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FINANCIAL SYSTEM
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The financial system refers to a system of borrowing and lending of funds or the demand for and supply of funds of all individuals, institutions, companies and of the Government.
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Role of financial system
Serves as a link between savers and investors Mechanism for exchange of goods and services Mechanism of transfer of resources Promotes process of capital formation Role of financial system
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Structure of financial system
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Financial Intermediaries
Financial system Financial Assets Financial Markets Financial Intermediaries
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Financial assets Perform significant role in transferring funds from lenders to borrowers Each asset differs from each other A financial asset is one which is used for production or consumption or for future creation of assets. Represent claim against future income and wealth of others. To suit different requirements, different securities are issued.
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Financial assets/ securities
Primary assets/ securities Direct securities Secondary assets/ securities Indirect securities
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Primary securities Issued directly by ultimate borrowers of the funds to the ultimate savers or investors. Example: Equity shares, preference shares and debentures.
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Secondary securities Not issued directly by ultimate borrowers
Issued by financial intermediaries to ultimate savers Example: Insurance policy, Mutual funds
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Financial Markets Market normally refers to a group of traders carrying on business at a definite place, building or locality. A financial market is a market for the creation and exchange of financial assets. Once engaged in buying or selling the financial assets, indicates that you are participating in financial markets in one way or the other. Institutional arrangement for dealing in financial assets of different types
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Functions of financial market
To facilitate creation and allocation of credit To serve as intermediary for mobilization of savings To assist the process of balanced economic growth To provide financial convenience To cater to various credit needs of the business houses
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Money Market Capital Market Financial Markets
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MONEY MARKET “The centre for dealings, mainly for short term character, in monetary assets, it meets the short term requirements of the borrowers and provide liquidity or cash to the borrowers.”
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Money Market All transactions in near money
Deal with short term funds in the economy Institutional arrangements for facilitating borrowing and lending of short term funds Funds borrowed for a short period (less than a year) Sub markets are: Call money market Treasury bill market Commercial paper market Certificate of deposits market
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Capital Market Institutional arrangements for facilitating the borrowing and lending of long term funds Medium through which investor hand over money today in exchange for promise of money far in the future.
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Financial Intermediaries
Facilitate smooth functioning of the financial system by making investors and borrowers meet Mobilize savings of surplus units and allocate them in productive activities promising a better return Act as a middlemen between savers and borrowers
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Types of financial intermediaries
Banking Institutions Organized sector - Commercial banks - Co-operative banks -Regional rural banks -Foreign banks Unorganized sector - Indigenous bankers - Money lenders Non banking financial institutions Organized financial institutions - Development finance institutions - Investment Institutions Unorganized financial institutions
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REGULATORY FRAMEWORK Plays a critical role in ensuring the health, soundness, reliability and stability of the financial system lays down the specific rules for behavior of participants in the financial system necessary to generate, maintain and promote this trust of the participants.
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Regulatory Bodies RBI SEBI IDBI NABARD
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RBI RBI seeks to regulate the volume and direction of the flow of bank credit Apex institution as the monetary authority of the country Acts as a guide, regulator, controller and promoter of the financial system.
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1 Formulates and implements monetary and credit policies 2 Functions as banker’s bank 3 Supervises the operations of credit institutions 4 Controls the money supply and credit 5 Considered as lender of last resort Functions of RBI
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RBI also performs several functions aimed at developing Indian financial system:
Integrate the unorganized financial sector with organized financial sector Encourages extension of commercial banking system in the rural areas Influences allocation of credit Promotes development of new institutions
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Techniques of monetary control
Open Market Operations: Through the open market sale and purchase of government securities takes place. RBI can affect the reserves position of banks, yields on government securities and the volume and cost of bank credit. 2. Bank Rate and Discretionary Control of Refinance: Bank rate is the standard rate at which the RBI is prepared to buy or rediscount the B/E or other eligible commercial papers. Used to regulate the cost and availability of refinance and to change the volume of lendable resources of banks and other financial institutions.
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3. Cash Reserve Ratio(CRR): It refers to the cash which banks have to maintain with the RBI as a certain percentage of their demand and time liabilities. 4. Statutory Liquidity Ratio(SLR): It is the ratio of cash in hand balances in current account with SBI, its subsidiaries other nationalized banks and the RBI; gold and unencumbered approved securities to total demand and time liabilities of the banks.
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Direct Credit Allocation and Credit Rationing:
Through this the RBI has regulated the allocation/distribution of credit among different sectors, borrowers and users and it has facilitated in narrowing down the regional/geographical imbalances. 6. Moral Suasion: This is another most actively and consistently used technique of monetary control. It takes the form of writing letters and holding discussions between the RBI and the banks about trends in the economy in general and in money, credit and finance in particular, and about the measures which ought to be taken from time to time in the light of national objectives.
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SEBI SEBI has emerged as an important constituent of the system that now is actively engaged in regulating, controlling and monitoring the Indian Financial System. Through SEBI, the regulation model which is sought to be put in place in the country, is one in which every aspect of securities market regulation is entrusted to a single highly visible and independent organization, which is backed by a statute, and which is accountable to the Parliament and in which investors can have trust and confidence.
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Functions of SEBI Regulates business in stock exchanges
Register and regulate working of mutual funds Prohibit insider trading in securities Register and regulate capital market intermediaries
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IDBI IDBI was set up to accelerate the development of the country
Was a wholly subsidiary of RBI Was expected to coordinate the activities of the institutions engaged in financing, promoting or developing industry.
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Functions of IDBI Act as an apex institution
Provide refinance for term loans granted by banks and financial institutions Coordinate the activities of institutions providing term finance to industry Provide technical and administrative assistance for promotion, management and growth of industry Grant direct loans and advances to industrial concerns
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NABARD Apex institution for financing agricultural and rural sectors
Main objectives are: To provide credit for development of agriculture, small scale industries and rural areas To provide short term refinance assistance To Sanction refinance assistance for government sponsored programs such as rozgar yojna etc.
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