A sound financial system is the base of every modern economy. A financial system is a set of institutional arrangements through which fiscal surpluses are mobilised from the units generating surplus income and transferring them to the others in need of them. In this article, we are going to discuss the functions of a good Financial System, how to ensure the growth of the Financial System, Financial Market and it’s components. Let’s start now.

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What are the Functions of a Good Financial System?

A sound financial system comprises of the following functions:

  1. Regulation of currency
  2. Provision of banking functions
  3. Performance of agency services
  4. Acting as custody of cash reserves
  5. Management of national measures of international money
  6. Credit control
  7. Administration of national, fiscal and monetary policy to ensure the economy’s stability
  8. Supply of funds
  9. Deployment of funds
  10. Maintenance of liquidity.

How can we ensure the long-term growth of the Financial System?

We can ensure the long-term growth of the Financial System by considering the following points:

  1. Educating the investors
  2. Giving autonomy to Financial Institutions to become efficient under competition
  3. Carrying out consolidation through mergers
  4. Facilitating entry of new institutions to add depth to the market
  5. Minimising regulatory measures and market segmentation.

What are Financial Markets?

Financial Markets are one of the major constituents of the Indian Financial System. The primary function of a financial market is to transfer resources efficiently from those having idle resources to others who have a pressing need for them. In other words, financial markets provide channels for allocation of savings to investments. The savers and investors are constrained not by their abilities, but by the economy’s strength, to invest and save respectively. The financial markets, thus, contribute to economic development. And rest it depends on the rates of savings and investments also.

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Components of Financial Markets

Financial Markets have two major components:

  1. Money Market
  2. Capital Market

Money Market

The market where borrowers and lenders exchange short-term funds in order to solve their liquidity needs is known as Money Market.

Money Market Instruments are generally financial claims that are characterised by:

  • Low default risk
  • Maturities under one year
  • High marketability

Capital Market

A market for business investments that are direct or indirect claims to capital is known as Capital Market. Capital Market is broader than the Securities Market. It covers all forms of lending and borrowing activities, whether or not evidenced by the creation of a negotiable financial instrument. The capital market encompasses the process by which already outstanding securities are transferred.

The Capital Market and in particular the Stock Exchange is referred to as the barometer of the Indian economy. The Capital Market further divided into:

  1. Securities Market
  2. Other forms of lending and borrowing

Securities Market

The market for those financial instruments or claims or obligations that are commonly and readily transferable by sale is known as Securities Market.

The Securities Market further divided into

  • New Issues Market (Primary Market)
  • Secondary Market
New Issues Market (Primary Market)

The Primary Market provides the channel for sale of new securities. Primary Market is also known to be the market wherein resources are mobilised by companies through the issue of new securities. The issuer of securities sells the securities in the primary market in order to raise funds for investment. The primary market is considered to be of much significance to the economy of a country.

It is the primary market that regulates the flow of funds for productive purposes from investors to entrepreneurs. The entrepreneurs then use the funds for creating new products and rendering new services to customers in and outside India, thereby affecting the global economy. The strength of the economy of a country is gauged by the activities of the Stock Exchanges. The primary market creates and offers merchandise for the secondary market.

Secondary Market

The secondary market deals in securities previously issued. The secondary market mainly comprises of Stock Exchanges which provide a platform for purchase and sale of securities by investors. The trading platform of stock exchanges is accessible only through Brokers. Trading of Securities is confined only to Stock Exchanges.

The Secondary Market or Stock Market ensures:

  • Free marketability
  • Negotiability
  • Price discharge

The Stock Market referred to as the ‘Nerve Centre’ of the Capital Market.

The secondary market is further sub-divided into:

  • Spot Market, where securities traded for immediate delivery and payment.
  • Future Market is those where the securities traded for future delivery and payment.
  • In Options Market securities are traded for conditional future delivery.

Options Market further segregated into two more parts:

    • Put Option, which permits the owner to sell a security to the writer of the option at a pre-determined price before a specific date.
    • Call Option permits the buyer to purchase a security from the writer of the option at a particular price before a specific date.

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So here is the brief discussion of Indian Financial System. Hope you like the article and please share it with your friends also. And if there is any doubt at any point, please write down in the comment section. We will be more than happy to respond.