SEMESTER – V MJD 9- INDIAN FINANCIALSYSTEM

Unit 1

1. Financial System – Meaning and Components

(A) Meaning

 A financial system is a set of institutions, markets, instruments, and services that

facilitate the transfer of funds from savers to borrowers.
 Functions as a link between surplus and deficit units in the economy.

(B) Components of Financial System

1. Financial Institutions → Banks, NBFCs, Insurance companies, Pension funds.

2. Financial Markets → Money market, capital market, forex market, derivatives market.
3. Financial Instruments → Shares, bonds, debentures, derivatives, mutual funds.
4. Financial Services → Credit rating, underwriting, investment advisory, portfolio
management.

2. Financial Markets

(A) Meaning

 Platforms where financial instruments are bought and sold.

(B) Types

1. Money Market → Short-term funds (up to 1 year), e.g., Treasury bills, commercial
paper.
2. Capital Market → Long-term funds (more than 1 year), e.g., stocks, bonds.
o Primary Market → New securities issued.
o Secondary Market → Existing securities traded.
3. Foreign Exchange Market → Buying/selling foreign currency.
4. Derivative Market → Futures, options, swaps.
5. Commodity Market → Trading in gold, silver, oil, agricultural products.

3. Financial Institutions

(A) Meaning

 Intermediaries that mobilize savings and provide credit.

(B) Types

1. Banking Institutions → Commercial banks, cooperative banks, regional rural banks.

2. Non-Banking Financial Companies (NBFCs) → Provide loans, credit facilities,
investments.
3. Insurance Companies → Life and non-life insurance, risk management.
4. Pension Funds → Retirement savings, annuities.
5. Development Financial Institutions (DFIs) → NABARD, SIDBI, IDBI (long-term
sectoral finance).

4. Financial Instruments

(A) Meaning

 Documents representing monetary value and claim.

(B) Types

1. Equity Instruments → Shares, stock options.

2. Debt Instruments → Bonds, debentures, treasury bills.
3. Derivatives → Futures, options, forwards, swaps.
4. Hybrid Instruments → Convertible debentures, preference shares.

5. Financial Services

(A) Meaning

 Services provided by financial institutions/markets to facilitate smooth operation of

financial system.

(B) Examples

 Fund transfer, portfolio management, credit rating, underwriting, leasing, factoring,

mutual fund management, insurance.

6. Financial System – Functions

A financial system connects savers (surplus units) and borrowers (deficit units) and
facilitates the smooth flow of funds. Its functions are broadly divided into primary functions,
secondary functions, and supporting functions.

1. Primary Functions

(A) Mobilization of Savings

 Collects savings from individuals, businesses, and government.

 Converts these savings into productive investments in the economy.
 Ensures that idle funds are effectively utilized.
(B) Allocation of Resources / Capital

 Channels funds to most productive sectors like industry, agriculture, and infrastructure.
 Helps in efficient allocation of resources by prioritizing projects with higher returns.

(C) Facilitation of Payments

 Provides mechanisms for transfer of funds in the economy.

 Includes banking services like NEFT, RTGS, cheques, credit/debit cards, digital
wallets.

(D) Risk Management / Risk Diversification

 Helps businesses and individuals manage financial risks through:

o Insurance (life, health, property)
o Derivatives (futures, options, swaps)
 Reduces uncertainty and encourages investment and entrepreneurship.

(E) Liquidity Provision

 Enables easy conversion of assets into cash without significant loss in value.
 Money markets, mutual funds, and secondary markets enhance liquidity.

2. Secondary / Supporting Functions

(A) Price Discovery

 Financial markets help determine the fair price of securities and commodities through
demand-supply interaction.

(B) Provision of Credit / Financing

 Provides short-term, medium-term, and long-term credit facilities to businesses,

government, and individuals.
 Examples: term loans, working capital loans, trade finance, and project finance.

(C) Facilitating Capital Formation

 Promotes investment in productive sectors, leading to economic growth.

 Encourages entrepreneurship and industrial expansion.

(D) Providing Information and Signaling

 Market prices and interest rates signal economic conditions.

 Investors use these signals to make investment decisions.
(E) Safeguarding Savings

 Regulated institutions (banks, mutual funds) ensure security of funds.

 Helps maintain investor confidence in the financial system.

3. Other Key Functions

1. Encouraging Investment
o Mobilizes capital for infrastructure, industrial, and agricultural projects.
2. Financial Inclusion
o Extends banking and financial services to under-served sectors, including rural
and low-income groups.
3. Supporting Government Policies
o Provides channels for public debt, fiscal operations, and subsidies.
4. Promoting Economic Growth
o By mobilizing funds, allocating capital efficiently, and facilitating trade &
commerce, the financial system drives overall economic development.

7. Significance of Financial System

1. Promotes economic growth by mobilizing funds.

2. Encourages savings and investment.
3. Facilitates efficient allocation of resources.
4. Helps in employment generation.
5. Reduces financial risks via insurance and derivatives.
6. Encourages entrepreneurship and industrial development.

8. Development of Financial Sector

 Meaning: Expansion and improvement of financial markets, institutions, instruments,

and services.
 Indicators of Development:
1. Increased financial depth (GDP % of financial assets).
2. Financial accessibility and inclusion.
3. Market efficiency and liquidity.
4. Technological advancement in payments and transactions.
5. Risk management tools and instruments availability.

9. Parameters of Development of Financial Sector

The development of a financial sector is assessed through various quantitative and qualitative
indicators that reflect its depth, efficiency, stability, and inclusiveness.

(A) Financial Depth

 Definition: Size of financial intermediaries and markets relative to GDP.

 Indicators:
1. Money supply (M2/M3) to GDP ratio
2. Credit to GDP ratio
3. Capital market capitalization / GDP
 Significance: Higher depth indicates greater mobilization and availability of funds.

(B) Financial Access / Inclusiveness

 Definition: Extent to which financial services reach all sectors of society.

 Indicators:
1. Number of bank branches per 100,000 adults
2. Number of ATMs, POS terminals, and digital banking penetration
3. Access to credit by rural and under-served sectors
 Significance: Promotes financial inclusion and equitable growth.

(C) Financial Efficiency

 Definition: Ability of the financial system to mobilize savings and allocate capital at
low cost.
 Indicators:
1. Interest rate spreads (lending vs deposit rates)
2. Transaction costs in markets
3. Operational efficiency of banks and financial institutions
 Significance: Reduces cost of capital and improves profitability of firms.

(D) Financial Stability

 Definition: Ability of the system to withstand shocks and maintain confidence.

 Indicators:
1. Non-Performing Assets (NPAs) of banks
2. Capital adequacy ratios
3. Volatility in markets
 Significance: Ensures sustained economic growth and investor confidence.

(E) Market Development

 Definition: Growth and sophistication of financial markets.

 Indicators:
1. Depth of capital and money markets
2. Diversity of financial instruments (equity, debt, derivatives)
3. Liquidity in secondary markets
 Significance: Facilitates efficient allocation of resources and price discovery

10. Regulatory Framework of Financial System in India

(A) Key Regulators

Institution Function
Regulates banking, money market, credit control,
RBI (Reserve Bank of India)
monetary policy
SEBI (Securities & Exchange Board of Regulates capital markets, protects investors,
India) oversees stock exchanges
IRDAI (Insurance Regulatory & Regulates insurance companies, protects
Development Authority of India) policyholders
PFRDA (Pension Fund Regulatory &
Regulates pension funds, retirement schemes
Development Authority)
Policy formulation, public debt management,
Ministry of Finance / Government
overall financial sector oversight
FSDC (Financial Stability & Development Coordinates financial regulators for systemic
Council) stability

Unit 2
1. Financial Markets – Meaning

 Definition: A financial market is a platform where buyers and sellers trade financial
assets and securities like shares, bonds, currencies, derivatives, and commodities.
 Purpose: Facilitates fund mobilization, price discovery, risk management, and
efficient allocation of resources.

2. Types of Financial Markets

(A) Capital Markets

 Meaning: Markets for long-term funds (more than 1 year).

 Components:
1. Primary Market – Issuance of new securities to raise capital.
2. Secondary Market – Trading of existing securities.
 Participants: Investors, issuers, underwriters, brokers, merchant bankers.
 Instruments: Equity shares, preference shares, debentures, bonds, mutual funds.
 Features:

o Long-term funds, risk-return trade-off, regulated.

(B) Money Markets

 Meaning: Markets for short-term funds (up to 1 year).

 Purpose: Provides liquidity for government, banks, and businesses.
 Participants: Commercial banks, RBI, NBFCs, corporations, money market mutual
funds.
 Instruments: Treasury bills, commercial papers, call money, certificates of deposit,
repos.
 Features:
o Short-term, high liquidity, low risk, low returns.

(C) Foreign Exchange (Forex) Market

 Meaning: Market for buying and selling foreign currencies.

 Purpose: Facilitates international trade, investment, remittances, and currency risk
management.
 Participants: Commercial banks, RBI, importers/exporters, forex brokers, multinational
corporations.
 Instruments: Spot contracts, forward contracts, swaps, options.
 Features:
o Global market, highly liquid, operates 24×7, influenced by macroeconomic
factors.
(D) Equity and Derivative Markets

Equity Market

 Purpose: Buying/selling shares of companies.

 Participants: Investors, brokers, companies, SEBI, stock exchanges (NSE, BSE).
 Instruments: Shares, stock options, ETFs, mutual funds.
 Features: Ownership participation, risk-return trade-off, regulated market.

Derivative Market

 Purpose: Risk management and speculation.

 Participants: Hedgers, speculators, arbitrageurs, brokers.
 Instruments: Futures, options, forwards, swaps.
 Features: Leverage, risk mitigation, underlying asset-based, highly regulated.

(E) Commodity Market

 Meaning: Market for trading physical goods or raw materials.

 Participants: Producers, consumers, traders, brokers, exchanges (MCX, NCDEX).
 Instruments: Futures contracts, spot contracts, options.
 Features: Price discovery, hedging of price risks, seasonal fluctuations, regulated by
Forward Markets Commission (FMC) merged with SEBI in India.

3. Characteristics / Features of Financial Markets

1. Liquidity → Easy conversion of assets into cash.

2. Price Discovery → Market determines fair price of instruments.
3. Risk Transfer → Hedging via derivatives and insurance.
4. Regulated → Ensures transparency, investor protection.
5. Efficiency → Quick flow of funds between surplus and deficit units.
6. Accessibility → Available to investors and institutions.

4. Participants in Financial Markets

1. Regulators → RBI, SEBI, IRDAI, PFRDA.

2. Financial Institutions → Banks, NBFCs, mutual funds, insurance companies.
3. Investors → Retail investors, high-net-worth individuals, foreign investors.
4. Intermediaries → Brokers, merchant bankers, underwriters, depositories.
5. Corporates & Government → Issuers of securities or borrowers.

5. Instruments Traded in Financial Markets

Market Type Instruments

Capital Market Equity shares, preference shares, debentures, bonds, ETFs

Market Type Instruments

Money Market Treasury bills, commercial papers, call money, certificates of deposit, repos

Forex Market Spot contracts, forward contracts, currency swaps, options

Derivatives Market Futures, options, forwards, swaps

Commodity Market Futures contracts, spot contracts, options on commodities

6. Challenges in Financial Markets

1. Market volatility → Price fluctuations increase risk.

2. Fraud and malpractices → Insider trading, price manipulation.
3. Liquidity risk → Inability to convert assets into cash.
4. Information asymmetry → Investors lacking complete information.
5. Regulatory compliance → Complex and evolving laws.
6. Global economic shocks → Impact of foreign exchange, interest rates, and trade
policies.

7. Role of SEBI (Securities and Exchange Board of India)

(A) Meaning

 SEBI is the regulator of the capital market in India.

 Established in 1988, statutory powers granted in 1992 SEBI Act.

(B) Objectives

1. Protect investors’ interests.

2. Promote development of capital markets.
3. Regulate the business of stock exchanges and intermediaries.
4. Ensure fair and transparent trading practices.

(C) Powers / Functions

 Registration of stock exchanges, brokers, mutual funds, and other intermediaries.

 Regulate issue of capital → IPOs, FPOs.
 Monitor market conduct, prevent insider trading, frauds.
 Conduct investor education programs.
 Investigate and penalize violations under SEBI Act.
Unit 3

1. Financial Institutions in India – Meaning

 Definition: Financial institutions are intermediaries that mobilize savings from surplus
units and provide finance to deficit units, supporting economic growth.
 Role: Facilitate credit, investment, risk management, and financial stability.

2. Banking Institutions in India

(A) Commercial Banks

 Definition: Banks that accept deposits and provide short-term and long-term loans to
businesses and individuals.
 Functions:
1. Accept deposits – savings, current, fixed.
2. Provide loans and advances – term loans, working capital loans.
3. Credit creation – through lending beyond deposits.
4. Payment and settlement services – NEFT, RTGS, cheques, cards.

(i) Spreads and NPAs

 Spreads: Difference between lending rate and deposit rate → main source of profit.
 Non-Performing Assets (NPAs): Loans on which interest/principal is overdue for >90
days.
o Impact: Reduces profitability and capital adequacy.

(ii) Capital Adequacy Norms

 Definition: Minimum capital a bank must maintain relative to risk-weighted assets.

 Objective: Ensure financial stability and absorb losses.
 Standard: As per Basel III norms, usually 9–10.5% of risk-weighted assets.

(iii) Capital Market Support

 Commercial banks help capital markets by:

o Underwriting securities
o Providing bridge loans to companies
o Acting as market makers or brokers

(B) Development Financial Institutions (DFIs)

 Definition: Specialized institutions providing long-term finance for industrial and

infrastructure development.
 Examples in India:
Institution Purpose

IFCI (Industrial Finance Corporation of

Industrial loans & equity support
India)

IDBI (Industrial Development Bank of India) Industrial finance, policy lending

ICICI (Industrial Credit & Investment

Project financing, corporate loans
Corporation of India)

SIDBI (Small Industries Development Bank

Finance for MSMEs
of India)

Provide loans to state-level industries &

SFCs (State Financial Corporations)
small businesses

1. IFCI – Industrial Finance Corporation of India

 Established: 1948
 Purpose: First Development Financial Institution in India to provide long-term finance
to industrial sector.
 Functions:
1. Provides term loans, project financing, equity support.
2. Helps modernization and expansion of industries.
3. Offers restructuring support for sick units.
 Significance: Facilitated industrial growth in post-independence India; supports MSMEs
and large projects.

2. IDBI – Industrial Development Bank of India

 Established: 1964 (as DFI, later became a commercial bank)

 Purpose: Promote industrial development and economic growth through long-term
financing.
 Functions:
1. Provides term loans to industries.
2. Refinances loans through other banks and financial institutions.
3. Provides equity capital, underwriting services, and advisory.
 Significance: Played key role in large-scale industrialization and bridging the gap
between project requirement and funding.

3. ICICI – Industrial Credit and Investment Corporation of India

 Established: 1955
 Purpose: Provide project financing and long-term credit for industrial development.
 Functions:
1. Term loans and working capital support for industries.
2. Provides underwriting and investment banking services.
3. Facilitates foreign capital inflow for Indian industries.
 Transformation: Converted into ICICI Bank in 2002 (universal banking operations).

4. SFCs – State Financial Corporations

 Established: Under State Financial Corporations Act, 1951

 Purpose: Provide long-term finance to small and medium industries at the state level.
 Functions:
1. Term loans, machinery finance, working capital support for SMEs.
2. Provides equity participation and guarantees.
3. Encourages regional industrial development.
 Example: Karnataka SFC, Maharashtra SFC, Tamil Nadu SFC.

5. SIDBI – Small Industries Development Bank of India

 Established: 1990 (succeeded SIDO and RBI-sponsored schemes)

 Purpose: Promote, finance, and develop Micro, Small and Medium Enterprises
(MSMEs) in India.
 Functions:
1. Refinance banks and financial institutions providing loans to MSMEs.
2. Direct financing for small industries, machinery, technology, and infrastructure.
3. Provides venture capital, equity support, and credit guarantee schemes.
4. Promotes innovation and entrepreneurship in MSME sector.
 Significance: Key institution for employment generation and rural-industrial
development.

Features of DFIs

1. Provide long-term finance for industrial growth.

2. Often state-supported or semi-government.
3. Focus on priority sectors and new industries.
4. May provide equity, term loans, and guarantees.

3. Development Banking vs Commercial Banking

Aspect Commercial Banks Development Banks (DFIs)

Profit-oriented, short-term
Objective Development-oriented, long-term lending
lending

Duration of loans Short to medium term Long term (5–20 years)

Risk Lower risk, liquid assets Higher risk, industrial projects

Aspect Commercial Banks Development Banks (DFIs)

Bonds, government support, retained

Sources of funds Deposits
earnings

Clients Individuals, businesses Industries, infrastructure, priority sectors

Example SBI, ICICI Bank IDBI, IFCI, SIDBI

4. Universal Banking

 Definition: Banking model where a single institution provides commercial banking +

investment banking services.
 Features:
1. Accept deposits, provide loans, and credit creation.
2. Offer underwriting, portfolio management, and advisory services.
3. Integrates development and commercial banking.
 Examples: ICICI Bank, HDFC Bank, SBI.

5. Regulation of Financial Institutions by RBI

 Reserve Bank of India (RBI) is the central bank and regulator of the banking and
financial system.
 Functions in regulation:
1. Licensing and registration of banks.
2. Monitoring capital adequacy and liquidity ratios.
3. Regulating NPAs and provisioning norms.
4. Setting interest rate policy and spreads.
5. Guidelines on mergers, acquisitions, and corporate governance.
6. Oversight of DFIs and commercial banks’ activities for financial stability.
7. Ensuring systemic stability and consumer protection.

Unit 4

1. Financial Instruments – Meaning

 Definition: Financial instruments are documents representing financial value or a
claim between parties.
 Purpose: Facilitate fund raising, risk management, investment, and trading.
 They can be negotiable (can be transferred) or non-negotiable.

2. Primary and Secondary Market Instruments

(A) Primary Market Instruments

 Meaning: Instruments issued for the first time to raise funds.

 Purpose: Mobilize capital for companies and governments.
 Features:
1. Issued directly by company or government.
2. Helps in capital formation.
3. Price determined via IPO/FPO process.
 Examples:

o Equity shares (IPO, FPO)

o Debentures, bonds
o Government securities

(B) Secondary Market Instruments

 Meaning: Instruments already issued in the primary market and traded among investors.
 Purpose: Provide liquidity and price discovery.
 Features:
1. Issuer does not get funds.
2. Enables investors to buy/sell existing securities.
3. Regulated market ensures transparency.
 Examples:

o Listed shares, bonds, ETFs

o Derivatives (futures/options)

(C) Distinctions

Feature Primary Market Secondary Market

Objective Raise new funds Provide liquidity
Issuer Involvement Direct No involvement
Price Determination Fixed / book building Market-driven
Investor Initial investors All market participants

3. Types of Financial Instruments

(A) Debt Instruments

 Definition: Instruments where issuer borrows money and promises repayment with
interest.
 Examples: Bonds, debentures, government securities, commercial papers, treasury bills.
 Features:
o Fixed income, maturity date specified, lower risk than equity, creditor rights.

(B) Equity Instruments

 Definition: Instruments representing ownership in a company.

 Examples: Common shares, preference shares.
 Features:
o Dividend depends on profits, voting rights, residual claim, higher risk-return.

(C) Hybrid Instruments

 Definition: Instruments combining debt and equity features.

 Examples: Convertible debentures, preference shares, warrants.
 Features:
o Can provide fixed returns + potential for capital gain.

(D) Innovative / New Instruments

 Examples:
1. Derivatives: Futures, options, swaps
2. Structured products: Asset-backed securities, mortgage-backed securities
3. Securitized instruments: Pass-through certificates, REITs

4. Mutual Funds

 Definition: Pools funds from investors and invests in securities like shares, bonds,
money market instruments.
 Features:
1. Professional management
2. Diversification reduces risk
3. Open-ended & closed-ended schemes
4. Provides liquidity via NAV-based pricing

5. Financial Instruments for Foreign Capital

1. Introduction

 Definition: Financial instruments for foreign capital are instruments through which
companies raise funds from international investors or allow foreign investors to invest
in domestic companies.
 Purpose:
1. Access global capital markets.
2. Diversify funding sources.
3. Attract foreign investment.
4. Facilitate currency inflow and strengthen foreign reserves.

2. ADR – American Depository Receipt

 Meaning: A negotiable certificate issued by a US bank representing shares of a foreign

(non-US) company traded on US stock exchanges.
 Features:
1. Denominated in US dollars.
2. Represents a specific number of underlying shares.
3. Provides dividends and voting rights in proportion to the shares.
 Purpose: Allows US investors to invest in foreign companies without trading on
foreign exchanges.

3. GDR – Global Depository Receipt

 Meaning: A financial instrument issued by a foreign company, representing shares,

that can be traded in multiple countries outside the home country.
 Features:
1. Denominated in foreign currency (USD, Euro).
2. Listed on international stock exchanges like London or Luxembourg.
3. Enables companies to raise capital globally.
 Purpose: Attracts cross-border investors and increases global visibility.

4. FCCB – Foreign Currency Convertible Bond

 Meaning: A bond issued by an Indian company in foreign currency that is

convertible into equity shares after a specified period.
 Features:
1. Fixed interest in foreign currency.
2. Convertible into equity at predetermined price.
3. Provides flexibility for investors and reduces initial interest burden on issuer.
 Purpose: Raises foreign funds while offering potential equity participation.

5. P-Notes – Participatory Notes

 Meaning: Offshore derivative instruments issued by registered foreign institutional

investors (FIIs) to investors who want exposure to Indian securities without registering
with SEBI.
 Features:
1. Used by investors outside India.
2. Derivatives linked to Indian shares or indices.
3. Issuers are FIIs registered with SEBI.
 Purpose: Attract foreign investment in Indian markets without direct SEBI
registration, especially for short-term traders.
 Caution: SEBI monitors for transparency and anti-money laundering purposes.

6. IDR – Indian Depository Receipt

 Meaning: A financial instrument issued by a foreign company in India, representing

equity shares of the issuing company.
 Features:
1. Traded on Indian stock exchanges (NSE, BSE).
2. Denominated in Indian Rupees.
3. Offers dividends and voting rights similar to underlying shares.
 Purpose: Allows foreign companies to raise capital in India and expand investor base.

7. Comparison Table

Instrument Issuer Currency Market Key Purpose

US stock US investors invest in foreign
ADR Foreign company USD
exchanges companies
International
GDR Foreign company USD/Euro Raise capital globally
exchanges
International / Raise foreign funds with
FCCB Indian company Foreign currency
Offshore equity conversion option
FIIs (for foreign Linked to INR Foreign investors invest
P-Notes Offshore / India
investors) securities without SEBI registration
Indian stock Foreign company raises
IDR Foreign company INR
exchanges capital in India

8. Significance of Foreign Capital Instruments

1. Access to global capital markets and foreign funds.

2. Reduces dependency on domestic sources of finance.
3. Enhances liquidity in both domestic and international markets.
4. Facilitates portfolio diversification for global investors.
5. Promotes foreign investment and economic integration.
Unit 5

1. Financial Services – Meaning

 Definition: Financial services refer to services provided by financial institutions,

intermediaries, and markets to facilitate fund mobilization, investment, risk
management, and financial intermediation.
 Purpose: Connect savers (investors) with borrowers (businesses/government) and
facilitate efficient flow of funds.
 Examples: Banking services, insurance, mutual funds, leasing, factoring, portfolio
management, underwriting.

2. Characteristics of Financial Services

1. Intangible Nature: Unlike physical goods, financial services cannot be seen or

touched.
2. Involvement of Money: Primarily monetary in nature; deals with money flow, credit,
and investment.
3. Risk-bearing: Many services involve risk sharing (insurance, derivatives).
4. Time-bound: Services may involve short-term or long-term contracts (loans, leasing).
5. Intermediation: Act as intermediaries between surplus and deficit units in the
economy.
6. Regulated: Subject to government and regulatory oversight (RBI, SEBI, IRDAI,
PFRDA).
7. Professionalism: Requires expert knowledge and skill in finance and management.

3. Types of Financial Services

Financial services can be broadly classified into the following categories:

(A) Fund-based Services

 Services where institutions provide funds to clients.

 Examples:
1. Loans and advances: Term loans, working capital finance, project finance.
2. Credit cards & overdraft facilities
3. Venture capital & private equity funding

(B) Fee-based / Non-Fund-based Services

 Services where institutions earn fees/commission without providing funds.

 Examples:
1. Underwriting of shares and debentures
2. Portfolio management and investment advisory
3. Brokerage services and mutual fund distribution
4. Factoring and bill discounting

(C) Specialized Financial Services

 Services involving risk management and securitization.

 Examples:
1. Insurance – life and non-life insurance, risk coverage
2. Derivatives trading – futures, options, swaps
3. Securitization of assets – mortgage-backed securities, pass-through certificates

4. Significance of Financial Services

1. Mobilization of Savings: Channels household savings into productive investment.

2. Economic Development: Provides credit for industries, SMEs, agriculture, and
infrastructure.
3. Risk Management: Insurance and derivatives help individuals and businesses hedge
against risks.
4. Investment Opportunities: Helps investors diversify and manage their portfolios.
5. Financial Inclusion: Extends financial access to rural and under-served sectors.
6. Liquidity Creation: Mutual funds, banks, and markets provide ease of converting
assets into cash.
7. Market Efficiency: Financial services reduce transaction costs and ensure smooth
functioning of markets.

5. Scope of Financial Services

 Breadth of Services: Financial services cover banking, insurance, investment, risk
management, advisory, and intermediation.
 Target Sectors: Individuals, corporate houses, SMEs, government projects,
exporters/importers.
 Innovations: Emergence of digital banking, fintech, e-wallets, robo-advisors, online
trading platforms.
 Globalization: Services now include foreign capital instruments – ADRs, GDRs,
FCCBs, P-Notes.
 Regulation & Compliance: Services are governed by regulatory frameworks – RBI,
SEBI, IRDAI, PFRDA – ensuring transparency and investor protection.

1. Fund-based Financial Services

 Meaning: Services where financial institutions provide funds or credit to clients,

earning income through interest, dividends, or capital gains.
 Objective: Help businesses and individuals meet capital requirements.

Key Examples

1. Loans and Advances:

o Short-term, medium-term, and long-term loans provided to businesses or
individuals.
o Types: Term loans, working capital loans, project finance.
2. Credit Facilities:
o Overdrafts, cash credit, credit cards.
3. Venture Capital / Equity Funding:
o Long-term financing to start-ups or expanding firms in return for ownership
stake.
4. Leasing and Hire-Purchase (explained below)

2. Fee-based (Non-Fund Based) Financial Services

 Meaning: Services provided by financial institutions where income is earned through

fees, commission, or charges, without providing funds directly.

Key Examples

1. Underwriting Services:
o Financial institutions guarantee subscription to new shares or debentures,
earning commission.
2. Portfolio Management:
o Professional management of client’s investments in stocks, bonds, mutual funds.
3. Advisory Services:
o Financial planning, investment advisory, mergers & acquisitions consultancy.
4. Factoring and Bill Discounting:
o Managing receivables and providing liquidity against invoices.
3. Leasing

 Meaning: A fund-based financial service where a firm (lessor) provides an asset to

another firm or individual (lessee) for use over a period in return for periodic payments.
 Types:
1. Operating Lease: Short-term lease; lessor bears maintenance cost; can be
canceled.
2. Finance / Capital Lease: Long-term lease; lessee bears maintenance; non-
cancelable; essentially a financing mechanism.
 Features:

o Ownership remains with lessor.

o Payments made periodically.
o Useful for firms lacking capital for direct purchase.
 Benefits:
o Conserves capital, reduces risk, provides flexibility, tax advantages.

4. Hire-Purchase

 Meaning: Another fund-based service where a client acquires an asset immediately

but pays in installments. Ownership transfers only after final payment.
 Features:
o Asset possession initially; ownership later.
o Installment payments include principal + interest.
o Often used for vehicles, machinery, or equipment.
 Benefits:
o Makes expensive assets affordable.
o Allows small businesses to use modern equipment without large upfront costs.

Difference Between Leasing and Hire-Purchase

Feature Leasing Hire-Purchase

Ownership Lessor Transfers to hirer after last installment
Duration Flexible, can be short-term Fixed, long-term
Maintenance Lessor (operating lease) Hirer
Risk Less for lessee More for hirer
Use Conserves capital Leads to eventual ownership

5. Merchant Banking Services

 Meaning: Professional financial services provided to corporates, institutions, and

governments for capital raising, advisory, and financial management.
 Functions / Services:
1. Issue Management: Managing IPOs, FPOs, rights issues, private placements.
2. Underwriting Services: Guaranteeing subscription of new securities.
3. Portfolio Management and Investment Advisory
4. Corporate Finance Advisory: Mergers, acquisitions, restructuring.
5. Project Finance: Evaluating feasibility, raising capital, and monitoring projects.
6. Credit Syndication: Arranging loans from banks/financial institutions.
 Significance:

o Ensures smooth capital raising, risk reduction, professional advisory, and efficient
financial management for companies.