Financial System 5t222x
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Indian Financial System Markets, Institutions and Services
Chapter 1: Financial system: An Introduction Figure 1.1
Chapter Objectives To understand: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Meaning of Financial system. Components of the Financial system. Functions of the Financial System. Key elements of the Financial System. Key elements of a well functioning financial system. Bank- based and Market- based financial systems. Nature and role of Financial Institutions and Markets. Link between Money market and Capital market. Link between Primary market and Secondary market Functions and Characteristics of Financial markets.
Meaning of Financial System • A set of sub systems of financial institutions, markets, instruments and services. •Intermediates with the flow of funds between savers and borrowers. •Facilitates transfer and allocation of scarce resources efficiently and effectively.
Types of Financial System •Formal financial system Organized, institutional and regulated
•Informal financial system
Advantages: Low transaction costs Minimum default risk Transparency of procedures Disadvantages: Wide range of interest rates Higher rates of interest Unregulated
Components of the Financial System •Financial Institutions •Financial Markets •Financial Instruments •Financial Services
Types of Financial Institutions
Banking and Non –Banking Banking: creators and purveyors of
credit.
Types: Commercial Banks Cooperative Banks
Non-Banking :purveyors of credit Types: Developmental financial institutions; Mutual Funds; Insurance companies; NBFCs
Functions of Financial Institutions
Provide three transformation services: Liability, asset and size transformation Maturity transformation Risk transformation
Financial Markets Types: Money Market – A market for short -term debt instruments
.
Capital Market - A market for long -term equity and debt instruments
Segments: Primary Market – A market for new issues
Secondary Market – A market for trading outstanding issues
Link Between Primary and Secondary Capital market:
A buoyant secondary market indispensable for the presence of a vibrant primary market Secondary market provides a basis for the determination of prices of new issues
Depth of the secondary market depends on the primary market
Bunching of new issues affects prices in the secondary market
Financial Instruments Types : Primary Secondary
Distinct Features : Marketable Tradeable Tailor-made
Financial Services Major categories : Funds Intermediation Payments Mechanism Provision of liquidity Risk Management Financial Engineering
Functions of Financial system
Mobilise and allocate savings
Monitor corporate performance
Provide payment and settlement systems
Optimum allocation of risk bearing and reduction
Disseminate prize related information
Offer portfolio adjustment facility
Lower the cost of transactions
Promote the process of financial deepening and broadening
Key elements of a well functioning financial system
A strong legal and regulatory environment Stable money Sound public finances and public debt management A central bank Sound banking system Information system Well -functioning securities market
Financial system designs Types : Bank – based Market – based
Market -based Financial System Advantages: Provide attractive to both investors and borrowers Facilitate diversification Allow risk sharing Allow financing of new technologies
Drawbacks: Prone to instability Exposure to market risk Free rider problem
Bank –based Financial System Advantages:
Close relationships with parties
Provide tailor made contracts
Efficient inter-temporal risk sharing
No free rider problem
Drawbacks:
Retards innovation and growth
Impedes competition
Functions of Financial Markets
Enabling economic units to exercise their time preference
Seperation, distribution, diversification and reduction of risk
Efficient payment mechanism
Providing information
Enhancing liquidity
Providing portfolio management services.
Chapter 1: Financial system: An Introduction Figure 1.1
Chapter Objectives To understand: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Meaning of Financial system. Components of the Financial system. Functions of the Financial System. Key elements of the Financial System. Key elements of a well functioning financial system. Bank- based and Market- based financial systems. Nature and role of Financial Institutions and Markets. Link between Money market and Capital market. Link between Primary market and Secondary market Functions and Characteristics of Financial markets.
Meaning of Financial System • A set of sub systems of financial institutions, markets, instruments and services. •Intermediates with the flow of funds between savers and borrowers. •Facilitates transfer and allocation of scarce resources efficiently and effectively.
Types of Financial System •Formal financial system Organized, institutional and regulated
•Informal financial system
Advantages: Low transaction costs Minimum default risk Transparency of procedures Disadvantages: Wide range of interest rates Higher rates of interest Unregulated
Components of the Financial System •Financial Institutions •Financial Markets •Financial Instruments •Financial Services
Types of Financial Institutions
Banking and Non –Banking Banking: creators and purveyors of
credit.
Types: Commercial Banks Cooperative Banks
Non-Banking :purveyors of credit Types: Developmental financial institutions; Mutual Funds; Insurance companies; NBFCs
Functions of Financial Institutions
Provide three transformation services: Liability, asset and size transformation Maturity transformation Risk transformation
Financial Markets Types: Money Market – A market for short -term debt instruments
.
Capital Market - A market for long -term equity and debt instruments
Segments: Primary Market – A market for new issues
Secondary Market – A market for trading outstanding issues
Link Between Primary and Secondary Capital market:
A buoyant secondary market indispensable for the presence of a vibrant primary market Secondary market provides a basis for the determination of prices of new issues
Depth of the secondary market depends on the primary market
Bunching of new issues affects prices in the secondary market
Financial Instruments Types : Primary Secondary
Distinct Features : Marketable Tradeable Tailor-made
Financial Services Major categories : Funds Intermediation Payments Mechanism Provision of liquidity Risk Management Financial Engineering
Functions of Financial system
Mobilise and allocate savings
Monitor corporate performance
Provide payment and settlement systems
Optimum allocation of risk bearing and reduction
Disseminate prize related information
Offer portfolio adjustment facility
Lower the cost of transactions
Promote the process of financial deepening and broadening
Key elements of a well functioning financial system
A strong legal and regulatory environment Stable money Sound public finances and public debt management A central bank Sound banking system Information system Well -functioning securities market
Financial system designs Types : Bank – based Market – based
Market -based Financial System Advantages: Provide attractive to both investors and borrowers Facilitate diversification Allow risk sharing Allow financing of new technologies
Drawbacks: Prone to instability Exposure to market risk Free rider problem
Bank –based Financial System Advantages:
Close relationships with parties
Provide tailor made contracts
Efficient inter-temporal risk sharing
No free rider problem
Drawbacks:
Retards innovation and growth
Impedes competition
Functions of Financial Markets
Enabling economic units to exercise their time preference
Seperation, distribution, diversification and reduction of risk
Efficient payment mechanism
Providing information
Enhancing liquidity
Providing portfolio management services.
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