Presented To :-

Presented by:-

Introduction to financial system

A financial system is a network of financial institutions, financial markets, financial instruments and financial services to facilitate the transfer of funds. The system consists of savers, intermediaries, instruments and the ultimate user of funds. The level of economic growth largely depends upon and is facilitated by the state of financial system prevailing in the economy. Efficient financial system and sustainable economic growth are corollary. The financial system mobilizes the savings and channelizes them into the productive activity and thus influences the pace of economic development. Economic growth is hampered for want of effective financial system. Broadly speaking, financial system deals with three inter-related and interdependent variables, i.e., money, credit and finance.

Definition of financial system

Financial system may be defined as “a set of markets and Institution to facilitate the exchange of assets and risks.”

Features of financial system

 Financial system provides an ideal linkage between depositors and investors, thus encouraging both savings and investments.

 Financial system facilitates expansion of financial markets over space and time.

 Financial system promotes efficient allocation of financial resources for socially desirable and economically productive purposes.

 Financial system influences both the quality and the pace of economic development.

Functions of financial system

Financial system works as an effective conduit for optimum allocation of financial resources in an economy.

It helps in establishing a link between the savers and the investors.

Financial system allows ‘asset-liability transformation’. Banks create claims (liabilities) against themselves when they accept deposits from customers but also create assets when they provide loans to clients.

Economic resources (i.e., funds) are transferred from one party to another through financial system.

The financial system ensures the efficient functioning of the payment mechanism in an economy. All transactions between the buyers and sellers of goods and services are effected smoothly because of financial system.

Financial system helps in risk transformation by diversification, as in case of mutual funds.

Financial system enhances liquidity of financial claims. Financial system helps price discovery of financial assets

resulting from the interaction of buyers and sellers. For example, the prices of securities are determined by demand and supply forces in the capital market.

Financial system helps reducing the cost of transactions.

Importance of financial system

The following benefits suggest the importance of financial system :

Facilitate economic / industrial activity and growth. Helps accelerate the volume and rate of savings. Monitors the management of companies (corporate sector). Facilitates execution of monetary policy by the Central

Bank. Facilitates evaluation of assets.

Components of Financial System

A financial system refers to a system which enables the transfer of money between investors and borrowers. A financial system could be defined at an international, regional or organization level.

Following are the Key Components of Financial System

Financial Institutions Financial Markets Financial Services Financial Instruments (Assets or Securities)

Financial institutions are those organizations that are involved in providing various types of financial services to their customers. The financial institutions are controlled and supervised by the rules and regulations delineated by government authorities.

These are the various Financial Institutions:  Banks Stock brokerage firms Credit unions Insurance companies etc.

Financial institutions deal with various financial activities associated with bonds, debentures, stocks, loans, risk diversification, insurance, hedging, retirement planning, investment, portfolio management, and many other types of related functions. With the help of their functions, the financial institutions transfer money or funds to various tiers of economy and thus play a significant role in acting upon the domestic and the international economic.

For carrying out their business operations, financial institutions implement different types of economic models. They assist their clients and investors to maximize their profits by rendering appropriate guidance. Financial institutions also impart a wide range of educational programs to educate the investors on the fundamentals of investment and also regarding the valuation of stock, bonds, assets, foreign exchanges, and commodities. 

Financial institutions can be both private and public in nature. 

Financial institution is that type of an institution, which performs the collection of funds from private investors and public investors and utilizes those funds in financial assets. The functions of financial institutions are not limited to a particular country, instead they have also become popular in abroad due to the growing impact of globalization

Financial Market, in very crude terms, is a place where the savings from various sources like households, government, firms and corporate are mobilized towards those who need it. Alternatively put, financial market is an intermediary which directs funds from the savers (lenders) to the borrowers. In other words, financial market is the place where assets like equities, Bonds, currencies, derivatives and stocks are traded.

Some of the salient features of financial market are

Transparent pricing Basic regulations on trading Low transaction costs Market determined prices of traded securities

Major Players in Financial Market:

The main participants in the financial market are as follows: 

BANKS : Largest provider of funds to business houses and corporate through accepting deposits.

INSURANCE COMPANIES : Issue contracts to individuals or firms with a promise to refund them in future in case of any event and thereby invest these funds in debt, equities, properties, etc.

  FINANCE COMPANIES : Engages in short to medium term

financing for businesses by collecting funds by issuing debentures and borrowing from general public.

MERCHANT BANKS : Funded by short term borrowings; lend mainly to corporations for foreign currency and commercial bills financing.

COMPANIES : The surplus funds generated from business operations are majorly invested in money market instruments, commercial bills and stocks of other companies.

MUTUAL FUNDS : Acquire funds mainly from the general public and invest them in money market, commercial bills and shares.

GOVERNMENT : Authorized dealers basically look after the demand-supply operations in financial market. Also works to fill in the gap between the demand and supply of funds.

The finance industry provides a number of services to the clients.

There are different types of financial services company to provide these services to different commercial sectors as well as to the individuals.

There are different types of financial services like lending money for different purposes, insurances, depository services, mortgage services, investment services, credit rating services and many more.

The different types of financial services company jointly create one of the largest industries of the world. There are a number of financial services Companies in the world. 

Some of these companies are the following:

Investment services company Insurance company Bank etc.

Bank

It is one of the biggest financial services companies of the world. There are different types of banks in the world. Some of these are commercial banks, private banks and many more. There are some banks that work for the capital markets only. Banks provide a number of financial services to the clients. These services include depository services, lending services, credit card facilities and many more. These services are provided for both the individuals and the commercial sector.

Insurance Companies

The insurance companies provide the clients with risk coverage services. These services are designed to cover a number of risks that are related to an individual's life, property and many more. These services are not only designed to provide security but at the same time there are a number of insurance plans that are designed to provide regular income to the clients. The insurance policies can be divided in several types like general insurance, life insurance, commercial insurances and a lot more.

Credit Rating Agencies The credit rating agencies are those

firms that evaluate different types of financial services companies. These ratings are based on a number of factors like the kind of services, risk factor involved with the services, customer facilitation and many more. 

A Financial Instrument is a legal document identified by cheques, drafts, bonds, shares, bills of exchange, futures or options contracts etc., which has a monetary value. The agreement is signed between two parties

regarding payment of money with specified conditions. 

Categories of Financial Instruments:

The financial instruments can be broadly classified under 3 categories:

Equity based: characterized by ownership of assets.

Debt based: loans from an investor to the owner of assets.

Foreign exchange instruments: unique instrument dealing with international currencies

Types of Financial Instruments: 

MUTUAL FUNDS: It is an investment scheme in which a group of people collectively invests funds with a predetermined objective. The pooled money is again invested in stocks, bonds, short term money market instruments and other securities by the mutual fund complexes. The major advantage in such an investment plan lies in its cost effectiveness, risk diversification, professional management and sound regulation.

  BONDS: Bonds are debt based financial instruments, bearing

interest on maturity. The organizations or companies generate funds by issuing bonds with fixed interest rate for a definite period of time (maturity period). Bonds have a maturity period of one year which distinguishes them from other debt securities like commercial papers, treasury bills and money market instruments. Bonds are issued by both private companies and government organizations. Usually, government bonds are a safe area for investment due to their lower risk level and fair returns.

 

CASH EQUIVALENTS: The name itself suggests that this is the most liquid investment option. These are the assets that can be readily converted into cash. Money market holdings, short-term government bonds or treasury bills, commercial papers, etc. are few examples of cash equivalents.

DEPOSITS: These are investment avenues where surplus funds are invested in banks or post-offices. The risks associated are the lowest in this case but so are the returns on such deposits.