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Indian Financial System by M Y Khan: A Comprehensive Guide




If you are looking for a book that covers all aspects of the Indian financial system, then you might want to check out Indian Financial System by M Y Khan. This book gives a comprehensive account of the main strands in the development of the industrial financing system of India. The content of this book is based on the information amassed from widely scattered original sources. Content in each chapter reflect the major developments since the publication of the earlier edition in 2017 until end of March 2019.




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In this article, we will give you a brief overview of what this book is about, why it is important, and what are its key features. We will also summarize some of the main topics covered by this book, such as:



  • The financial system: An introduction



  • The financial system and the economy



  • Reforms in the financial system



  • The money market



  • The capital market



  • The primary market



  • Disinvestment of public sector undertakings



  • The secondary market



By reading this article, you will get a glimpse of what you can learn from this book, and how it can help you understand the Indian financial system better.


The Financial System: An Introduction




What is the financial system? How does it work? What are its components and functions? These are some of the questions that this chapter answers. The financial system can be defined as a set of institutions, markets, instruments, and services that facilitate the flow of funds between savers and investors. The financial system plays a vital role in the economic development of a country by mobilizing, allocating, and utilizing funds efficiently and effectively.


The financial system consists of four main components: financial markets, financial institutions, financial instruments, and financial services. Financial markets are the platforms where buyers and sellers of financial assets interact and exchange funds. Financial institutions are the intermediaries that facilitate the transfer of funds between savers and investors. Financial instruments are the contracts that represent claims on future cash flows or ownership rights. Financial services are the activities that provide various benefits to the participants of the financial system, such as advisory, brokerage, underwriting, etc.


The financial system performs several functions that are essential for the smooth functioning of the economy. Some of these functions are:



  • Providing a mechanism for saving and investment



  • Enabling price discovery and risk sharing



  • Facilitating trade and commerce



  • Promoting innovation and entrepreneurship



  • Supporting monetary and fiscal policies



The financial system also has a significant impact on the economic growth, stability, and efficiency of a country. A well-developed and well-regulated financial system can foster economic development by enhancing capital formation, productivity, innovation, and competitiveness. A sound and resilient financial system can also maintain economic stability by preventing and managing financial crises, shocks, and contagion. A competitive and inclusive financial system can also improve economic efficiency by reducing transaction costs, information asymmetry, and market imperfections.


The Financial System and the Economy




How does the financial system affect the economy? What are the challenges and opportunities for the financial system in a globalized economy? These are some of the questions that this chapter addresses. The relationship between the financial system and the economy is complex and dynamic. The financial system influences the economy through various channels, such as interest rates, credit availability, asset prices, wealth effects, confidence effects, etc. The economy also affects the financial system through various factors, such as income levels, inflation rates, exchange rates, fiscal deficits, etc.


The impact of the financial system on economic development can be positive or negative depending on various factors, such as the level of development, quality of institutions, degree of integration, etc. A positive impact occurs when the financial system facilitates capital accumulation, technological innovation, resource allocation, risk management, etc. A negative impact occurs when the financial system causes financial instability, misallocation of resources, excessive leverage, speculation, etc.


The challenges and opportunities for the financial system in a globalized economy are manifold. On one hand, globalization offers several benefits to the financial system, such as increased access to markets, capital flows, diversification opportunities, etc. On the other hand, globalization also poses several risks to the financial system, such as increased volatility, contagion effects, regulatory arbitrage, etc.


Therefore, the financial system needs to adapt to the changing environment and adopt appropriate policies and strategies to harness the potential of globalization and mitigate its pitfalls.


Reforms in the Financial System




Why were reforms needed in the Indian financial system? What were the objectives and outcomes of these reforms? How can these reforms be evaluated? These are some of the questions that this chapter answers. The need for reforms in the Indian financial system arose due to various factors, such as low efficiency, high intermediation costs, poor asset quality, inadequate regulation, etc.


The objectives of the financial sector reforms in India were to create a more efficient, stable, and competitive financial system that could support the economic growth and development of the country. The major reforms in the banking sector, capital market, insurance sector, and pension sector included measures such as deregulation of interest rates, liberalization of entry norms, strengthening of prudential norms, introduction of new instruments, enhancement of disclosure standards, establishment of new institutions, etc.


The outcomes of the financial sector reforms in India were mixed. On one hand, the reforms led to significant improvements in the performance, soundness, and resilience of the financial system. On the other hand, the reforms also created some challenges and issues for the financial system, such as increased competition, financial inclusion gaps, financial literacy gaps, cybersecurity threats, etc.


The evaluation of the financial sector reforms in India can be done using various criteria, such as growth, stability, The Money Market




What is the money market? How is it structured and regulated? What are its instruments and participants? What are its role and functions? These are some of the questions that this chapter answers. The money market is a segment of the financial market where short-term funds with maturity ranging from overnight to one year are traded. The money market instruments are deemed to be close substitutes of money, as they are highly liquid and low-risk. The money market in India is regulated by both RBI (the Reserve Bank of India) and SEBI (the Securities and Exchange Board of India).


The money market in India consists of several sub-markets, each dealing in a specific type of instrument. Some of these sub-markets are:



  • The call money market: This is a market where funds are borrowed and lent for a very short period, ranging from one day to fourteen days. The interest rate in this market is known as the call rate. The participants in this market are mostly banks and financial institutions.



  • The treasury bill market: This is a market where government securities with a maturity of less than one year are issued and traded. The interest rate in this market is known as the treasury bill rate. The participants in this market include banks, financial institutions, corporates, mutual funds, etc.



  • The commercial paper market: This is a market where unsecured promissory notes issued by corporates with a maturity of up to one year are traded. The interest rate in this market is known as the commercial paper rate. The participants in this market include banks, financial institutions, corporates, mutual funds, etc.



  • The certificate of deposit market: This is a market where negotiable certificates issued by banks and financial institutions with a maturity of up to one year are traded. The interest rate in this market is known as the certificate of deposit rate. The participants in this market include banks, financial institutions, corporates, mutual funds, etc.



  • The repo market: This is a market where funds are borrowed and lent against the collateral of government securities for a short period, usually overnight. The interest rate in this market is known as the repo rate. The participants in this market include banks, financial institutions, primary dealers, etc.



The money market plays an important role and performs several functions in the economy. Some of these functions are:



  • Providing a mechanism for liquidity management: The money market enables the central bank to implement monetary policy by influencing the supply and demand of money through open market operations, repo operations, etc.



  • Providing a benchmark for short-term interest rates: The money market rates serve as reference rates for pricing various short-term financial instruments and contracts.



  • Providing a source and avenue for short-term funds: The money market enables the surplus and deficit units of funds to meet their short-term requirements at competitive rates.



  • Providing a transmission channel for monetary policy: The money market rates affect the cost and availability of credit in the economy, which in turn affect the aggregate demand, output, inflation, etc.



The Capital Market




What is the capital market? How is it structured and regulated? What are its instruments and participants? What are its role and functions? These are some of the questions that this chapter answers. The capital market is a segment of the financial market where long-term funds with maturity of more than one year are raised and invested. The capital market instruments include equity shares, preference shares, debentures, bonds, etc. The capital market in India is regulated by SEBI (the Securities and Exchange Board of India).


The capital market in India consists of two segments: the primary market and the secondary market. The primary market is the market where new issues of securities are offered to the public for subscription. The secondary market is the market where existing securities are traded among investors. The primary market and the secondary market are linked by the process of listing, which enables the securities issued in the primary market to be traded in the secondary market.


The capital market plays an important role and performs several functions in the economy. Some of these functions are:



  • Providing a mechanism for capital formation: The capital market mobilizes the savings of the households and the corporates and channels them into productive investments.



  • Providing a benchmark for long-term interest rates: The capital market rates serve as reference rates for pricing various long-term financial instruments and contracts.



  • Providing a source and avenue for long-term funds: The capital market enables the government, public sector undertakings, corporates, and other entities to raise funds for their long-term projects and programs.



  • Providing a platform for price discovery and risk sharing: The capital market facilitates the determination of the fair value of securities based on the demand and supply forces. It also enables the investors to diversify their portfolios and hedge their risks.



The Primary Market




What is the primary market? How are funds raised in this market? What are the regulations and institutions governing this market? What are the trends and issues in this market? These are some of the questions that this chapter answers. The primary market is the market where new issues of securities are offered to the public for subscription. The funds raised in this market are used for setting up new businesses, expanding existing businesses, diversifying businesses, etc.


The methods and processes of raising funds in the primary market vary depending on the type and size of the issuer, the type and size of the issue, the type and size of the investors, etc. Some of the common methods of raising funds in the primary market are:



  • Public issue: This is a method where securities are offered to the general public through a prospectus, which contains all the relevant information about the issuer and the issue. The public issue can be further classified into initial public offer (IPO), where securities are offered for the first time by the issuer, and follow-on public offer (FPO), where securities are offered subsequently by the issuer.



  • Private placement: This is a method where securities are offered to a selected group of investors, such as institutional investors, high net worth individuals, etc. The private placement can be further classified into qualified institutional placement (QIP), where securities are offered only to qualified institutional buyers, and preferential allotment, where securities are offered to existing shareholders or promoters on a preferential basis.



  • Rights issue: This is a method where securities are offered to existing shareholders of the issuer in proportion to their shareholding. The shareholders have the right to subscribe to the new securities or renounce their right in favor of others.



  • Bonus issue: This is a method where securities are issued to existing shareholders of the issuer free of cost by capitalizing the reserves or surplus of the issuer.



The regulations and institutions governing the primary market in India include:



  • SEBI (the Securities and Exchange Board of India): This is the apex regulatory authority for the capital market in India. It regulates the issuers, intermediaries, investors, and instruments in the primary market. It also frames rules and guidelines for disclosure, listing, pricing, allotment, etc. of securities in the primary market.



  • Stock exchanges: These are the platforms where securities issued in the primary market are listed for trading in the secondary market. They also provide facilities for clearing and settlement of transactions in the secondary market. Some of the major stock exchanges in India are BSE (Bombay Stock Exchange), NSE (National Stock Exchange), MSEI (Metropolitan Stock Exchange of India), etc.



Disinvestment of Public Sector Undertakings




What is disinvestment? Why is it done? How is it done? What are the benefits and challenges of disinvestment? These are some of the questions that this chapter answers. Disinvestment is a process of public asset sales done by the President of India on behalf of the Government of India. It can be directly offered for sale to the private sector or indirectly done through a bidding process. The public enterprises that are disinvested are known as public sector undertakings (PSUs).


The main objective of disinvestment is to reduce the financial burden on the government and improve the efficiency and competitiveness of the PSUs. The government also aims to mobilize resources for social and infrastructure development, promote wider ownership of PSUs, and enhance market discipline and corporate governance in PSUs.


The methods of disinvestment vary depending on the extent and mode of transfer of ownership and control of PSUs. Some of the common methods of disinvestment are:



  • Strategic sale: This is a method where a substantial portion of the government's shareholding in a PSU along with transfer of management control is sold to a strategic partner, who is selected through a competitive bidding process.



  • Initial public offering (IPO): This is a method where a part of the government's shareholding in a PSU is offered to the public for subscription through a prospectus.



  • Offer for sale (OFS): This is a method where a part of the government's shareholding in a PSU is offered to institutional and retail investors through a stock exchange platform.



  • Exchange traded fund (ETF): This is a method where a basket of government's shares in various PSUs is created and units representing this basket are issued to investors.



  • Asset monetization: This is a method where non-core assets such as land, buildings, machinery, etc. owned by PSUs are sold or leased to private entities.



The benefits of disinvestment include:



  • Reducing fiscal deficit and debt burden of the government



  • Improving operational efficiency and profitability of PSUs



  • Enhancing transparency and accountability in PSUs



  • Creating competitive market conditions and consumer welfare



  • Generating employment and investment opportunities



The challenges of disinvestment include:



  • Facing political and social opposition from various stakeholders



  • Ensuring fair valuation and optimal realization of PSUs



  • Protecting the interests of workers and minority shareholders



  • Maintaining strategic and security interests of the nation



  • Addressing environmental and social concerns



The Secondary Market




The Secondary Market




What is the secondary market? How are securities traded in this market? What are the regulations and institutions governing this market? What are the trends and issues in this market? These are some of the questions that this chapter answers. The secondary market is the market where existing securities are traded among investors. The secondary market enables the investors to buy and sell securities at any time after they are issued in the primary market. The secondary market also provides liquidity and price discovery for securities.


The securities traded in the secondary market can be classified into two types: equity and debt. Equity securities represent ownership rights in a company, such as shares, warrants, etc. Debt securities represent claims on future cash flows of a borrower, such as bonds, debentures, etc. The secondary market can be further divided into two segments: exchange-traded and over-the-counter (OTC). Exchange-traded securities are traded on organized platforms such as stock exchanges, where standardized rules and regulations apply. OTC securities are traded directly between buyers and sellers, without any intermediation of an exchange.


The secondary market in India is regulated by SEBI (the Securities and Exchange Board of India), which is the apex authority for the capital market. SEBI frames rules and guidelines for the protection of investors, prevention of malpractices, promotion of fair practices, and development of the market. SEBI also regulates various intermediaries involved in the secondary market, such as stock brokers, sub-brokers, depositories, custodians, etc.


The institutions involved in the secondary market in India include:



  • Stock exchanges: These are the platforms where securities are listed and traded. They provide facilities for trading, clearing, settlement, risk management, etc. Some of the major stock exchanges in India are BSE (Bombay Stock Exchange), NSE (National Stock Exchange), MSEI (Metropolitan Stock Exchange of India), etc.



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