Introduction of Financial

Services
Prepared By: Taral Patel
 Introduction
• In an economy, the financial services sector plays a vital role in
the resource allocation process. The real sector {read
'manufacturing sector') needs the services of the financial
services sector in the mobilisa­tion of capital, payment and
settlement of funds, risk management and project financing The
financial markets, financial institutions (FIs), regulatory
framework and the financial instruments make up the financial
system in an economy.
 Financial Services: Concept
• Services industry is of diverse nature. The term 'services' broadly covers hospitality,

tourism, health services, education, professional services and others, For the purpose of

reviewing an economy, we divide the economy into agriculture, industry and services.

Within this 'services' sector lies the 'financial services' sector and it forms the main

focus of this book.

• In general, the term 'financial services' refers to those services rendered by banks, FIs,

insurance companies and other intermediaries in the financial market intermediaries.

Financial services include money management, portfolio management, stock broking

and custodial services. In a broader spec­trum, the term 'financial services' includes

equipment leasing, retail financing, credit cam services,

 Nature of Financial Services
• Generally, services have four important
characteristics that distinguish them from the physical
prod­ucts. They are: intangibility, inseparability,
heterogeneity and perishability.
1. Intangibility
2. Inseparability
3. Heterogeneity
4. Perishability
5. Advisory
6. Marketing of financial services
7. Techno savvy
 Indian Financial System
• Financial services are offered by the banks and other institutions in a financial

system. A financial system is the subset of the economic system.

• In a broader framework, Indian financial system com­prises the banking sector,

insurance sector, FIs, the Non-Banking Financial Companies (NBFCs) and the

Housing Finance Companies (HFCs). The term 'financial system' encompasses the

institu­tions, the financial markets, financial instruments and a host of financial

services.

• It can be stated that a financial system comprises the market, market participants,

the financial instruments, the rules and procedures, and the market regulator.

• The RBI's Report on Currency and Finance regu­larly presents the statistics on the

financial system in a particular format.

Structure of Indian financial service
 Regulators

• The Government of India, Reserve Bank of India (RBI), Securities and Exchange

Board of India (SEB), Insurance Regulatory and Development Authority (IRDA),

the Ministry of Corporate Affairs (MCA) and the Ministry of Finance (MOF) are

some of the regulatory agencies that govern the functioning of the financial

system.

• Besides the basic stat­utes relating to the functioning of banks and other FIs, we

also have the guidelines, circulars, orders and instructions issued by the regulatory

agencies from time to time regarding their operations in the financial market.
 Commercial banks:
• Commercial banks form the major segment of the financial system. A strong

network of commercial banks comprising of the public sector banks, private sec­tor

banks, foreign banks and co-operative banks exists in the Indian financial system.

• Banks facilitate the mobilization of savings of individuals and institutions and lend

the same as loans and advances to the companies. Thus, banks do a financial

intermediation job.

• In line with the Basel norms, stringent capital adequacy requirements are adopted

by banks. Further, the RBI ensures a close monitoring and supervision of

commercial banks in the country through the Board for Financial Supervision.
 Financial institutions:
• These institutions, started by the government, serve as pillars of
indus­trial and trade development. Therefore, these institutions
are described as the Development. Finance Institutions DFls
• IFCI,
• IDBI
• SIDBI,
• IDFC,
• NABARD,
• EXIM Bank,
• NHB,
• SFCs
• ,ECGC are also included in this category.
 NBFCs:

• The NBFCs are yet another segment of non-banking

institution in the financial system. Within this category
there are deposit taking and non-deposit taking NBFCs
and Residuary Non-Banking Companies (RNBCs).
• NBFCs play a key role in consumer credit, equipment
leasing and vehicle financing through hire-purchase
finance.
Insurance companies and the HFCs
• Life Insurance Corporation (LIC), general insurance companies
and private sector insurance companies constitute the
insurance industry in India. This sector is currently emerging as
an industry with high potential for growth.

• More private insurance firms have entered into insurance

business due to the opening up of the sector. The HFCs provide
long-term housing finance for residential and commercial
properties. The HFCs have refinance facility from NHB.
 Mutual funds
• These are investment institutions. Mutual funds enable the
pooling of savings of retail investors and channelise them for
investment in capital market and money market securities.

• The mutual fund industry in India is at a mature stage with the

number of funds being large and the Assets Under the
Management (AUM) have also increased substantially
 Financial Markets
• Financial markets trade in financial instruments. The term 'financial market' includes capital market,

money market, foreign exchange market and derivatives market. An exchange of financial instruments, like

equity shares, bonds (or debentures), mutual fund units and derivative securities, like futures and option

contracts, takes place in the financial markets.

• Financial markets determine theasset prices. The markets consisting of buyers and sellers determine the

price after an evaluation ofthe risk and return on the securities. Therefore, the prices reflect the risk—

return trade-off and serve as a means of ascertaining the value of securities.

• Capital market is the market for long term securities.

1. Primary market

2. The secondary market

Money market

Derivative market
 Financial Instruments
• Financial instruments are the financial securities issued by the government, companies

or the local authorities. They represent the financial claims of the investors on the

issuers, namely, the govern­ment, companies and the local authorities. The term

'securities' is defined in the Securities Contract (Regulation) Act to include mutual fund

units and derivative securities (futures contract and option contracts) apart from the

traditional securities like shares and bonds.

• Feature of securities

1. Transferability

2. Differences in the risk profile

3. Structured instrument

4. Security on security

5. From
 Financial service
• The term 'financial services' was defined earlier in this chapter. However, we

recapitulate certain fea­tures here, in our attempt to complete our discussion on the

financial system. First, financial services are intermediary services in the financial

market place. The suppliers of capital and the user of capital are brought together

by the financial services industry. Suppliers of capital might be individual

investors or the institutional investors like the FIs, mutual funds or the insurance

companies. Project financing , bridge finance , portfolio management , wealth

management , foreign exchange advisory and risk management are some financial

services.
 Function of the financial system
• Financial system of a country has a significant role to
play in the economy.
• Money supply, inflation, credit creation, foreign
exchange reserves, flow of foreign capital and
regulation of the banks and FIs are some of the key
areas of control in a financial system.
• A well-functioning financial system is essential for the
growth of the economy.
• The financial system handles huge volume of money
and securities and therefore needs proper checks and
balances to ensure stability and public confidence.
• Mechanism for mobilising savings: A financial system has demanders

of funds in certain sectors and suppliers of funds in certain other sectors

like the household and the foreign sectors. The role of a financial system

lies in channeling the money (savings) from the 'surplus' sector to the

'deficit' sector. Financial instruments are used for this purpose.

• Mechanism for storing wealth: Financial system facilitates the

investors to store their wealth in the form of financial instruments. These

instruments generate income for the investor and help them preserve the

value of the assets they hold. The risk of loss is much less in financial

instruments as compared to other forms of stored wealth.

• Liquidity: The financial markets provide the
most important attribute of the securities
namely, liquidity. Financial market provides a
means of converting financial instruments in to
cash or vice versa.
• Credit mechanism: Financial system
facilitates the process of extending credit
through the banking sector as well as through
other FIs to the households, business firms and
the government.
• Payment system: The financial system is the
mechanism for making payments for goods and
services. The flow of funds in the banking system is
an example. Cheques are issued in the course of
business transactions and it serves as a medium of
exchange in effecting the pay­ments. So is the case of
other modes of payment like the use of credit cards.
Credit cards are accepted as a convenient means of
payment.
• Risk management: Financial markets offer a wide range of insurance

products to manage the life, health, property and income risks. Further,

the risks arising from the currency expo­sures in international transactions

could be managed through the forward contracts or the currency option

contracts.

• Policy implementation: In managing the economy, the government brings

our several policy measures. For example, in an attempt to regulate credit

and control inflation, the government regularly comes out with

appropriate monetary policy. The government can affect the bor­rowing

and spending plans of the public through the changes in the interest rates.
• Information provider: The financial markets trade in various
financial assets like shares, bonds and government securities.
The asset prices are available on a daily basis in the finan­cial
press. With the introduction of technology, the price
information is currently available on a real-time basis too.
The provision of quick access to information with the least
cost makes the market more efficient.
 Mutual fund
• Mutual funds are investment institution in
capital market.
• By pooling the resources of small investors, a
mutual fund builds a corpus of funds.
• Capital instrument and money market
instrument ( securities)
• These are a number of mutual fund schemes to
suit the risk preference of investor.
 Derivative Securities
• Derivative securities have become an integral part
of our financial system.
• Future contract and the option contract are the
derivative securities dealt with in a derivatives
market.
• These securities were designed to hedge the risk
arising from other assets like stock, currencies or
loans.
• Future contract
• Option contract: Call and Put
Money Market