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Indian Financial System

Indian Financial System

The Indian Financial System is one of the most important aspects of the economic development of our country. This system manages the flow of funds between the people (household savings) of the country and the ones who may invest it wisely (investors/businessmen) for the betterment of both the parties.

This is an important topic with respect to the various Government exams conducted in the country, and aspirants must carefully consider going through this article and prepare themselves accordingly.

In this article, you shall know about what the Indian Financial system is, its components and how it helps in the economic growth of a country. Also, get some Sample Questions on Indian Financial System further below in this article.

Indian Financial System – An Overview

The services that are provided to a person by the various Financial Institutions like banks, insurance companies, pensions, funds, etc. constitute the financial system. 

Given below are the features of the Indian Financial system:

  • It plays a vital role in the economic development of the country as it encourages both savings and investment
  • It helps in mobilising and allocating one’s savings
  • It facilitates the expansion of financial institutions and markets
  • Plays a key role in capital formation
  • It helps forms a link between the investor and the one saving
  • It is also concerned with the Provision of funds
  • The financial system of a country mainly aims at managing and governing the mechanism of production, distribution, exchange and holding of financial assets or instruments of all kinds.

    Further below in this article, we shall discuss the various components of the financial system in India.

  • Components of Indian Financial System

    There are four main components of the Indian Financial System. This includes:

    1. Financial Institutions
    2. Financial Assets
    3. Financial Services
    4. Financial Markets

    Let’s discuss each component of the system in detail. 

    1. Financial Institutions

    The Financial Institutions act as a mediator between the investor and the borrower. The investor’s savings are mobilised either directly or indirectly via the Financial Markets. 

    The main functions of the Financial Institutions are as follows:

    • A short term liability can be converted into a long term investment
    • It helps in conversion of a risky investment into a risk-free investment
    • Also acts as a medium of convenience denomination, which means, it can match a small deposit with large loans and a large deposit which small loans

    The best example of a Financial Institution is Bank. People with surplus amounts of money make savings in their accounts, and people in dire need of money take loans. The bank acts as an intermediate between the two.

    The financial institutions can further be divided into two types:

    • Banking Institutions or Depository Institutions – This includes banks and other credit unions which collect money from the public against interest provided on the deposits made and lend that money to the ones in need
    • Non-Banking Institutions or Non-Depository Institutions – Insurance, mutual funds and brokerage companies fall under this category. They cannot ask for monetary deposits but sell financial products to their customers.

    Further, Financial Institutions can be classified into three categories:

    • Regulatory – Institutes that regulate the financial markets like RBI, IRDA, SEBI, etc.
    • Intermediates – Commercial banks which provide loans and other financial assistance such as SBI, BOB, PNB, etc. 
    • Non Intermediates – Institutions that provide financial aid to corporate customers. It includes NABARD, SIBDI, etc. 

    2. Financial Assets

    The products which are traded in the Financial Markets are called the Financial Assets. Based on the different requirements and needs of the credit seeker, the securities in the market also differ from each other. 

    Some important Financial Assets have been discussed briefly below:

    • Call Money – When a loan is granted for one day and is repaid on the second day, it is called call money. No collateral securities are required for this kind of transaction. 
    • Notice Money – When a loan is granted for more than a day and for less than 14 days, it is called notice money. No collateral securities are required for this kind of transaction.
    • Term Money – When the maturity period of a deposit is beyond 14 days, it is called term money.
    • Treasury Bills – Also known as T-Bills, These are Government bonds or debt securities with maturity of less than a year. Buying a T-Bill means lending money to the Government.
    • Certificate of Deposits – It is a dematerialised form (Electronically generated) for funds deposited in the bank for a specific period of time.
    • Commercial Paper – It is an unsecured short-term debt instrument issued by corporations.

    3. Financial Services

    Services provided by Asset Management and Liability Management Companies. They help to get the required funds and also make sure that they are efficiently invested.

    The financial services in India include:

    • Banking Services – Any small or big service provided by banks like granting a loan, depositing money, issuing debit/credit cards, opening accounts, etc. 
    • Insurance Services – Services like issuing of insurance, selling policies, insurance undertaking and brokerages, etc. are all a part of the Insurance services
    • Investment Services – It mostly includes asset management
    • Foreign Exchange Services – Exchange of currency, foreign exchange, etc. are a part of the Foreign exchange services

    The main aim of the financial services is to assist a person with selling, borrowing or purchasing securities, allowing payments and settlements and lending and investing. 

    4. Financial Markets

    The marketplace where buyers and sellers interact with each other and participate in the trading of money, bonds, shares and other assets is called a financial market. 

    The financial market can be further divided into four types:

    • Capital Market – Designed to finance the long term investment, the Capital market deals with transactions which are taking place in the market for over a year. The capital market can further be divided into three types:

             (a)Corporate Securities Market

             (b)Government Securities Market 

             (c)Long Term Loan Market 

    • Money Market – Mostly dominated by Government, Banks and other Large Institutions, the type of market is authorised for small-term investments only. It is a wholesale debt market which works on low-risk and highly liquid instruments. The money market can further be divided into two types:

             (a) Organised Money Market

             (b) Unorganised Money Market

    • Foreign exchange Market – One of the most developed markets across the world, the Foreign exchange market, deals with the requirements related to multi-currency. The transfer of funds in this market takes place based on the foreign currency rate.
    • Credit Market – A market where short-term and long-term loans are granted to individuals or Organisations by various banks and Financial & Non-Financial Institutions is called Credit Market
    • Sample Questions on Indian Financial System

      Given below are a few sample questions for the candidates to have an idea about the type of questions asked in the Government exams on the topic: Indian Financial System:

      Q 1. Which of these is not a type of Capital Market?

      1. Corporate Securities Market
      2. Government Securities Market
      3. Long Term Loan Market 
      4. All of the Above
      5. None of the Above

      Answer: (4) All of the Above

      Q 2. Which of these is not a type of Financial Assets?

      1. Cheque
      2. Call Money
      3. Notice Money
      4. Treasury Bill
      5. Commercial Paper

      Answer: (1) Cheque

      Q 3. Which of these is not a fundamental objective of Indian Financial System?

      1. To give time value to money
      2. Offer Services that reduce risk of loss
      3. Issuing Bank Notes
      4. Provide a payment System
      5. All of the above

      Answer: (3) Issuing Bank Notes

      Q 4. When a loan is granted for only one day, it is called _________?

      1. Notice Money
      2. Immediate Bill
      3. Treasury Bill
      4. Call Money
      5. Commercial Bill

      Answer: (4) Call Money

      Questions for descriptive answers can also be asked from this topic


      Frequently Asked Question – Financial System in India

      Q.1. What is the use of the financial system?

      Ans. The Financial System of an economy provides a way to exchange funds between the lenders and the borrowers. The efficient allocation of economic resources is achieved by a financial system.

      Q.2. What is the Financial System?

      Ans. The Financial System is a set of institutions, markets or instruments that promotes savings by channelising them to the most efficient use.

      Q.3. What are the important functions of a financial system?

      Ans. Capital accumulation, Production and Growth are what a financial system helps in. Thus, functions of the financial system are encouraging saving, mobilising savings and allocation the funds to alternative uses.

      Q.4. What are the objectives of a financial system?

      Ans. Facilitating payments, a link between the lender and borrower, help in capital formation, ensuring the safety of investment and economy growth are a few objectives of a financial system.

      Q 5. Indian Financial System is divided into how many categories?

      Ans. Broadly there are two categories of Indian Financial System, i.e. Indian Money market and Indian capital Market:

          • Indian Money Market – in which short term funds are lent and borrowed.
          • Indian Capital Market – where medium and long term exchanges happen.