Indian Financial System | Components – Definition and Function

Indian financial system

In this article, we will explore the key components of Indian Financial System and definition, meaning and functions. You’ll be able to learn the following concepts by the end of this article.

  • What is Financial System of India and how it works?
  • Structure of the Indian Financial System
  • Importance of financial system
  • Financial Institutions 
  • Financial Market 
  • Financial Instruments 
  • Financial Services 
  • Financial Regulators 

What is the Financial System?

The economic system of a country consists of two segments, people with surplus funds and people with deficit funds. The individuals with deficit money will have to arrange money and people with surplus money willing to invest so that they can yield returns on it.

Therefore, the financial system provides links between lenders and borrowers so that money may flow from surplus funds to deficit funds.

Definition of Financial System:

“The Financial System is defined as the composition of different financial institutions, Markets, regulators, transactions, analytic agencies and fund managers.”

Thus the financial system develops a common platform for borrowers as well as investors so that investors may invest their money and borrowers may arrange funds.

Now let us consider the financial system of India, we can categorise the Indian Financial System in two sections.

  • Informal Section
  • Formal section
Moneylenders, local bankers, traders and landlords basically come under the informal section.
Now let us explore the formal section of the Indian Financial System that consists of the following
5 components which are also known as components of financial systems.

Components of Indian Financial System:

components of indian financial system
There are basically 5 components of Indian financial systems.
  • Financial Institutions
  • Financial Markets
  • Financial Instruments
  • Financial Services
  • Financial Regulators

1) Financial Institutions:

Financial institutions are the business enterprise which avails various services regarding management of funds ( investment or lending, borrowing).

It functions as an intermediary between investors and borrowers. Commercial banks, insurance companies, stockbrokers, non-banking finance companies (NBFC) are known as financial institutions.

Scheduled banks play a major role in the management of money throughout a country at a very foundation level.

2) Financial Market:

The financial market is a venture where actual transactions (sales and purchase) of financial instruments such as shares, bonds, commodities or government securities happens between seller and purchaser.
It can be broadly classified into three categories.
Bombay Stock Exchange (BSE), NSE (National Stock Exchange), NYSE (New York Stock Exchange) are some examples of the financial market.
For more details on the financial market check the link below.

3) Financial Instruments:

A financial instrument refers to a monetary document/ contract between two parties which are traded in the financial markets (Money market, capital market or derivative market). It represents an asset of one party and at the same time, the liability of another party.

The financial instruments can be of two types as follows:

4) Financial Services:

The services offered by the different financial institutions for the management, lending, borrowing and for the investment of funds is called as financial services. There are various services provided by financial companies, few of them are:

  • Housing finance
  • Debit and credit card
  • Consumer finance
  • Asset management
  • Depository services
  • Online share trading
  • Investment banking
  • Credit rating services
  • Different types of loans

5) Financial Regulators:

Financial Regulators refers to the government bodies which are accountable to regulate, inspect, monitor the functions of various financial institutions like banks, insurance companies, business enterprises, Non-banking financial companies (NBFCs) etc.
Financial Regulators are the apex bodies of financial institutions of respective sectors which register and functions under these financial regulatory institutions. Few examples of financial regulators in India are below.
  • RBI (Reserve Bank of India)
  • IRDA (Insurance Regulatory and Development Authority)
  • SEBI (Securities Exchange Board of India)
  • PFRDA (Pension Fund Regulatory and Development Authority)
  • FMC ( Forward Market Commission)

Importance of Financial System:

  1. The financial system fulfils the requirements of funds for business sectors.
  2. It brings economic growth by allocating the money to those who can better utilise it.
  3. It leads to capital formation.
  4. Enables investment by business sectors
  5. It encourages saving and hence takes back money into circulation.
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