1. The Indian Financial
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System
Markets, Institutions and
Services
The Indian Financial System, 2e -- Pathak

2. Copyright© 2008 Dorling Kindersley India Pvt. Ltd
1
Financial System: An
Introduction
The Indian Financial System, 2e -- Pathak

3. The Indian Financial System
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The Indian Financial System, 2e -- Pathak

4. Chapter Objectives
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To understand the
 meaning of financial system
 components of the financial system
 functions of the financial system
 key elements of the financial system
 key elements of a well functioning financial
system
 bank-based and market-based financial
systems
 nature and role of financial institutions and
markets
 link between money market and capital
market
 link between primary market and secondary
The Indian Financial System, 2e -- Pathak
market

5. Meaning of the Financial
System
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 A set of sub systems of financial
institutions, markets, instruments and
services
 Intermediates with the flow of funds
between savers and borrowers.
 Facilitates transfer and allocation of scarce
resources efficiently and effectively
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6. Types of Financial
System
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 Formal financial system – organized,
institutional and regulated
 Informal financial system
Advantages
Low transaction costs
Minimum default risk
Transparency of procedures
Disadvantages
Wide range of interest rates
Higher rates of interest
Unregulated
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7. Components of the Financial
System
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 Financial Institutions
 Financial Markets
 Financial Instruments
 Financial Services
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8. Types of Financial
Institutions
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 Banking: creators and purveyors of credit.
Types
Commercial Banks
Cooperative Banks
 Non-banking: purveyors of credit
Types
Developmental financial
institutions
Mutual funds
Insurance companies
NBFCs
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9. Functions of Financial
Institutions
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Provide three transformation services
 Liability, asset and size transformation
 Maturity transformation
 Risk transformation
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10. Financial Markets
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Types
 Money Market – A market for short-term debt
instruments
 Capital Market – A market for long-term equity
and debt instruments
Segments
 Primary Market – A market for new issues
 Secondary Market – A market for trading
outstanding issues
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11. Link Between Primary and
Secondary Capital Market
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 A buoyant secondary market is
indispensable for the presence of a
vibrant primary market.
 The secondary market provides a basis for
the determination of prices of new issues.
 Depth of the secondary market depends on
the primary market.
 Bunching of new issues affects prices in the
secondary market.
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12. Financial Instruments
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Types
Primary
Secondary
Distinct Features
Marketable
Tradable
Tailor-made
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13. Financial Services
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Major Categories
Funds intermediation
Payments mechanism
Provision of liquidity
Risk management
Financial engineering
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14. Functions of Financial
System
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Mobilise and allocate savings
Monitor corporate performance
Provide payment and settlement systems
Optimum allocation of risk bearing and
reduction
Disseminate prize related information
Offer portfolio adjustment facility
Lower the cost of transactions
Promote the process of financial deepening
and broadening
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15. Key Elements of a Well-
functioning Financial System
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A strong legal and regulatory
environment
Stable money
Sound public finances and public debt
management
A central bank
Sound banking system
Information system
Well-functioning securities market
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16. Financial System Designs
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Types
Bank-based
Market-based
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17. Market-based Financial
System
Advantages
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Provide attractive terms to both investors
and borrowers
Facilitate diversification
Allow risk sharing
Allow financing of new technologies
Drawbacks
Prone to instability
Exposure to market risk
Free-rider problem
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18. Bank-based Financial
System
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Advantages
Close relationships with parties
Provide tailor-made contracts
Efficient inter-temporal risk sharing
No free-rider problem
Drawbacks
Retards innovation and growth
Impedes competition
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19. Functions of Financial
Markets
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Enabling economic units to exercise their
time preference
Separation, distribution, diversification and
reduction of risk
Efficient payment mechanism
Providing information
Enhancing liquidity
Providing portfolio management services
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