Financial Systems

Introduction

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In its simple meaning
the term ‘finance’ refers to monetary resources & the term ‘financing’
refers to the activity of providing required monetary resources to the needy
persons and institutions. The term ‘financial system’ refers to a system that
is concerned with the mobilization of the savings of the public and providing
of necessary funds to the needy persons and institutions for enabling the
production of goods and/or for provision of services. Thus, a financial system
can be understood as a system that allows the exchange of funds between
lenders, investors, and borrowers. In other words, the system that facilitates
the movement of finance from the persons who have surplus funds to the persons
who need it is called as financial system. It consists of complex, closely
related services, markets, and institutions used to provide an efficient and
regular linkage between investors and depositors. Financial systems operate at
national, global, and firm-specific levels.

It includes the public,
private and government spaces and financial instruments which can relate to
countless assets and liabilities.

 

Components
of Financial System

1. Financial Assets

2. Financial
Intermediaries/Financial Institutions

3. Financial Markets

4. Financial Rates of
Return

5. Financial
Instruments

 

 

 

 

Functions
of Financial System

 1. Provision of liquidity

 2. Mobilization of savings

3. Size
transformation/Capital formation

4. Maturity
transformation

5. Risk transformation

6. Lowering of cost of
transaction

7. Payment mechanism

8. Assisting new
projects

9. Enable better
decision making

10. Meet short and long
term financial needs

11. Provide necessary
finance to the Government

12. Accelerate the
process of economic growth of the country

 

Characteristics
of Financial System

1. Financial system
acts as a bridge between savers and borrowers

2. It consists of a set
of inter-related activities and services

3. It consists of both
formal and informal financial sectors. The existence of both formal and
informal system is also called as financial dualism.

4. It formulates
capital, investment and profit generation

5. It is universally
applicable at firm level, regional level, national level and international
level

6. It consists of
financial institutions, financial markets, financial services, financial
instruments, financial practices and financial transactions.

 

FINANCIAL
ASSETS

Financial assets refer
to the cash or cash equivalents that are used for production or consumption or
for further creation of assets. Cash, Bank Deposits, Shares, Debentures,
Investment in Gold, Land & Buildings, Contractual right to receive cash or
another financial asset, etc., are called as financial assets.

Classification
of Financial

Assets Financial assets
are classified in two ways

1. On the basis of
marketability

2. On the basis of
nature Classification of Financial Assets

 

On the basis of
marketability

1. Marketable – The
financial assets that can be bought and sold are called as marketable financial
assets. They include Shares, Government Securities, Bonds, Mutual Funds, Units
of UTI, Bearer Debentures

2. Non-marketable – The
financial assets that cannot be bought and sold are called as nonmarketable
finance assets. They include Bank Deposits, Provident Funds, LIC Policies,
Company Deposits, Post Office Certificates

Classification of
Financial Assets on the basis of nature

1. Money or Cash Asset
– Coins, Currency Notes, Bank Deposits

2. Debt Asset –
Debenture & Bonds

3. Stock Asset – Equity
Shares & Preference Shares

 

FINANCIAL
INTERMEDIARIES/FINANCIAL INSTITUTIONS

Different kinds of
organizations/institutions which intermediate and facilitate financial
transactions of both individual and corporate customers are called as financial
intermediaries or financial institutions.

Basically they are
classified into two types:

1. Unorganized Sector

2. Organized Sector

Unorganized
Sector

The sector that is not
governed by any statutory or legal authority is known as unorganized sector.
This sector consists of the individuals and institutions for whom there are no
standardized rules and regulations governing their financial dealings. They are
not under the supervision and control of RBI or any other regulatory body. This
sector consists of the individuals and institutions like Local money lenders,
Pawn brokers, Traders, Landlords, Indigenous bankers, etc., who lend money to
needy persons and institutions.

Organized
Sector

The sector that is
governed by some statutory or legal authority is known as organized sector.
This sector consists of the institutions like Commercial Banks, Non Banking
Financial Institutions, etc. They are further classified into two:

1. Capital Market
Intermediaries

2. Money Market
Intermediaries

Capital
Market Intermediaries

Capital Market refers
to the market for long term finance. The intermediaries provide long term
finance to individuals and corporate customers. IDBI, SFCs, LIC, GIC, UTI, MFs,
EXIM BANK, NABARD, NHB, NBFCs (Hire Purchasing, Leasing, Investment and Finance
Companies) Government (PF, NSC) etc., are in the organized sector providing
long term finance.

 

 

Money
Market Intermediaries

Money Market refers to
the market for short term finance. The intermediaries provide short term
finance to individuals and corporate customers. RBI, Commercial Banks,
Co-operative Banks, Post Office Savings Banks, Government (Treasury Bills) are
in the organized sector providing short term finance.

 

FINANCIAL
MARKETS

The group of
individuals and corporate institutions dealing in financial transactions are
termed as financial markets. The centres or arrangements that facilitate buying
and selling of financial assets, claims and services are the constituents of
financial market.

Basically they are
classified into two categories:

1. Unorganized Market

2. Organized Market

Unorganized
Market

The sector that is not
governed by any statutory or legal authority is known as unorganized sector.
This sector consists of the individuals and institutions for whom there are no
standardized rules and regulations governing their financial dealings. They are
not under the supervision and control of RBI or any other regulatory body.
Local money lenders, Pawn brokers, Traders, Landlords, Indigenous bankers,
etc., who lend money are in the unorganized sector.

Organized
Market

The sector that is
governed by some statutory or legal authority is known as organized sector.
This sector consists of the institutions for whom there are standardized rules
and regulations governing their financial dealings. They are under the
supervision and control of RBI and other statutory bodies. They are further
classified into two:

A. Capital Market

B. Money Market

C. Foreign Exchange
Market