The functions that sets the pace for
The economic scene in the post independence period has seen a sea change; the end result being that the economy has made enormous progress in diverse fields.
There has been a quantitative expansion as well as diversification of economic activities. The experiences of the 1980s have led to the conclusion that to obtain all the benefits of greater reliance on voluntary, market-based decision-making, India needs efficient financial systems. The financial system is possibly the most important institutional and functional vehicle for economic transformation. Finance is a bridge between the present and the future and whether it be the mobilisation of savings or their efficient, effective and equitable allocation for investment, it is the success with which the financial system performs its functions that sets the pace for the achievement of broader national objectives.
1.1 Significance and Definition The term financial system is a set of inter-related activities/services working together to achieve some predetermined purpose or goal. It includes different markets, the institutions, instruments, services and mechanisms which influence the generation of savings, investment capital formation and growth. Van Horne defined the financial system as the purpose of financial markets to allocate savings efficiently in an economy to ultimate users either for investment in real assets or for consumption.
Christy has opined that the objective of the financial system is to “supply funds to various sectors and activities of the economy in ways that promote the fullest possible utilization of resources without the destabilizing consequence of price level changes or unnecessary interference with individual desires.” According to Robinson, the primary function of the system is “to provide a link between savings and investment for the creation of new wealth and to permit portfolio adjustment in the composition of the existing wealth.” From the above definitions, it may be said that the primary function of the financial system is the mobilisation of savings, their distribution for industrial investment and stimulating capital formation to accelerate the process of economic growth. FINANCIAL SYSTEM SAVINGS FINANCE The Concept of the Financial System The process of savings, finance and investment involves financial institutions, markets, instruments and services. Above all, supervision control and regulation are equally significant. Thus, financial management is an integral part of the financial system. On the basis of the empirical evidence, Goldsmith said that “.
.. a case for the hypothesis that the separation of the functions of savings and investment which is made possible by the introduction of financial instruments as well as enlargement of the range of financial assets which follows from the creation of financial institutions increase the efficiency of investments and raise the ratio of capital formation to national production and financial activities and through these two channels increase the rate of growth……” The inter-relationship between varied segments of the economy are illustrated below:- INVESTMENT CAPITAL FORMATION ECONOMIC GROWTH ECONOMIC GROWTH GOAL FINANCIAL SYSTEM SYSTEM FINANCIAL INSTITUTIONS FINANCIAL SYSTEM MARKETS FINANCIAL INSTRUMENTS Inter-relationship in the Financial System A financial system provides services that are essential in a modern economy. The use of a stable, widely accepted medium of exchange reduces the costs of transactions.
It facilitates trade and, therefore, specialization in production. Financial assets with attractive yield, liquidity and risk characteristics encourage saving in financial form. By evaluating alternative investments and monitoring the activities of borrowers, financial intermediaries increase the efficiency of resource use.
Access to a variety of financial instruments enables an economic agent to pool, price and exchange risks in the markets. Trade, the efficient use of resources, saving and risk taking are the cornerstones of a growing economy. In fact, the country could make this feasible with the active support of the financial system.
The financial system has been identified as the most catalyzing agent for growth of the economy, making it one of the key inputs of development 1.2 The Organisation of the Financial System in India The Indian financial system is broadly classified into two broad groups: i) Organised sector and (ii) unorganised sector. “The financial system is also divided into users of financial services and providers. Financial institutions sell their services to households, businesses and government. They are the users of the financial services. The boundaries between these sectors are not always clear cut. In the case of providers of financial services, although financial systems differ from country to country, there are many similarities. (i) Central bank (ii) Banks (iii) Financial institutions (iv) Money and capital markets and (v) Informal financial enterprises.
i) Organised Indian Financial System The organised financial system comprises of an impressive network of banks, other financial and investment institutions and a range of financial instruments, which together function in fairly developed capital and money markets. Short-term funds are mainly provided by the commercial and cooperative banking structure. Nine-tenth of such banking business is managed by twenty-eight leading banks which are in the public sector. In addition to commercial banks, there is the network of cooperative banks and land development banks at state, district and block levels. With around two-third share in the total assets in the financial system, banks play an important role. Of late, Indian banks have also diversified into areas such as merchant banking, mutual funds, leasing and factoring.
The organised financial system comprises the following sub-systems: 1. Banking system 2. Cooperative system 3. Development Banking system (i) Public sector (ii) Private sector 4.Money markets and 5. Financial companies/institutions.
Over the years, the structure of financial institutions in India has developed and become broad based. The system has developed in three areas – state, cooperative and private. Rural and urban areas are well served by the cooperative sector as well as by corporate bodies with national status. There are more than 4,58,782 institutions channellising credit into the various areas of the economy. ii) Unorganised Financial System