Financial System Bcom Notes

Financial System Bcom Notes

Financial System Bcom Notes:- In this post, you will get the notes of 3rd year money and financial system, by reading this post you can score well in the exam, hope that this post has helped you with this post to all your friends and all groups right now I must share it so that every student can read this post and it can also be helped in this post. Financial System Bcom Notes


Meaning of Financial System

The financial system of a country comprises a complex set of financial itutions, financial markets, financial instruments and so on. It provides an effective credit and payment mechanism, and hence, it plays a key role in ensuring that the real sector can function smoothly. It refers to a set of institutional arrangement through which financial surpluses in the economy are mobilised from surplus units and transferred to the deficit units. The institutional arrangement includes (a) the conditions and mechanisms governing the production, distribution, exchange and holding of financial assets or instruments; (b) working of financial markets, and (c) organisation and operation of financial institutions. Thus, financial system implies a set of complex and intimately connected and interlinked institutions, agents, practices, transactions, markets, claims and liabilities in the economy.

Constituents of Financial System

There are three main constituents of the financial system: (a) the financial assets, (b) the financial market and (c) the financial institutions.

  1. Financial Assets: The financial assets or near-money assets are the claims to money and perform some functions of money. They have high degree of liquidity but are not as liquid as money is. Financial assets are of two types: (a) primary or direct assets, and (b) secondary or indirect assets. Primary assets are the financial claims against real-sector units created by real-sector units as ultimate borrowers for raising funds to finance their deficit spending; they are the obligations of ultimate borrowers. The examples of rimary assets are bills, bonds, equities, book debits, etc. Secondary assets are financial claims issued by financial institutions against themselves to raise funds from the public; these assets are the obligations of the financial institutions. The examples of secondary assets are bank deposits, life insurance policies, Unit Trust of India units, etc.
  2. Financial Markets: The financial system of a country works through the financial markets and the financial institutions. The financial markets deal with the financial assets of different types, currency deposits, cheques, bills, bonds, etc. Financial markets perform the following functions: (a) They create and allocate credit. (b) They serve as intermediaries in the process of mobilisation of saving. (c) They provide convenience and benefits to the lender and borrowers. (d) They promote economic development through a balanced regional and sectoral allocation of investible funds.

Financial markets are credit markets which cater the credit needs of individuals, firms and institutions. Since credit is required and supplied for short period and long period, the financial markets are broadly divided into two types: (a) money market and (b) capital market. Money market deals with the short-period borrowing and lending of funds; in the money market, the short term securities are exchanged. Capital market deals with the long period borrowing and lending of funds; in the capital market, long-term securities are exchanged.

Financial market may also be categorised into: (a) primary market, and (b) secondary market. Primary market is a market in which newly issued credit instruments are sold and purchansed. Secondary market, on the other hand, is market in which previously issued credit instruments are bought and sold.

  1. Financial Institutions: Financial institutions or financial inter-mediaries act as half-way houses between the primary lenders and the final borrowers. They borrow funds (or accept deposits) from those who are willing to give up their current purchasing power and lend to (or buy securities from) those who require the funds for meeting the current expenditures. Financial institutions are generally dividend into two categories (a) banks, and (b) non-bank financial intermediaries. The main difference between banks and non bank financial intermediaries is that the former possess credit creating power, while the latter do not possess the demand deposits or credit-creating power.

Functions and Significance of Financial System

Financial system ensures the smooth functioning of the real sector by putting in place an efficient credit and payment mechanism. It helps production, capital accumulation and growth by (i) encouraging savings, (ii) mobilising them, and (iii) allocating them among alternative uses and users.

The main functions of the financial system be summarized follows:

(a) To enable and encourage economic agents to utilize their income flows over time in accordance with their intertemporal preference,

(b) to reduce risk on behalf of the lenders,

(c) to mobilise the savings of the community,

(d) to channelise the flow of savings to meet investment demand,

(e) to allocate resources for investment purposes in accordance with the principles of efficiency and social needs,

(f) to design a cheep, quick, reliable and extensive payment mechanism.

(g) to facilitate all kinds of financial transactions by putting in place the necessary service-providing mechanism.

Meaning Of Money Market

A money market is a mechanism which makes possible for borrowers and lenders to come together. Essentially it refers to a market of short-term funds. It meets the short-term requirements of the borrowers and provides liquidity of cash to the lenders. In the words of Crowther, money market is the name given to the various firms and institutions that deal with various grade of money. According to Madden and Nadler, “a money market is a mechanism through which short-term loans are loaned and borrowed and through which a large part of the financial transactions of a particular country or of the world are cleared”

The importance of the money market for the nation does not solely lie on its size; it lies rather in its liquidity and in its capacity for furnishing cash to any part of the country at a few hours notice.

Although money market does not refer to any specific place, it may be located in or associated with a particular place or geographical locality where short-term funds from an entire region or country or countries are attracted. Mumbai Money Market in India, is a typical example. There are also a few money markets which are international in character e.g. London Money Market, New York Money Market etc. These serve not only specific areas or countries but several countries in the world.

The money market is a wholesale market. The volume of business is very large and generally transactions are settled on a daily basis. There are a large number of participants in the money market i.e. commercial banks, mutual funds, investment institutions, financial institutions and finally the central bank. The central bank occupies a strategic and pivotal position in the money market. The money market can obtain funds from the central banks either by borrowing or through sales of securities. By varying the liquidity and regulating accession to the accommodation, the central bank influences the cost and availability of credit. A well-developed money market contributes to an effective implementation of monetary policy.

Financial System Bcom Notes

The Constituents or Components of Money Market

A money market consists of several sectors or sub-markets; each specialising in a particular type of lending. The important sectors are:

  1. The call money market: The call money is the market where financial institutions invest their short-term surplus funds on day-to-day basis. The funds invested can be called back any time at the discretion of lender. In this market generally the banks invest their surplus funds, and therefore it is also called inter bank call money market. The rate of interest is decided on demand and supply of funds. If supply of funds in more than its demand interest rate comes down and if demand is more than supply, interest rate goes up. Earlier RBI uses to take as active role to match demand and supply of funds and market base interest rate. But now there is very little interference by RBI but brokers and other institutions play important role to bring lender and borrower in touch of each other to finalize the transaction.
  2. The Treasury Bill Market: The second Component of money market is treasury Bill market which deals in treasury bill through RBI which are issued by the central government of different durations for less than one year. At present there are treasury bills for 14 days, 91 days, 182 days and 364 days. These bills are offered by the government to meet its ways and means requirement but till recently they were issued to financial budgetory deficit. These bills help cash mangagement of government of one side and utilization of surplus funds of financial system on the other side. The discount rate on these bills is dependent upon liquidity position in the money market.
  3. Commercial Paper Market: Another component of money market is commercial paper market. The commercial paper is a short-term instrument of raising funds. Commercial papers are essentially short-term unsecured promisory notes issued by highly ruled companies. The duration of CP is not fixed and is dependent upon the need of borrowing company. The CP is generally for a period of 3 to 6 months but before issue, CP company has to get rate by the approved rating agency. This instrument is very popular in may countries like UK, USA, Australia. These papers are discounted in the money market over its face value and the rate of discount depends upon the prevailing rate of interest in the money market. The CPs are allowed to be issued by company who have working capital of not less than Rs.5 crore. The companies who want to issue CPS will have to get themselves rated every six months from rating agency so that their health may be known by the market before discounting these papers. One of the biggest advantage of CP is that the borrower is not required to apply to the bank for loan and saves lot of time and procedure.
  4. Money market mutual Funds Market: The scheme of money market mutual fund was introduced by the Reserve Bank of India in April, 1992. The scheme aims to provide an additional short-term avenue to investors. The scheme was not popular in the beginning and to make it popular certain relexations were made by RBI in november 1995. The new guideline have allowed banks and public financial institutions to set up MMMF.
  5. Inter-bank Term market: Inter bank Term market is a market exclusively for commercial and cooperative banks to borrow and lend funds for a period over 14 days but upon 90 days without any collateral security. The rate of discount is decided by the market based on interest rate prevailing in the money market.

Financial System Bcom Notes

Functions /Importance of Money Market

Importance of money market may be summarized as follows:

  1. Encourages Financial Mobility: The money market by facilitating the transfer of surplus funds from one institution to other provides financial mobility which helps economic development.
  2. Promotes Liquidity: The call money and other market provides liquidity to banks and other financial institutions funds. Thus, it helps in the best use of surplus funds.
  3. Bring Equilibrium between Demand and supply of Funds: It provides an avenue for equilibrating the short term requirements of borrowers. An important feature of the money market instruments is that they are liquid with varying degree and can be traded at low cost.
  4. Source of Finance: It is a source of finance to the industry and commerce. It should provide reasonable access to the users of short-term money to meet their requirements at realistic prices.
  5. Helps to use Surplus Funds: It provides an avenue to banks, insurance companies, development banks, mutual funds, NBFC and corporation to make best use of surplus funds by investing them for short-period till they are not required.

Commercial banks and financial institutions are helped to march their assets and liabilities as per regulations and financial procedure. It helps them to gainfully deploy and borrow to adjust their short-term surpluses-deficits.

  1. Helps Government to raise short-term Funds economically: When government raises funds through treasury bill of 15 days to 364 days, it helps to prevail economic interest rate which can be repaid as revenue are received.
  2. Helps in Formulating and Implementing Monetary Policy: It helps RBI to effectively implement the monetary policy through intervention in the market.
  3. Helps in Fixing Interest Rate: The money market through the process of bringing equilibrium in demand and supply of cash also helps in fixing interest rate at proper level which indirectly influences interest rates in unorganised banking system also.

Financial System Bcom Notes

Financial System Bcom Notes
Financial System Bcom Notes

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