STRUCTURE

OF FINANCIAL
SYSTEM
A V V S PRASAD
Assoc. Prof.
MBA.,M.Phil.,Ph.D.
UNIT 1
 Financial System in India: Introduction
 Evolution of Banking
 Phases of development
 RBI and the Financial System
 Committees on Banking Sector
Reforms
 Prudential Banking
 RBI Guidelines and directions.
FINANCIAL SYSTEM:-
 System  “a set of complex and closely
connected or intermixed institutions,
agents, practices, markets, transactions,
claims, and liabilities in the economy”.
 Financial System is concerned about
○ Money –current medium of exchange
○ Credit –money returned normally with
interest
○ Finance –monetary resources comprising
debt and ownership funds
 Financial
System

Financial
Financial Financial Instruments Financial
Institutions Markets (Claims, Assets, Services
Securities)

Non-
Regulatory Intermediaries
Intermediaries
Others Organized Unorganized Primary Secondary

Non- Short
Banking
Banking Term

Equity Market Primary Secondary

Debt Market Medium

Term

Derivative Market Capital Money

Markets Markets Long
Term
 FINANCIAL
INSTITUTIONS

REGYLATORY INTERMEDARIES NON-

OTHERS
INTERMEDARIES

RBI

IDBI,
BANKING NON NABARD
BANKING

COMM. NFBIS, UTI,

BANKS LIC, GIC
FINANCIAL INSTITUTIONS
 Business organizations that act as mobilizes and
depositories of savings, and as purveyors of credit or
finance
 Intermediaries intermediate between savers
and investors
—lend money as well as mobilize savings
—liability towards the ultimate savers
—assets are from the investors or borrowers
Intermediaries– all banking institutions, non-banking
Financial intermediaries (NBFIs) –UTI, LIC, GIC
Non-intermediary institutions --> do loan business
 but resources not directly obtained from the
savers
Non-intermediaries – IDBI, NABARD, IFC—also
called non-banking statutory financial
organizations(NBFSO)
 FINANCIAL
MARKETS

CO-
ORGANISED OPERATIVE
UNORGANISED SECTOR

CAPITAL MONEY
MARKET MARKET

PRIMARY CALL MONEY CHIT

MONEY LENDERS FUNDS

SECONDARY COMMERCIAL
BILLS

TREASURY
 FINANCIAL MARKETS
 Provide facilities for buying and selling of
financial claims and services
Primary and Secondary Markets
Money and Capital Markets
○ Both perform same function of transferring resources
to the producers
○ Distinction based on – differences in period of maturity
of financial assets issued in these markets
○ Money market – short-term claims (<1 year) – T-bills,
call money market, commercial bills
○ Capital market – long-term claims (>1 year) – stock
market, govt. bonds market
○ Commercial banks belong to both
 FINANCIAL
INSTRUMENTS
(CLAIMS,
SECURITIES,ASSETS.)

PRIMARY SECONDRY
MARKETFINANCIAL FINANCIAL
INSTRUMENTS INSTRUMENTS

SHORT

MEDIUM

LONG
FINANCIAL INSTRUMENTS AND
SERVICES
Financial asset – represents a claim to the
payment of a sum of money in the
future and/or a periodic payment in the
form of interest or dividend.
Financial securities – primary and
secondary
 Financial services are the
economic services provided by
the finance industry, which
encompasses a broad range of
businesses that manage money,
including credit unions, banks, credit-
card companies, insurance companies,
accountancy companies, consumer-
finance companies, stock
brokerages, investment funds,
individual ...
 FINANCIAL
SERVICES

TRADITIONAL MODERN

NON-FUND
FUND BASED BASED

1.Lease Project
financing. 1. Hire purchase. advisory
2.Consumer 2. Venture capital. services.
credit. 3. Housing finance. Planning M&A.
3.Bill discounting. 4. Insurance JVs.
4.Factoring. service Hedging risk.
5.Forfeiting.
FUNCTIONS
OF
FINANCIAL
SECTOR
 Liability- Asset
transformation
function

FUNCTIONS
Maturity Size
OF
transformation transformation
function. FINANCIAL function
SECTOR

Risk
transformation
function.
Liability- Asset transformation
function
 Asset transformation is the process of
creating a new asset (loan)
from liabilities (deposits) with different
characteristics by converting small
denomination, immediately available
and relatively risk free bank deposits
into loans
size transformation function of
financial system
 A type of transformation that is
performed by banks and other
depositary institutions whereby small
deposits by different types of depositors
are pooled in order to issue large loans
to seekers of funds
risk transformation function of
financial system
 Risk transformation is about how to
mitigate risk and in parallel develop
competitive advantages. ... Risk may
include financial risk, security/safety-
related risks, uncertainty,
and risk through action or lack of action.
maturity transformation
function of financial system
 Maturity transformation is the practice
by financial institutions of borrowing
money on shorter timeframes than they
lend money out.
Equilibrium in Financial Markets
 Equilibrium in financial markets– usually determined by
assuming perfect competition
 Financial markets are said to be perfect when
 A large number of savers and investors operate in markets
 The savers and investors are rational
 All operators in the market are well-informed and information is
freely available to all of them
 There are no transaction costs
 The financial assets are infinitely divisible
 The participants in markets have homogenous expectations
 There are no taxes
 Under these ideal conditions, the financial markets attain
equilibrium position when supply and demand are equal
 the interest rate at which the supply curve and
demand curve intersect with each other
EQUILIBRIUM CONTD.,
 The equilibrium in financial markets is
established when the expected demand
for funds (credit) for short-term and long-
term investments matches with the
planned supply of funds generated out
of saving and credit creation.
 Supply of funds
○ Aggregate savings by household, business
and govt. sectors
EQUILIBRIUM CONTD.,
 Demand of funds
○ Investment in fixed and circulating (working)
capital
○ Demand for consumer durables
○ Investment in housing
○ Current level of capital stock
○ Capacity utilization
○ Desired capital stock
○ Availability of internal funds
○ Cost of funds
○ Technological changes
 RELATIONSHIP
BETWEEN
FINANCIAL SYSTEM
AND
ECONOMIC
DEVELOPMENT
 Economic
development

Spending
Industrialization economic
units

RELATIONSHI
P BETWEEN
FINANCIAL
SYSTEM
AND
Capital ECONOMIC Income-
formation DEVELOPMENT expenses

Financial Surplus/
system saving
Financial System and Economic Development
1.Finance is not important at all
Ex: environment- friendly, appropriate
technology.
2.Finance is very important.
3. Cautionary View:
Economic Growth – growth results
predominantly not from the increase in labor
and capital but from the technical progress,
which is external  money and finance and
the policies about them cannot contribute to the
growth process.
A well developed financial system can
contribute significantly to the acceleration of
economic development through –
Technical progress is endogenous ( human and
physical capital are its important sources 
dependent on financial system)
Good financial system  rate of capital formation
(finance available in time, in adequate quantity and
on favorable terms)  economic development
Financial system enhances the efficiency of the
function of medium of exchange  helps in
economic development.
Thank
you….