Corporations -1971

• IRCI – Industrial Reconstruction Corporation of India

• IRBI- Industrial Reconstruction Bank of India -1984

• PFI- Public Financial Institution – 1997

• IIBI- Industrial Investment Bank of Indian -1997

• TCOs- Technical Consultancy Organisations

• SIDBI- Small Industrial development Bank of Indian

• LIC – Life Insurance Corporation -1951
• UTI – Unit trust of India -1964