FMIS unit 1

Financial System and Its Technology

Overview of Financial System

  • A financial system comprises institutions, markets, instruments, and services that manage the flow of funds.

  • It facilitates the conversion of savings into investment, contributing significantly to economic development.

Functions of Financial System

  1. Link Between Savers and Investors: Channels mobilized savings into productive investments.

  2. Project Selection: Assists in identifying and reviewing the performance of financed projects.

  3. Payment Mechanism: Provides a system for the exchange of goods and services.

  4. Resource Transfer: Enables resource transfer across geographical boundaries.

  5. Risk Management: Helps in managing and controlling financial risks.

  6. Capital Formation: Aids in the accumulation of capital for investment.

  7. Cost Reduction: Lowers transaction costs and increases returns on investments.

  8. Information Provision: Offers detailed market information to all players involved.

Structure and Components of Financial System

  • Major Components:

    1. Financial Institutions

    2. Financial Markets

    3. Financial Instruments/Securities

    4. Financial Services

    5. Financial Intermediaries

  • Each component plays a vital role within the financial ecosystem and operates closely in combination.

Types of Financial Institutions

  • Banking Institutions: Centralized under RBI’s regulation, consisting of commercial banks, cooperative banks, regional rural banks, etc.

  • Non-Banking Financial Institutions (NBFIs): Include development banks and specialized financial entities.

Financial Technology (Fintech)

  • Fintech encompasses the innovations aimed at improving financial services efficiency, primarily through technology.

  • Examples include online banking, electronic payments, automated teller machines (ATMs), and blockchain technology.

Financial Innovation

  • Refers to the creation of new financial instruments or methods which enhance the financial system's efficiency.

  • Institutional, product, and process innovations are key aspects contributing to the evolution of the financial landscape.

Development Finance vs Universal Banking

  • Development Finance focuses on promoting projects through specialized institutions.

  • Universal Banking combines commercial banking and investment services, facilitating a broader range of financial products under one roof.

Reserve Bank of India (RBI)

  • Role of RBI:

    • Functions as the apex institution governing the financial system.

    • Aims at enhancing public welfare through monetary policy aimed at economic stability and growth.

  • Monetary Policy: A tool for regulating the money supply to achieve macroeconomic objectives such as inflation control and employment facilitation.

Objectives and Tools of Monetary Policy

  • Key Objectives:

    • Expansion or Contraction of Credit: Adjusting the credit amount in the economy to maintain economic health.

    • Regulation of Currency Supply: Ensuring that the money supply aligns with economic demand.

  • Tools:

    1. Bank Rate: Rate at which RBI lends to commercial banks.

    2. Cash Reserve Ratio (CRR): Minimum percentage of deposits banks must maintain with RBI.

    3. Statutory Liquidity Ratio (SLR): All banks must maintain a specific proportion of their net demand and time liabilities.

    4. Open Market Operations: Buying and selling government securities to control liquidity in the economy.

Challenges in the Indian Financial System

  • Weaknesses include lack of coordination among institutions, monopolistic tendencies, and need for regulatory reform to enhance efficiency.

  • Factors affecting financial stability include economic shocks, regulatory frameworks, and the effectiveness of financial governance.

  • Development finance institutions have emerged to meet the demands of long-term financial needs effectively.