What is 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 channelization 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.
Definition of Financial System
According to Robinson, the primary function of the financial system is:
"To provide a link between savings and investment for the creation of new wealth and to permit portfolio adjustment in the composition of the existing wealth".
According to Christy, the objective of the financial system is to :
"Supply funds to various sectors and activities of the economy in ways that promote the fullest possible utilization of resources without the destabilizing consequence of price level changes or unnecessary interference with individual desires".
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. The flow of funds in Indian financial system is explained by figure given below :
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.
Functions of Financial System
Following are the financial system functions :
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 channelizing 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 set 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 scenario 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 deepening refers to an increase of financial assets as a percentage of the Gross Domestic Product (GDP). Financial broadening refers to building an increasing number and a variety of intermediary and instruments.
Features of Financial System
Following are the features characteristics of financial system :
- 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,
- Financial system contributes towards the expansion and the development of financial markets.
- Financial system facilitates the efficient allocation of financial resources for the benefit of the society and the public at large.
- Financial system boasts the economic quality and accelerates economic development.
- Financial system lays the foundation for an ideal economy.
- Financial system builds an efficient portfolio for the fund seeker.
- Financial system reduces the transaction costs.
- Financial system ensures availability of all the price-related information.
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 channelized 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 i instruments are the basic market transformers. who get adequate funds which leads to economic development. The financial system directs towards savings and contributing more values added areas which lead to national development.
2) Accelerating the Quantum and Pace of Savings :
Apart from channelizing 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 effective 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
Industrialization 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 instrument 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. 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 indispensable 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. This, there exists an unfavorable balance between owners' contribution and the debt portion. In the past, to curb this practice, actions have been taken to promote capital market. Different FIs are also being integrated.
Thus, rapid changes are taking place in the Financial System to make it a developed one.
Structure and Components of Financial System
There are four segments or components of the Indian financial system. These are financial institutions, financial markets, financial instruments and financial services. The components / structure of financial system in India is shown in the figure below :
Let's discuss each component of financial system in detail :
- Financial Institutions
- Financial Markets
- Financial Instruments/ Securities/Assets
- Financial Services
Financial Institutions
Different kinds of organisations which act as an intermediary and facilitator in financial transactions at the individual and the corporate level are included in the term financial institutions. Thus, covers both the institutions providing finance and the investing institutions in it. They are the ones who channelize the savings and allocate the funds in the most optimum manner. They are further classified in three different categories :
- Regulatory Institutions
- Banking Institutions
- Non-banking Institutions
Regulatory Institutions
Regulatory are the ones who provides rules and guidelines for a particular market. It comprises of RBI, SEBI, IRDA, AMC, etc. Primarily, an investor would want the funds to be under the control and to be safe to invest. This assurance is rendered by the regulatory authority that is regulating the particular market. For example, money market instruments are regulated by the RBI whereas the capital market instruments are regulated by SEBI.
Banking Institutions
The banking institutions are of two types :
1) Intermediaries :
Intermediaries are the ones who fulfill the short-term requirement of funds of corporate as well as the individual clients. They comprise of banking as well as non-banking intermediaries.
For example, banks like SBI, PNB, etc. whereas examples of non-banking intermediaries comprise of GIC, UTI. LIC, etc.
Other important services like credit rating, leasing. merchant banking, hire-purchase are also provided by these financial intermediaries. These services are required while creating a new firm, during expansion and the economic growth. The two types of banking intermediaries are as follows :
i) Commercial Banks :
These banks hold deposits on behalf of the customers and thus ensure the safety of the funds. The primary purpose was thus to hold the same for the customers who do not wish to hold the same on their own. As a result, the need for the customers to keep funds in the form of cash has reduced and he can thus use the services of credit cards, cheques, net banking for entering into any financial transaction. These banks also provide loans to individuals and businesses for long-term purposes and also for financing the working capital requirements.
ii) Co-operative Bank :
The co-operative banks give financial help to the agriculture sector and also helps in establishing the credit system. It basically helps the rural areas of the country as commercial banks are not able to reach the rural areas. The long-term loans are required for purchasing of land or permanent improvement on land which is provided by the land development bank and the short-term loan is provided for purchasing implements, fertilizers and seeds, etc. which is given by the co-operative banks.
2) Non-Intermediaries :
They are engaged in providing funds on long-term basis to individuals as well as corporate clients. They comprise of institutions who are lending on term basis. For example, financial corporations and investment institutions like IDBI, NABARD, IFCI, etc.
Non-Banking Institutions
The non-banking includes following institutions :
1) Non-Banking Financing Institutions (NBFI) :
A Non-Banking Financing Institution (NBFI)/Non-Banking Financing Intermediary has alternate roles in different parts of the world :
- It is an institution which is not just a bank but is engaged in the function of finance.
- Financial institutions who do not accept demand deposits.
- Financial institutions who do not accept any deposit.
2) Investment Companies :
They may be called a trust or a corporation which facilitates an individual to invest in different diversified and professionally managed securities by arranging pool of funds from other investors. The individual need not invest in single company stocks but can rather purchase units directly from the investing company which are well diversified. For example, UTI and Mutual Fund.
3) Insurance Companies :
They create a risk pool by way of collection of premium from the people at large who wishes to buy a protection either for a person or for a property. It helps to mitigate the loss and preserve the wealth and meet out the uncertainties. By insuring large groups, risk is spread over the entire insured and even in the event of paying claims, they end-up with sufficient amount of profits unless there is a natural calamity or disaster.
Financial Markets
There does not exist a physical or geographical location that can be termed as a financial market but all the financial transactions are deemed to occur in the financial market. So, it can be said that as financial transactions are pervasive in nature, financial markets are also pervasive. Basically, a financial market is a common place where the buyers and the sellers of financial instruments meet and exchange products. Stock exchange may be termed as a place where these transactions take place and a location for the financial market. In India, financial markets are classified as unorganized and organised markets.
Under the "unorganized market", there exists a large number of indigenous bankers, money lenders, traders, etc., who lends the money to the public at large through informal sources. The indigenous bankers are responsible for collecting deposits while the others may lend. Some other forms like private financing companies, Nidhi's, chit funds are also available and are engaged in the same line of activity. Presently, they are not monitored by RBI, but recently RBI is making efforts to convert the same into an organised sector.
Under the organised markets, standardized regulations and norms are framed that governs. financial trading. RBI exercises strict supervision and control on the financial transactions taking place under this type of market. Financial market is further classified in two types of market :
- Money Market
- Capital Market
Money Market
It means a ready market or a short-term market where securities are bought or sold only for a very short duration. The tenure usually does not exceed one year thus is considered to be an equivalent to cash only. The securities are highly liquid in nature and can be readily converted to the cash. The transaction cost is also the minimum.
Capital Market
It is a market where securities are usually held for long-term basis, i.e., more than one year. They do not have a fixed maturity or expiry date. The buyer can hold the same, till the time he wishes to do so.
1) Equity Market :
It comprises of the equity shares of the company. Equity shares are further classified in two categories :
i) Primary Market :
Where the shares are. being sold for the very first time, i.e., Initial Public Offer (IPO) and Right Issues.
ii) Secondary Market :
Where the existing shares are bought or sold, after they were originally issued to the public. These shares are listed on stock exchange through which they can be traded.
2) Debt Market :
It is the financial market in which debt securities are bought and sold by the investors. These securities are in the nature of bonds or debentures and carry a fixed rate of return. Therefore, they are fixed income bearing securities that are issued by the Central and State Governments municipal corporations, other government bodies, and commercial entities like financial institutions, banks, PSU, public limited companies, etc.
Financial Instruments/ Securities/Assets
A financial instrument is an acknowledgement for a person entitling him against the claim that is receivable from another person or institution, while the person is in regular receipt of interest or dividend. These financial instruments assist the market in routing the funds from the lender to the borrower in consideration of interest. There are number of products that are available and they vary in terms of return, liquidity, marketability, reversibility, types of assets, risk and the transaction cost. Following are the two major forms of the Indian financial instruments and assets :
- On the Basis of Term
- Types of Securities
On the Basis of Term
On the basis of term the financial instruments can be classified into following three types :
- Short-Term
- Long-Term
- Medium-Term
1) Short-Term Financial Instruments :
The short-term financial instruments include the instruments which are of less than one year. The various types of securities are T-bills and commercial paper. The different kinds of cash can be deposits, certificate of deposits, etc. which are as follows :
i) Treasury Bills :
Treasury bills show the responsibilities of Government of India. It is basically of 91 days and 364 days. They are given to the customers on the auction basis every week which has certain small denominations which are issued by the Reserve Bank of India. It does not have any specific interest rate so they are sold on discount or are redeem at par.
ii) Commercial Paper (CP) :
A commercial paper is an unsecured promissory note and money market instrument, issued by large corporate houses for raising funds with a view to meeting their short-term debt obligations such as payroll. CP is not secured by collateral security. It is supported by an issuing bank or company who promise to pay the face value at the maturity date indicated on the note, As it is an unsecured instrument, only the organizations with exceptional credit ratings are capable of issuing their commercial paper at an economical price. The maturity period of Commercial Paper ranges between 15 days and one year. On maturity date, the issuer has to repay the due amount without any delay. There is no provision of grace period in this case.
iii) Certificates of Deposit (CD) :
CD is also a money market instrument issued by banks to the depositors, in the form of certificate showing the existence of such deposit with them. These certificates are in turn traded by the depositors (when such a need arises) between their business associates. In short, under this arrangement, the Bank deposit may be transferred from one owner to another, any number of times, before its maturity. Interest on such deposits continues to be paid in the normal course. The price of CD depends on the (a) Rate of interest available on the Bank Deposit (which is fixed), and (b) Rate of interest prevailing in the market at that particular time.
iv) Letter of Credit (LC) :
Letter of Credit (LC) is a form of Bank Guarantee. It is an arrangement, under which a bank helps its customer to obtain credit from its (customer's) suppliers, by undertaking the responsibility to honour the commitment of its customer, in case of the customer's inability to do so. LCs is opened by banks in respect of specific transactions entered into by their customers.
2) Medium-Term Financial Instruments :
The medium-term instruments consist of the instruments which has the maturity of 1 to 5 years. The various types of medium-term instruments are as follows :
i) Bank Deposits :
In bank deposits, an individual opens a bank account and deposit the money in that. The different kinds of bank accounts are current accounts, fixed deposits, term deposits, savings bank account, recurring deposits, post office deposits, public provident fund, employee provident fund scheme, etc.
ii) Mutual Funds :
A mutual fund is referred to as collection of investment scheme which has the money from various sources and is professionally managed. The investment is done in stocks, bonds, short-term money market instruments and other securities. Hence, it helps the investors to earn more profits of diversified portfolio.
iii) Life Insurance :
The life insurance provides the protection to the policyholder from any uncertain situation like death or long-term sickness and disability which may affect the financial condition of the policyholders. These policies help the policyholder to arrange for funds required for certain work like regular income at the time of retirement or repayment of loan
3) Long-Term Financial Instruments :
This sub-category comprises instruments with maturity longer than those of short- and medium term instruments. Some of the long-term instruments are as follows :
i) Equity Shares :
Equity shares are also termed as ordinary shares or common shares. Holders of the equity shares are the owners of the company as they have invested in the company. They have the voting rights and part of decision-making process on major issues relating to the affairs of the company. The shareholders' return on the funds invested by them in the company is in the form of 'Dividend".
ii) Preference Shares :
Preference shares have the unique characteristics of being hybrid in nature, i.e., they have certain features of equity and at the same time certain features of debentures. It is similar to equity shares in the following ways :
- From disposable profits, the dividend of preference shares is paid.
- Preference dividend is not compulsory for the payment of fixed amount of dividend. It totally depends upon the director's decision.
- There is no tax-deduction in Preference Dividend.
iii) Debentures :
A debenture is an instrument through which an Indian Public Limited Company can raise funds from the market. A debenture is signed by the company with its seal, to acknowledge the debt of the person(s). ensuring the advanced amount of debt. So this is a security issued by a company against debt. A company may issue debentures after getting Certificate of Commencement of Business, provided its Memorandum of Association contain a clause which permits the company to issue debentures.
iv) Term Loan :
Term loans are loans procured for the acquisition of fixed assets and working capital margins and are repayable over a long period of time, generally ranging between one year and ten years. Term loans are extended by banks and other financial institutions set up for the purpose of extending term finance. Term loans differ from short-term bank loans, also known as 'Working Capital Finance', which are sanctioned by banks to meet day-to-day business requirements like purchase of raw material, work-in-progress and finished goods, etc. They are self liquidating over a period of time.
v) Bonds :
A bond is a debt security, in which the authorized issuer owes the holder a debt and is obliged to repay the principal and interest (the coupon) at a later date, termed maturity. A bond is simply a loan in the form of a security with different terminology; the issuer is equivalent the borrower, the bond holder to the lender, and the coupon to the interest. Bonds enable the issuer to finance long-term investments with external funds. Bonds are issued by public authorities, credit institutions, companies and supranational institutions in the primary markets.
Securities
There are two types of securities are as follows :
- Primary Securities
- Secondary Securities
1) Primary Securities :
It is a kind of financial investment where the price is dependent on its market value. For example, bonds, stocks, certificates of deposits, bills and other securities that have their own value. On the contrary, instruments like options, futures and swaps do not have their own market price, rather it is based upon the underlying asset:
i) Equity :
It represents the ownership of the company. They are the holders of the equity stock and carry a voting right. There are different types of equity shares that are available in the market.
ii) Forwards :
This type of contract is a tailor-made contract, catering the need of the two parties. Under this, the contract is settled at a certain future date at a predetermined price.
iii) Futures :
This is an arrangement between two parties, where they agree to purchase or sell a particular asset on a predetermined time in future on a specific price. They are just like the forward contracts, the only difference being that the forwards contracts are standardized and dealt on the stock exchange.
iv) Options :
There are two types of options - Call and the put option. Under the call option, the buyer has the right and not the obligation to purchase the security anytime before or on a certain future date. On the other hand, put gives an option to the buyer to sell but he is under no obligation to sell before or on the specified date.
v) Swaps :
They are private contracts among two persons for exchange of cash flows at a future date on pre-decided terms. They may also be termed as the portfolios of forward contracts.
vi) Commercial Paper :
It is a short duration instrument. They can be purchased directly from the market or through the intermediary and the amount is repayable on a certain future date. Companies having a high credit rating, issue the same by way of promissory note which is redeemable on a future date. Usually, it does not demand any guarantee being a money market. instrument. It is issued for a period up to 90 days.
vii) Treasury Bills :
They are short-term (till 91 days) money market instrument, issued by the Government to meet its short-term deficiency of funds.
2) Secondary Securities :
It comprises of fixed income bearing instruments like corporate/gilt edged bonds, debentures, preference stock. fixed term deposit, etc. Other variable income bearing securities are also included in this, like equity, mutual funds and derivatives :
i) Equity Shares :
They represent the ownership of the company. In the ordinary course, a share means an equity share. The holder becomes the proportionate shareholder in the company to the extent of the holding. A shareholder being the entrepreneur bears all the risk and carries all the surplus profits. Apart from the share in the profits they also enjoy the voting rights in the company.
ii) Rights Issue or Rights Shares :
They are issued to the existing shareholders in a pre-determined ratio of their holding.
iii) Bonus Shares :
These are issued by companies for free to their shareholders by capitalizing the reserves. They are declared out of the profits of the previous years.
iv) Preference Shares :
Preference shareholders enjoy a fixed rate of dividend even though the company does not make profit in a year. The rate of return is fixed and is not dependent on the volume of the profits earned and they get preference over the equity in terms of dividend. They may or may not participate in the surplus of the company. In case of liquidation also, they are paid in prior to the equity shareholders but only after payment has been made to the creditors and to the debenture holders.
v) Government Securities :
They are also termed as G-Secs. They are sovereign (risk-free credit) interest bearing instruments issued by RBI on behalf of the Government to comply with the Central Government's market borrowing programme. The securities issued carry a fixed interest rate payable on pre-determined rates semi-annually basis.
vi) Debentures :
They are the kinds of bonds that are issued by companies carrying a fixed coupon rate which is normally payable half-yearly on pre-determined dates and the principal amount is repayable at the time of redemption. Usually the debenture holders carry some kind of charge on the debentures held by them.
vii) Bond :
It is a certificate of the indebtedness of the firm and normally does not carry any security. Usually they are issued by a company. municipality or government agency. An investor in this case, lends a money to the issuer in lieu of regular payment of interest and principal payment on the specified maturity date. The interest is paid during the entire life span of the bond.
Financial Services
Important financial services like that of leasing. credit rating, hire purchase, merchant banking, etc., are rendered by these financial intermediaries. These services are crucial in reducing the gap resulting out of ignorance and availability of information among the investors and the rising complexity in financial instruments and the markets. These financial services. play a crucial role in the creation of the firms, expansion of the industry and thus leading to the economic growth.
Fund/Asset Based Financial Services
Asset based finance is termed as funding against a range of corporate assets including accounts receivable, inventory, plant and machinery, real estate and sometimes even intellectual property and brands. It is the method of making a loan secured by an asset. It includes the following :
1) Lease Financing :
It is a financial contractual arrangement where one party having ownership of an asset lends the same to another for usage for certain duration in lieu or regular and periodic payments known as rent. At the expiry of the lease period the assets comes back to the original owner known as the lessor from the lessee. However, the parties may further renew the agreement.
2) Hire Purchase :
It refers to hiring of an asset for a certain period and after the expiry of the period acquiring the same asset. The concept of time sharing is followed in this case. The person who hires the asset eventually ends up purchasing it. It is used as a tool in financing capital goods like industrial finance, consumer goods.
3) Factoring :
It is type of finance where a business will sell its account receivable to third party to fulfill its short-terms requirements.
4) Forfaiting :
Forfaiting is a form of financing of receivables arising in the course of overseas trade. It refers to the purchasing of trade bills or promissory notes issued by the banks or the financial institutions without recourse to seller. Finance is carried out by discounting the instruments and taking over the entire risk involved in case of default payment.
5) Mutual Fund :
Under this, the investment made by the investors are pooled together and the same is invested in securities like stock, bonds and money market instrument and other allied assets.
6) Exchange Traded Fund :
It is just like other investment funds that are traded on the stock exchange. Assets like stock, commodities, bonds, etc., are traded close to their NAV during the daily trading. Majority of these funds track an index like stock or the bond index.
7) Consumer Credit or Consumer Finance :
It is the phenomenon of providing credit to the consumers for the purchase of consumer durable goods for everyday use. There are other names for the same concept like deferred payments, credit merchandising, installment buying, pay as you earn scheme, pay out of income scheme, hire purchase, easy payment, installment credit plan, credit buying etc.
8) Bill Discounting :
It denotes a short-term money market instrument and assists in financing credit trade related transactions. Normally, bills are discounted with the bank in the ordinary course of the trading activity.
9) Housing Finance :
It is a set of financial arrangements which are rendered by the Housing Finance Companies to finance the need of funds for the construction and the purchase of house.
10) Venture Capital :
It consists of two words that are, venture and capital. The first term venture means a course or a proceeding where the result is uncertain but the risk of loss arising exists. While the other term capital means the funds required to initiate the venture.
11) Non-Fund or Fee-Based Financial Service :
Fee based financial service do not create the funds on the outset, rather they ensure that the funds are created through the services for which a fee is charged by them.
Fee-Based Financial Services
Fee-based financial services do not create funds on the outset, rather, they ensure that the funds are created via their services for which a fee is charged by them. It comprises of :
1) Merchant Banking :
It may be an institution or an individual who may be an agent for the corporation and the municipalities issuing securities. Further, broker or dealer operations are also maintained by them alongside and they also trade in existing issued securities. They also offer advice related to the investments to the investors in general.
2) Credit Rating :
It is the process of allocating symbols having unique reference to the different instruments being rated, that indicate the opinion of the issuer to issue debt-related instruments on the ability to pay off the debt in timely manner is known as credit rating.
3) Stock Broking :
The mechanism under which the buyer and the seller of the securities come to a particular place like stock exchange for transaction dealing is termed as stock broking.
4) Debt Securitisation :
It is the process by which assets like auto loan receivables, cash credit receivables, mortgage loans are converted into trad-able investment.
5) Letters of Credit :
It is commonly referred as LC. It is a written document which is issued by the buyers bank to the sellers bank to reimburse the cost of goods and services that are supplied by the seller to the buyer when the documents are submitted within the particular time frame at a specified time and specified place, up to a certain amount and to a particular bank on the condition that the documents are submitted in accordance with terms and the conditions implied.
6) Bank Guarantees :
It is the contract between the client and the issuing bank where the bank assumes the responsibility to settle the claims of the client for the customer for which the guarantee was given.
Role of Financial System in Economic Development
The various roles of financial system in the economic development of the country are as follows :
1) Saving Mobilization :
The financial markets collect funds from the savers or surplus units like household individuals, business firms, public sector units, central governments, etc. The borrowers like bond issuers and lenders like bond buyers are connected in the financial markets.
2) Investment :
The financial system helps in investing funds. The firms and individuals by the help of financial markets make investments by buying stocks of various companies.
3) Banking Systems :
The banks play an important role in national financial system. The banks provide individuals the way to save their earnings. It gives capital to the companies which either want to start the operation or want to stay the market by giving loans. If the companies do not get the sufficient amount of capital then their growth will decrease and they will not be able to earn profit for the owner and investors. The banks invest the savings into the business in the form of loans. They also offer various kinds of loans like car loan, home loan, etc., to individuals who indirectly help in increasing the economic growth and development of the country.
4) National Growth :
The financial system enables continuous movement of surplus funds to required sectors which helps in maintaining the national growth. The financial system provides funds to various firms and industries according to the demand and supply of the products.
5) Monetary Policy :
The financial system is required for issue of currency and also provides interest rates for the central bank. They are also required for framing monetary policy. It sets high interest rate for helping the currency value and low interest rate helps in increasing the lending and investment along with the risk of currency devaluation and price inflation. The constant monetary policy helps in increasing the economic stability and growth.
6) Entrepreneurship Growth :
The financial system gives various kinds of assistance to an entrepreneur like providing funds required for the projects and companies.