Financial System

An institutional framework existing in a

country to enable financial transactions
Three main parts
Financial assets (loans, deposits, bonds, equities,
etc.)
Financial institutions (banks, mutual funds,
insurance companies, etc.)
Financial markets (money market, capital market,
forex market, etc.)
Regulation is another aspect of the financial
system (RBI, SEBI, IRDA, FMC)
Financial assets/instruments
Enable channelising funds from surplus units
to deficit units
There are instruments for savers such as
deposits, equities, mutual fund units, etc.
There are instruments for borrowers such as
loans, overdrafts, etc.
Like businesses governments too raise funds
through issuing of bonds, Treasury bills, etc.
Instruments like PPF, KVP, etc. are available
to savers who wish to lend money to the
government
 Money Market Instruments
Call money- money borrowed/lent for a day.
No collateral is required.
Inter-bank term money- Borrowings among
banks for a period of more than 14 days
Treasury Bills- short term instruments issued
by the Union Govt. to raise money. Issued at a
discount to the face value
Certificates of Deposit- Issued by banks to
raise money. Minimum value is Rs. 1 lakh,
tradable in the market
CDs can be issued by banks/FIs
 Money Market Instruments
(2)
Commercial Paper (CPs) are issued by
corporates to raise short term money
Issued in multiple of 25 lakhs, can be
issued by companies with a net worth of
at least 5 crores
CP is an unsecured promissory note
privately placed with investors at a
discount rate to face value. The maturity
of CP is between 3 and 6 months
 Financial Institutions
Includes institutions and mechanisms
which
Affect generation of savings by the
community
Mobilisation of savings
Effective distribution of savings
Institutions are banks, insurance
companies, mutual funds-
promote/mobilise savings
Individual investors, industrial and
 Financial Markets
Money Market- for short-term funds
(less than a year)
Organised (Banks)
Unorganised (money lenders, chit funds,
etc.)

Capital Market- for long-term funds

Primary Issues Market
Stock Market
Bond Market
 Organised Money Market
Call money market
Bill Market
Treasury bills
Commercial bills
Bank loans (short-term)
Organised money market comprises
RBI, banks (commercial and co-
operative)
 Call money market (1)
It deals with one-day loans (overnight, to be
precise) called call loans or call money
Participants are mostly banks. Also called
inter-bank call money market.
The borrowing is exclusively limited to banks,
who are temporarily short of funds.
On the lending side, besides banks with
excess cash and as special cases few FIs like
LIC, UTI
All others have to keep their funds in term
deposits of minimum 15 days with banks to
earn interest
 Call money market (2)
Call loans are generally made on a clean
basis- i.e. no collateral is required
The main function of the call money market is
to redistribute the pool of day-to-day surplus
funds of banks among other banks in
temporary deficit of funds
The call market helps banks economise their
cash and yet improve their liquidity
It is a highly competitive and sensitive market
It acts as a good indicator of the liquidity
position
 Bill Market
Treasury Bill market- Also called the T-Bill
market
These bills are short-term liabilities (91-day, 182-
day, 364-day) of the Government of India
It is an IOU of the government, a promise to pay the
stated amount after expiry of the stated period
from the date of issue
They are issued at discount to the face value and at
the end of maturity the face value is paid
The rate of discount and the corresponding issue
price are determined at each auction
Commercial Bill market- Not as developed in
India as the T-Bill market