INDIAN FINANCIAL SYSTEM

 Introduction to Indian Financial System

 For economic transformation of a country , the financial system is the key for the institutional and functional vehicle . Finance assists in reducing the gap between the present and the future , and covers every aspect like channelisation and effective usage of savings and making an efficient investment . It formulates the base , the sets and the tone for the accomplishment of wider national objectives .

. A financial system acts as an intermediary where there is surplus and deficiency of funds . It bridges the gap between the two segments . It comprises of various institutions , markets , regulations , laws , money managers , experts and many others .

In the context of " financial system " the term system means a sequence of complex and closely attached variables like institutions , agents , practices , markets , transactions , claims and liabilities in an economy . The main function of a financial system is to take care of the money , credit and finance . However , these three terms may appear to be same but still there is some difference among each term . The Indian financial system comprises of the financial market , financial instruments , financial intermediary and also the financial services .

 Characteristics of Financial System 

Following are the characteristics of the Indian financial system :

 1 ) Financial system establishes a link between the one having surplus funds with those who are in need of such funds . Both the investment and the savings aspects are encouraged .

 2 ) Financial system contributes towards the expansion and the development of financial markets .

 3 ) Financial system facilitates the efficient allocation of financial resources for the benefit of the society and the public at large 

4 ) Financial system boosts the economic quality and accelerates economic development .

 5 ) Financial system lays the foundation for an ideal economy .

 6 ) Financial system builds an efficient portfolio for the fund seeker .

 7 ) Financial system reduces the transaction costs .

 8 ) Financial system ensures availability of all the price - related information .

Functions of Financial System

1 ) To Connect the Investors with the Savers : The key function of a financial system is to bridge the gap between the one who saves money and the one who needs the funds . Thereby , the financial system helps in channclising the savings in an effective manner to reap the best possible outcome . The resources are allocated in such a manner that there is a regular advancement in technology and sustained growth can be achieved .

 2 ) Assistance in Selection of a Project : A good financial system helps in selection of an optimum project for investment purpose . Alongside , it also constantly monitors the outcome of the project . It facilitates in the payment process for goods and services and the movement of the products to different industries and geographical areas .

3 ) Risk Allocation : A good financial system assists in the optimum distribution of the risk component . It restricts and controls the investment in the form of savings in a particular risky venture . The basic idea is to sel a tolerance limit and to ensure that investments are made only within the prescribed limits

 . 4 ) Availability of Information : It further ensures that the information associated with the price is available all the time which helps in taking economic and financial decisions 

. 5 ) Reducing the Cases of Asymmetric Information : An ideal financial system aims in avoiding the occurrence of cases when the information available is found to be asymmetric . Such situations are highly adverse in nature and affect the motivation among the operators and also to a person who possesses information which the other person does not have . Besides this , it provides other services like insurance pension and adjustment of portfolio , etc.

           

6 ) Reduction in the Borrowing and the Transaction Cost : A sound financial system creates an ideal financial nario that reduces the cost of the transactions . By reducing the cost , the returns for the investors are likely to rise . The borrowing cost is similarly reduced . So this builds the habit of saving among the society . 

7 ) Liquidity Promotion : In a financial system , the key function is to have adequate resources of money for the manufacturing of goods and services . In case of a production firm , the money should not fall Short . Here , the term " money " and " monetary resources " signify liquidity . Liquidity in liberal sense is that form of the asset that can be readily converted into cash . In a financial system , all the activities are thus related with money and focus is on having a better liquidity position to ensure that the activities carry on in a smooth and effective manner . 

8 ) Financial Broadening and Deepening : An ideal financial system encourages the process of financial deepening and broadening , . Financial broadening refers to building an increasing number and a variety of intermediary and instruments .

Importance of financial system

 Following are the significance of the financial system : 

1 ) Increment in the Output and Production of the Economy : The surplus savings are channelised in such a manner that adequate resources are available for the production sector . This eventually results in the increase in output of the economy . The market , institutions and instruments are the basic market transformers who get adequate funds which leads to economic development . The financial system directs towards savings and contributing more value added areas which lead to national development 

. 2 ) Accelerating the Quantum and Pace of Savings : 

Apart from channelising of savings , a financial system also drives the rate of savings by diversifying the financial instruments , thus making number of options available for the investors to invest in . This creates competition among the intermediary ; hence the investor gets the maximum return . 

3 ) Facilitates Innovation :

 Healthy competition is promoted in the financial system . 

This leads to innovation of new products and investment opportunities . The overall cost is reduced which enhances profitability Countries having a well - diversified financial system maintain national competitiveness and their products are regularly updated .

 4 ) Evaluation of Assets , Increasing the Liquidity , Production and Spreading of Information : Apart from having an effect on the rate of return , it also influences economic development . A good financial system evaluates the assets , increases the liquidity and transmits the required information .

 5 ) Provide Risk Management Services :A financial system is a need  based system . It changes with the change in requirement for funds . During the current scenario , the world has observed an increase in demand for better risk management services . This was fulfilled by increasing the trading volume and by introducing risk management products . So , the economic growth and the financial system work hand in hand . 

6 ) To Ensure Stability and Resilience :Financial market is a part of the main branch of the financial system . There will be more stability and resilience as the system gets deeper . The Central Bank of the country can make cffective policies if it is supported by well organised money and capital market instruments . The onus is on the financial markets to create a well - balanced and efficient financial system which comprises of both the financial market and the financial institutions . If there is any imbalance , similar problems will arise as experienced in South - East Asia .

 7 ) Introduction of Discipline in Management Companies and Guiding them : The financial system also ensures that management companies work under the discipline and constantly guides for the same . When the domestic and the foreign financial system are linked together , the flow of the capital is increased . This combination reduces the risk by diversifying the portfolio and boosts the growth .

 8 ) Accelerating the Rate of Economic Growth : There exists a bilateral and mutual relation between the financial system and the economic growth . A well developed and balanced financial system boosts the rate of the economic growth .

 Limitations / Issues of Financial System 

Industrialisation has happened at a very fast rate since the concept of planning has been introduced . Growth can thus be observed in both the corporate as well as in government sector .

 So , to cater the increasing requirement of the industry , new and strategic financial instruments have phased in . Dramatic change has also been observed in the financial system of the country . Apart from all these measures , there still exists some issues that need to be given proper consideration .

 Indian financial system faces the following issues : 

1 ) Missing Coordination among the Financial Institutions : Significant number of financial institutions exists and the government controls and operates the most important ones . Alongside controlling the FIS , government also exercises control over the regulatory of the financial institutions . Such situation leads to lack of coordination . With the presence of number of institutions in the financial system , there always exists lack of coordination in their operations .

 2 ) Monopolistic Market Structure : In India , some of the financial institutions capture the major portion of the market share and thus it leads to a monopolistic structure in the financial system . For example , LIC holds majority stake of the life insurance business in India . So the presence of these large corporations may disrupt the entire financial system of the nation .

 3 ) Major Hold of Development Banks in the Industrial Financing : Development banks are considered as the most indispensible part of the financial system and hold a significant role in the capital market . In India , majority of the industrial financing is routed through the financial institutions which are created by the government at the national as well as the regional level . However , new methods of raising finance from the public have been introduced in the recent past like issuing bonds or debentures

  4 ) Inactive and Erratic Capital Market : At present , due to regular frauds and scams taking place , the public at large is losing confidence in the market and thus is not an attractive and dependable segment for the investors . This causes a serious area of concern in the capital market 

5 ) Imprudent Financial Practice : The development banks hold majority of the market share among the corporate clients and has lead to the development of imprudent market practices . Majority of the funds are provided by them in form of term loans giving rise to the debt content in the capital structure . Thus , there exists an unfavourable balance between owners ' contribution and the debt portion . In the past , to curb this practice , actions have been taken to promote capital market . Different Fls are also being integrated .