Financial SystemsIntroductionIn its simple meaning the term ‘finance’ refers to monetary resources & the term ‘financing’ refers to the activity of providing required monetary resources to the needy persons and institutions.
The term ‘financial system’ refers to a system that is concerned with the mobilization of the savings of the public and providing of necessary funds to the needy persons and institutions for enabling the production of goods and/or for provision of services. Thus, a financial system can be understood as a system that allows the exchange of funds between lenders, investors, and borrowers. In other words, the system that facilitates the movement of finance from the persons who have surplus funds to the persons who need it is called as financial system. It consists of complex, closely related services, markets, and institutions used to provide an efficient and regular linkage between investors and depositors.
Financial systems operate at national, global, and firm-specific levels. It includes the public, private and government spaces and financial instruments which can relate to countless assets and liabilities. Components of Financial System 1.
Financial Assets 2. Financial Intermediaries/Financial Institutions 3. Financial Markets 4. Financial Rates of Return 5. Financial Instruments Functions of Financial System The financial system of a country performs certain valuable functions for the economic growth of that country. The main functions of a financial system may be briefly discussed as below: 1.
Saving function: An important function of a financial system is to mobilise savings and channelize them into productive activities. It is through financial system the savings are transformed into investments. 2. Liquidity function: The most important function of a financial system is to provide money and monetary assets for the production of goods and services. Monetary assets are those assets which can be converted into cash or money easily without loss of value.
All activities in a financial system are related to liquidity-either provision of liquidity or trading in liquidity. 3. Payment function: The financial system offers a very convenient mode of payment for goods and services. The cheque system and credit card system are the easiest methods of payment in the economy. The cost and time of transactions are considerably reduced. 4. Risk function: The financial markets provide protection against life, health and income risks. These guarantees are accomplished through the sale of life, health insurance and property insurance policies.
5. Information function: A financial system makes available price-related information. This is a valuable help to those who need to take economic and financial decisions. Financial markets disseminate information for enabling participants to develop an informed opinion about investment, disinvestment, reinvestment or holding a particular asset.
6. Transfer function: A financial system provides a mechanism for the transfer of the resources across geographic boundaries. 7.
Reformatory functions: A financial system undertaking the functions of developing, introducing innovative financial assets/instruments services and practices and restructuring the existing assts, services etc, to cater the emerging needs of borrowers and investors (financial engineering and re engineering). 8. Other functions: It assists in the selection of projects to be financed and also reviews performance of such projects periodically. It also promotes the process of capital formation by bringing together the supply of savings and the demand for investible funds Characteristics of Financial System 1. Financial system acts as a bridge between savers and borrowers 2.
It consists of a set of inter-related activities and services 3. It consists of both formal and informal financial sectors. The existence of both formal and informal system is also called as financial dualism. 4. It formulates capital, investment and profit generation 5. It is universally applicable at firm level, regional level, national level and international level 6. It consists of financial institutions, financial markets, financial services, financial instruments, financial practices and financial transactions. FINANCIAL ASSETS Financial assets refer to the cash or cash equivalents that are used for production or consumption or for further creation of assets.
Cash, Bank Deposits, Shares, Debentures, Investment in Gold, Land & Buildings, Contractual right to receive cash or another financial asset, etc., are called as financial assets. Classification of Financial Assets Financial assets are classified in two ways 1. On the basis of marketability 2. On the basis of nature Classification of Financial Assets On the basis of marketability 1. Marketable – The financial assets that can be bought and sold are called as marketable financial assets. They include Shares, Government Securities, Bonds, Mutual Funds, Units of UTI, Bearer Debentures 2.
Non-marketable – The financial assets that cannot be bought and sold are called as nonmarketable finance assets. They include Bank Deposits, Provident Funds, LIC Policies, Company Deposits, Post Office Certificates Classification of Financial Assets on the basis of nature 1. Money or Cash Asset – Coins, Currency Notes, Bank Deposits 2. Debt Asset – Debenture & Bonds 3. Stock Asset – Equity Shares & Preference Shares FINANCIAL INTERMEDIARIES/FINANCIAL INSTITUTIONS Different kinds of organizations/institutions which intermediate and facilitate financial transactions of both individual and corporate customers are called as financial intermediaries or financial institutions.
Basically they are classified into two types: 1. Unorganized Sector 2. Organized Sector Unorganized Sector The sector that is not governed by any statutory or legal authority is known as unorganized sector. This sector consists of the individuals and institutions for whom there are no standardized rules and regulations governing their financial dealings. They are not under the supervision and control of RBI or any other regulatory body.
This sector consists of the individuals and institutions like Local money lenders, Pawn brokers, Traders, Landlords, Indigenous bankers, etc., who lend money to needy persons and institutions. Organized Sector The sector that is governed by some statutory or legal authority is known as organized sector. This sector consists of the institutions like Commercial Banks, Non Banking Financial Institutions, etc. They are further classified into two: 1.
Capital Market Intermediaries 2. Money Market Intermediaries Capital Market Intermediaries Capital Market refers to the market for long term finance. The intermediaries provide long term finance to individuals and corporate customers. IDBI, SFCs, LIC, GIC, UTI, MFs, EXIM BANK, NABARD, NHB, NBFCs (Hire Purchasing, Leasing, Investment and Finance Companies) Government (PF, NSC) etc., are in the organized sector providing long term finance.