Chapter: 2Financial System

Sections

• Functions of financial system• Financial assets• Financial market•Market returns• Financial intermediaries•Regulatory framework

Financial intermediaries

BanksInsurance

MFNBFC

Demanders of fundsIndividualsBusinesses

Government

Supplier of fundsIndividualsBusinesses

Government

Financial markets

Money mktCapital mkt

deposits

funds

loansfunds

securities

fundsfunds

securities

2.1 Functions of financial system•Pooling of funds• Transfer of resources•Risk management (hedge, insurance,

diversification)•Price information•Deal with incentive problems

2.2 Financial Assets(1) Tangible AssetsEg Real Assets(2) Intangible AssetsEg• Bonds• Debenture• Loan• Equity shares• Call or put options

2.3 Financial Markets

Functions• Facilitate price discovery•Provide liquidity•Reduce cost of transaction

Classification of financial markets

(1)Nature of claim : Debt and Equity(2)Maturity of claim: Money and Capital(3)Seasoning of claim: Primary and Secondary(4)Timing of Delivery: Cash/ spot and

Forward/future(5)Organisation Structure: Exchange traded and

OTC market

2.4 Financial Market returns:

• Interest rates• ROR on risky assets• Nominal and real rate

Factors affecting Returns:• Degree of uncertainty• Productivity of capital• Time preferences• Risk Capacity

2.5 Financial Intermediaries

Rationale or Advantages:• Diversification• Lower transaction cost• Economies of scale• Confidentiality• Signaling

Key Financial Intermediaries(1) Commercial banks• Public banks• Private banks• Foreign banks

(2) Financial Institutions• IFCI, IDBI, ICICI• SIDBI, NABARD, EXIM, SCICI, NHB, IDFC

(3) Insurance:• Life and general insurance companies• Public and private

(4) Mutual FundsAsset Management Companies

(5) Non-banking Financial Companies• Sundaram finance• Dewan housing• Religare Finvest• Kotak Mahindra Finance

(6) Allied services• Credit rating• Merchant banker• Depositories

2.6 Regulatory Authorities

(1) Reserve Bank of India (RBI)• Central bank of India• Provide currency• Banker’s bank• Supervise the credit institutes• Regulate foreign exchange• Promote development of new institutions

(2) Securities Exchange Board of India

• Regulate stock exchanges• Regulate securities market• Regulate capital market intermediaries• Register and regulate mutual fund industry• Prohibit fraudulent and unfair trade practices• provide investor education• Prohibit insider trading• Regulate acquisitions and mergers