Financial System Structure and Linkages

The term "finance" in our simple understanding it is perceived as equivalent to 'Money'.

But finance exactly is not money, it is the source of providing funds for a particular activity.

Thus finance does not mean the money with the Government, but it refers to sources of raising revenue for the activities and functions of a Government.

The word "system", in the term "financial system", implies a set of complex and closely connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities in the economy. 

The financial system is concerned about money, credit and finance-the three terms are intimately related yet are somewhat different from each other

Financial markets: institutions through which savers can directly provide funds to borrowers. Examples:

– The Bond Market

A bond is a certificate of indebtedness.

– The Stock Market.

A stock is a claim to partial

ownership in a firm.

Financial intermediaries: institutions through which savers can indirectly provide funds to borrowers. Examples:

– Banks

– Mutual funds: institutions that sell shares to the public and use the proceeds to buy portfolios of stocks and bonds

• The amount of money that is left over after personal expenses have been met can be positive.

• For those who tend to rely on credit and loans to make ends meet, they will have negative savings.

• Savings can be turned into further increased income through investing.

An investment is a monetary asset purchased with the idea that the asset will provide income in the future or appreciate and be sold at a higher price.

These are the business organizations that act as mobilizes of savings, and as purveyors of credit or finance

Also provide various financial services Deal in financial assets such as deposits, loans, securities These assets can be seen on the asset side of the balance

sheet of banks or any other financial institutions.

1. Banking financial institutions Which participate in the economy’s payments system i.e.,They provide transaction services Their deposits liabilities constitute a major part of the national money supply

2. Non-banking financial institutions Which act as mere purveyors of credit and they will not create. e.g., LIC, UTI, IDBI

•Financial intermediaries are those institutions which intermediate between savers and

investors

•Non-financial intermediaries are those institutions which do the loan business but their

resources are not directly obtained from the savers.

•e.g., LIC, GIC, IDBI, IFC, NABARD.

Facilities the flow of savings into investment against capital formationFinancial markets are the centers or arrangements that provide facilities for buying and selling of financial claims and servicesThe participants in the financial markets are corporations, financial institutions, individuals and the governmentEither directly or through brokers and dealers in organized exchanges or off-exchanges

1. Debt market: The debt market is the financial

market for fixed claims like debt instruments

2. Equity Market: The equity market is the

financial market for residual claims i.e., equity

instruments

1. Money markets

o A market where short-term funds are

borrowed and lent is called ‘money

market

2. Capital Markets

o Capital markets deal in the long-term

claims, securities, and stocks with a

maturity period of more than one year.

1. Primary markets

• Which deal in the new financial claims

or new securities, and, also known as

new issue markets

2. Secondary market

• Which deal in securities already

issued or existing or outstanding1. Cash/spot market

Stocks are sold for cash and delivered

immediately after the purchase or sale of

securities.

2. Forward or future market

Buy and sell stocks/ commodities, contracts

and the delivery of securities occurs at a

pre-determined time in future.

1. Organized markets

The financial transactions which take

place within the well established

exchanges

2. Unorganized markets.

The financial transactions which take

place without systematic and orderly

structure or arrangements

Which are used for raising resources for corporate activities

That are used for raising capital through the capital market are known as ‘capital

market instruments’

Preference shares, equity shares, warrants, debentures and bonds

That are used for raising and supplying money in short period not exceeding one year

through various securities are called ‘money market instruments’

For example, treasure bills, gilt-edge securities, state government and public sector

instruments, commercial paper, commercial bills etc.

1. Financial institutions serve individuals and institutional investors.

2. help to raise the required funds and assure the efficient deployment of funds.

3. extend their service up to the stage of servicing of lenders.

4. provide services like bill discounting, factoring of debtors, parking of short-term funds

in the money market, e-commerce, securitization of debts

5. provide some specialized services like credit rating, venture capital financing, lease

financing, factoring, mutual funds, merchant banking, stock lending, depository, credit

cards, housing finance, and merchant banking