14-Mar-2023

BBA 216
FINANCIAL MARKETS AND INSTITUTIONS

Supplementary Study Material

Unit I - Introduction to Financial System

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Financial System

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A financial system is a set of institutions, such as banks, insurance companies, and stock
exchanges, that permit the exchange of funds. Financial systems exist on firm, regional, and
global levels. Borrowers, lenders, and investors exchange current funds to finance projects,
either for consumption or productive investments, and to pursue a return on their financial
assets. The financial system also includes sets of rules and practices that borrowers and
lenders use to decide which projects get financed, who finances projects, and terms of financial
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deals.
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Functions of a financial system
Some functions of these fiscal systems include:
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I. Ensure liquidity
For individuals and institutions to run asset and fund transfers, enough asset liquidity is
necessary to match demand. The financial institutions, markets, and service providers
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involved in these systems ensure a fluid flow of funds so investors can buy and sell
assets at will and make these assets easily accessible. Liquidity also contributes to the
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system's stability and can make it less prone to financial crises or collapse.

II. Create a payment system

Financial institutions and service providers within a fiscal system provide a payment
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system for individuals. They create an efficient and seamless process that allows
merchants and businesses to send and receive money in exchange for products and
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services. Additionally, they enable individuals to access cash regardless of location.

Through this system, individuals can make payments with credit cards, checks, or cash.

III. Manage risk

A monetary system can provide risk management by ensuring the protection of financial
assets against systemic and systematic risks. For instance, a bank may conduct
payment and refinancing operations and participate in preparing policy measures and
systems development. It may analyze threats to financial stability while working closely
with regulatory bodies to prevent financial crises.

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A system may also include insurance services to protect financial assets from mishaps
through insurance schemes. Financial institutions, such as credit agencies, may gather
and distribute relevant information to help individuals and institutions make informed,
risk-free decisions. These risk-management services help to maintain efficient payment
and economic systems at different levels of operations.

IV. Provide financing

A function of these systems is to develop a network of financial institutions that work
together to provide financing through the transfer and exchange of capital across

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locations. For example, you may seek a loan from a bank or similar financial institution
when starting a project. These banks collect deposits from individuals with excess cash

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as savings and provide capital as debts to borrowers.

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While the typical lenders are individual account holders, financial institutions may also
get funds from public entities, firms, and non-residents who lend out excess funds.
Typical borrowers include governments and non-financial corporations who use these
funds to provide more accessible products and services while providing additional jobs
and investment opportunities, driving economic growth. This coordinated service

V.
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between lenders and borrowers channels funds from net savers to net spenders.

Inform and implement government policy

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Governments use fiscal systems and their components to regulate and stabilize the
economy. For instance, they may set policies to control specific economic occurrences,
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such as unemployment, inflation, and interest rates. These systems can also assist in
the formation of policies that address individuals of different financial classes. As
governments develop strategies to ensure stable economic systems at the individual,
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corporate, provincial, and federal levels, fiscal institutions oversee the financial and
operational requirements to ensure the implementation of those government regulations.
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VI. Increase individual ability to save

A primary function of these systems is to use financial institutions and services to help
individuals save assets. For instance, a financial institution may use a long-term
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investment such as pension savings for an extended period to manage the effect of
inflation. The client receives interest in exchange for the use of this money, increasing
their savings. These savings can have a circular effect, as when investors grow their
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assets and wealth, they typically contribute to economic development.

Financial Intermediaries
A financial intermediary refers to an institution that acts as a middleman between two parties in
order to facilitate a financial transaction. The institutions that are commonly referred to as
financial intermediaries include commercial banks, investment banks, mutual funds, and

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pension funds. They reallocate uninvested capital to productive sectors of the economy through
debts and equity.

In simple terms, financial intermediaries channel funds from individuals or corporations with

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surplus capital to other individuals or corporations that require cash to carry out certain
economic activities.

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Functions of Financial Intermediaries

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A financial intermediary performs the following functions:
A. Asset storage
Commercial banks provide safe storage for both cash (notes and coins), as well as
precious metals such as gold and silver. Depositors are issued deposit cards, deposit
slips, checks, and credit cards that they can use to access their funds. The bank also
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provides depositors with records of withdrawals, deposits, and direct payments they
have authorized. To ensure the depositors’ funds are safe, the Federal Deposit
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Insurance Corporation (FDIC) requires deposit-taking financial intermediaries to insure
the funds deposited with them.
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B. Providing loans
Advancing short-term and long-term loans is the core business of financial
intermediaries. They channel funds from depositors with surplus cash to individuals who
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are looking to borrow money. Borrowers typically take out loans to purchase
capital-intensive assets such as business premises, automobiles, and factory equipment.
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Intermediaries advance the loans at interest, some of which they pay the depositors
whose funds have been used. The remaining amount of interest is retained as profits.
Borrowers undergo screening to determine their creditworthiness and their ability to
repay the loan.
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C. Investments
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Some financial intermediaries, such as mutual funds and investment banks, employ
in-house investment specialists who help clients grow their investments. The firms
leverage their industry experience and dozens of investment portfolios to find the right
investments that maximize returns and reduce risk.
The types of investments range from stocks to real estate, Treasury bills, and financial
derivatives. Sometimes, intermediaries invest their clients’ funds and pay them an
annual interest for a pre-agreed period of time. Apart from managing client funds, they
also provide investment and financial advice to help them choose ideal investments.

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Benefits of Financial Intermediaries

Financial intermediaries offer the following advantages:

A. Spreading risk
Financial intermediaries provide a platform where individuals with surplus cash can
spread their risk by lending to several people rather than to only one individual. Lending
to just one person comes with a higher level of risk. Depositing surplus funds with a
financial intermediary allows institutions to lend to various screened borrowers. This
reduces the risk of loss through default. The same risk reduction model applies to

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insurance companies. They collect premiums from clients and provide policy benefits if
clients are affected by unforeseeable events like accidents, death, and disease.

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B. Economies of scale

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Financial intermediaries enjoy economies of scale since they can take deposits from a
large number of customers and lend money to multiple borrowers. The practice helps to
reduce the overall operating costs that they incur in their normal business routines.
Unlike borrowing from individuals with inadequate funds to loan the requested amount,
financial institutions can often access large amounts of liquid cash that they can loan to
individuals with a strong credit rating.
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C. Economies of scope
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Intermediaries often offer a range of specialized services to clients. This enables them to
enhance their products to cater to the requirements of different types of clients. For
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example, when commercial banks are lending out money, they can customize the loan
packages to suit small and large borrowers. Small and medium enterprises often make
up the bulk of borrowers. Preparing packages that suit their needs can help banks grow
their customer base.
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Similarly, insurance companies enjoy economies of scope in offering insurance

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packages. It allows them to enhance their products and services to satisfy the needs of a
specific category of customers such as people suffering from chronic illnesses or senior
citizens.
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Examples of Financial Intermediaries

1. Bank
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A bank is a financial intermediary that is licensed to accept deposits from the public and
create credit products for borrowers. Banks are highly regulated by governments, due to
the role they play in economic stability. They are also subject to minimum capital
requirements based on a set of international standards known as the Basel Accords.

2. Credit union
A credit union is a type of bank that is member-owned. It operates on the principle of
helping members access credit at competitive rates. Unlike banks, credit unions are

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established to serve their members and not necessarily for profit purposes. Credit unions
claim to provide a wide variety of loan and saving products at a relatively lower price
than other financial institutions offer. They are governed by a board of directors, who are
elected by the members.

3. Mutual funds
Mutual funds pool savings from individual investors. They are managed by fund
managers who identify investments with the potential of earning a high rate of return and
who allocate the shareholders’ funds to the various investments. This enables individual
investors to benefit from returns that they would not have earned had they invested

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independently.

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Generally, fund managers in mutual fund companies invest the money collected from
retail investors in different financial assets and distribute the return to the retail investors

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proportional to their investment. Based on the client preferences and investment fund
managers focusing on growing the investors’ wealth, select appropriate securities and
compile them to form the portfolio. Mutual fund companies help clients with investment
management.

4. Insurance companies A
Insurance companies provide various insurance policies like life insurance, home
insurance, and liability insurance designed to give financial protection to the customers.
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They deal with different entities like brokers and agents for completing the transactions.
It pools policyholders' premiums and invests them in various investment vehicles like
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bonds and other money market instruments. Moreover, this way, they make a huge profit
and pay claims and other liabilities without incurring massive losses even if the payouts
are large. The income from their investments ensures that the insurance company is
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cushioned against this.

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5. Stock exchanges
The stock exchange reflects a marketplace where buyers and sellers engage in trading
financial instruments like stocks and derivatives. It connects companies that need
funding and investors who have excess funds to invest as an intermediary. Even with a
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small amount of money, one can have an ownership interest in a blue-chip company
which may have otherwise been impossible.
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Indian Financial System

The politico-economic background of the financial development in India has been determined by
the nature of our mixed economic system. Some of the marked characteristics of Indian
economy are continuous inflation, increasing internal and external deficits, industrialisaton,
urbanisation, and significant structural transformation. The Indian financial system comprises
multiple components and the structure that clarifies the involvement of the rules and policies to
keep up with the investment and the savings. India is among the largest economies and in the

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5th position based on its nominal GDP. The Indian financial system is related to the pecuniary
facilities for the trade and transfer systems. The independent pillars of the financial context in
India comprise ‘insurance’, ‘liabilities’, ‘banking’, ‘transactions’, ‘capital and stock markets’,
‘claims’, and ‘investments’. The financial system of India comprises production, capital
collection, mobilization, allocation, and encouragement of savings. The financial system of India
is formative but ideal for managing the whole structure of the overall economy. Along with the
ideal effects, the challenges are visible in this context as well.

The financial system enables lenders and borrowers to exchange funds. India has a financial
system that is controlled by independent regulators in the sectors of insurance, banking, capital

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markets and various services sectors.

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Thus, a financial system can be said to play a significant role in the economic growth of a
country by mobilizing the surplus funds and utilizing them effectively for productive purposes.

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Features of Indian Financial System

● It plays a vital role in the economic development of a country.

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It encourages both savings and investment.

It links savers and investors.

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● It helps in capital formation.
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● It helps in allocation of risk.

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● It facilitates expansion of financial markets

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Components of Indian Financial system

The following are the four major components that comprise the Indian
1. Financial Institutions
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2. Financial Markets
3. Financial Instruments/ Assets/ Securities
4. Financial Services.
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Financial Institutions
The Financial Institutions act as a mediator between the investor and the borrower. The
investor’s savings are mobilized either directly or indirectly via the Financial Markets.
The main functions of the Financial Institutions are as follows:
● A short term liability can be converted into a long term investment
● It helps in conversion of a risky investment into a risk-free investment

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● Also acts as a medium of convenience denomination, which means, it can match a small
deposit with large loans and a large deposit with small loans

The best example of a Financial Institution is a Bank. People with surplus amounts of money
make savings in their accounts, and people in dire need of money take loans. The bank acts as
an intermediate between the two.

The financial institutions can further be divided into two types:

● Banking Institutions or Depository Institutions
● Non-Banking Institutions or Non-Depository Institutions

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Further, Financial Institutions can be classified into three categories:

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● Regulatory – Institutes that regulate the financial markets like RBI, IRDA, SEBI, etc.
● Intermediates – Commercial banks which provide loans and other financial assistance

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such as SBI, BOB, PNB, etc.
● Non Intermediates – Institutions that provide financial aid to corporate customers. It
includes NABARD, SIBDI, etc.

Banking Institutions A
The Indian banking industry is subject to the control of the Central Bank. The RBI as the apex
institution organises, runs, supervises, regulates and develops the monetary system and the
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financial system of the country. The main legislation governing commercial banks in India is the
Banking Regulation Act, 1949.
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Organized Banking Sector

The organized banking sector consists of commercial banks, cooperative banks and the
regional rural banks. The Indian banking system consists of 12 Public Sector Banks, 22 Private
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Sector Banks, 46 Foreign Banks, 56 Regional Rural Banks, 1485 Urban Cooperative Banks and
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96,000 Rural Cooperative Banks in addition to co-operative credit institutions (source: RBI, data
as on: 31st March 2021)

(a) Commercial Banks: The commercial banks may be scheduled banks or non – scheduled
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banks. At present only one bank is a non - scheduled bank. All other banks are scheduled
banks. Prior to 1969, all major banks with the exception of State Bank of India belonged to the
private sector. An important step towards public sector banking was taken in July 1969, when 14
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major private banks with a deposit base of 50 crores or more were nationalised. Later in 1980
another 6 were nationalised bringing up the total number banks nationalised to twenty.

(b) Co-operative banks:

● It is an institution established on a cooperative basis to deal with the ordinary banking
business. Cooperative banks are founded by collecting funds through shares, accepting
deposits, and granting loans.

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● They are Cooperative credit societies where members from a community group together
to extend loans to each other, at favorable terms.
● Co-operative bank members are both customer and owner of the bank.
● A significant part of the yearly profit, benefits or surplus is usually allocated to constitute
reserves and a part of this profit can also be distributed to the co-operative members,
with legal and statutory limitations.
● They are registered under the Cooperative Societies Act of the State concerned or the
Multi-State Cooperative Societies Act, 2002.
● They are broadly divided into Urban and Rural cooperative banks. Two of the largest
co-operative banks in India are Saraswat Co-operative Bank and Cosmos Co-operative

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Bank.

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(c) Regional Rural Banks (RRBs):
● RRBs are financial institutions which ensure adequate credit for agriculture and other

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rural sectors.
● The RRBs combine the characteristics of a cooperative in terms of the familiarity of the
rural problems and a commercial bank in terms of its professionalism and ability to
mobilise financial resources.
● After the reforms in the 1990s, the government in 2005-06 initiated a consolidation
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program that resulted in the number of RRBs declining from 196 in 2005 to 43 in FY21,
and 30 of the 43 RRBs reported net profits.
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(d) Foreign Banks:
● Foreign banks are registered and have their headquarters in another country, but they
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have branches in our country.

● A foreign bank branch is a type of foreign bank that is required to follow both the home
and host country's regulations.
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● Banks frequently open a foreign branch in order to better serve their multinational
corporate clients. Standard Chartered Bank and HSBC are examples of foreign banks in
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India

Unorganised Banking Sector

In the unorganised banking sector are the Indigenous Bankers, Money Lenders.
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A. Indigenous Bankers
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Indigenous Bankers are private firms or individual who operate as banks and as such
both receive deposits and given loans. Like bankers, they also financial intermediaries.
They should be distinguished from professional money lenders whose primary business
is not banking but just money lending.

B. Money Lenders:

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Money lenders depend entirely on their own funds. Money Lenders may be rural or
urban, professional or non-professional. They include a large number of farmers,
merchants, traders. Their operations are entirely unregulated. They charge a very high
rate of interest.

C. Unregulated Non-Bank Financial Intermediaries

These are functioning in the form of chit funds, NIDHIs (operate in South India, which
lend to only their members) and loan companies. They charge very high interest rates
(i.e., 36 to 48 per cent per annum), thus, are exploitative in nature and have selective

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reach in the economy

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Non-Banking Financial Institutions

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Non-Banking Financial Companies (NBFC) are establishments that provide financial services
and banking facilities without meeting the legal definition of a Bank.
● They are covered under the Banking regulations laid down by the Reserve Bank of India
and provide banking services like loans, credit facilities, TFCs, retirement planning,
investing and stocking in the money market. However, they are restricted from taking any
form of deposits from the general public.
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● These organizations play a crucial role in the economy, offering their services in urban
as well as rural areas, mostly granting loans allowing for the growth of new ventures.
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● NBFCs also provide a wide range of monetary advice and has become a very important
part of our nation’s Gross Domestic Product.
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There are a few key ways that non-banking financial institutions differ from banks.
I. Non-banking financial institutions are not regulated by the government like banks are.
This means that they are not subject to the same laws and regulations.
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II. Non-banking financial institutions do not take deposits from customers. Instead, they
raise money by selling securities or borrowing money.
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III. Non-banking financial institutions are not required to maintain a reserve ratio like banks
are. This ratio is the percentage of deposits that a bank must keep in reserve in case of
withdrawals.
IV. Non-banking financial institutions are not subject to the same capital requirements as
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banks. This means that they are not required to have a certain amount of money in the
reserve to protect against losses.
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V. Finally, non-banking financial institutions are not subject to the same lending restrictions
as banks. This means that they can lend money to anyone they choose, without having
to follow the government’s guidelines.

There are a few different types of non-banking financial institutions, which include:
I. Insurance companies: These companies sell insurance policies to individuals and
businesses. The policies can provide coverage for things like car accidents, medical
expenses, or property damage.

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II. Investment banks: These banks help companies raise money by issuing and selling
securities. They also provide advice on mergers and acquisitions, and they trade stocks
and bonds.
III. Pension funds: These funds provide retirement income for workers. The money is
invested in stocks, bonds, and other assets.
IV. Mutual funds: These funds pool money from investors and invest it in a portfolio of
stocks, bonds, and other assets.
V. Hedge funds: These funds are private investment partnerships that use a variety of
investment strategies to make money.
VI. Private equity firms: These firms invest in private companies and help them grow. They

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may also take the companies public.
VII. Venture capital firms: These firms invest in early-stage companies with high growth

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potential.
Each of these non-banking financial institutions serves a different purpose, but they all work

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towards the ultimate goal of providing funding for businesses and individuals.

Financial Markets
It is through financial markets and institutions that the financial system of an economy works.
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Financial markets refer to the institutional arrangements for dealing in financial assets and credit
instruments of different types such as currency, cheques, bank deposits, bills, bonds etc.
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Various functions of Financial Markets are as follows:
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I. Price Determination
The financial market performs the function of price discovery of the different financial
instruments traded between the buyers and the sellers on the financial market. The
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prices at which the financial instruments trade in the financial market are determined by
the market forces, i.e., demand and supply. So the financial market provides the vehicle
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by which the prices are set for both financial assets which are issued newly and for the
existing stock of the financial assets.

II. Funds Mobilization

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Along with determining the prices at which the financial instruments trade in the financial
market, the required return out of the funds invested by the investor is also determined
by participants in the financial market. The motivation for persons seeking the funds is
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dependent on the required rate of return, which the investors demand.

Because of this function of the financial market only, it is signaled that funds available
from the lenders or the investors of the funds will get allocated among the persons who
need the funds or raise funds through the means of issuing financial instruments in the
financial market. So, the financial market helps in the mobilization of the investors’
savings.

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III. Liquidity
The liquidity function of the financial market provides an opportunity for the investors to
sell their financial instruments at their fair value prevailing in the market at any time
during the working hours of the market.

In case there is no liquidity function of the financial market. The investor forcefully have
to hold the financial securities or the financial instrument until the conditions arise in the
market to sell those assets or the issuer of the security is obligated contractually to pay
for the same, i.e., at the time of maturity in debt instrument or at the time of the
liquidation of the company in case of the equity instrument is until the company is either

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voluntarily or involuntarily liquidated.

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Thus, investors can sell their securities readily and convert them into cash in the
financial market, thereby providing liquidity.

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IV. Risk sharing
The financial market performs the function of risk-sharing as the person who is
undertaking the investments is different from the persons who are investing their fund in
those investments.
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With the help of the financial market, the risk is transferred from the person who
undertakes the investments to those who provide the funds for making those
investments.
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V. Easy Access
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The industries require the investors to raise funds, and the investors require the
industries to invest their money and earn the returns from them. So the financial market
platform provides the potential buyer and seller easily, which helps them save their time
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and money in finding the potential buyer and seller.

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VI. Reduction in Transaction Costs and Provision of the Information

The trader requires various types of information while doing the transaction of buying
and selling the securities. For obtaining the same time and money is required.
But the financial market helps provide every type of information to the traders without the
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requirement of spending any money by them. In this way, the financial market reduces
the cost of the transactions.
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VII. Capital Formation

Financial markets provide the channel through which the new investors’ savings flow in
the country, which aids in the country’s capital formation.

Example
Let’s consider an example of the company XYZ ltd, which requires the funds to start a new
project, but at present, it doesn’t have such funds. On the other hand, some investors have

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spare money and want to invest in areas where they can get the required rate of expected
returns.
So, in that case, the financial market will function where the company can raise funds from the
investors, and the investors can invest their money through the help of the financial market.

These organised markets can be further classified into

(i) Capital Market,
(ii) Money Market
(iii) Foreign Exchange Market

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Capital Markets

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The capital market is a market for financial assets which have a long or indefinite maturity.
Generally, it deals with long term securities which have a maturity period of above one year.

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Capital market may be further divided into three namely:
(i) Industrial securities market
(ii) Government securities market, and
(iii) Long term loans market

Industrial Securities Market A

As the very name implies, it is a market for industrial securities namely, Equity shares or
ordinary shares, Preference shares and Debentures or bonds. It is a market where industrial
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concerns raise their capital or debt by issuing appropriate instruments. It can be further
subdivided into
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A. Primary market or New issue market - Primary market is a market for new issues or
new financial claims. Hence, it is also called the New Issue market. The primary market
deals with those securities which are issued to the public for the first time.
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B. Secondary market or Stock exchange - Secondary market is a market for secondary

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sale of securities. In other words, securities which have already passed through the new
issue market are traded in this market. Generally, such securities are quoted by the
Stock Exchange and it provides a continuous and regular market for buying and selling
of securities. This market consists of all stock exchanges recognised by the Government
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of India. The stock exchanges in India are regulated under the Securities Contracts
(Regulation) Act 1956. The Bombay Stock Exchange (BSE) and the National Stocks
Exchange (NSE) are the two principal stock exchanges in India which sets the tone of
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the other stock markets.

Government Securities Market

It is otherwise called Gilt - Edged securities market. It is a market where Government securities
are traded. In India there are many kinds of Government Securities - short term and long term.
Long term securities are traded in this market while short term securities are traded in the
money market. Securities issued by the Central Government, State Governments, Semi
Government authorities like City Corporations, Port Trusts etc. Improvement Trusts, State

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Electricity Boards, All India and State level financial institutions and public sector enterprises are
dealt in this market.

Long-term Loans Market

Development banks and commercial banks play a significant role in this market by supplying
long term loans to corporate customers. Long term loans market may further be classified into:

A. Term Loans Market - As far as Term Loans in India are concerned, many industrial
financing institutions have been created by the Government both at the national and
regional levels to supply long term and medium term loans to corporate customers

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directly as well as indirectly. These development banks dominate industrial finance in
India. Institutions like IDBI, IFCI, ICICI, and other financial corporations come under this

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category.

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B. Mortgages Market - A mortgage loan is a loan against the security of immovable
property like real estate. The transfer of interest in a specific immovable property to
secure a loan is called a mortgage.

Money Market A
The money market is a wholesale debt market for low-risk, highly-liquid, short-term instruments.
Funds are available in this market for periods ranging from a single day up to a year. This
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market is dominated mostly by the government, banks and financial institutions.
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The money market may be subdivided into four. They are:

(i) Call money market

(ii) Commercial bills market
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(iii) Treasury bilis market

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(iv) Short term loan market.

Foreign Exchange Market

The Foreign Exchange market deals with the multicurrency requirements which are met by the
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exchange of currencies. Depending on the exchange rate that is applicable, the transfer of
funds takes place in this market. This is one of the most developed and integrated markets
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across the globe.

Financial Instruments
Financial instruments refer to those documents which represent financial claims on assets.
Financial asset refers to a claim to the repayment of a certain sum of money at the end of a
specified period together with interest or dividend.

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Financial securities can be classified into:

(i) Primary or direct securities.
(ii) Secondary or indirect securities.

Primary Securities
These are securities directly issued by the ultimate investors to the ultimate savers. Eg. shares
and debentures issued directly to the public.

Secondary Securities

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These are securities issued by some intermediaries called financial intermediaries to the
ultimate savers. Eg. Unit Trust of India and mutual funds issue securities in the form of units to

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the public and the money pooled is invested in companies. These securities may be classified
on the basis of duration as follows:

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● Short - term securities -: those which mature within a period of one year. Eg, Bill of
Exchange, Treasury bill, etc.
● Medium term securities -: those which have a maturity period ranging between one
and five years. Eg. Debentures maturing within a period of 5 years
● Long - term securities. -: those who have a maturity period of more than five years. Eg,
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Government Bonds maturing after 10 years.
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Financial Services
Financial services are the services provided by Asset Management and Liability Management
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Companies. They help to get the required funds and also make sure that they are efficiently
invested. The main aim of the financial services is to assist a person with selling, borrowing or
purchasing securities, allowing payments and settlements and lending and investing.
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The financial services in India include:

● Banking Services-: Any small or big service provided by banks like granting a loan,
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depositing money, issuing debit/credit cards, opening accounts, etc.

● Insurance Services-: Services like issuing of insurance, selling policies, insurance
undertaking and brokerages, etc. are all a part of the Insurance services
● Investment Services-: It mostly includes asset management
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● Foreign Exchange Services-: Exchange of currency, foreign exchange, etc. are a part of
the Foreign exchange services
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Overview of Financial Sector in India

India has a diversified financial sector undergoing rapid expansion, both in terms of strong
growth of existing financial services firms and new entities entering the market. The sector
comprises commercial banks, insurance companies, non-banking financial companies,
co-operatives, pension funds, mutual funds and other smaller financial entities. The banking
regulator has allowed new entities such as payment banks to be created recently, thereby
adding to the type of entities operating in the sector. However, the financial sector in India is

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predominantly a banking sector with commercial banks accounting for more than 64% of the
total assets held by the financial system.

The Government of India has introduced several reforms to liberalise, regulate and enhance this
industry. The Government and Reserve Bank of India (RBI) have taken various measures to
facilitate easy access to finance for Micro, Small and Medium Enterprises (MSMEs). These
measures include
● launching Credit Guarantee Fund Scheme for MSMEs,
● issuing guidelines to banks regarding collateral requirements and setting up a Micro
Units Development and Refinance Agency (MUDRA).

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With a combined push by the Government and private sector, India is undoubtedly one of the
world's most vibrant capital markets.

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Market Size

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● As of October 2022, AUM managed by the mutual fund industry stood at Rs. 39.50
trillion (US$ 483.63 billion), and the total number of accounts stood at 139.1 million.

○ Inflow in India's mutual fund schemes via systematic investment plan (SIP) stood
at Rs. 87,275 crore (US$ 10.68 billion). Equity mutual funds registered a net
A
inflow of Rs. 22.16 trillion (US$ 294.15 billion) by end of December 2021.
G
● Another crucial component of India’s financial industry is the insurance industry. The
insurance industry has been expanding at a fast pace. The total first-year premium of life
insurance companies reached US$ 40.1 billion in FY22. In FY23 (until May 2022)
A

non-life insurance sector premiums reached US$ 4.68 billion.

● Furthermore, India’s leading bourse, Bombay Stock Exchange (BSE), will set up a joint
T

venture with Ebix Inc to build a robust insurance distribution network in the country
through a new distribution exchange platform.
JA

● In FY22, US$ 14.55 billion was raised across 127 initial public offerings (IPOs). The
number of companies listed on the NSE increased from 135 in 1995 to 2,012 by FY22.
A

● According to the statistics by the Futures Industry Association (FIA), a derivatives trade
association, the National Stock Exchange of India Ltd. (NSE) emerged as the world’s
R

largest derivatives exchange in 2020 in terms of the number of contracts traded.

● NSE was ranked 4th worldwide in cash equities by number of trades as per the statistics
maintained by the World Federation of Exchanges (WFE) for CY2020.

● In September 2021, eight Indian banks announced that they are rolling out—or about to
roll out—a system called ‘Account Aggregator’ to enable consumers to consolidate all
their financial data in one place.

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Government Initiatives
Some of the major Government Initiatives in the financial sector are as follows:
● In August 2021, Prime Minister Mr. Narendra Modi launched e-RUPI, a person and
purpose-specific digital payment solution. e-RUPI is a QR code or SMS string-based
e-voucher that is sent to the beneficiary’s cell phone. Users of this one-time payment
mechanism will be able to redeem the voucher at the service provider without the usage
of a card, digital payments app, or internet banking access.

● In September 2021, the international branch of the National Payments Corporation of

L
India (NPCI), NPCI International Payments (NIPL), has teamed with Liquid Group, a
cross-border digital payments provider, to enable QR-based UPI payments to be

A
accepted in 10 countries in north and southeast Asia.

RW
● On September 30, 2021, the IFSC Authority constituted an expert committee to
recommend an approach towards development of a sustainable finance hub and provide
a road map for the same.

Road ahead
A
India’s financial services industry has experienced huge growth in the past few years. This
momentum is expected to continue. India’s private wealth management Industry shows huge
G
potential.
● India is expected to have 6.11 lakh HNWIs by 2025. This will indeed lead India to be the
fourth largest private wealth market globally by 2028.
A

● India’s insurance market is also expected to reach US$ 250 billion by 2025. This will
further offer India an opportunity of US$ 78 billion of additional life insurance premiums
from 2020-30.
T

● India is today one of the most vibrant global economies on the back of robust banking
and insurance sectors. The relaxation of foreign investment rules has received a positive
JA

response from the insurance sector, with many companies announcing plans to increase
their stakes in joint ventures with Indian companies.
● The Association of Mutual Funds in India (AMFI) is targeting a nearly five-fold growth in
AUM to Rs. 95 lakh crore (US$ 1.47 trillion) and more than three times growth in investor
A

accounts to 130 million by 2025.

● India’s Fintech space is expected to further fuel this growth in various segments. India's
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mobile wallet industry is estimated to grow at a Compound Annual Growth Rate (CAGR)
of 150% to reach US$ 4.4 billion by 2022, while mobile wallet transactions will touch Rs.
32 trillion (USD$ 492.6 billion) during the same period.
● According to Goldman Sachs, investors have been pouring money into India’s stock
market, which is likely to reach more that US$ 5 trillion, surpassing the UK, and become
the fifth-largest stock market worldwide by 2024.

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Insurance Industry in India

India’s Insurance industry is one of the premium sectors experiencing upward growth. This
upward growth of the insurance industry can be attributed to growing incomes and increasing
awareness in the industry. The insurance industry of India has 57 insurance companies - 24 are
in the life insurance business, while 34 are non-life insurers. Among the life insurers, Life
Insurance Corporation (LIC) is the sole public sector company. There are six public sector
insurers in the non-life insurance segment. In addition to these, there is a sole national
reinsurer, namely General Insurance Corporation of India (GIC Re). Other stakeholders in the
Indian Insurance market include agents (individual and corporate), brokers, surveyors and third

L
party administrators servicing health insurance claims.

A
● India is the fifth largest life insurance market in the world's emerging insurance markets,
growing at a rate of 32-34% each year.

RW
● In recent years the industry has been experiencing fierce competition among its peers
which has led to new and innovative products within the industry.
● Foreign Direct Investment (FDI) in the industry under the automatic method is allowed up
to 26% and licensing of the industry is monitored by the insurance regulator the
Insurance Regulatory and Development Authority of India (IRDAI).
● The life insurance industry is expected to increase at a CAGR of 5.3% between 2019
A
and 2023. India’s insurance penetration was pegged at 4.2% in FY21, with life insurance
penetration at 3.2% and non-life insurance penetration at 1.0%.
G
● The market share of private sector companies in the general and health insurance
market increased from 48.03% in FY20 to 49.31% in FY21. Six standalone private sector
health insurance companies registered a jump of 66.6% in their gross premium
A

● According to S&P Global Market Intelligence data, India is the second-largest insurance
technology market in Asia-Pacific, accounting for 35% of the US$ 3.66 billion
insurtech-focused venture investments made in the country.
T

● Life insurance industry in the country is expected to increase by 14-15% annually for the
next three to five years.
JA

● Currently, there are 110+ InsurTech start-ups operating in India. These startups are
expected to provide a major boost to the industry and help increase India’s insurance
penetration which plays a crucial role in the overall development of the country.
● In the past, the Indian government has played a crucial role in increasing the scope of
A

the insurance sector through various policies and schemes. This trend will continue in
the further through schemes like the Pradhan Mantri Fasal Bima Yojana (PMFBY)
R

providing crop insurance and Pradhan Mantri Jeevan Jyoti Bima Yojana (PMJJBY)
providing life insurance coverage to the youth at an affordable price.
● Schemes like these coupled with India’s demographic factors such as a growing middle
class, young insurable population and growing awareness of the need for protection and
retirement planning will support the growth of the Indian insurance sector.

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Recent Trends in Financial Market

The Indian financial markets have witnessed many changes in recent years and are faced with
ever changing trends that ultimately shape the financial markets. Some of the recent trends in
the Indian financial markets are highlighted below.

● Growth of Digital Finance

There has been an exponential increase in digital finance in India over recent years. This
is further backed by various measures under the ‘Digital India’ vision of the government.
This includes digital payment methods such as UPI, mobile banking, and e-wallets. This

L
growth is also the result of the increase in internet and smartphone penetration which
has taken digital finance to even the rural parts of the country.

A
● Focus on Financial Inclusion

RW
Financial inclusion has been the focus of the Indian government and regulators for many
years now. Many measures for financial inclusion include increasing access to financial
services for under-served populations such as farmers and small businesses. The
government has also launched many flagship schemes to promote financial inclusion
and provide financial security to empower the poor and unbanked in the country. These
A
include the Pradhan Mantri Jan Dhan Yojana, Pradhan Mantri Mudra Yojana, Stand-Up
India Scheme, Pradhan Mantri Jeevan Jyoti Bima Yojana, Pradhan Mantri Suraksha
Bima Yojana, and Atal Pension Yojana.
G
● Rise of Mutual Funds
A

Mutual funds have become increasingly popular and a staple among retail investors as a
way to invest in the stock market. The introduction of direct plans has also made them
more accessible and cost-effective for the average investor.
T

● Increased Focus on ESG Investing

JA

Social consciousness has been increasing greatly among the public at large over the
years. This has therefore resulted in an increase in Environmental, Social, and
Governance (ESG) investing which is gaining prominence as investors increasingly seek
to align their investments with their values.
A

● Emergence of Robo-Advisors
Financial markets have also seen a rise in Robo-advisors. These are algorithms that
R

provide investment advice based on AI. Such platforms are becoming quite popular by
offering low-cost and personalized investment solutions to businesses and investors.

These trends are shaping the future of the Indian financial market and are likely to continue to
drive growth and innovation in the years to come.

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Financial System and Economic Development

Financial institutions and markets are together called the financial system. This financial system
is the backbone of the national economy. This is because the efficiency with which the financial
system works plays a very important role in the economic development of a nation. The role of
the financial system may not be apparent since we assume its existence to be a given.
However, when we do start paying attention to the financial system, it is easy to see why it plays
a foundational role in the economic development of a country.

L
Patterns of Relationships between Financial and Economic
Development

A
How does financial development occur? Is it influenced by economic development? Does the

RW
does the former always precede the latter? Some authors have argued that there are three
possible patterns of relationship between economic development and financial development.

I. First, economic progress induces an expansion of the financial system; as the per capita
income in the country increases, investor demand for diversified financial assets
increases. At low levels of income, there is lack of demand for varied financial services.
A
As the real economy grows, there is more and more demand for such services, which is
met by the financial system rather passively. This has been designated as
G
‘demand-following’ financial development or a ‘passive’ financial development in the
literature.
A

II. Second, financial development precedes economic development, and it is brought about
through a conscious, deliberate policy by the authorities. Newer and more financial
institutions are established and promoted, newer and newer financial instruments and
T

services are introduced by the authorities and this helps to accelerate the rate of real
JA

growth. This has been designated as ‘supply leading’ financial development.

III. Third, the direction of causality between economic development and financial
development does not remain the same in all stages of development. In the beginning of
the development process, the financial development may be undertaken or promoted by
A

the authorities, which may induce innovations, capital formation and growth, but as the
growth proceeds, this ‘supply-leading’ financial development may be reinforced by
R

‘demand-following’ development. It is difficult to establish precisely the sequence of

economic development and financial development; it is difficult to disentangle their cause
and effect relationship; while the financial system accelerates growth, it itself grows with
economic advancement.

Therefore, it is more realistic and accurate to say that the relationship between economic
development and financial development is symbiotic, mutually reinforcing and intertwined.

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Relationship between Financial System and Economic

Development
Following points explain how financial systems play an important role in the economic
development of a nation.

Savings-Investment relationship
The primary role of financial systems in economic development is to complete the
savings-investment relationship. Those with surplus funds will look for a way to use their funds

L
productively but that is not always simple for the majority of people. On the other end of this
relationship many individuals, organizations and enterprises have a project they want to

A
undertake but lack the funds to do so. Financial institutions act as intermediaries between the
two groups and connect the savings of the surplus group to the investments of the deficit group.

RW
Interest Rates Stabilization
The financial system ensures that all the organizations and institutions which it is composed of,
behave as one unified system. Generally, healthy competition is promoted between the
members of the system. This means that members have to compete with each other by lowering
A
their costs. As a result, the benefits of lower interest rates are passed on to the consumers. It is
the existence of the financial system, which ensures that interest rates remain stable across the
G
country. The banking system led by a central bank makes this possible. In the absence of a
financial system, each region would have its own interest rate based on the availability of
capital. However, with the financial system in place, interest rates remain the same across the
A

entire country. As a result, businessmen and entrepreneurs throughout the country are on an
equal footing.
T

Facilitates trade and commerce

JA

Credit risk has always been the main factor that inhibits trade and commerce. If a seller is not sure about
whether they will get paid for the goods which they sold, then they will not sell more goods till the earlier
payment has been received. This reduces inventory turnaround and leads to a decline in trade and
commerce. Financial systems ensure quick and timely payment. With the advent of advanced technology,
it is now possible to remit money to any part of the world within a few seconds. Hence, financial markets
A

and institutions aid in trade and commerce and even improve the gross domestic product of a country.
R

Facilitates International Trade

The risks inherent in trade and commerce get multiplied several times when it comes to
international trade. This is because firstly, the seller and buyer, are in different legal jurisdictions.
Hence, the enforceability of contracts is reduced. Secondly, the quantity of goods involved in
import and export transactions is extremely large. Hence, the outstanding amounts also become
large, and this ends up increasing the overall risk in the transaction.

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Financial systems play a very important role in the international trade process. This is because
importers and exporters generally use banks as an intermediary in the process. The importer
deposits money with the bank in the form of a letter of credit. This letter of credit is then paid to
the exporter by the bank when goods are received. As a result, neither party has to rely on each
other. Instead, both of them can rely on the bank, which has a higher credit rating and therefore
aids in the reduction of risk. Similarly, countries have created special boards for export credit
and promotion. These boards provide important services like insurance and payment
guarantees in international trade. It would be fair to say that in the absence of financial markets
and systems, international trade would be negatively impacted.

L
Infrastructure

A
Financial markets play a vital role in infrastructure development, as well. This is because the
private sector may face great difficulties in raising large amounts of funds for projects with a high

RW
gestation period. It is the financial markets that provide the liquidity required by investors.
Investors can sell their securities and cash out whenever they want. It is not important for the
same investor to hold on to the security for the entire tenure of the loan. Key sectors like power
generation, oil, and gas, transport, telecommunication, and railways receive a lot of funding at
concessional rates thanks to the financial markets.
Financial markets also allow governments to raise large sums of money. This enables them to
A
continue deficit spending. In the absence of financial markets, governments would not be able
to continue deficit spending, which is important to fund infrastructure projects in the short run.
G
Employment Creation
A

Another important role of financial systems in economic development is to support employment

growth. The role of financial systems in economic development is to provide finance and
support to those who have ideas that can be turned into businesses and they, in turn, employ
T

people to carry out their visions. Employment growth is a very important measure of economic
development in a country. More people employed roughly means the Gross Domestic Product
JA

and Gross National Income of a country will also grow.

Promotes funding to startups

A

Venture capital is a type of financing for start-up companies that involves patient capital willing
to invest in innovative ideas from the ground up. Venture capitalists are generally willing to wait
very long periods for companies to grow and will not demand or expect dividends during the
R

growth phase. Traditional investment has a bias towards medium-term returns through dividend
or disposal. The role of financial systems in economic development is to promote funding
systems such as venture capital which support important innovative enterprises.

Growth Of Capital Markets

Financial systems include stock exchanges which are financial institutions that connect
companies with the public for investment. Stock exchanges are referred to as capital markets
because they provide a platform for those seeking capital to those who have it. The role of

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financial systems in economic development is to grow the capital markets. A larger capital
market benefits economic development through improving access to capital, reduced cost of
capital and improved investment relationships.

Balanced Economic Growth

By connecting those with surplus money to those with a deficit and allowing more options for
people to direct their savings, financial systems give the people and investing institutions the
right to decide where the capital should be allocated to. Generally speaking, businesses which
are addressing problems faced in economies effectively and efficiently generate high income

L
and therefore high profit. They are therefore able to reward investors and investors are attracted
by high returns. The role of financial systems in economic development is to simply offer the

A
platform for net savers to direct their savings to investments of their choice.

RW
Financial Sector Reforms in India

Development of Banking Sector

A
Pre Independence Period (1786-1947)
● The first bank of India was the “Bank of Hindustan”, established in 1770 and located in
G
the then Indian capital, Calcutta. However, this bank failed to work and ceased
operations in 1832.
A

● During the Pre Independence period over 600 banks had been registered in the country,
but only a few managed to survive.
● During British rule in India, The East India Company had established three banks: Bank
T

of Bengal, Bank of Bombay and Bank of Madras and called them the Presidential Banks.
These three banks were later merged into one single bank in 1921, which was called the
JA

“Imperial Bank of India.”

● Reserve Bank of India (RBI) came into formation on April 1, 1935, with the enactment of
the Reserve Bank of India Act, 1934.
● The objective of establishing the Reserve Bank, as stated in the preamble to the RBI
A

Act, was to “regulate the issue of banknotes and the keeping of reserves with a view of
securing monetary stability in India”.
R

Post Independence Period (1947-1991)

● Even after independence, the banks were mainly urban-oriented and were beyond the
reach of the rural population. A large section of the rural population still had to look upon
the moneylenders as their resort for credit.
● That’s why the government decided to nationalize all the major banks in India. These
were the banks whose national deposits were more than 50 crores. The first

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Nationalization took place in 1969 in which 14 banks were nationalized. It was followed
by nationalization of another 6 banks in 1980.
● The Imperial Bank of India which had been set up in 1921 was later nationalized in 1955
and was named The State Bank of India, which is currently the largest Public sector
Bank.
● The Regional Rural Banks in India were established in the year 1975 for the
development of rural areas in India.

Impact of Nationalization
Nationalization lead to an increase in funds and thereby increasing the economic

L
●
condition of the country
Increased efficiency

A
●
● Helped in boosting the rural and agricultural sector of the country
● It opened up a major employment opportunity for the people

RW
● The Government used profit gained by Banks for the betterment of the people

Need of reforms (1991)

● The Indian economy witnessed a series of difficulties like uncertain political situation,

●
A
persistent fiscal imbalance, double-digit inflation, the balance of payments crisis, etc.
The fiscal situation, which was under strain throughout the 1980s, reached a critical
situation in 1990-91. The external payment crisis and the high rate of inflation both
G
reached their peak level in the middle of 1991.
● Growth of real GDP decelerated partly because of lower industrial growth and partly
A

because of the slowdown in agriculture.

● The industries were affected because of lower government investment, non-availability
of inputs due to import squeeze, recession prevailed in the industrial economy due to the
collapse of demand in the markets of Kuwait and Iraq in the wake of Gulf crisis, and the
T

collapse of the erstwhile Soviet Union.

JA

● Since the banking sector was totally owned by the government, operational efficiency of
these banks gradually declined leading to lower profitability and higher profits.

Two Stages of Reforms

A

● The first stage of reforms was shaped by the recommendations of the Committee on the
Financial System (Narasimham Committee), which submitted its report in December
R

1991, suggesting reforms in banking, the government debt market, the stock markets,
and in insurance, all aimed at producing a more efficient financial sector.

● Subsequently, the East Asian crisis in 1997 led to a heightened appreciation of the
importance of a strong banking system, not just for efficient financial intermediation but
also as an essential condition for macroeconomic stability.

● In 1998, the Government set up a Committee on Banking Sector Reforms in India under
the chairmanship of M. Narasimham in order to review the progress of banking sector

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reforms to date and chart a programme of financial sector reforms necessary to

strengthen the Indian Financial System and make it internationally competitive.

● The two reports provided a road map that has guided the broad direction of reforms in
this sector.

Broad Approach to Reform

The strategy for banking reforms was broadly similar to that followed in other countries, but with
some important differences. It was similar to the extent that it focused on imposing prudential

L
norms and improving regulatory supervision to meet Basel I standards (standards that were
formulated by the committee of the Bank of International Settlement, or BIS, based in Basel,

A
Switzerland), and it aimed at increasing competition to promote greater efficiency. However,
there were two important differences compared with reforms in other countries.

RW
● First, the reforms in banking were much more gradualist than in most countries, a course
of action that was in line with the general strategy of reforms in India. As a consequence
of this gradualist process, income recognition norms and capital adequacy norms have
been fully aligned with Basel I standards but yet to be fully aligned with Basel II
standards.

●
A
Second, unlike the case in many other countries, there was never any intention to
privatize public sector banks. The government also declared its intention to strengthen
G
public sector banks and enable them to meet competition. It was clearly recognized that
competition was desirable, and this implied that both private sector banks and foreign
banks should be allowed to expand their market share if they could.
A

Major Banking Sector Reforms

T
JA

A. Prudential Measures

● Introduction and phased implementation of international best practices and

norms on risk-weighted capital adequacy requirement, accounting, income
recognition, provisioning and exposure.
A

● Measures to strengthen risk management through recognition of different

R

components of risk, assignment of risk-weights to various asset classes,

application of marked-to-market principle for investment portfolio and limits on
deployment of funds in sensitive activities.

B. Competition Enhancing Measures

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● Granting of operational autonomy to public sector banks, reduction of public

ownership in public sector banks by allowing them to raise capital from the equity
market up to 49 per cent of paid-up capital.

● Transparent norms for entry of Indian private sector, foreign and joint-venture
banks and insurance companies,

● Permission for foreign investment in the financial sector in the form of Foreign
Direct Investment (FDI) as well as portfolio investment, permission to banks to
diversify product portfolio and business activities.

L
C. Measures Enhancing Role of Market Forces

A
● Sharp reduction in pre-emption through reserve requirement, market determined

RW
pricing for government securities,

● Disbanding of administered interest rates with a few exceptions and enhanced

transparency and disclosure norms to facilitate market discipline.

● A
Facilitation of improved payments and settlement mechanisms.

D. Institutional and Legal Measures

G
● Settling up of Lok Adalats (people’s courts), debt recovery tribunals, asset
A

reconstruction companies, settlement advisory committees, corporate debt

restructuring mechanism, etc. for quicker recovery/restructuring.
T

● Promulgation of Securitisation and Reconstruction of Financial Assets and

Enforcement of Securities Interest (SARFAESI), Act and its subsequent
JA

amendment to ensure creditor rights.

● Setting up of Credit Information Bureau for information sharing on defaulters as

also other borrowers.
A

● Setting up of Clearing Corporation of India Limited (CCIL) to act as central

counterparty for facilitating payments and settlement systems relating to fixed
R

income securities and money market instruments.

E. Supervisory Measures

● Establishment of the Board for Financial Supervision as the apex supervisory

authority for commercial banks, financial institutions and non-banking financial
companies.

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● Introduction of CAMELS (Capital adequacy, Asset quality, Management,

Earnings, Liquidity, and Sensitivity) supervisory rating system.

F. Technology Related Measures

● Setting up of INdian FInancial NETwork (INFINET) as the communication

backbone for the Indian Banking and Financial Sector. The INFINET is a Closed
User Group (CUG) Network for the exclusive use of Member Banks and Financial
Institutions. All Banks, Public Sector, Private Sector, Cooperative, etc., and the
premier Financial Institutions in the country are eligible to become members of

L
the INFINET.

A
● Introduction of Negotiated Dealing System (NDS) for screen-based trading in
government securities and other money market instruments.

RW
● Introduction of Real Time Gross Settlement (RTGS) System through which
payments, amounting to minimum two lakhs, are settled in real time on a
transaction-by-transaction basis, as soon as the system accepts them.

A
Recent Reforms in the Banking Sector
G
● The Ministry of Finance in its Economic Survey 2015-16 suggested four R’s –
Recognition, Recapitalization, Resolution, and Reform to address the problem of NPAs.
A

● In May 2015, the RBI advised all PSBs to appoint an internal Ombudsman to further
boost the quality of customer service and to ensure that there is undivided attention to
the resolution of customer complaints in banks.
T

● Since 2014, the banking sector has witnessed the adoption of the JAM (Jan-Dhan,
JA

Aadhaar, and Mobile) trinity, and the issuance of licenses to Payments Banks and Small
Finance Banks (SFBs) to achieve last-mile connectivity in the financial inclusion drive.

● The government recently announced new banking reforms, involving the establishment
A

of a Development Finance Institution (DFI) for infrastructure, creation of a Bad Bank to

address the problem of chronic non-performing assets (NPAs), and privatization of public
R

sector banks (PSBs) to ease its burden in terms of mobilizing additional capital.

Primary and Secondary Market Reforms

A. Establishment of Creditors Rating Agencies
● Three creditors rating agencies viz The Credit Rating Information Services of
India Limited (CRISIL-1988), the Investment Information and Credit Rating
Agency of India Limited (ICRA-1991) and Credit Analysis and Research Limited

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14-Mar-2023

(CARE) were set up in order to assess the financial health of different financial
institutions and agencies related to the stock market activities. It is a guide for the
investors also in evaluating the risk of their investments.

B. Setting up of National Stock Exchange (NSE):

● NSE was set up in November 1992 and started its operations in 1994; which has
now developed into a sophisticated, electronic market, which ranked fourth in the
world by equity trading volume.

C. Over the Counter Exchange of India (OTCEI)

L
● It was set in 1992. It was promoted by a consortium of leading financial
institutions of India including UTI, ICICI, IDBI, IFCI, LIC and others.

A
● It is an electronic national stock exchange listing an entirely new set of
companies which will not be listed on other stock exchanges

RW
D. Disclosure and Investor Protection (DIP) Guidelines for New Issues
● In order to remove inadequacies and systemic deficiencies, to protect the
interests of investors and for the orderly growth and development of the
securities market, the SEBI has put in place DIP guidelines to govern the new
issue activities. A
● Companies issuing capital in the primary market are now required to disclose all
material facts and specify risk factors with their projects
G
E. Depository System
A

● A major reform in the Indian Stock Market has been the introduction of depository
system and scrip less trading mechanism since 1996.
● Before this, the trading system was based on physical transfer of securities.
T

● A depository is an organization which holds the securities of shareholders in

electronic form, transfers securities between account holders, facilitates transfer
JA

of ownership without handling securities and facilitates their safekeeping

F. The National Securities Clearing Corporation Ltd. (NSCCL)

● The NSCL was set up in 1996. It has started guaranteeing all trades in NSE
A

since July 1996.

● The NSCL is responsible for post-trade activities of the NSE. Clearing and
settlement of trades and risk management are its central functions
R

G. Trading in Central Government Securities

● In order to encourage wider participation of all classes of investors, including
retail investors, across the country, trading in government securities has been
introduced from January 2003.
● Trading in government securities can be carried out through a nationwide,
anonymous, order-driver, screen-based trading system of stock exchanges in the
same way in which trading takes place in equities.

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14-Mar-2023

H. Mutual Funds
● Emergence of diversified mutual funds is one of the most important
developments of the Indian capital market.
● Their main function is to mobilize the savings of the general public and invest
them in stock market securities.
● Mutual funds are an important avenue through which households participate in
the securities market.

Government Securities Market Reforms

L
A. Institutional Measures

A
● Administered interest rates on government securities were replaced by an
auction system for price discovery.

RW
● Automatic monetisation of the fiscal deficit through the issue of ad-hoc Treasury
Bills was phased out.
● Delivery versus Payment (DvP) settlement system was introduced. It guarantees
that the transfer of securities only happens after payment has been made.
● The Liquidity Adjustment Facility (LAF) was introduced through which RBI injects
A
or absorbs liquidity into or from the banking system.
● The Market Stabilization Scheme (MSS) has been introduced, which has
expanded the instruments available to the Reserve Bank for managing the
G
surplus liquidity in the system.
● Increase in Instruments in the Government Securities Market -
A

○ A 91-day Treasury bill was introduced for managing liquidity and

benchmarking.
○ Zero Coupon Bonds, Floating Rate Bonds, Capital Indexed Bonds were
T

issued and exchange traded interest rate futures were introduced.

○ OTC interest rate derivatives like IRS/FRAs were introduced.
JA

B. Enabling Measures
● Foreign Institutional Investors (FIIs) were allowed to invest in government
securities subject to certain limits.
A

● Introduction of automated screen-based trading in government securities through

Negotiated Dealing System (NDS).
● Setting up of risk-free payments and settlement systems in government securities
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through Clearing Corporation of India Limited (CCIL).

● Phased introduction of Real Time Gross Settlement System (RTGS).
● Introduction of trading of government securities on stock exchanges for
promoting retailing in such securities, permitting non-banks to participate in the
repo market.

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Brief Summary of Financial Sector Reforms in India

Reforms in the Banking Sector
● Reduction in CRR and SLR has given banks more financial resources for lending to the
agriculture, industry and other sectors of the economy.
● The system of administered interest rate structure has been done away with and RBI no
longer decides interest rates on deposits paid by the banks.
● Allowing domestic and international private sector banks to open branches in India, for
example, HDFC Bank, ICICI Bank, Bank of America, Citibank, American Express, etc.

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● Issues pertaining to non-performing assets were resolved through Lok adalats, civil
courts, Tribunals, The Securitisation And Reconstruction of Financial Assets and the

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Enforcement of Security Interest (SARFAESI) Act.
● The system of selective credit control that had increased the dominance of RBI was

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removed so that banks can provide greater freedom in giving credit to their customers.

Reforms in the Debt Market

● The 1997 policy of the government that included automatic monetization of the fiscal
deficit was removed resulting in the government borrowing money from the market
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through the auction of government securities.
● Borrowing by the government occurs at market-determined interest rates which have
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made the government cautious about its fiscal deficits.
● Introduction of treasury bills by the government for 91 days for ensuring liquidity and
meeting short-term financial needs and for benchmarking.
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● To ensure transparency the government introduced a system of delivery versus payment

settlement.
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Reforms in the Foreign Exchange Market

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● Market-based exchange rates and the current account convertibility was adopted in
1993.
● The government permitted the commercial banks to undertake operations in foreign
exchange.
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● Participation of newer players allowed the rupee foreign currency swap market to
undertake currency swap transactions subject to certain limitations.
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● Replacement of foreign exchange regulation act (FERA), 1973 was replaced by the
foreign exchange management act (FEMA), 1999 for providing greater freedom to the
exchange markets.
● Trading in exchange-traded derivatives contracts was permitted for foreign institutional
investors and non-resident Indians subject to certain regulations and limitations.

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Reforms in Insurance Sector

● A specialized regulator for the insurance sector (IRDA) was constituted in 1999 to
protect the interests of insurance policyholders and to regulate, promote, and ensure
orderly growth of the insurance industry.

● New insurance products have been introduced, such as weather insurance, group health
insurance for the poor, product liability insurance, life insurance with critical and terminal
illness riders, and package insurance for small and medium enterprises.

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● Foreign Direct Investment (FDI) in the industry under the automatic method is allowed up
to 26%.

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Impact of Various Reforms in the Financial Sector

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● Financial sector reforms increased the resilience, stability and growth rate of the Indian
economy from around 3.5 % to more than 6% per annum.
● A resilient banking system helped the country deal with the Asian economic crisis of
1977-98 and the Global subprime crisis.
● The emergence of private sector banks and foreign banks increased competition in the
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banking sector which has improved its efficiency and capability.
● Better performance by stock exchanges of the country and adoption of international best
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practices.
● Better budget management, fiscal deficit, and public debt conditions have improved after
the financial sector reforms.
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Other Useful Links

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● Difference between Scheduled and Non-Scheduled Banks -

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https://www.goodreturns.in/classroom/difference-between-scheduled-bank-and-non-sche
duled-banks-1208206.html

References
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https://www.investopedia.com/terms/f/financial-system.asp
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https://corporatefinanceinstitute.com/resources/economics/financial-intermediary-transactions/
https://www.encyclopedia.com/international/encyclopedias-almanacs-transcripts-and-maps/bank
ing-sector-reform-1991
https://www.civilserviceindia.com/subject/Management/notes/recent-reforms-in-financial-sector.h
tml
https://pscnotes.in/banking-sector-reform-india/
https://www.insightsonindia.com/indian-economy-3/indian-financial-system-ii-money-and-capital-
market-in-india/capital-market-reforms/secondary-market-reforms/

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https://unacademy.com/content/railway-exam/study-material/economics/indian-financial-system/
https://www.ibef.org/economy/indian-economy-overview
https://www.ibef.org/industry/insurance-sector-india
https://www.managementstudyguide.com/role-of-government-in-financial-systems.htm
https://ca.indeed.com/career-advice/career-development/financial-systems
https://www.drishtiias.com/

Articles for discussion:

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● Time for 5th generation banking reforms -
https://www.thehindubusinessline.com/opinion/time-for-5th-generation-banking-reforms/a

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rticle34500228.ece

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● Silicon Valley Bank: why did it collapse and is this the start of a banking crisis? -
https://www.theguardian.com/business/2023/mar/13/silicon-valley-bank-why-did-it-collap
se-and-is-this-the-start-of-a-banking-crisis

Note:
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The supplementary study material is not exhaustive and is for reference purposes only. It is
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strongly recommended that students thoroughly read suggested readings for examination.
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JA
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