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Overview Of Indian Financial System

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  • Last Updated : 20 Jun, 2022

The Indian Financial System plays a very important role in the Indian Economy and it shows the economic growth of our economy. This chapter covers all the government sector exams in our economy. It helps in the flow of funds to people and the people use this money economically for their betterment.      
                        

 

 Definition of Financial System:

The various type of services that are provided by financial institutions like banks, insurance companies, pensions, fund etc. to the people of the country makes a financial system. 

1. The Financial Institutions in India are broadly divided into two categories viz. Banks and Non-Banking Financial Institutions (NBFI). A bank accepts demand deposits while NBFIs do not accept them. The banks have been authorised to issue checks but NBFIs cannot issue them.

2. Banks are classified into commercial and cooperative. Commercial banks operate their business for profit purposes while the basis of operation for cooperative banks is on cooperative lines i.e. service to its members and the society. In comparison to a commercial bank, Cooperative banks provide a higher rate of interest.
Commercial banks are of two categories viz. 

a) Scheduled commercial banks 
b) Non-scheduled commercial banks. 

A scheduled bank is a bank that has been included in the 2nd schedule of the RBI Act 1934. A scheduled bank also had to be a corporation and the Paid-up capital for it should be at least Rs. 500 crores. 

The Non-Scheduled banks have to put some reserve requirements like SLR, and CRR according to the banking regulation act 1949. Scheduled Banks are required to maintain reserve requirements with RBI as per the RBI Act 1934.

3. Co-operative Banks:  These are of two types- 

a) Urban Co-operative banks (UCB) 
b) Rural Co-operative banks. 
The Urban Co-operative banks (UCB) are also known as Primary Co-operative Banks. They help the communities, and localities workplace groups and are set up mostly in urban and semi-urban areas. Their main customers are mainly small borrowers and businesses. 
These UCBs are also classified into Scheduled and Non-scheduled categories, which are then further classified into a single state and multi-state.

4. Public Sector Banks: 

Banks are controlled by the federal or state governments, with a combined ownership of more than 51 percent. SBI and its affiliates, Punjab National Bank, Bank of India, and others are examples. Those Nationalized Banks (private banks taken over by the government) which were nationalized in 1969 and 1980s are also public sector banks as the government owns more than 51% of these banks.

5. Private Sector Banks: 

These are those Indian Banks that are owned by private individuals for example ICICI bank, HDFC bank, Axis Bank etc.

6. Foreign Banks: 

Those Banks that are established and provided services of banking in India but are owned by foreign entities are called foreign banks. for example, Citi Bank, HSBC Banks, Standard chartered banks etc.

7. Regional Rural Banks (RRBs):

The Regional Rural Banks Act of 1976 established RRBs in 1975 with the goal of developing the rural economy by providing credit and other facilities, particularly to small and marginal farmers, agricultural labourers, artisans, and small entrepreneurs, for the purpose of developing agriculture, trade, commerce, industry, and other productive activities in rural areas. The national government, the concerned state government, and the sponsor bank each own 50:15:35 of RRBs (each RRB is sponsored by a particular bank). RRBs are required to distribute 75% of their funding to priority industries. NABARD also supervised RRBs.

8. Local Area Banks (LAB):

They were established in 1996 as part of a Government of India scheme. The government intended to establish new private local banks with control over two or three adjacent areas. The goal of establishing local area banks was to allow local institutions to mobilise rural savings and make them available for investments in local areas. There are just four Non-Scheduled Local Area Banks in India, one of which is Coastal Local Area Bank in Vijayawada, Andhra Pradesh.

The RBI regulates and supervises three main areas of the Non-Banking Financial Institutions (NBFIs) sector in India: All India Financial Institutions (AIFIs), Non-Banking Financial Companies (NBFCs), and Primary Dealers (PDs). Credit Information Companies (CIC) are a type of non-banking financial organisation regulated by the Reserve Bank of India.

9. AIFIs are institutional mechanisms tasked with delivering long-term finance to specific sectors. The RBI currently regulates and supervises four AIFIs, also known as Development Financial Institutions (DFIs).

10. NABARD: 

NABARD was established in 1982 under the provisions of the National Bank for Agriculture and Rural Development Act 1981. NABARD gives credit to promote agriculture, small scale industries, cottage and village industries, handicrafts and other rural crafts and other allied economic activities in rural areas. NABARD extends assistance to the government, RBI and other organizations in matters relating to rural development. It offers training and research facilities for banks, cooperatives and organizations in matters relating to rural development

11. Small Industries Development Bank of India (SIDBI):

SIDBI was established in 1990 under the provisions of the Small Industries Development of India Act 1989 SIDBI serves as the primary financial institution for promoting, funding, and developing the Micro, Small, and Medium Enterprise (MSME) sector, as well as for coordinating the functions of other organisations involved in similar activities. SIDBI primarily provides banking institutions with indirect financial support (in the form of refinancing) in order for them to lend to MSMEs.

12. MUDRA Bank: 

MUDRA (Micro Units Growth and Refinance Agency Ltd.) is a government-owned financial agency dedicated to the development and refinancing of micro-enterprises. MUDRA Ltd, a non-banking finance company, has been set up as a subsidiary of SIDBI pending the passing of an act creating MUDRA Bank. MUDRA’s goal is to provide funding to non-corporate (informal sector) small businesses in rural and urban areas with financing needs of up to Rs 10 lakhs, such as small manufacturing units, shopkeepers, etc. MUDRA would be in charge of refinancing all Last Mile Financiers, including Micro Financial Institutions, Non-Banking Finance Companies, Societies, Trusts, Companies, Co-operative Societies, Small Banks, Scheduled Commercial Banks, and Regional Rural Banks, who lend to micro/small business entities engaged in manufacturing, trading, and services.

13. Non-Banking Financial Companies (NBFCs): 

The NBFC is a company governed by the Companies Act, 1956/2013, that deals with loans and advances, the acquisition of shares/bonds/debentures issued by the government or a local authority, or other marketable securities of a similar nature, leasing, hire-purchase, insurance, and chit business, but not with agriculture, industrial activity, or the purchase or sale of any goods. Private sector institutions make up the majority of NBFCs.

14. Primary dealers (PDs): 

Primary dealers are RBI-registered companies with the authority to buy and sell government securities. In the primary market, PDs purchase government securities directly from the government (RBI issues these assets on behalf of the government), with the intention of reselling them to other buyers in the secondary market. As a result, they play an important role in the primary and secondary government securities markets.

15. Credit Information Companies (CIC): 

A CIC is a non-profit organisation that accepts banks, NBFCs, and financial institutions as members and collects data and identity information for individual customers and enterprises. CICs tell banks whether or not a potential borrower is creditworthy based on his payment history. The ability of lenders to assess risk and of consumers to receive credit at competitive rates is determined by the quality of information available. The RBI regulates and licenses credit information companies (CICs) under the Credit Information Companies (Regulation) Act 2005. TransUnion Credit Information Bureau of India Limited (CIBIL), Equifax, Experian, and High Mark Credit Information Services are the four CICs currently operating in India.

16. Payment Banks:  

In August 2015, the Reserve Bank of India (RBI) approved 11 applications for Payment Bank licenses. The Reserve Bank of India has capped the amount of deposits that payment banks can receive from individuals at Rs. 1 lakh. Only those companies that are truly engaged in targeting the poor will be able to apply for payment bank licenses as a result of this restriction. As a result, migrant workers, self-employed individuals, low-income households, and others will be the primary beneficiaries of payment banks’ low-cost savings accounts and remittance services, allowing those who currently transact only in cash to make their first foray into the formal banking system (payment banks will not be permitted to lend or issue credit cards). Only demand deposits will be accepted by payment banks.

17. Small Finance Banks: 

In September 2015, RBI granted licenses to 10 applicants for Small Finance Banks which is a step in the direction of furthering financial inclusion. 

The small finance banks shall primarily undertake basic banking activities of acceptance of deposits and lending to unserved and underserved sections including small business units, small and marginal farmers, micro and small industries and unorganized sector entities. 

Components of the Financial System:

Financial institutions
The term financial institution defines those institutions which provide a wide variety of deposit, lending, and investment products to individuals, businesses, or both. Some other financial institutions provide services and account for the general public, others are more likely to serve only certain consumers with more specialized offerings. 

1. Central Banks

These are the financial institutions that regulate, oversight and look after the management of all other banks. RBI is known as the central bank of India. An individual does not have direct contact with a central bank instead, large financial institutions work directly with the RBI to provide products and services to the general public. 

2. Retail and Commercial Banks

These Banks provide products to consumers and commercial banks worked directly with businesses. At present, most banks offer deposit accounts, lending and financial advice. These banks cater for services like checking and savings accounts, certificates of deposit (CDs), personal and mortgage loans, credit cards, and business banking accounts. 

3. Internet Banks

These types of banks work the same as retail banks. Internet bank is of two type-
• Digital banks- These are online-only platforms affiliated with traditional banks.
• Neo banks- These banks are not affiliated with any bank but themselves. These are pure digital native banks. 

4. Credit Unions

These are the financial institution that was founded and administered by its member and provide standard banking services. 
These unions help a specific population based on their field of membership, such as military personnel or teachers.

5. Insurance Companies

These companies help individuals in transferring the risk of loss. These companies take care of individuals and businesses from financial loss caused due to disability, death, accidents, property damage and other catastrophes.  

Financial Markets 

The marketplace where buyers and sellers participate in the trade of assets such as equities, bonds, currencies, and derivatives.

Consists of 2 types:
1. Money Market – deals in short-term credit (< 1 yr).
2. Capital Market –handles medium-term & long-term credit. (> 1 yr).

Money Market:
It is characterised by two sectors:

1. Organised sector — this sector comes within the direct purview of RBI. It includes banking & sub-markets.

a. Banking sector – Commercial banks [under Banking regulation act 1949 & consist of both private & public], RRBs, Cooperative Banks.
b. Sub Markets – Meet the need of govt and industries. It includes call money, Bill market [Commercial bill, T-Bill], Certificate of Deposit [CD] & Commercial Paper [CP].

2. Unorganised sector– consists of indigenous bankers, money lenders, non-banking financial institutions, etc.

Capital Market:

This market comprises buyers & sellers, who trade in equity (ownership of asset) &debt (loan). It is regulated by SEBI (established in 1992).
The institutions in the capital market are called NBFCs (Non-banking financial companies). But it’s not necessary that all NBFCs are capital market institutions.

RBI defines NBFC as – ‘A NBFC is a company registered under the Companies Act, 1956 and is engaged in the buss of loans & advances, acquisition of share/ stock issued by Government. It doesn’t include any institution whose principal buss is agriculture activity, industrial activity, or sale/purchase of the immovable property.

Security Market:

This market is known as-

a) Government Securities [gilt edge] security market and 
b) Industrial Security Market [New Issue Market is the primary market & Old Issue Market is the secondary market].
Development Financial Institutions: They provide long-term loans to industries engaged in infrastructure where projects have long gestation periods & require long term loans.

Financial services: 

The purpose of Financial Services is to cater for a person with borrowing, selling or purchasing securities, allowing payments and settlement, lending and borrowing. These services help in the management of funds as the money is invested efficiently and also help to get the required funds. These services are provided by the assets management and liability management companies.
These services are-
• Banking services- like cash deposit, issuing debit and credit cards, opening accounts, Fixed deposit, loan facility etc. 
• Insurance services- like issuing of insurance, selling policies, insurance undertaking and brokerages, etc. 
• Foreign exchange services- currency exchange, foreign exchange, etc.
• Investment services- like asset management etc.

Important questions related to the article:

Q1: What is the maximum period for call money?

A. 60 days
B. 30 days 
C. 20 days
D. 15 days
E. 14 days

Answer: E

Q2: The sale of securities with an agreement to purchase them later greater than their original price is called?

A. Repurchase agreements
B. Repo 
C. CRR
D. SLR
E. CRAR

Answer: A

Q3: Which of the following regulate the scheduled commercial banks of India?

A. RBI
B. SEBI
C. NABARD
D. SIDBI
E. NHB

Answer: A

Q4: Which of the following is issued as a promissory note?

A. Commercial paper
B. Treasury bills
C. Participatory notes
D. Certificate of deposits
E. Govt securities

Answer: A

Q5: What is the minimum subscription required for commercial paper?

A. 1 cr
B. 2 cr
C. 3 cr
D. 4 cr
E. 5 cr

Answer: A

Q6: What is the minimum subscription required for the Certificate of deposits?

A. 1 lakh 
B. 3 lakh 
C. 2 lakh
D. 4 lakh 
E. 5 lakh

Answer: A

Q7: What is the sale and purchase of short term government securities by the central government called?

A. T-bills
B. Commercial bills
C. P notes
D. Promissory notes
E. Cash management bills

Answer: A

Q8: What is the minimum period required to issue certificates of deposits (CDs)?

A. 7 days
B. 30 days
C. 15 days
D. 14 days
E. 60 days

Answer: A

Q9: Which of the following agencies issue T-bills in India?

A. RBI
B. SBI
C. SEBI
D. SIDBI
E. Ministry of finance

Answer: A

Q10: Which of the following market deals for the short term period?

A. Financial market
B. Money market
C. Capital market
D. Gilt-edged security market
E. Stock market

Answer: B

Q10: Which of the following market deals for the medium and long term period?

A. Financial market
B. Money market
C. Capital market
D. Primary market
E. Stock market

Answer: C

Q11: Which of the following is not a type of financial service?

A. Banking
B. Insurance
C. Brokerage
D. Foreign exchange
E. Investment  

Answer: C

Q12: Which of the following certificates/bill launched to fulfil the mismatches in the cash flow of the central government?

A. Cash management bills
B. Promissory notes
C. Certificate of deposits
D. Commercial paper
E. Repo

Answer: A

Q13: Which of the following bills is issued by traders?

A. T-bills
B. Cash management bills
C. Commercial bills
D. Financial bills
E. Promissory notes

Answer: C

Q14: Which of the following bills also work as a Zero-coupon bond?

A. Commercial paper
B. Cash management bill
C. Repurchase agreement
D. T-bills
E. P notes

Answer: D

Q15: Which of the following market is regulated by SEBI?

A. Financial market
B. Money market
C. Capital market
D. Primary market
E. Security market

Answer: C


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