module 1 - overview of financial system - uae

8/10/2019 Module 1 - Overview of Financial System - UAE

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Overview of Financial System

CA. Sonali Jagath Prasad


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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

mobilization of savings or their efficient, effective and equitable

allocation for investment Its the access with which the financial system performs its functions

that sets the pace for the achievement of broader national

objectives.

According to Robinson, the primary function of the system is to

provide a link between savings and investment for the creation ofnew wealth and to permit portfolio adjustment in the composition of

the existing wealth.

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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.

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Financial System

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, markets, regulations and

laws, practices, money manager analyst, transactions and claimsand liabilities.

Functions of financial system: 1.Promotion of liquidity

2. Link between savers and investors

3. Information available

4. Helps in projects selection 5. Allocation of risk

6. Minimizes situations of Asymmetric information - It provides financial services such as

insurance and pension and offers portfolio adjustments facilities.

7. Reduce cost of transaction and borrowing

8. Financial deepening and broadening

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FunctionsFacilitates capital formation by providing a link between savers &

Investors

a market for creation and exchange of financial assets

Performs the following Functions essential for the modern economy:

Payment

SystemTransfer Of

Resources

Pooling Of

Funds

Risk

Manageme

nt

Price

Information


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Indian Financial Sys tem An Overv iew

FUNCTIONS Collection of SAVINGS & Distribution for INDUSTRIAL INVESTMENT.

Stimulating CAPITAL FORMATION & ACCELERATING THE ECONNOMICGROWTH

STRUCTURES1. Regulatory Bodies (RBI/SEBI/IRDA/PFRDA)2. Financial Intermediataries

3. Financial Markets

4. Financial Assets / Instruments

5. Financial services

PHASES* Upto 1951 Pvt. Sector* 1951 to 1990 Public Sector

* Early Ninties Privatisation

* Present Status Globalisation


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Process of Capital Formation

Involves three distinct, although inter-related activities.

(i) Savings:The ability by which resources are set aside and becomeavailable for other purpose.

(ii)Finance:The activity by which claims to resources are either assembledfrom those released by domestic savings, obtained from abroad, or speciallycreated usually as bank deposits or notes and then placed in the hands ofthe investor.

(iii)Investments: The activity by which resources are actually committed toproduction.

The financial system is a link between the savers (savingssurplus economicunits) and the investors (savingsdeficit economic units). It is made up of all thosechannels through which savings become available for investment.


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Orderly mechanism & structure in economy.

Mobilises the monetary resources/capital from

surplus sectors.

Distributes resources to needy sectors.

Transformation of savings into investment &

consumption.

Financial MarketsPlaces where the

above activities take place.

Financial Sys tem An Overv iew


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Indian

Financial

System

Formal(organized

Financial

system)

Informal(Unorganized

financial

system)

Regulators;

MoF, SEBI,

RBI, IRDA

Financial

Institutions

(Intermediaries)

Financial

Markets

Financial

InstrumentFinancial

Services

Money lenders,

Local bankers,

Traders

Landlor


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Formal and Informal Financial

System The financial systems of most developing

countries are characterized by co-existence andco-operation between the formal and informalfinancial sectors.

The formal financial sector is characterized bythe presence of an organized, institutional andregulated system which caters to the financialneeds of the modern spheres of economy.

The informal financial sector is anunorganized, non-institutional and non-regulatedsystem dealing with traditional and rural spheresof the economy.

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Component of Formal Financial

System

Regulators

Financial Intermediaries / Institutions

Financial Markets

Financial Instruments

Financial Services

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Regulators

The formal financial system comes under

the regulations of the Ministry of finance

(MOF), Reserve Bank of India (RBI),

Securities and Exchange board of India(SEBI) and other regulatory bodies.

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Constituents of a Financial System


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ORGANISATION Financial System consists of

What they do Who They Are

Financial Intermediaries/ Institutions (a) Collect Savings(b) Issue claim against themselves Banks, NBFC,

(c) Use Funds, thus raised, to purchase M.F, insurance

ownership or debt-claims organisations etc.

Notes: Characteristics of claims issued against

self & debt-claims are absolutely different.

(ii) Financial Markets (a) Not a Source of funds Call Market

(b) Act as a facilitating organisation and link T-Bill Market

saver & investor CP-Market

(c) Based on nature of work they are classified Repo Market

as (1) Money Market (2) Capital/Security Stock Exchange

Markets.

(iii) Financial Asset/Instrument/ (a) Financial Productinnovation Shares, Debt

Security (b) Three broad categories Instruments,

(1) Direct/Primary e.g. Share, Debt., Debentures etc.Pref. Share etc.

(2) Indirect - MF, Security Receipts,

Securitized Debt Investment.

(3) Derivatives- Forward, Future, Options.


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Components of Financial SystemFinancial

Intermediaries

Banks

NBFCs,

IncludesDevelopment

financial

institutions &

State level

financialinstitutions

Mutual

Funds

Insurance

Organizations

Financial

Markets

Money

markets (Short

term)

CapitalMarkets (long

term)

Main

Participants

FIIsMutual

Funds

Individuals

Corporates

InsuranceCos

Financial

Instruments

Primary

securities

(Direct)Eg.

Debentures,

equity

shares,etc

SecondarySecurities

(Indirect)

Eg. Bank

deposits,

Insurancepolicies,etc

Financial

Services Merchant

Banking, Credit

rating, etc. Bridges the

gap between

the knowledge

on the part of

investors &

increasingsophistication

of financial

instruments &

Markets


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Financial Institutions

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FinancialInstitutions

(Intermediaries)

Banking

InstitutionsNon-Banking

InstitutionsMutual Funds

Insurance

and

Housing

Finance companies

Public sector Private Sector

http://www.authorstream.com/Presentation/nehasinghal-721270-financial-institutions-of-india/
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Financial Institution 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 vendors of credit.

While the liabilities of banks are part of the money supply, this may not betrue 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).17


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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 fordealing 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. They are alsodivided into 2primary market and secondary market

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STRUCTURE OF FINANCIAL MARKETS IN INDIA

Financial Markets in India

Debt Market

Primary /

Secondary

Forex

Market

Capital Market

Primary /

Secondary &

Depository

Insurance

Life/General

Banks (including

RRBs, co-op etc)

Mutual Funds,

Venture Funds,

Investment

Bonds

RBI RBI SEBI IRDA RBI RBI/SEBI

REGULATORY AUTHORITY


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Financial Instruments/ assets

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FinancialInstruments

PrimarySecurities

Equity,Preference

shares, Debt

SecondarySecurities

Time deposits,MF units

Insurance policies


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Features of Financial Instruments i. Most of the instruments can be easily transferred from one hand to another without many

cumbersome formalities.

ii. They have a ready market, i.e., they can be bought and sold frequently and thus, trading in

these securities is made possible.

iii. They possess liquidity, i.e., some instruments can be converted into cash readily. For instance,

a bill of exchange can be converted into cash readily by means of discounting and rediscounting.

iv. Most of the securities posses security value, i.e., they can be given as security for the purpose

of raising loans.

v. Some securities enjoy tax status, i.e., investment in these securities are exempted from income

tax, wealth tax, etc., subject to certain limits. E.g. public sector tax free bonds, magnum tax saving

certificates.

vi. They carry risk in the sense that there is uncertainty with regard to the payment of principle or

interest or dividend as the case may be.

vii. These instruments facilitates future trading so as to cover risks due to price fluctuations,

interest rates, etc.

viii. These instruments involve less handling costs since expenses involved in buying and selling

these securities are generally much less.

ix. The return on these instruments is directly in proportion to the risk undertaken.

x. These instruments may be short-term or medium term or long term depending upon the

maturity period of these instruments.

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Financial Instruments Financial instruments refers to those 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.

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Financial Instruments Primary s ecur i t ies

These are securities directly issued by the ultimate investors to the ultimate savers.

Examples, shares and debentures issued directly to the public.

Secondary s ecuri t ies

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 maturityperiod ranging between one and five years.

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.

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Capital market Instruments

Equity Shares.

Preference shares.

Debentures.

Forward Contract.

Options.

Futures.


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Money Market InstrumentsCommercial Paper.

Call Money market.

Inter-bank term money.

Money market mutualfunds.

Inter-corporate

Deposits.

Certificate of Deposit.

Commercial Bills.

Treasury Bills.

Repo.


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MEANING OF FINANCIAL

SERVICES

Typically, it means mobilizing and allocating

SAVINGS.

It includes all activities involved in the

transformation of SAVINGS into

INVESTMENTS.

Financial Services can also be called

Financial Intermediation.


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Financial services Financial intermediaries provide key financial services such as merchant

banking, leasing hire purchases, credit-rating, and so on.

Financial services rendered by the financial intermediaries bridge the gap

between lack of knowledge on the part of investors and increasing

sophistication of financial instruments and markets.

These financial services are vital for creation of firms, industrial expansion,

and economic growth. Before investors lend money, they need to be reassured that it is safe to

exchange securities for funds. This reassurance is provided by the financial

regulator, who regulates the conduct of the market, and intermediaries to

protect the investors interests. The Reserve Bank of India regulates the

money market and Securities Exchange Board of India (SEBI) regulates

capital market.

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FEATURES OF FINANCIAL

SERVICES

Customer Oriented

Intangibility

Simultaneous Performance

Dominance Of Human Elements

Perishability


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IMPORTANCE OF FINANCIAL

SERVICES

Economic Growth

Promotion of Savings

Capital Formation

Provision of Liquidity

Financial Intermediation

Contribution to GNPCreation of Employment Opportunities


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CLASSIFICATION of providers of

financial services

1. CAPITAL MARKET:

Term Lending Institutions

Investing Institutions

Long Term Funds

2. MONEY MARKET:

Consists of Commercial banks, Co-operativebanks and other agencies.

Short term funds.


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SCOPE OF FINANCIAL SERVICES

A. TRADITIONAL ACTIVITIES

1. FUND BASED ACTIVITIES: includes

Underwriting

Dealing in secondary market activities

Participating in money market instruments

Leasing, hire-purchase, venture capital, etc.


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2. FEE BASED ACTIVITIES: includes

Managing the capital issues

Arrangements for placement of capital anddebt instruments

Arrangement of funds from financial

institutions

Assisting in Government and other clearance


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B. MORDERN ACTIVITIES

Few of them are:

1. Rendering project advisory services

2. Planning for Mergers and Acquisitions

3. Acting as trustees to the Debenture-holders

4. Hedging of risks

5. Managing the portfolio of large public sectorcompanies.

6. Undertaking risk management services.


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FINANCIAL SERVICES AND PROMOTION OF

INDUSTRIES

Industrial promotion through Merchant

Banking Services

Working Capital Finance Through Factoring

Services

Equipment Finance through Leasing

Financial resources through Mutual Funds

Long-term Risk Capital through Venture

Capital


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Risk Management through Derivatives

Debenture issue through Credit rating

Development Finance through DevelopmentBanking Sector

Industrial Development through Specialized

Services


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NEW FINANCIAL PRODUCTS AND SERIVES

Merchant Banking

Loan Syndication

Leasing

Mutual Funds

Factoring

Venture Capital

Custodial Services


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Corporate Advisory Services Securitization

Reverse Mortgage

Derivatives:

- Forward Contract- Options

- Futures

- Swaps


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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)


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Financial assets/Instruments

Enable channelizing 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


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Financial Institutions

Includes institutions and mechanisms

which

Affect generation of savings by the community

Mobilization of savings

Effective distribution of savings

Institutions are banks, insurance

companies, mutual funds- promote/mobilize savings

Individual investors, industrial and trading

companies- borrowers


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Financial Markets

Money Market- for short-term funds (lessthan a year)Organised (Banks)

Unorganised (money lenders, chit funds, etc.)

Capital Market- for long-term funds

Primary Issues MarketStock Market

Bond Market


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Function of the Financial System

Prevision of liquidity

liquidity refers to cash or money and other

assets which can be converted into cash readily

without loss of value and time.

Mobilization of savings

f f


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Weaknesses of India financial

system

Lack of co-ordination between differentfinancial institutions.

Monopolistic market structures

-LIC in life insurance-UTI in mutual fund

Dominance of development banks inindustrial financing

Inactive and erratic capital market

Imprudent financial practice

module 1 - overview of financial system - uae

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