Overview of Financial System

Financial System

Financial system is a structure that is available in economy to mobilize capital from various surplus sectors of economy and allocate and distribute the same to the various needy sectors of the economy. It provides a system by which savings are transformed into investments.

The place where this activity of transformation takes place is known as Financial Market. Various intermediaries like banks, financial institutions, mutual funds etc. are involved in this process of transformation.

Brief overview of role of RBI

  • Monetary Control: RBI controls the flow of liquidity in the system by using various instruments like CRR, SLR, Bank and Repo Rate.
  • Supervision of Banks: It acts as supervisor of banks by performing their offsite and onsite surveillance to ensure healthy banking system.
  • Lender of last resort to banking system

Commercial Banks

Commercial Banks includes all public sector banks, foreign banks, new and old private banks. These banks accept deposit from public for the purpose of lending or investment.

Non-Banking Financial Companies (NBFCs)

NBFCs are allowed to raise deposit from public and lend through instruments like leasing, hire purchase and bill discounting etc.
NBFCs are licensed by RBI. No NBFC can operate without valid license from RBI.

Primary Dealers (PDs)

Primary Dealers mainly deals with government securities. Their primary purpose is to provide market for government securities and strengthen them. They are also called market makers of government securities.

Financial Institutions (FIs)

FIs focus on dealing with financial transactions such as investments, deposits and loans. These are development institutions which provide long-term funds for industry and agriculture. FIs raise resources through long-term bonds from financial system and borrowing from international FIs. They are under offsite and onsite surveillance of RBI.

Cooperative Banks

Cooperative banks serve the needs of agriculture and allied activities, rural based industries and to lesser extent trade and industry in urban areas. They are allowed to raise deposit and give advance from and to the public. They provide higher interest on deposits.

Urban cooperative banks are controlled by state government and RBI while other cooperative banks are controlled by NABARD.

Payment and Settlement System

An efficient payment and settlement system is the backbone for smooth functioning of financial system. Payment and settlement system is undertaken by RBI. It includes:

  • Maintenance of clearing houses at various centers
  • Creation of currency holding chests in various geographical locations
  • Creation of mechanism for electronic transfer of funds.

Bankers to Government

RBI maintains accounts and deposits of government. It carries out their cash management through issue of bonds and Treasury bills.

Cash Reserve Ratio (CRR)

CRR is the amount of cash that scheduled commercial banks are required to maintain with RBI. It is percentage of their Net Demand and Time Liabilities. It enables RBI to control liquidity in the banking system thereby, controlling inflation and bank lending.

Statutory Liquidity Ratio (SLR)

SLR is percentage of Net Demand and Time Liabilities of a bank to be held in prescribed securities mainly government securities. These are liquid assets in the form cash, gold and un-encumbered approved government securities.