A system that aims at establishing and providing a regular smooth, efficient and cost effective linkage between depositors and investors is known as Financial System. A set of complex and closely connected instructions, agents practice, markets, transactions, claims and liabilities relating to finance aspects of an economy may be referred to as financial system. Accordingly, all those activities related to finance and organized into a system may be called financial system. A well developed financial system allows or the transfer of resources from depositors to investors and thus lays a crucial role in the functioning of the economy.
The features of a financial system are as follows:
1. Financial system provides an ideal linkage between depositors and investors, thus encourage 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 faces both the quality and the pace of economic development
A financial system comprises of financial institutions, financial services, financial markets and financial instruments. These constituents are closely related and work in conjunction with each other. Financial institutions operate in financial market – generating, purchasing and selling financial instruments and rendering various financial services in accordance with the practices and procedures established by law or tradition. The different constituents of a financial system are explained below:
Institutions that provide credit and credit related services are called financial institutions. Chief characteristics of financial institutions are as follows:
1. Savings mobilizers: Financial institutions act as mobilizers and transferors of savings or funds from surplus units to deficit units.
2. Participants: Financial institutions are the major participants in the financial system of a country.
3. Dealers: Financial institutions deal in financial resources, collecting resources by accepting deposits from individuals and institutions and lending them to trade, industry and others. Financial institutions deal in financial assets, accept deposits, grant loans and invest in securities, besides rendering various specialized financial service.
4. Generators: Financial institutions buy and sell financial instruments and are responsible for generating financial instruments.
5. Regulation: Financial institutions are regulated of their working by a regulatory body, such as SEBI, RBI, etc.
6. Types: Financial Institutions are of two types, banking and non banking institutions. Baking institutions such as commercial Banks collect money from depositors directly and lend to investors or borrowers, whereas non-banking institutions such as UTI, LIC are engaged in obtaining and from depositors indirectly.
7. Special Institutions: Special financial institutions are those that are engaged in providing financial assistance for specific purposes and sectors to bring about a desired pattern of development. Examples include NABARD, EXIM Bank, IDBI etc.
Financial services comprise of various functions and services that are provided by financial institutions in a financial system. Financial services are offered by both asset management companies, which include leasing companies, mutual funds, merchant bankers, issue/portfolio managers and liability management companies which included bill discounting houses and acceptance houses. Financial services help not only in raising the required funds but also in ensuring their effective distribution. Financial services are provided by stock exchanges, specialized and general financial institutions, bask and insurance companies. They are regulated by the securities and Exchange Board of India (SEBI), Reserve Bank of India and the Department of Banking and Insurance, Government of India, through a plethora of legislations.
Following are some of the examples of financial services:
1. Leasing credit cards, factoring portfolio management, technical and economic consultancy, credit information.
2. Underwriting, discounting and rediscounting of bills
3. Acceptances, brokerage and stock holding
4. Depository, housing finance and book building
5. Hire purchase and installment credit
6. Deposit insurance
7. Financial and performance guarantees
8. E-commerce and securitization of debts
9. Loan syndicating and credit rating
Financial markets facilitate buying and selling of financial claims, assets, services and securities. In financial markets, funds or savings are transferred from surplus units to deficit units. A financial market comprises of players such as banking and non-banking financial institutions, dealers, borrowers and lenders, investors and depositors and agents. These participants take an active in driving demand and supply in the financial market. Financial market is said to exist wherever financial transactions take place.