Indian Financial System —An Overview
Introduction:
A sound financial system is necessary in an economy. It plays an important role in transforming savings into investments and consumption. Financial assets that aid the transformation process meet the investors' and spenders' individual demands and needs. Intermediaries such as financial institutions and banks support the offerings of financial assets and intermediate between investors and spenders.
Let's review the different aspects of the Indian financial system.
Learning Objectives :
- Review the roles and functions of the Central Banking Authority.
- Review the role of the Capital Market Regulatory Authority.
- Review the role of the Insurance Regulatory and Development Authority (IRDA).
- Examine the functions of the Multi Commodity Exchange of lndia (MCX).
A financial system is categorised into various constituents based on the activities that they perform. There are three regulatory authorities that control the constituents.
Financial System Mainly divide into 3 segments
1. Central Banking Authority and its Functions :
Reserve Bank of lndia (RBI) is the Central Banking Authority of the country. Two of its most distinct roles are bank supervision and monetary control. It maintains the overall financial health of banks by carrying on-site and off-site surveillance. RBI uses mechanisms such as CRR, SLR and REPO rates to control the prime rates of leading banks, thereby exercising monetary control. RBI maintains the payment and settlement system, manages Government debt and serves as bankers to the Government and as lenders of last resort to banks.
- Supervises over commercial banks, (NBFCs), Primary Dealers (PD), Financial Institutions (Fls), Cooperative Banks, and the Clearing and Settlement system
- Regulates money markets through instruments such as Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), bank rate, REPO rate and Marginal Standing Facility (MSF)
Payment& Settlement :
The Central Bank undertakes different activities to maintain an efficient payment and settlement system. The activities include creation of currency, holding chests in various geographical areas, maintaining clearings houses and creating mechanism for electronic transferring of funds.
Government Debt :
Managing the issue and servicing of Government debt is another important function ofthe Central Bank. The activity includes price discovery, raising volumes, matching the overall cash management with the tenure of debt.
Government Bankers : The Central Bank acts as the banker to the Government by maintaining its account, deposits and executes cash management by issuing bonds
and treasury bills.
Bank Lender : The Central Bank facilitates banks by providing liquidity support on a temporary basis through REPO of securities to meet their short-term liquidity requirements.
Cash Reserve Ratio ( C R R ):
CRR is the mandatory deposit, which a bank holds with the Central Bank. It is the percentage of the bank's net demand and times liabilities; this is calculated from all demand and time liabilities of the bank after removing those liabilities as mandated by the RBI. The Central Bank affects the increase or decrease in order to pump in or suck the liquidity in the banking system. The contraction and enhancement of credit creation is effected by the
increase or decrease of CRR.
Statutory Liquidity Ratio (SLR) :
SLR is the mandatory deposit in the form of securities and Government securities that a bank holds with the Central Bank. It is the prescribed percentage of its net demand and times liabilities; this too is calculated from all demand and time liabilities of the bank after removing those liabilities as mandated by the RBI. However, do note that the liabilities not to be included here could be different from the ones for CRR calculation. The contraction and enhancement of credit creation is effected by the increase or decrease of SLR.
Commercial Banks and Other Financial Institutions :
The Central Banking Authority has the commercial banks and various financial institutions such as NBFCs, Fls,cooperative banks and PDs under its direct supervision. These banks and financial institutions form a major constituent ofthe financial system.
Commercial Banks :
Public sector banks, private sector banks and foreign banks fall under the purview of commercial banks. Their main function is to accept deposits from the public for the purpose of lending and investing. The commercial banks function under the strict regulations of RBI.
Non Banking Financial Companies ( N B F C ) :
NBFC's collect fund from the public in the form of deposits. They then use various instruments like hire purchase, leasing, bill discounting etc. to lend money. The RBI has allowed them these activities by issuing valid licenses without which no NBFC can operate.
Financial Instutions:
Fl's working under the surveillance of RBI provide long-term funds to industry and agriculture. These institutions raise money by borrowing from international Fl's and through long-term bonds from the financial system.
Cooperative Banks:
Cooperative banks have been authorised to raise deposits from the public and give them advances.RBI and state governments control the urban cooperative banks. National Bank for Agriculture and Rural Development (NABARD) and state governments control the other cooperative banks.
Primary Dealers :
PD's deal in government securities, both in primary and secondary markets. They help strengthen the market through their deals.
2. Capital Markets Regulatory Authority
- Supervises and controls equity and debt market - Supervises over stock exchanges, brokers, equity and debt raisers, investment bankers, Foreign Institutional Investors (Flls), custodians, depositories, mutual funds and listed companies - Supervises service providers like registrars
Capital Market Regulatory Authority
The Capital Market Regulatory Authority, Securities and Exchange Board of lndia (SEBI), controls and supervises the equity and debt market. It keeps a strict surveillance on various players of the market such as stock exchanges, brokers, equity and debt raisers, investment bankers,Fll's, depositories and registrars. After obtaining the approval of SEBI, all securities quoted, bought and sold on these exchanges can be issued. SEBI approves the mutual funds in starting an asset management company as well initiating and running any scheme.
Stock Exchanges: SEBI approves the stock exchanges to provide sale and purchase of securities on behalf of the investors. Securities include equities, debt and derivatives. They also provide clearing house facilities for the purpose of netting payments and securities delivery.
Brokers : Brokers operating on the stock exchange are solely approved by SEBI. They play the role of intermediaries between the buyers and sellers of securities. In exchange of brokerage, they aid to build-up order book, carry out price discovery and are responsible for brokers' contracts being honoured.
Equity & Debt Raiser: Equity and debt raising companies have to apply in prescribed applications and proforma prospectus to the SEBI to seek permission for raising equity or debt through stock exchanges.
Investment Bankers : Investment Bankers (Merchant Banks) are provided licenses by
SEBI to perform various duties such as issuing stock, fund raising and fund management. Other services provided by them include acquisitions, advisory services and counsel on mergers.
FII's ( Foreign Institutional Investors ) : Authorized by the SEBI, foreign—based funds such as Foreign Institutional Investors (Fll's) invest in the Indian equity and debt market through stock exchanges.
Depositories : A depository transfers securities from the buyers to sellers' accounts in electronic form. It carries out this activity on instructions of the stock exchange clearing house, supported by valid documentation. It holds securities in Demat form and maintains accounts of depository participants. On the other hand, depositary participants maintain sub-accounts of their customers.
Registrars : Approved by SEBI, registrars maintain a register of share and debenture holders and process share and debenture allocation.
Multi Commodity Exchange (MCX):
The Multi Commodity Exchange of India (MCX) is an independent commodity exchange that is used for trading, clearing and settlement of commodity futures transactions. It is India's first listed exchange,established in 2003. The MCX was earlier governed by the Forward Markets Commission (FMC) which was the primary regulator of commodity futures markets in India. However, in 2016, FMC was merged with SEBI, and MCX came under the regulatory overview of SEBI.
Commodities:
MCX handles trading in a wide variety of commodity futures such as:
Bullion: — Gold, Silver
Metals: —Aluminium, Copper, Lead, Nickel,Zinc
Energy: — Crude oil, Brent, Natural gas
Agri: — Cardamom, cotton, etc.
Operations:
MCX focuses on providing a transparent trade mechanism to participants through:
- Electronic platform: The use of Trading Work Station, a computerised platform for
placing and managing orders
- Monitoring: A clearing house facility has been set up to ensure smooth clearing and settlement
- Documentation: A delivery department at MCX ensures clear documentation of all trades and settlements
Warehousing and Logistics: Any physical requirement for storing goods is handled by this department
3 .Insurance and Pension Regulators:
- Frame rules and regulations for running an insurance business
- Supervise all insurance companies
- Regulate pricing, investment and cost structure of insurance companies
- Regulate insurance brokers that include agencies, both individuals and banks
- Frame rules for pension funds
- Regulate all pension funds
IRDA ( Insurance Regulatory and Development Authority ) :
The IRDA is the regulator for the insurance business. It handles both general (non-life) insurance as well as life insurance. IRDA has the authority to issue licenses to the insurance companies. It can issue the certificate of registration to an applicant, renew, modify, withdraw, suspend or cancel the same. It performs the duty of regulating and promoting the insurance business.
. PFRDA is a statuary pension regulatory authority established in 2003 under
the PFRDA Act.
- It functions under the aegis of Union Ministry of Finance, Department of
Financial Services.
. PFRDA promotes old age income security by establishing, developing and
regulating pension funds.
- It also protects interests of subscribers to schemes of pension funds and
related matters.
. It is responsible for appointment of various intermediate agencies such as
Central Record Keeping Agency (CRA), Custodian, Pension Fund Managers,
Summary :
Let's recap the key points ofthis lesson.
Being the Central Bank ofthe country, RBI plays a very important role in the Indian financial system. Along with it, other regulatory bodies such as SEBI, IRDA and various financial
intermediaries make up the system. The financial system, thus, is an amalgamation of the financial instruments, intermediaries and the financial market. In this lesson,
you have learnt about:
- The constituents and functioning ofthe financial system
- The roles and functions ofthe Central Banking Authority
- The role ofthe Capital Market Regulatory Authority
- The role ofthe IRDA and MCX
Thank you sir
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