This document provides an overview of the key components of the Indian financial system. It discusses financial intermediaries like banks, mutual funds, insurance companies, and pension funds. It also describes different types of financial markets including money markets, bond markets, stock markets, and derivatives markets. It outlines various financial instruments such as bonds, stocks, and derivatives. Finally, it discusses the different regulators that oversee the various segments of the Indian financial system, including the RBI, SEBI, and IRDA.

1. UNDERSTANDING THE
FINANCIAL SYSTEM
- Prof. Bhattacharyya

2. Questions
1. What does a Financial System facilitate?
2. What are different components/ segments of
financial system?
3. What is the difference between secured and
unsecured bond?
4. What is a ‘put bond’ and ‘callable bond’?
5. What is Convertible Bond?
6. What is Floating Rate Bond?

3. Questions
7. What is the function of Primary Dealer?
8. What are the requirements of a good Financial
System ?
9. Name different regulators of Financial Markets.
10. What is LBO ?
11. Mr. Watson a British National wants to Invest in
Indian Market without getting into regulatory
hassle. What is the easiest way out ?
12.Who regulates G-Sec Market in India ?

4. Financial System
• Transfer of Resources
1. Financial Intermediaries
2. Financial Instruments
3. Financial Assets

5. Intermediaries Market Responsibilities
Stock Exchange Capital Secondary market
Inv. Bankers Capital, Credit Issue of Securities, Advisory
Underwriters Capital, Money Subscribe
Registrars, Depositories,
Custodians
Capital Issue securities,handle share
transfer
P Ds Money G-Secs
Forex Dealers Forex Ensure exchange

6. CURRENT REGULATORS OF THE INDIAN
FINANCIAL SYSTEM
The regulation and supervision of the financial system in India is
carried out by different regulatory authorities.
• Reserve Bank of India (RBI) regulates commercial banks, urban
cooperative banks (UCBs), some financial institutions and non-banking
finance companies (NBFCs).
• Securities Exchange Board of India (SEBI) regulates the capital
market, mutual funds, and other capital market intermediaries.
• Insurance Regulatory and Development Authority (IRDA) regulates
the insurance sector.
• The Pension Funds Regulatory and Development Authority
(PFRDA) regulates the pension funds.
• Forward Markets Commission (FMC) is a regulatory authority for
commodity futures market in India.

7. CURRENT REGULATORS OF THE INDIAN
FINANCIAL SYSTEM
• Some of the financial institutions, in turn,
regulate or supervise other institutions in the
financial sector, for instance,
– Regional Rural Banks and the Co-operative banks
are supervised by National Bank for Agriculture
and Rural Development (NABARD); and
– Housing finance companies by National Housing
Bank(NHB).

8. FINANCIAL INSTITUTIONS
• Channelise funds from suppliers to users.
• E.g. Commercial banks, Finance companies, Insurance
companies, MFs, Pension Funds, etc..
• Monitoring costs (use quality and quantity of information.)
• Asset transformer.
• Diversify risk
• Reduced transaction cost
• Maturity Intermediation
• Denomination Intermediation

9. Diagram

10. FINANCIAL INSTITUTIONS
• Economic function of FIs.
• Transmission of Monetary Policy
• Credit allocation
• Time Intermediation
• Payment services

11. FINANCIAL MARKETS
• Primary and Secondary
• Money and Capital

12. FINANCIAL MARKETS
• Facilitate sale & resale of transferable
securities.
• Securities arising out of direct lending.
• Principal Financial Markets:
a) Market for G-Sec
b) Mortgage Market
c) Debt Market
d) Equity Market
e) Derivative Market

13. FINANCIAL MARKETS
• Bond issues vs Stock issues
• Debt vs Equity
• Safe Debt – Minimum maintenance
• Risky Debt – High Maintenance
• Benchmark Rate
• Preferred Equity
• Secured Bonds
• Mortgage Bonds

14. FINANCIAL MARKETS
• Unsecured Bonds
• Put Bonds
• Callable Bonds
• Floaters / Variable rate bonds
• Convertible bonds
• Market for New Issues – Underwriters
• Secondary Market – Price discovery

15. Monetary Aggregates in India
• M1 = Currency with the public + demand
deposits of the Public
• M2 = M1 + Term deposits with maturity upto
one year + CDs
• M3 = M2 + Time deposits of the Public with
banks for more than 1 year

16. Financial Markets
• Definition
An institution or arrangement that facilitates the
exchange of financial instruments, including
deposits and loans, corporate stocks and bonds,
government bonds, and more exotic instruments
such as options and futures contracts.
The place where people and organizations wanting to
borrow money are brought together with those having
surplus funds is called a “financial market.”

17. Functions
• Intermediary Functions
• Financial Functions

18. Intermediary Functions
• Transfer of resources
• Enhancing income
• Productive usage
• Capital formation
• Price determination
• Sale mechanism
• Information

19. Financial Functions
• Providing the borrowers with funds so as to enable
them to carry out their investment plans
• Providing the lenders with earning assets so as to
enable them to earn wealth by deploying it in
productive ventures
• Providing liquidity in the market so as to facilitate
trading of funds

20. Requirements of a Good Financial
System
• Legal and Regulatory environment
• Stable Money
• Sound Public Debt Management
• Central Bank
• Banking System
• Information System
• Security Market

21. NBFCs
• A Non-Banking Financial Company (NBFC) is a company
registered under the Companies Act, 1956
• It is engaged in the business of loans and advances,
acquisition of shares/stock/bonds/debentures/securities
issued by Government or local authority or other
securities of like marketable nature, leasing, hire-purchase,
insurance business, chit business but does not
include any institution whose principal business is that of
agriculture activity, industrial activity,
sale/purchase/construction of immovable property.
• A non-banking institution which is a company and which
has its principal business of receiving deposits under any
scheme or arrangement or any other manner, or lending
in any manner is also a non-banking financial company
(Residuary non-banking company).

22. N B F C
• They provide various types of fund and non-fund
based services. Depending on the type of
services provided they could be : Leasing /
hire-purchase/Housing finance companies/
Venture capital funds/Stock-broking firms etc.

23. MUTUAL FUNDS
• A Mutual Fund is a trust that pools the savings of a number of investors
who share a common financial goal.
• The money thus collected is then invested in capital market instruments
such as shares, debentures and other securities.
• The income earned through these investments and the capital
appreciation realised are shared by its unit holders in proportion to the
number of units owned by them.
• Mutual Fund Operation Flow Chart

24. Mutual Funds
• Mutual funds are set up in the form of trust
comprising of a) sponsor b) trustees c) AMC
and d) custodian. Sponsor is the promoter.
Trustees hold the assets for the benefit of the
unit holders. The AMC manages the funds by
investing in various types of securities. The
custodian holds the securities of the various
schemes in its safe custody.

25. Mutual Funds
• They offer convenience because of lower
denomination of investment and liquidity,
lower risk through diversification, expertise in
management and low transaction costs due to
economies of scale. Biggest advantage is
diversification
• NAV – Market price of the securities + other
assets – total liabilities outstanding on the
date.

26. HEDGE FUNDS
• A hedge fund is an investment fund charging a
performance fee and typically open to only a limited
range of investors.
• Like MFs.
• Unlike MFs.
• Incentives compensate risk.
• Poor liquidity.
• In the United States, hedge funds are open to
accredited investors only. Because of this restriction
they are usually exempt from any direct regulation by
the SEC, NASD and other regulatory bodies.
• Sketchy data. .
• Leveraged.

27. Hedge Fund
• Three important players :
• 1. The Fund Manager
• 2. Prime Broker
• 3 Administrator

28. Private Equity
• Market for relationship equity financing.
• Private equity returns derive from an
appreciation in value of the acquired asset or
company. Such investments are often
followed by efforts at restructuring to
resuscitate loss making companies or
substantially improving performance of profit
making companies.
• Providers of private equity do their own
monitoring and control.

29. Private Equity
• Investment in equity linked to an asset which is not
listed and therefore not publicly traded in stock
markets. In short private equity is acquired either
through the private placement of new shares or the
sale of pre-existing shares by the controlling interest
or minority interest
• Organized private equity management –
intermediated.
• Angel Investing
• Organized P E Market – V.C., Expansions, Buyouts,
Vulture Capital
• Exit mechanism.

30. Participatory Notes
• PNs are instruments used by foreign funds /
investors who are not registered with SEBI but
are interested in taking exposure in Indian
securities.FIIs that do not wish to register with
the SEBI but would like to have exposure in
Indian securities also use the participatory
notes.
• Instruments that derive their value from an
underlying financial instrument e.g. equity
share.
• Offshore derivative instruments.

31. INSURANCE BASICS
• "Insurance is a contract between two parties whereby one
party called insurer undertakes in exchange for a fixed sum
called premiums, to pay the other party called insured a fixed
amount of money on the happening of a certain event.“
• Insurance is a protection against financial loss arising on the
happening of an unexpected event. Insurance companies
collect premiums to provide for this protection. A loss is paid
out of the premiums collected from the insuring public and
the Insurance Companies act as trustees to the amount
collected.
• Insurance Companies are quite dominant intermediaries in
the financial systems

32. PENSION PLAN
• Defined Benefit
• Defined Contribution

33. DEFINED BENEFIT PLAN
• Participants promised a level of benefits upon
retirement. No. of years an employee has
worked in the organization, persons’ pay in
the final years of employment are some of the
factors taken into account.

34. DEFINED CONTRIBUTION PLAN
• Each participant has an account where
sponsor contributes certain amount every
year. Sometimes participants also contribute.
Contribution is proportional to earnings.
• Upon retirement, the amount at the credit of
the account is paid out to the participant.
- Investment risk
- Inflation risk

35. Pension Fund Assets to GDP for India

36. • PFRDA – NPS – defined contribution largest
pension markets – U.S.A., U.K., Japan.

37. Financial System Designs
• Bank-dominated system
In Germany, where a few large banks play a
dominant role and the stock market is not
important.
• Market-dominated system
In US, where financial markets play an
important role while the banking industry is
much less concentrated.
• In India, banks have traditionally been the
dominant entities of financial intermediation.

38. Nature & Role of Financial Institutions
• Liability, asset and size transformation
consisting of mobilization of funds, and their
allocation by providing large loans on the
basis of numerous small deposits.
• Maturity transformation by offering the savers
tailor-made short term claims or liquid
deposits.
• Risk transformation by transforming and
reducing the risk involved in direct lending by
acquiring diversified portfolios.

39. Financial Markets
• Financial markets are an important
component of the financial system. They are a
mechanism for the exchange trading of
financial products under a policy framework.
Financial markets comprise two types of
markets :
1) Money Market
2) Capital Market

40. Money Market
• It is a short-term debt instruments.
• It is a highly liquid market wherein securities
are bought and sold in large denominations to
reduce transaction costs.

41. Functions Of Money Market
• To serve as an equilibrating force that
redistributes cash balances in accordance with
the liquidity needs of the participants.
• To form a basis for the management of
liquidity and money in the economy by
monetary authorities.
• To provide reasonable access to the users of
short-term money for meeting their
requirements at realistic prices.

42. Capital Market
• A capital market is a market for long-term
securities. The purpose of capital market is –
– to mobilize long-term savings to finance long-term
investments.
– to provide risk capital in the form of equity or quasi-equity
to entrepreneurs.
– to encourage broader ownership of productive assets.
– to provide liquidity with a mechanism enabling the
investor to sell financial assets.
– to lower the costs of transactions and information
– to improve the efficiency of capital allocation through
a competitive pricing mechanism.

43. Characteristics Of Financial Markets
• Large volume of transactions and the speed
with which financial resources move from one
market to another.
• There are various segments like stock markets,
bond markets, primary and secondary
segments where savers decide when and
where they should invest money.
• Instant arbitrage among various markets and
types of instruments.

44. • Highly volatile and susceptible to panic and
distress selling as the behaviour of a limited
group of operators can gen generalized.
• Markets are dominated by financial
intermediaries who take investment decisions as
well as risks on behalf of their depositors.
• Negative externalities are associated with
financial markets.
• Domestic financial markets are getting integrated
with world wide financial markets.

45. THANK YOU