Role of Finacial System in Indian Economy

AIJRRLSJM VOLUME 1, ISSUE 10 (2016, NOV) (ISSN-2455-6602) ONLINE
ANVESHANA’S INTERNATIONAL JOURNAL OF RESEARCH IN REGIONAL STUDIES, LAW, SOCIAL

SCIENCES, JOURNALISM AND MANAGEMENT PRACTICES
ROLE OF FINACIAL SYSTEM IN INDIAN ECONOMY

C.A. MAHESH KUMAR, E.GIREESH A.JITHENDRA
(Asst,,prof),Deportment of P.G Student, Department Of P.G Student, department of
Management, Gates Institute Management Studies Gates Management Studies Gates
of Technology,Gooty- Institute Of Technology, institute of Technology,
515401,A.P.E- Gooty-515401, A.P. E-mail: Gooty-515401, A.P E-mail:
mail:maheshkumar6684@g [email protected] [email protected]
mail.com, m m
ABSTRACT
Finance holds the key to achieving long-term growth prospective for any country. As the
economy grows and becomes more complex and market-oriented, the financial sector starts
playing a crucial role in supporting growth by channeling domestic and foreign capital into
productive investments. Increasing access to the financial system is also a main concern for
making growth more balanced and sustainable, from both economic and social perspectives.
Financial systems one of the industries in an economy. It performs certain essential functions
for the economy including maintenance of payment system, collection & allocation of the
savings of society and creation of a variety of stores of wealth to suit the preferences of
savers. It is a link between the saving & investments by providing the mechanism through
which savings of savers are pooled and are put into the hands of those able & willing to
invest by financial intermidateres. The role of financial system is thus, to promote savings
and their channelization in the economy through financial assets that are more productive
than the physical assets. Developing countries attach great importance to financial sector
development and deepening in the pursuit of their poverty reduction goal. By mobilizing
savings, facilitating payments and trade of goods and services, and promoting efficient
allocation of resources, the financial sector is seen as playing a critical role in facilitating
economic growth and, directly through broadening access to finance and indirectly through
growth, contributing to poverty reduction
Keywords: Economic, poverty reduction, Financial services, Finacial Intermidaters,
Fiancial Assets, Foreign Capital.
INTRODUCTION
INDIAN FINANCIAL SYSTEM
Meaning and definition of financial system:
The financial system is possibly the most important institutional and functional vehicle for
economic transformation. Finance is a bridge between the present and the future and whether
the mobilization of savings or their efficient, effective and equitable allocation for
investment, it the access with which the financial system performs its functions that sets the
pace for the achievement of broader national objectives.
According to Christy, the objective of the financial system is to “supply funds to various
sectors and activities of the economy in ways that promote the fullest possible utilization of
resources without the destabilizing consequence of price level changes or unnecessary
interference with individual desires.”
According to Robinson, the primary function of the system is “ to provide a link between
savings and investment for the creation of new wealth and to permit portfolio adjustment in
the composition of the existing wealth.
A financial system or financial sector functions as an intermediary and facilitates the flow of
funds from the areas of surplus to the deficit. It is a composition of various institutions,

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40
markets, regulations and laws, practices, money manager analyst, transactions and claims and
liabilities.
Features of financial system

The features of a financial system are as follows
1. Financial system provides an ideal linkage between depositors and investors, thus
encouraging both savings and investments.
2. Financial system facilitates expansion of financial markets over space and time.
3. Financial system promotes efficient allocation of financial resources for socially
desirable and economically productive purposes.
4. Financial system influences both the quality and the pace of economic development.
CONSTITUENTS OF FINANCIAL SYSTEM

The financial system consists of four segments or components. These are: financial
institutions, financial markets and financial services.
1. Financial institutions: Financial institutions are intermediaries that mobilize savings &
facilitate the allocation of funds in an efficient manner.
Financial institutions can be classified as banking & non-banking financial institutions.
Banking institutions are creators of credit while non-banking financial institutions are
purveyors of credit. While the liabilities of banks are part of the money supply, this may not
be true of non-banking financial institutions. In India, non-banking financial institutions,
namely, the developmental financial institutions (DFIs) & non-banking financial companies
(NBFCs) as well as housing finance companies (HFCs) are the major institutional purveyors
of credit. Financial institutions can also be classified as term-finance institutions such as the
industrial development bank of India (IDBI), industrial credit & Investment Corporation of
India (ICICI), industrial financial corporation of India (IFCI), small industries development
bank of India (SIDBI) & industrial investment bank of India (IIBI).
2. Financial markets:
Financial markets are a mechanism enabling participants to deal in financial claims.
The markets also provide a facility in which their demands & requirements interact to set a
price for such claims. The main organized financial markets in India are the money market &
capital market. The first is a market for short-term securities. Money market is a market for
dealing with financial assets & securities which have a maturity period of upto one year.
While the second is a market for long term securities, that is, securities having a maturity
period of one year or more. The capital market is a market for financial assets which have a
long or indefinite maturity.
Money market consists of:

Call money market:
Call money market is a market for extremely short period loans say one day to fourteen days.
It is highly liquid.
Commercial bills market:

It is a market for bills of exchange arising out of genuine trade transactions. In the case of
credit sale, the seller may draw a bill of exchange on the buyer. The buyer accepts such a bill
promising to pay at a later date the amount specified in the bill. The seller need not wait until
the due date of the bill. Instead, he can get immediate payment by discounting the bill.

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Treasury bills market:

It is a market for treasury bills which have „short-term‟ maturity. A treasury bill is a
promissory note or a finance bill issued by the government. It is highly liquid because its
repayment is guaranteed by the government.
Short-term loan market:
It is a market where short- term loans are given to corporate customers for meeting their
working capital requirements. Commercial banks play a significant role in this market.
Capital market consists of:
Industrial securities market:
It is a market for industrial securities namely equity shares or ordinary shares, preference
shares & debentures or bonds. It is a market where industrial concerns raise their capital or
debt by issuing appropriate instruments. It can be further subdivided into primary &
secondary market.
Government securities market:
It is otherwise called gilt-edged securities market. It is a market where government securities
are traded. In India there are many kinds of govt securities- short-term & long-term. Long-
term securities are traded in this market while short term securities are traded in the money
market.
Long-term loans market:
Development banks & commercial banks play a significant role in this market by supplying
long term loans to corporate customers. Long-term loans market may further be classified
into:
Term loans market
Mortgages market
Financial guarantees market
3. Financial Instruments:
Financial instruments refer to that document which represents financial claims on assets. As
discussed earlier, financial assets refers to a claim to the repayment of certain sum of money
at the end of specified period together with interest or dividend. Examples : bills of exchange,
promissory notes, treasury bills, government bonds, deposit receipts, shares debentures etc.
Financial instruments can also be called financial securities. Financial securities can be
classified into:
i. Primary or direct securities
ii. Secondary or indirect securities.
Primary securities
These are securities directly issued by the ultimate investors to the ultimate savers. Examples,
shares and debentures issued directly to the public.
Secondary securities
These are securities issued by some intermediaries called financial intermediaries to the
ultimate savers. E.g. unit trust of India and Mutual funds issue securities in the form of units
to the public and money pooled is invested in companies.
Again these securities may be classified on the basis of duration as follows:
i. Short-term securities
ii. Medium-term securities
iii. Long-term securities.
Short-term securities are those which mature within a period of one year. E.g. Bills of
exchange, treasury bills, etc. medium term securities are those which have a maturity period
ranging between one and five years.

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e.g. Debentures maturing within a period of 5 years. Long-term securities are those which
have a maturity period of more than five years. E.g. government Bonds maturing after 10
years.
Structure and Function of of Indian Financial System
Financial System is a set of institutional arrangements through which financial surpluses in
the economy are mobilised from surplus units and transferred to deficit spenders.
The institutional arrangements include all conditions and mechanisms governing the
production, distribution, exchange and holding of financial assets or instruments of all kinds
and the organisations as well as the manner of operations of financial markets and institutions
of all descriptions.
Thus, there are three main constituents of financial system:
(a) Financial Assets
(b) Financial Markets, and
(c) Financial Institutions.
Financial assets are subdivided under two heads:

Primary securities and secondary securities. The former are financial claims against real-
sector units, for example, bills, bonds, equities etc. They are created by real-sector units as
ultimate borrowers for raising funds to finance their deficit spending. The secondary
securities are financial claims issued by financial institutions or intermediaries against
themselves to raise funds from public. For examples, bank deposits, life insurance policies,
UTI units, IDBI bonds etc.
Functions of Financial System:
The financial system helps production, capital accumulation, and growth by (i) encouraging
savings, (ii) mobilising them, and (iii) allocating them among alternative uses and users. Each
of these functions is important and the efficiency of a given financial system depends on how
well it performs each of these functions.
(i) Encourage Savings:
Financial system promotes savings by providing a wide array of financial assets as stores of
value aided by the services of financial markets and intermediaries of various kinds. For
wealth holders, all this offers ample choice of portfolios with attractive combinations of
income, safety and yield.
With financial progress and innovations in financial technology, the scope of portfolio choice
has also improved. Therefore, it is widely held that the savings-income ratio is directly
related to both financial assets and financial institutions. That is, financial progress generally
insures larger savings out of the same level of real income.

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As stores of value, financial assets command certain advantages over tangible assets
(physical capital, inventories of goods, etc.) they are convenient to hold, or easily storable,
more liquid, that is more easily encashable, more easily divisible, and less risky.
(ii) Mobilisation of Savings:
Financial system is a highly efficient mechanism for mobilising savings. In a fully-monetised
economy this is done automatically when, in the first instance, the public holds its savings in
the form of money. However, this is not the only way of instantaneous mobilisation of
savings.
.
(iii) Allocation of Funds:
Another important function of a financial system is to arrange smooth, efficient, and socially
equitable allocation of credit. With modem financial development and new financial assets,
institutions and markets have come to be organised, which are replaying an increasingly
important role in the provision of credit.
Structure of Indian Financial System:
Financial system operates through financial markets and institutions.
The Indian Financial system (financial markets) is broadly divided under two heads:
(i) Indian Money Market
(ii) Indian Capital Market
The Indian money market is the market in which short-term funds are borrowed and lent. The
money market does not deal in cash, or money but in bills of exchange, grade bills and
treasury bills and other instruments. The capital market in India on the other hand is the
market for the medium term and long term funds.
Role of financial system in economic development of a country
Finance
Relationship between financial system and economic development
The development of any country depends on the economic growth the country achieves over
a period of time. Economic growth deals about investment and production and also the extent
of Gross Domestic Product in a country. Only when this grows, the people will experience
growth in the form of improved standard of living, namely economic development.
Role of financial system in economic development of a country
The following are the roles of financial system in the economic development of a country.
Savings-investment relationship
To attain economic development, a country needs more investment and production. This can
happen only when there is a facility for savings. As, such savings are channelized to
productive resources in the form of investment. Here, the role of financial institutions is
important, since they induce the public to save by offering attractive interest rates. These
savings are channelized by lending to various business concerns which are involved in
production and distribution.
Financial systems help in growth of capital market
Any business requires two types of capital namely, fixed capital and working capital. Fixed
capital is used for investment in fixed assets, like plant and machinery. While working capital

44
is used for the day-to-day running of business. It is also used for purchase of raw materials
and converting them into finished products.
 Fixed capital is raised through capital market by the issue of debentures and shares.
Public and other financial institutions invest in them in order to get a good return with
minimized risks.
 For working capital, we have money market, where short-term loans could be raised by
the businessmen through the issue of various credit instruments such as bills, promissory
notes, etc.
Foreign exchange market enables exporters and importers to receive and raise funds for
settling transactions. It also enables banks to borrow from and lend to different types of
customers in various foreign currencies. The market also provides opportunities for the banks
to invest their short term idle funds to earn profits. Even governments are benefited as they
can meet their foreign exchange requirements through this market.
Government Securities market
Financial system enables the state and central governments to raise both short-term and long-
term funds through the issue of bills and bonds which carry attractive rates of interest along
with tax concessions. The budgetary gap is filled only with the help of government securities
market. Thus, the capital market,money market along with foreign exchange market and
government securities market enable businessmen, industrialists as well as governments to
meet their credit requirements. In this way, the development of the economy is ensured by the
financial system.
Financial system helps in Infrastructure and Growth
Economic development of any country depends on the infrastructure facility available in the
country. In the absence of key industries like coal, power and oil, development of other
industries will be hampered. It is here that the financial services play a crucial role by
providing funds for the growth of infrastructure industries. Private sector will find it difficult
to raise the huge capital needed for setting up infrastructure industries. For a long time,
infrastructure industries were started only by the government in India. But now, with the
policy of economic liberalization, more private sector industries have come forward to start
infrastructure industry. The Development Banks and the Merchant banks help in raising
capital for these industries.
Financial system helps in development of Trade
The financial system helps in the promotion of both domestic and foreign trade. The financial
institutions finance traders and the financial market helps in discounting financial instruments
such as bills. Foreign trade is promoted due to per-shipment and post-shipment finance by
commercial banks. They also issue Letter of Credit in favor of the importer. Thus, the
precious foreign exchange is earned by the country because of the presence of financial
system. The best part of the financial system is that the seller or the buyer do not meet each
other and the documents are negotiated through the bank. In this manner, the financial system
not only helps the traders but also various financial institutions. Some of the capital goods are
sold through hire purchase and installment system, both in the domestic and foreign trade. As
a result of all these, the growth of the country is speeded up.
Employment Growth is boosted by financial system
The presence of financial system will generate more employment opportunities in the
country. The money market which is a part of financial system, provides working capital to
the businessmen and manufacturers due to which production increases, resulting in
generating more employment opportunities. With competition picking up in various sectors,
the service sector such as sales, marketing, advertisement, etc., also pick up, leading to more
employment opportunities. Various financial services such as leasing, factoring, merchant
banking, etc., will also generate more employment. The growth of trade in the country also

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induces employment opportunities. Financing by Venture capital provides additional

opportunities for techno-based industries and employment.
Venture Capital
There are various reasons for lack of growth of venture capital companies in India. The
economic development of a country will be rapid when more ventures are promoted which
require modern technology and venture capital. Venture capital cannot be provided by
individual companies as it involves more risks. It is only through financial system, more
financial institutions will contribute a part of their investable funds for the promotion of new
ventures. Thus, financial system enables the creation of venture capital.
Financial system ensures Balanced growth
Economic development requires a balanced growth which means growth in all the sectors
simultaneously. Primary sector, secondary sector and tertiary sector require adequate funds
for their growth. The financial system in the country will be geared up by the authorities in
such a way that the available funds will be distributed to all the sectors in such a manner, that
there will be a balanced growth in industries, agriculture and service sectors.
Financial system helps in fiscal discipline and control of economy
It is through the financial system, that the government can create a congenial business
atmosphere so that neither too much of inflation nor depression is experienced. The industries
should be given suitable protection through the financial system so that their credit
requirements will be met even during the difficult period. The government on its part, can
raise adequate resources to meet its financial commitments so that economic development is
not hampered. The government can also regulate the financial system through suitable
legislation so that unwanted or speculative transactions could be avoided. The growth of
black money could also be minimized.
Financial system’s role in Balanced regional development

Through the financial system, backward areas could be developed by providing various
concessions or sops.
CONCLUSION
Based on this paper The Indian financial system has undergone structural transformation over
the past decade. The financial sector has acquired strength, efficiency and stability by the
combined effect of competition, regulatory measures, and policy environment. While
competition, consolidation and convergence have been recognized as the key drivers of the
banking sector in the coming years
Financial system plays a significant role in the economic development of a country.

Financial markets present three major efficiencies for the sake of development and they are
allocation, information, and operational efficiency. Financial institutions are profit
maximizing businesses that earn profits by acquiring funds at interest rates lower than they
earn on their assets.
REFERENCES
 Bhole L M, "Financial Institutions and markets", Tata McGraw-Hall, New Delhi,

1999.
 Khan M Y, "Indian Financial System, Tata Mc Graw-Hill, New Delhi, 2001..
 Pandey I M, Financial Management, Vikas Publications, New Delhi, 2000.

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 Mishra R K, An Overview of financial services, financial services, emerging trends,

Delta, Hyderabad, 1997.
 Mishra R K, "Development of financial services in India some perspectives",
Financial services in India Delta, Hyderabad, 1998.
 Financial Markets and Services, Gordon, Natarajan, Himalaya Publishing House,
4th revised edition, 2007.
 www.bseindia.com
 www.nseindia.com
 www.rbi.org.in
 www.sebi.gov.in
 www.indiainfoline.com

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AIJRRLSJM VOLUME 1, ISSUE 10 (2016, NOV) (ISSN-2455-6602) ONLINE

ANVESHANA’S INTERNATIONAL JOURNAL OF RESEARCH IN REGIONAL STUDIES, LAW, SOCIAL