The formal financial system comes under the purview
of the Ministry of Finance (MOF), Reserve Bank of India (RBI), Securities
Exchange Board of India (SEBI) and other regulatory bodies. Formal financial
sector is characterized by the presence of an organized institutional and
Formal financial system
A financial institution is an establishment that is engaged in the business of
dealing with monetary transactions such as deposits, loans and exchange of
currency. They are the intermediaries of financial markets; they act as a
middlemen between savers and borrowers. They facilitate the allocation of funds
in an effective manner. Financial institutions mainly provide 3 transformation
services such as Liability, asset and size transformation, Maturity
transformation and Risk transformation.
are classified into Banking institutions, Non-banking institutions, Mutual
funds and Insurance and Housing Corporation.
Banking institutions include public and private
sector banks that collects deposits from the public in return for interest and
utilize that money for providing loans to customers. They are the creators of
credit in the country. They act as an intermediary between depositors and
borrowers. Banks are highly regulated in the country because of their importance
in controlling the financial stability of the country. Apart from accepting
deposits and lending, they also offer services like wealth management, currency
exchange and safe deposit locker facilities.
Banking institutions include Scheduled Commercial
Banks and Scheduled Cooperative banks. Scheduled Banks in India refer to those
banks which have been included in the 2nd schedule of RBI Act, 1934.
Scheduled Banks include Public Sector banks, Private Sector Banks, Foreign Banks
and Regional Rural Banks.
Public Sector Banks are those banks where more than
50% of the total stake will be held by the Government. There are total 21 PSBs
in the country. The shares of these banks are listed in the stock exchange. Some
of PSBs are State Bank of India, Punjab National Bank, etc… Private Sector
banks are those where majority of the stakes are held by the private parties,
not the Government. Some of the Private sector banks include Axis Bank, HDFC
Bank, etc… Foreign Banks are those banks which has its headquarters in another
country but has branches in other countries. Such banks are supposed to follow
all the rules and regulations of the country in which it is operating. It
includes Royal bank of Scotland, Citi Bank, etc… Apart from the ownership, all
these banks provide equally better service and they have almost the same rate
of interest. Regional Rural Banks or RRBs are local small level banks operating
in all the states of the country. The main aim of RRB is to serve the rural
areas which has basic banking and financial services. They have been formed to
cater the needs of weak and poorer sections of the society. RRBs are regulated
by the National Bank for Agriculture and Rural Development (NABARD).
Cooperative Banks in India are registered under the
Co-operative Societies Act. It is a bank that holds deposits, provides loans
and various financial services to the cooperatives and member owned organizations.
They mainly serve small industry and self employed workers
Non-banking institutions are the purveyors of credit
in the country. They does not have a full banking license and they are not
supervised by any banking regulatory agency. All the non-banking institutions
in the country are regulated by the Reserve Bank as in the case of banking
Non-banking institutions can be divided into
Non-banking Finance Companies and Development Finance Institutions. According
to The Reserve Bank of India (RBI), “A Non-Banking Financial Company (NBFC) is a
company registered under the Companies Act, 1956 engaged in the business of
loans and advances, acquisition of shares/stocks/bonds/debentures/securities
issued by Government or local authority or other marketable securities.” They
can provide services like accepting deposits and lending money, but they do not
have a banking license and they cannot issue cheques to its customers. They can
provide services in money markets, underwriting, etc…
Mutual fund is a professionally managed investment
fund that pools money from the investors and invests them in securities like
shares, bonds and other money market instruments by a professionally managed
fund manager who is specialized in the work. They generate revenue from the
funds and it is passed back to investors. It is an ideal investment for people
who wants to invest money but does not have much information about investing.
Insurance is an agreement or a contract where the
insurer undertakes to provide guarantee to pay a certain sum of money to the
insurer in the case of any unforeseen events or for any uncertain financial
loss, as mentioned in the insurance contract. The insured pays a certain sum of
money known as premium to the insurer for the service provided.
Financial Markets: It is a
marketplace where traders buy and sell assets such as equities, bonds,
currencies, etc… It can be divided into capital market and money market.
Capital market deals in long term securities over one year. Capital market are
markets for selling and buying equity and debt instruments. It channelize
savings and investment between suppliers of capital. It channel the wealth of
savers to those who can it invest it productively. Capital market can be
divided into equity market and debt market. Equity market includes Public issues,
Private placement, National Stock Exchange, Bombay Stock Exchange, Derivatives
market, etc… Money market deals with short term securities of less than one
year. They are short term instruments of high liquidity which are issued by the
Governments, financial institutions and large corporations. It involves
Treasury bills, call money market, Commercial bills, Commercial papers,
certificates of deposit and Term money.
Financial Markets can
be either organized markets or unorganized markets. Organized Markets are
markets where all the transactions are regulated by the rules and regulations
of a particular exchange that deals in trading. Unorganized Markets include the
financial transactions that takes place outside a regulated exchange.