The Indian financial system has several features that help to meet the financial needs of individuals and businesses. Here are some of the key features of the Indian financial system: Mobilization of Savings: The Indian financial system helps to mobilize savings from various sectors of the economy and channel them towards productive investments. This is achieved through various financial intermediaries such as banks, mutual funds, and insurance companies. Allocation of Credit: The Indian financial system also plays a key role in allocating credit to different sectors of the economy. Banks and other financial institutions provide loans and credit facilities to businesses and individuals to help them meet their financial needs. Payment System: The financial system provides a safe and efficient payment mechanism to facilitate transactions between different individuals and businesses. This is achieved through various payment systems such as NEFT, RTGS, and IMPS. Risk Management: The financial system helps to manage risks associated with financial transactions. Financial intermediaries such as insurance companies provide risk management products such as life insurance, health insurance, and property insurance. Price Discovery: The Indian financial system also helps in the discovery of prices of financial assets such as stocks, bonds, and commodities. This is achieved through various financial intermediaries such as stock exchanges and commodity exchanges. Economic Development: The financial system plays a critical role in the economic development of the country. It provides financial resources for investment in infrastructure, industries, and other productive sectors of the economy. Financial Inclusion: The Indian financial system also strives to promote financial inclusion by providing access to financial services to individuals and businesses in remote and underdeveloped areas of the country Explain the role of financial system? Financial systems play a crucial role in the economy by facilitating the flow of funds between savers and borrowers. Here are some key points regarding the role and importance of financial systems: 1. Intermediation: Financial systems act as intermediaries between savers (those with excess funds) and borrowers (those in need of funds). They help channel savings from individuals, businesses, and governments to productive investments. 2. Capital Allocation: The financial system helps allocate capital efficiently by directing funds to their most productive uses. This allocation of capital is essential for economic growth and development. 3. Risk Management: Financial systems provide mechanisms for managing risk. Through diversification, insurance, hedging, and other financial instruments, individuals and businesses can mitigate various types of risks, such as market risk, credit risk, and operational risk. 4. Liquidity Provision: Financial systems provide liquidity by enabling individuals and businesses to convert assets into cash quickly and easily. This liquidity is essential for economic transactions and ensures the smooth functioning of the economy. 5. Price Discovery: Financial markets help determine the prices of financial assets based on supply and demand dynamics. Price discovery is crucial for efficient resource allocation and for signaling information about the health and prospects of companies and the economy. 6. Facilitating Economic Growth: A well-functioning financial system plays a vital role in fostering economic growth by providing the necessary funds for investment, innovation, and entrepreneurship. It helps mobilize savings, promote capital formation, and support economic activities. 7. Promoting Financial Inclusion: Financial systems can also promote financial inclusion by providing access to financial services for individuals and businesses that were previously underserved or excluded. This can help reduce poverty, stimulate economic activity, and promote social development. UNIT 1 INTRODUCTION TO FINANCIAL SYSTEM 8. Monetary Policy Transmission: Financial systems serve as a conduit for monetary policy transmission. Central banks use various tools to influence interest rates, money supply, and credit conditions to achieve macroeconomic objectives such as price stability, full employment, and economic growth. In summary, financial systems are essential for the functioning of modern economies. They play a critical role in mobilizing savings, allocating capital efficiently, managing risk, promoting economic growth, and facilitating transactions. A well-developed and stable financial system is vital for overall economic stability and prosperity. What are the components of financial system? Components of the Indian Financial System Financial Institutions Financial Institutions serve as a go-between for the investor and the borrower. The Financial Markets are used to mobilise the investor’s funds, either directly or indirectly. A bank is the greatest illustration of a financial institution. People who have extra money put it in savings accounts, while others who are short on cash take out loans. The bank serves as a link between the two. Financial institutions are further classified into two categories: 1. Banking Institutions or Depository Institutions- This category comprises banks and credit unions that accept money from the public in exchange for interest on deposits and then lend it to those in need. 2. Non-Banking Institutions or Non-Depository Institutions- Insurance, mutual funds, and brokerage firms are examples of non-banking institutions or non-depository institutions. They are unable to request monetary deposits, but they can market financial goods to their clients. Financial Assets Financial Assets are the items that are exchanged in the Financial Markets. The securities in the market differ from one another based on the distinct criteria and demands of the loan applicant. The following are some major financial assets that have been briefly discussed: 1. Call Money- It is a term used to describe a loan that is given for one day and then repaid the next day. This type of transaction does not necessitate the use of collateral security. 2. Notice Money- It is a term used to describe a loan that is provided for more than a day but less than 14 days. This type of transaction does not necessitate the use of collateral security. 3. Term Money- Term money refers to a deposit that has a maturity time longer than 14 days. 4. Treasury Bills, or T-Bills- These are short-term government bonds or debt instruments that mature in less than a year. Purchasing a T-Bill entails making a loan to the government. 5. Certificates of Deposits (CDs) – These are dematerialised (electronic) forms for cash placed in a bank for a certain length of time. 6. Commercial Paper is a type of unsecured short-term financial instrument issued by businesses. Financial Services Management of financial instruments (assets or securities) and liability management firms provide services to assist in obtaining the necessary finances as well as ensuring that they are invested effectively. India’s financial services include: 1. Banking Services- Any little or large service given by banks, such as lending money, depositing money, providing debit/credit cards, opening accounts, and so on. 2. Insurance Services- Insurance services include services such as issuing insurance, selling policies, insurance undertakings, and brokerages, among others. 3. Investment Services- Asset management is a common example of investment services. 4. Foreign Exchange Services- Foreign exchange services include currency exchange, foreign exchange, and so on. Financial Markets A financial market is a marketplace where buyers and sellers engage and trade financial instruments (assets or securities) like money, bonds, stocks, and other assets. UNIT 1 INTRODUCTION TO FINANCIAL SYSTEM There are four different types of financial markets: 1. Capital Market- The capital market, which is designed to finance long-term investments, deals with transactions that take place in the market for more than a year. 2. Money Market- This sort of market is only permitted for short-term investments and is dominated by the government, banks, and other large institutions. It’s a wholesale debt market that specialises in low-risk, high-liquid securities. 3. Foreign Exchange Market- The foreign exchange market, one of the most established marketplaces in the world, deals with multi-currency requirements. In this market, monies are transferred based on the foreign exchange rate. 4. Credit Market- A credit Market is a market where short-term and long-term loans are issued to individuals or organisations by various banks, financial institutions, and non-financial institutions. What are the functions of financial system? Functions of financial system are discussed in brief. 1. Pooling of Funds: In a financial system, the Savings of people are transferred from households to business organizations. With these production increases and better goods are manufactured, which increases the standard of living of people. 2. Capital Formation: Business require finance. These are made available through banks, households and different financial institutions. They mobilize savings which leads to Capital Formation. 3. Facilitates Payment: The financial system offers convenient modes of payment for goods and services. New methods of payments like credit cards, debit cards, cheques, etc. facilitates quick and easy transactions. 4. Provides Liquidity: In financial system, liquidity means the ability to convert into cash. The financial market provides the investors the opportunity to liquidate their investments, which are in instruments like shares, debentures, bonds, etc. Price is determined on the daily basis according to the operations of the market force of demand and supply. 5. Short and Long Term Needs: The financial market takes into account the various needs of different individuals and organizations. This facilitates optimum use of finances for productive purposes. 6. Risk Function: The financial markets provide protection against life, health and income risks. Risk Management is an essential component of a growing economy. 7. Better Decisions: Financial Markets provide information about the market and various financial assets. This helps the investors to compare different investment options and choose the best one. It helps in decision making in choosing portfolio allocations of their wealth. 8. Finances Government Needs: Government needs huge amount of money for the development of defense infrastructure. It also requires finance for social welfare activities, public health, education, etc. This is supplied to them by financial markets. 9. Economic Development: India is a mixed economy. The Government intervenes in the financial system to influence macro-economic variables like interest rate or inflation. Thus, credits can be made available to corporate at a cheaper rate. This leads to economic development of the nation. Write a short note of flow of funds? The flow of funds is essentially a financial report or account that illustrates fund inflow and outflow in an economy across different sectors operating within it on a whom-to-whom basis. The flow of funds matrix is the form in which FOF of an economy is represented. It primarily shows six economic sectors. These are – Household sector – this sector involves Non-profit organizations within an economy. Financial institutions. Non-financial corporations – this sector includes, inter alia, insurance companies, mutual funds, pension funds, savings and loan associations. Government (central, state, and local). Savings and Investment. Rest of the world or foreign sector. UNIT 1 INTRODUCTION TO FINANCIAL SYSTEM Each of these sectors consists of two divisions highlighting the sources and uses of funds side by side in the form of a matrix. As per Flow of Funds in financial system, the heading of Sources of Funds denotes all income and borrowing in a sector, and another heading, i.e. Uses of Funds represents all expenses and advances/lending. Moreover, in the flow of funds accounts, sources relate to change in the value of assets, whereas uses relate to change in the value of liabilities. What are the Limitations of Flow of Funds Accounts? 1. Due to its meticulous recording of sectoral financial transactions, it is difficult to analyse and resultantly more complicated. 2. It does not account for human capital flow. 3. It is challenging to record assets, obligations, and claims sans a fixed value. Nevertheless, despite its few limitations, the Flow of Funds approach is an exceptional financial account to determine how a nation’s economy is performing and also helps understand its financial standing vis- á-vis different sectors.