International Journal of Business Administration and Management.

ISSN 2278-3660 Volume 7, Number 1 (2017),

© Research India Publications http://www.ripublication.com

A study of Structure and Functions of Capital Markets in

India
Mohammed Rubani
Ph.D Scholar (Commerce)
(2014-2017)
Kalinga University, Raipur, C.G.
Enrollment No. 15020086 (KU002MMXIV02010138)

Abstract

Capit a l is one o f t he import ant fact ors of produc t ion in any econo my. I n
econo my, a well organized financial syst em provides adequat e capit a l
for mat io n t hrough savings, finance and invest ment s 1. An invest ment
depends upon S avings and in t urn Savings depends upon ear nings o f a n
individual or profit s o f t he organizat ion. This syst em may be viewed as a
set of sub- syst ems wit h so many ele ment s which are int erdependent and
int er linking wit h each ot her t o produce the purposeful r esu lt wit h in t he
boundar y. Hence, t he t er m s yst em in t he cont ext of finance means a set of
co mplex and closely connect ed financial inst it ut io ns, inst rument s, agent s,
market s and so on which are int erdependent and int er linking wit h eac h
ot her t o produce t he econo mic growt h wit h in t he count r y. Transfer
process is effect ively fulfilled by t he financial syst em t o facilit at e
econo mic growt h t hrough t he channel of finance. This st udy aims at
analys ing t he st ruct ure and funct ions o f Capit a l Market in I ndia.

1
L. M. Bhole, Financial Institutions and Markets: Structure, Growth and Innovation. (New Delhi, Tata
McGraw-Hill, 2007) pp. 6-14.

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1. Introduction

St art ing fro m a co nt rolled eco no my, I ndia has mo ved t owards a wor l d
where pr ices fluct uat e ever y day. T he int roduct ion o f r isk management
inst rument s in I ndia ga ined mo ment um in t he last few years due t o
liber alisat ion process and Reser ve Bank of I ndia‟s (RBI) effort s in
creat ing currency forward market . Derivat ives are an int egr al part of
liber alisat ion process to manage r isk. NSE gauging t he market
requir ement s init iat ed t he process o f sett ing up der ivat ive market s in
India. I n July 1999, der ivat ives t rading commenced in I ndia. 2

In pract ice, so me foreign invest ors also invest in I ndian market s b y

issu ing Part icipat ory Not es to an o ff- shore invest or. Amo ng exchange -
t raded der ivat ive market s in Asia, I ndia was ranked second behind S.
Korea for t he first quart er o f 2005. How about China, wit h who India is
frequent ly co mpared in ot her respect s? China is prepar ing t o develop it s
der ivat ives mar ket s rapidly. It has recent ly ent ered int o jo int vent ures
wit h t he lead ing U.S. fut ures exchanges. It has t aken st eps t o loosen
currency cont rols, and t he Cent ral Bank has allowed do mest ic and foreig n
banks t o trade yuan forward and swaps cont ract s on behalf o f client s.
However, unlike I ndia, China has not fully imple ment ed necessar y
refor ms o f it s st ock market s, which is likely t o hamper growt h o f it s
der ivat ives market s. I ndian market has equalled or exceeded many ot her
regio nal market s. While t he growt h is being spear headed mainly by ret ai l
invest ors, pr ivat e sect or inst it ut io ns and large corporat ions, sma ller
co mpanies and st at e-owned inst it ut ions ar e gradua lly get t ing int o t he act .
Foreign brokers such as JP Morgan Chase are boost ing t heir presence in
India in react io n t o t he growt h in der ivat ives. T he var iet y o f der ivat ives
inst rument s available for t rading is also expanding.

2
Susan, Thomas (ed), Derivative Markets in India, (New Delhi, Tata McGraw-Hill 2003), p. 15

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There remain major areas o f co ncer n for Indian der ivat ive s user s. Large
gaps exist in t he range o f der ivat ives product s t hat are t raded act ively. I n
equit y der ivat ives, NSE figur es show t hat almo st 90% o f act ivit y is due t o
st ock fut ures or index fut ures, whereas t rading in opt ions is limit ed t o a
few st ocks, part ly because t hey are set t led in cash and not t he under lying
st ocks. Exchange-t raded der ivat ives based on int erest rat es and currencie s
are virt ually absent .

2 Objectives and Research Methodology

Objectives of study:

1. To analyze t he st ruct ure of Financia l Mar ket in I ndia.

2. To underst and Funct ions o f Indian Capit al Market

Research Methodology

It is always import ant to be cr it ical o f t he infor mat io n pr esent ed in

sources, especia lly since t he mat er ial might have been gat her ed t o address
a differ ent problem ar ea. Moreover, many secondar y sources do not
clear ly descr ibe issues such as t he purpose o f a st udy, how t he dat a has
been gat hered, analysed and int erpr et ed making it difficult for t he
resear cher t o assess t heir usefulness. I n order to address t his proble m I
have t r ied to t riangulat e t he seco ndar y dat a by using numerous
independent sources.

The infor mat io n about t he problem is collect ed fro m t he Researc h

Journals, Trade Magazines, Annual Report s of Banks and t he I nt ernet . For
evaluat ing „St ructu re and Functi ons of Capital Market s in India ‟, I
have fo cused o n as r ecent mat er ial as possible. I n order t o get access t o
t he lat est develo pment s in t his area I have used a number o f art icles
published in academic jour nals and t rade magazines. We have also used
seco ndar y infor mat io n fro m I nt ernet based discussio n forums.

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3. Results and Discussion

Financia l syst em is a co mplex set up for any count y, which inc ludes
financial inst it ut ions like banks, NBFCs (No n Banking Financia l
Co mpanies), regu lat ors, product s et c. Bro adly t he I ndian Financia l S yst em
can be classified in t o t wo heads, viz, t he inst it ut ions and regulat ors in
t he filed o f banking and allied ser vices and t he inst it ut ion and regulat ors
in t he filed o f financial mar ket . Banking sect or inst it ut ions include
Reser ve Bank o f I ndia, Pubic Sect or Banks, Pr ivat e Sect or Banks, Co -
operat ive Banks, and Foreign Banks. NBFCs and organizat ions like LI C,
GIC et c also play a major ro le in t he financial syst em. Ther e are many
nat ional level organizat ions like ICICI, IDBI, IF CI et c and st at e level
organizat io ns like St at e Financial Corporat io ns (S FCc) provide lo ng t er m
finance t o t he require ment s of indust r y. Specialized organizat ions like
NABARD, EXIM Bank et c also jo in in providing lo ng t er m as well short
t erm finance t o spe cific sect or of indust ry. 3 Financia l Market co nst it ut es
t he next major co mponent of t he financial syst em. Financia l market can be
classified in t o money market and capit al market .

Money market is t he market for financial inst rument s having a life o f less
t han one year. Money market includes Tr easur y Bills, Co mmer cial P aper,
Cert ificat e o f Deposit and Call Money. Pr imar y Market and Secondar y
Market const it ut es t he secondar y market . Pr imar y market , which is also
called IPO market is t he market for rais ing ow ner‟s equit y and fr es h
shares ar e issued in t he pr imar y market . The issued shares are t raded in
t he secondar y market or stock exchange. NSE (Nat io nal St ock Exchange)
and BSE (Bo mbay St ock Exchange) are t he t wo major st ock exchanges in
India for t rading in financia l inst rument s. Screen based t rading and
co mpet it io n killed major it y o f o ld exchanges in I ndia and now major share
of t rading vo lume is co nt r ibut ed by NSE and BSE.

3
U. R. Bhat, ‘The Market Needs A Make Over’, The Economic Times, (December 13 2004), 8

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Capit a l is one o f t he import ant fact ors of product ion in any econo my. I n
econo my, a well organized financial syst em provides adequat e capit a l
for mat io n t hrough savings, finance and invest ment s 4. An invest ment
depends upon S avings and in t urn Savings depends upon ear nings o f a n
individual or profit s o f t he organizat ion. This syst em may be v iewed as a
set of sub- syst ems wit h so many ele ment s which are int erdependent and
int er linking wit h each ot her t o produce the purposeful r esu lt wit h in t he
boundar y. Hence, t he t er m s yst em in t he cont ext of finance means a set of
co mplex and closely connect ed financial inst it ut io ns, inst rument s, agent s,
market s and so on which are int erdependent and int er linking wit h eac h
ot her t o produce t he econo mic growt h wit h in t he count r y. Transfer
process is effect ively fulfilled by t he financial syst em t o facilit at e
econo mic growt h t hrough t he channel o f finance.

In t he r ecent past t he I ndian Financia l S yst em has undergo ne sea changes

and invent ed many new channels o f financial sub -s yst ems t hrough t he
process o f financ ial refor ms. T his t hesis is based on t his „rec ent past ‟
which will be dealt t horoughly lat er in coming chapt ers on “der ivat ives”.
Let ‟s have a br ief look at t he I ndian financial syst em and it s co mponent s
to have background knowledge fir st .

3.1 Structu re of Financial Market: Indian financ ial syst em c an be

broadly grouped int o fo llowings inc luding financial market , financial
int er mediar ies, financ ial inst rument s, financial ser vices.

i. Financial Intermediari es:

Financia l I nt er mediar ies also t er med as Financia l I nst it ut ions. We can

classify t he financial int er mediar ies int o t wo groups one is organized
financial int er mediar ies and ot her one is unorganized financia l
int er mediar ies. Organized financial int ermediar ies co mes under t he
4
L. M. Bhole, Financial Institutions and Markets: Structure, Growth and Innovation. (New Delhi, Tata
McGraw-Hill, 2007) pp. 6-14.

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purview of regulat ing aut hor it ies namely Reser ve Bank of India,
Secur it ies Exchange Board of I ndia, Companies Act , Secur it ies Co nt ract
(Regulat io n) Act and so on. Whereas unorganized financial inst it ut ions
are not cover under t he pur view o f t hese regulat ing aut hor it ies, such t ype
of inst it ut ions are called local mo ney len ders, pawn brokers et c. Our st udy
is ma inly focusing on for mal or organized financial int er mediar ies‟ only. 5

Organised financial int er mediar ies can be classified as Banking

Inst it ut ions, Non Banking Financial I nst it ut io ns, I nsurance Co mpanies and
Housing Finance Co mpanies.

These financial int er mediar ies plays vit al role in t he capit al for mat ion by
means of mo biliz ing savings and facilit at ing t he allocat io n of funds in an
effect ive manner. T hese int er mediar ies provide t he convenience t o t he
small invest or s by mo bilizing t heir savings in t he for m o f divisibilit y and
dist r ibut e t he claims at t he t ime o f mat ur it y or redempt io n.

ii. Financial inst ru ments:

Financial inst rument s can be cat egor ized int o var io us part s namel y
equit y shares, prefer ence shares, debt inst rument s and var io us
co mbinat io ns o f t hese, t ime deposit s, Mut ual Funds and insurance po lices,
fut ures, opt ions et c.

A financ ial asset /Inst rument /secur it y is a claim against anot her econo mic
unit and is held as a st ore of value and for t he ret u r n t hat is expect ed 6.
While t he value o f a t angible/phys ica l asset depends on it s physical
propert ies such as buildings, machines, furnit ur e's, vehicles and so on, a
financial asset represent s a cla im t o fut ure cash flows in t he for m o f
int erest , dividends and so on. T hey are a claim o n a st ream o f inco me

5
Ajit Singh, ‘Financial Liberalization, Stock Markets and Economic Development.’ The Economic Journal, vol.
107 (May 1997), pp. 607-12.
6
Bimal, Jalan,, ‘Finance and Development’, RBI bulletin, (June 2000), pp. 29-45

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and/or part icular asset s.. The ent it y/econo mic unit t hat offer t he fut ure
cash flows are t he issuer o f t he financ ial inst rument ‟ and t he owner o f t he
secur it y is t he invest or‟.

Depend ing upon t he nat ure of claim/ret urn, an inst rument may be

a. debt (secur it y) such as bonds, debent ures, t erm loans,

b. Equit y (secur it y) shares and
c. Hybr id secur it y such as prefer ence shar es and convert ibles.

Based o n t he t ype o f issuer, t he secur it y may be (1) direct (2) indir ect
and (3) der ivat ive. T he secur it ies issued by manufact ur ing co mpanies are
direct asset s (e.g. shares/debent ures). I ndirect asset s are cla ims against
financial int er mediar ies (e.g. unit s o f mut ual funds). The der ivat ive
inst rument s include opt ions and fu t ures. The prevalence of a var iet y o f
secur it ies t o suit t he invest ment requirement s o f het erogeneous invest ors
offer s different iat ed invest ment cho ice t o t hem and is an import ant
element in t he mat ur it y and sophist icat io n of t he financia l syst em.

iii. Financial Services:

Financial ser vices have been growing rapidly wit h t he emergence o f new
invest ment flows in financial r econst it ute a large and growing sect or in
almost all eco no mies. Trade and invest ment flows in financia l ser vices
have been growing r ap idly wit h t he emergence o f new and growing
market s in developing and t ransit io n econo mies, wit h moder nizat ion,
rapid t echno logical change, use o f new financ ial inst rument s, and
financial and t rade liber alizat ion 7. The financial ser vices sect or is also
quit e large and co mplex and covers a wide range o f act ivit ies and
inst rument s, inc luding for inst ance, corporat e banking, der ivat ives,
fact oring, foreign exchange t rading, pensio ns and invest ment fund
management , advisor y and consult ancy ser vices, insurance br oking and
7
Bharati, Pathak, Indian Financial Systems, (Delhi, Pearson Education, 2006), pp. 4-5.

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underwr it ing, pro ject finance, secur it ies t rading, vent ure capit al, and
who lesale and ret ail banking ser vices. Given t he range o f inst rument s and
act ivit ies t hat fall under t he pur view o f t he financ ial ser vices sect or, t here
are also a large numb er o f player s.

iv. Financial Market:

The I ndian Financial Market promot es t he enor mous savings o f t he

econo my, by providing an effect ive channel o f ret urns t o t he invest ors
fro m who m t he savings are mo bilized. Hence, t he t er m F inancial Market s
can be defined as a market for t he exchange of capit al and credit
inc luding t he mo ney mar ket s and t he capit al market s. Financia l Market s
are fac ilit at ing t ools for procurement of funds and invest in t o var ious
asset s. 8

The main act ivit ies o f Financia l Market s can be viewed as sale or
purchase o f shares or st ocks, bonds, bills o f exchange, co mmodit ies,
fut ure and opt ions, foreign currenc y et c. Financia l market can be broadl y
classified int o ( i) Mo ney market ( ii) Capit al market .

v. Money Market

The Mone y Market refer s t o t he market for short t er m debt inst rument
which has mat ur it y less t han o ne year. The Money Market provides t he
borrower t o borrow t he funds for short er per iod wit h lowest cost of funds.
At t he same t ime it also facilit at es to t he invest or a plat for m t o invest his
savings which can generat e int erest t hereon. Money Market s does not
have an organised t rading market place such as t he st ock exchange for it s
pr imar y issue and seco ndar y market t rades. The part ic ipant s in t he mo ne y
market are banks, pr imar y dealers, and financial inst it ut ions, mut ua l
funds, and no n- bank financial co mpanies, manufact ur ing co mpanies, St at e
Gover nment s, provident funds, no n-resid ent Indians, overseas corporat e
8
Bharati, Pathak, Indian Financial Systems, (Delhi, Pearson Education, 2008), pp. 42-45.

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bodies, foreign inst it ut ional invest ors and t rust s. The RBI and S ecur it ies
and Exchange Board of India (SEBI) regulat e t he part icipant s and use of
inst rument s in t he mo ney market depending upon t heir respect ive ro les in
t he financial syst em 9. For inst ance, financial inst it ut ions and mut ual funds
are allowed only as lend er s in t he call money market but are per mit t ed t o
buy and se ll Co mmer cial Paper.

vi. Capital Market:

Capit a l Market is t he market for lo ng t erm finance wit h t he mat ur it y

per iod more t han one year. The Capit al Market deals wit h t he st ock
market s which pro vide financing t hrough t he issuance o f shar es or
co mmo n st ock in t he pr imar y market , and enable t he subsequent t rading i n
t he seco ndar y market . Capit al Market s also deals wit h Bo nd Market whic h
provide financing t hrough issuance o f Bonds in t he pr imar y m arket and
10
subsequent trading t her eo f in t he secondary market .

3.2 Functions of Capital Market s: Capit al market pla ys an import ant

role in mo bilis ing resources, and divert ing t hem in product ive channels.
In t his way, it facilit at es and promot es t he proc ess o f econo mic growt h in
t he count r y. Var io us funct ions and significance o f capit al market are
discussed below;

i. Link b etween Savers and Investors: T he cap it al market funct io ns as a

link bet ween saver s and invest ors. It plays an import ant role in mo bili sing
t he savings and divert ing t hem in product ive invest ment . In t his way,
capit al market plays a vit al ro le in t ransferr ing t he financia l resources
fro m surplus and wast eful areas t o deficit and product ive areas, t hus
incr easing t he product ivit y and prosp er it y of t he count r y.

9
Ibid
10
Bharati, Pathak, Indian Financial Systems, (Delhi, Pearson Education, 2008), pp. 42-45.

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ii. Encou ragement to Saving: Wit h t he development o f capit al, market ,

t he banking and non- banking inst it ut ions provide facilit ies, whic h
encourage people t o save more. I n t he less - develo ped count r ies, in t he
absence o f a capit al mark et , t here are ver y lit t le savings and t hose who
save o ft en invest t heir savings in unproduct ive and wast eful direct io ns,
i.e., in real est at e ( like land, gold, and jeweller y) and conspicuous
consu mpt ion.

iii. Encou ragement to Invest ment: The capit al market facilit at es lending
to t he businessmen and t he gover nment and t hus encourages invest ment . It
provides facilit ies t hrough banks and nonbank financial inst it ut io ns.
Var ious financ ial asset s, e.g., shares, secur it ies, bonds, et c., induce saver s
to lend t o t he gover nment or invest in indust r y. Wit h t he develop ment of
financial inst it ut io ns, capit al beco mes mo re mobile, int erest rat e falls and
invest ment increases.

iv. Promotes Economic G rowth: T he capit al market not only reflect s t he

general co ndit io n o f t he eco no my, but also smoot hens and accelerat es t he
process o f econo mic growt h. Var ious inst it ut ions o f t he capit al market ,
like no nbank financial int er mediar ies, allocat e t he resources rat ionally in
accordance wit h t he deve lopment needs of t he count r y. The pr oper
allocat io n o f resources result s in t he expansio n o f t rade and indust r y i n
bot h public and pr ivat e sect ors, t hus pro mot ing balanced econo mic growt h
in t he count r y.

v. Stability in Secu rity Prices: T he capit al market t ends t o st abilise t he

values o f st o cks and secur it ies and reduce t he fluct uat ions in t he pr ices t o
t he minimu m. T he process of st abilisat io n is facilit at ed by providing
capit al t o t he borrowers at a lower int erest rat e and reduc ing t he
speculat ive and unproduct ive act ivit ies.

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4. Conclusion

In t he recent past t he Indian Financial S yst em has undergo ne sea changes

and invent ed many new channels o f financial sub -s yst ems t hrough t he
process o f financial refor ms. T he past decade has wit nessed t he mult ip le
growt hs in t he vo lume o f int er nat io nal t r ade and business due t o t he wave
of glo balizat io n and liber alizat ion all over t he wor ld. As a result , t he
demand for t he int er nat ional mo ney and financial inst rument s increased
significant ly at t he glo bal level. I n t his respect , changes in t he int erest
rat es, exchange rat es and st ock market pr ices at t he different financia l
market s have incr eased t he financial r isks to t he corporat e world. Adverse
changes have even t hreat ened t he ver y surviva l o f t he business wor ld. It
is, t her efore, to manage such r isks; t he new financia l inst rument s have
been developed in t he financia l market s, which are also popular ly know n
as financia l der ivat ives. T he basic purpose of t hese inst rument s is t o
provide co mmit ment s t o prices for fut ure dat es for giving prot ect ion
against ad ver se mo vement s in fut ure pr ices, in order to reduce t he ext ent
of financia l r isks. Not only t his, t hey also provide opport unit ies t o earn
profit for t hose persons who are ready to go for higher r isks. In ot her
words, t hese inst rument s, indeed, facilit at e t o t ransfer t he r isk fro m t hose
who wish t o avo id it to t hose who are willing t o accept t he same.

5. References

1. Ajit S ingh, „Financial Liber alizat ion, St ock Market s and Econo mic
Develo pment .‟ T he Econo mic Jour nal, vo l. 107 (May 1997), pp. 607 -
12.

2. Bharat i, Pat hak, Indian Financia l S yst ems, (Delhi, Pearso n

Educat ion, 2006), pp. 4 -5.

3. Bharat i, Pat hak, Indian Financia l S yst ems, (Delhi, Pearso n

Educat ion, 2008), pp. 42 -45.

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4. Bimal, Jalan,, „Finance and Development ‟, RBI bullet in, ( June 2000),
pp. 29-45.

5. Debashish, S at hya Swaroop, “I mpact of Fut ures Trading Act ivit y o n

Stock Pr ice vo lat ilit y o f NSE Nift y Stock Index”, Derivative
Market s, IUP, Vol. V, No. 4, 2008, pp. 75-78.

6. Figlewaski S, “Fut ures Trading and Vo lat ilit y in GNMA

fut ures”, T he Journal of Finance, Vo l. 36, 1981, pp. 445 -456.

7. Gaut ham, Kaushik, “Der ivat ives – Ris k Management Tool”, Capital
Market, ICFAI, 3-16 May 2008.

8. Graham S mit h, “St ock Index Fut ures Trading and Vo lat ilit y in
Int ernat ional Equit y Market s”, Journal of Futures Market s, Vo l.20,
2003, pp. 661-685.

9. L. M. Bho le, Financia l I nst it ut ions and Market s: St ruct ure, Growt h
and Inno vat io n. (New Delhi, Tat a McGraw -Hill, 2007) pp. 6-14.

10. L. M. Bho le, Financia l I nst it ut ions and Market s: St ruct ure, Growt h
and Inno vat io n. (New Delhi, Tat a McGr aw-Hill, 2007) pp. 6-14.

11. Susan, T ho mas (ed), Der ivat ive Market s in I nd ia, (New Delhi, Tat a
McGraw-Hill 2003), p. 15

12. U. R. Bhat , „The Market Needs A Make Over‟, The Econo mic T imes,
(December 13 2004), p. 8

194