Topic 1-5.pdf - AN OVERVIEW OF FINANCIAL SYSTEMS The...

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AN OVERVIEW OF FINANCIAL SYSTEMS The financial system of a country consists of money, financial instruments, financial markets, financial institutions, and the central bank. The financial systems of the most of the developing countries are characterised by the coexistence of formal and informal financial sectors. This is commonly referred to as ‘ financial dualism ’. The formal financial sectors are organized, institutional and regulated systems while the informal financial sectors are unorganized, non- institutional and non-regulated systems primarily operating in the rural areas. The informal sector survives primarily because of the inaccessibility of certain sections of the population to the formal financial sectors. In India the formal financial system comes under the purview of Ministry of Finance, RBI and SEBI (Securities and Exchange Board of India) along with other regulatory bodies. This chapter will cover functions and components of formal financial systems with a focus on India financial system. Functions of financial systems A developed and efficient financial system is highly beneficial for economic growth and development as it performs certain very important functions. First of all, it acts as a link between the savers and the investors by mobilizing and allocating resources from the savers to the investors. This in turn reduces transaction costs. Second, it not only allocates funds to projects for investments, but also entails monitoring of the project performance. Poor corporate performance results in bankruptcies and takeovers. Third, efficiency of a financial system makes payment and settlement mechanism also highly efficient which are backbone of a modern economic system. Fourth, it facilitates the process of optimum risk allocation. It limits, pools and trades in risks involved in mobilizing savings and allocating credits. Risks are reduced by laying rules governing the operations, holding diversified portfolios and screening of borrowers. Fifth, it performs a very important task of disseminating price related information which assists the investors in decision making and the managements of corporations to evaluate and revise their strategies. Overall it reduces information asymmetry. Sixth, it also offers portfolio adjustment facility which includes services of providing a quick, cheap and reliable way of buying and selling a wide variety of financial assets. And, seventh, a well developed financial system helps in financial deepening and broadening. Financial deepening refers to the increase in liquid financial assets as a percentage of GDP. Financial broadening is measured in terms increase in the number and variety of participants and instruments. Financial instruments Among the components, money has already been discussed. Now, financial (market) instruments are written legal obligations of one party to transfer something of value, usually money, to another party at some future date, under certain conditions. Stocks, loans, insurance all are examples of financial instruments. However, some of the financial instruments are marketable and some are
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  • Spring '18
  • raghav thapar
  • Money market, treasury bills, maturity period, ) instruments

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