The Indian financial system can be broadly classified into the formal (organized) financial system and the informal (unorganized) financial system. The formal financial system comes under the purview of the Ministry of Finance (MOF) Reserve Bank of India (RBI), Securities Exchange Board of India (SEBI) and other regulatory bodies. The informal financial system consists of: (i) Individual money lenders such as neighbors, relatives, land lords, traders, store owners and so on. (ii) Groups of persons operating as funds or ‘associations’. These groups function under a system of their own rules. (iii) Partnership firms consisting of local brokers, pawn brokers and non banking financial intermediaries such as finance, investment, chit fund companies. In India the spread of banking in rural areas has helped in enlarging the scope of the formal financial system. 66 Components of formal financial system Formal financial system consist of four segments, these are financial institutions, financial markets, financial instruments and financial services. Financial institutions are intermediaries that mobilize the savings and facilitate the allocation of funds in an efficient manner. Financial institutions are classified as banking and non banking financial institutions. Banking institutions are creator of credit while non banking financial institutions are purveyors of credit. In India non banking financial institutions namely the Development Financial Institutions (DFIs) and Non Banking Financial Companies (NBFCs) as well as Housing Finance Companies (HFCs) are the major institutional purveyors of credit. Financial institutions are further classified as Term Finance Institutions such as Industrial Development Bank of India (IDBI), Industrial Credit and Investment Corporation of India (ICICI), Industrial Financial Corporation of India (IFCI), Small Industries Development Bank of India (SIDBI) and Industrial Investment Bank of India (IIBI). Specialized finance institutions like the Export Import Bank of India (EXIM), Tourism Finance Corporation of India (TFCI), ICICI Venture, Infrastructure Development Finance Company (IDFC) and sectoral financial institutions such as National Bank for Agricultural and Rural Development (NABARD) and National Housing Bank (NHB). Investment institutions in the business of mutual funds (UTI, Public Sector and Private Sector Mutual Funds) and insurance activity (LIC, GIC and 67 its subsidiaries) are also classified as financial institutions. There are state level financial institutions such as State Financial Corporation and State Industrial Development Corporation (SIDCs) which are owned and managed by the State Governments. Financial markets are a mechanism enabling participants to deal in financial claims. Money market and capital market are the organized financial markets in India. Money market is for short term securities while capital market is for long term securities. Primary market deals in new issues, the secondary market is meant for trading in outstanding or existing securities. Financial instrument is a claim against a person or an institution for the payment at a future date a sum of money or a periodic payment in the form of interest or dividend. Financial instruments may be primary or secondary securities. Primary securities are issued by the ultimate borrowers of funds to the ultimate savers e.g. Bank Deposits, Mutual Fund Units, Insurance Policies, etc. Financial instruments help the financial markets and the financial intermediaries to perform the important role of channelising funds from leaders to borrowers. Financial services include merchant banking, leasing, hire purchase, credit rating etc. Financial services rendered by the financial intermediaries’ bridge the gap between lack of knowledge on the part of the investors and increasing sophistication of financial market and instruments. 68 The four components are interdependent and they interact continuously with each other. Their interaction leads to the development of a smoothly functioning financial system. Savings and Investment Saving is abstaining from present consumption for a future use. Savings are sometimes autonomous coming from households as a matter of habit but the bulk of the savings come for specific objectives like interest on income, future needs, contingencies, precautionary purposes, growth in future wealth, leading to rise in the standard of living etc. Investment is the exchange of the money or cash for a future claim on money or the purchase of a security or a promise to pay at a later date along with a regular income as in the case of a share, bond, debenture etc. Investment is also a service like consultancy, construction, hotel or hospital and services in future as in the case of consumer durables. Securities purchases are investment for the economy and some investments are offset by corresponding disinvestments. Gross investments are total investments made from all sources by an economy or a single economic unit and net investment are those which are gross investment minus disinvestments for an economic unit. Gross Assets and Investments minus Depreciation for the economy or a company or corporate sector or government sector is net investment, which is termed as capital formation. 69 Changes or fluctuations in economic activity may occur when investment spending is greater or smaller than the savings at a given level of income. The resources going into the productive process, i.e. capital formation, may have direct relationship with economic growth. All economic activities – agricultural, industrial or services – depend on the availability of financial resources. The amount of financial resources and the volume of capital formation depend upon the intensity and efficiency with which savings are encouraged, gathered and directed towards investment. Investment purpose The investment purpose of public may be set out in terms of their savings for: (i) Transactions purpose (for daily needs or regular payments) (ii) Precautionary purposes (for contingencies or special needs) (iii) Speculative or asset purposes (for capital gains and building of assets). Investment for Consumption and Business The income is divided into two components namely Consumption and Investment. The amounts not consumed are saved and invested. Investments are also useful for present and future consumption in the case of consumer durables, cars, gold and silver etc. Investments generally promote larger 70 consumption in future as they lead to more income and larger capital appreciation in the years to come. Investment and speculation Purchases of assets like shares and securities can be for either investment or speculation or for both. Investment is long term in nature while speculation is short term. All investments are risky to some extent but speculation is most risky as it involves short term trading, buying and selling which may lead to profits sometimes and losses at other times. Financial Investment and Physical Investment The savings at household sector which account for the bulk of savings are measured by the total financial savings and savings in physical assets. The savings in financial form include savings in currency, bank deposits, non bank deposits, life insurance funds, provident and pension funds, claims on government, shares and debentures, units of UTI, mutual funds and trade debts. The currency and deposits are voluntary savings and motivated by transactions and precautionary motives and are governed by income and other incentives. The savings in life insurance, provident fund and pension fund are contractual savings governed by precautionary and contingency motives. The claims on government are compulsory deposits, tax credits and investment in government bonds, etc. The savings in the form of units, shares and debentures etc are 


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