Definition of Financial system

A financial system is a complex network of financial institutions, financial markets,

participants, regulators, currencies, instruments, rules, policies and practices at a
regional, and global levels that addresses the need of humans to satisfy their desire
to lead a desired standard of life.
In any functional economy, economic resources are limited, with individuals having
unlimited wants and desires. This problem, referred to as scarcity, is one of the
significant drivers of an economy. However, it challenges an economy in determining
when, where, to whom to distribute its resources. Consequently, it resulted in a
financial system structure capable of efficiently allocating economic resources to
stimulate growth.
Financial Institutions are at the core of the financial system, giving individuals the
ability to save and invest whenever and wherever they want. Investors put their
money in these institutions, which offer them a reward for saving and use it to lend to
borrowers. The borrowers can use these funds to build goods and services or fund
other projects. All this activity helps promote economic growth – either by creating
additional jobs or generating a profit and contributing back to the economy.
The funds mobilised by financial institutions are channelised to the financial markets
through a variety of financial products. Risk and reward are basic ruling forces. Risks
mitigation gives rise to another set of institutions covering derivatives and insurance.
Financial systems are an essential part of an economy, and without them, the flow of
funds would cease to exist. It keeps evolving considering the regional or global
economic situations.
A currency is a form of payment to exchange products, services, and investments
and holds value to society.

A financial system allows its participants to prosper and reap the benefits. It also
helps in borrowing and lending when needed.
A financial system allows its participants to prosper and reap the benefits. It also
helps in borrowing and lending when needed. In simpler words, it will circulate the
funds to different parts of an economy.
A financial system addresses the demands of liquidity and returns. It creates credit,
circulates the money and converts unproductive financial assets into productive
assets.
A centrally planned economy is structured around a central authority, such as a
government, which makes economic decisions regarding the manufacturing and
distribution of products for a specific country. A market economy is when the pricing
of goods and services is dictated by the aggregated decision of citizens and
business owners, often resulting in the effects of supply and demand.
Meaning of Financial Intermediaries
A financial intermediary refers to a third-party, forming environment for conducting
financial transactions between different parties. They significantly manage financial
assets and liabilities to stimulate economic activity. They are a connecting link
between places of fund surplus and fund deficit entities.
This may happen through banks which accept deposit from the general public and
lends to those who are qualified and in need of funds for producing further assets.
The interest rate is the linkage between the investor or depositor and the destination
of funds. The financial intermediaries don’t gain from the interest rates but earn from
the commission income.
They are a store house of information. The financial intermediaries connect the
demand and suppliers of capital. The main difference between other intermediaries
is the angle of fiduciary responsibility and use of technology.
Examples of Financial Intermediaries
1. Banks
2. NBFCs ( Non Banking Financial Companies)
3. Insurance companies
4. Insurance agents
5. Banking correspondents
6. Credit counsellors, who advises on availability of credit and sources of credit
7. Financial advisors, who prepare financial planning for investors, reviews
financial plans and available options of investments
8. Mutual Funds, who aggregates retail investment and channelises into market
9. Credit Unions and credit rating agencies, who evaluate credit worthiness of
borrowers based on past track records.
10. Brokerage houses, in various markets eg equity, forex, etc
11. Merchant Bankers, who take active role in launching the IPOs
12. Pension funds, who collects the lumpsum from the pensioners and pay
annuity payments

Financial Intermediaries interact with both the markets and the investors.
They are proving to be an important linkage between the two. With financial
transactions becoming increasingly complex and speed becoming faster, the
leverage of the intermediaries is rising. The competition is also high as the
income incurred from intermediary is fee based and donot involve credit risk.
The globalisation has been connecting the intermediaries from different
countries and they are not being limited to their home markets. Moreover the
intermediaries from different categories are interacting with each other for
effecting transactions. E.g Banks and credit rating agencies are based on
each other, similarly the mutual fund companies and insurance companies are
engaging banks as their corporate sales agents.
Need for Financial Intermediaries
Financial intermediaries are an integral part of any financial system. They joins the
source and destination of capital in a way that the reverse flow of capital (returns)
are also ensued. Following are the need of the financial intermediaries :
1. Storehouse of information. The financial intermediaries have access to the
markets, asset classes, retail investors, foreign institutions and hence can
connect the demand and supply points.
2. Finds investors for the markets. Markets exist only if investors are interested
in investing. The financial intermediaries bring the investors to the markets,
create buyers and sellers and keep the markets running.
3. Finds markets or destinations for the investors. The investors have different
risk appetites, preferences and financial goals. The financial intermediaries
helps them choose the proper markets thus finding proper destinations.
4. Reduces risk through credit rating. The credit rating agencies specialize in
finding the credit worthiness of a customer. This helps loan providers in
assessing the risks and pricing the loans accordingly
5. Increases awareness. The financial intermediaries creates awareness among
general public about different financial instruments, returns, markets and risks
to enable public in choosing their investment options.
6. Addresses funding and liquidity concerns. The banks address the liquidity
concerns by providing loans. What matters is the timeliness of availing a loan.
If businessmen donot get a loan when an order is at hand, or when one
wants to buy a house but fails as loan is not available the economic activity
will reduce.
7. Provides options for investment. The financial intermediaries are providing
investors a wide plethora of investment options ranging from equities, debt to
commodities
8. Reduces inefficiency of capital utilisation. If funds are raised by paying more
interest, it is inefficiency. The financial intermediaries help the borrowers by
connecting the lenders who may give at the lowest rate. Similarly, the lenders
are connected to borrowers through credit rating which helps in reducing
credit provisioning.
9. Diversification of asset class. Diversification of the investment from risky to
less risky assets reduces risk.
10. Aids financial planning . Financial planners help investors realize their
financial goals and review them periodically to change strategy for
reinvestment.
11. Retirement benefits through pension funds. Pension reduces insecurity and
proper channelisation of funds and reduces pressure on government to care
for the old.
12. Contingent liability is reduced through insurance. Insurance may be life and
non-life. In either case, they act as counterweights to support financially
people if any negative contingent event takes place.
13. Credit counselling. Credit counselling helps ordinary people in staying away
from the debt trap and choosing the right bank. In the larger level, syndication
of loans are helped by financial intermediaries in addressing huge loan
requirement by corporates from multiple banks.
Role and functions of Financial Intermediaries
1. Connect investors with markets.
The markets mainly in the form of exchanges are able to perform if the
investors are present in the market. Similarly, investors can invest only if they
are brought in contact with the markets. This role is played by the
intermediaries who have a vast storehouse of information.
2. Increases depth of market.
The markets become more liquid and its depth increases if more number of
investors are drawn into it and transactions increase. This makes price
discovery realistic. The size of the markets increases due to increase in
investor participation, which is catalysed by the intermediaries.
3. Ensures existing rules and regulations are complied with by investors
The brokers ensure rules and regulations laid down by SEBI are complied
with by the investors entering into an agreement with the exchange. Similarly,
the RTAs do the same in case of mutual fund industry
4. Aids documentation, translates needs to the depositors/ investors
The banks, banking correspondents help depositors with the form filling
especially in case of rural areas and acceptable documentation needs. These
efforts help them mobilise deposits for the banking industry which result in
increase in liquidity.
5. Addresses liquidity concerns.
They play a very important role when it comes to credit counselling. They help
retail customers scout for banks and financial institutions offering matching
interest rates as well as large corporates in syndication of loans.
6. Creates financial planning strategies and increases investor wealth
Financial advisors help realize the financial goals of individuals. They chalk
out strategies in respect of income levels, obligations, risk appetite and time
horizon. This helps investors remain focussed on the financial goals.
7. Advises investors about current market trends, sectoral growth and KYC
guidelines. Being a storehouse of information the financial intermediaries are
in a position to advise them about market dynamics so that they may take a
holistic view in decision making.
8. Guides savings and unproductive investment into productive investment
avenues. Without proper guidance and advise, people will tend to invest in
unproductive and illiquid assets like gold ornaments and property with a
speculative attitude rather than a disciplined approach as advised by financial
intermediaries.
9. Plays important roles in raising capital for corporates. Merchant bankers play
a pivotal role in raising capital through IPOs
10. Provides vital information about investor sentiment, changes in risk appetite,
growth of wealth, etc. The financial intermediaries are in constant touch with
the depositors and investors and hence are in a better position to judge the
investor sentiment for the near term and middle term outlook.
Advantages of Financial Intermediaries
1. They provide a convenient means to investors and borrowers, who are not
financial experts but require to partake in a financial transaction.
2. They do the work of analysing and interpreting risk and reward for the
investor.
3. They help lower the cost of financing due to the economies of scale.
4. They help spread the risk between investors, providing a safer and more
secure form of investment.
5. They provide investors a wide choice of investments options
6. They provide risk diversification and financial planning strategies
7. They help bring banking facilities to the unbanked population
8. They help raise funds through IPO and makes an issue successful
9. They lend huge financial support to domestic equity markets through mutual
funds and pension funds.
10. They decrease systematic risks by advising investors to stay away from very
high risk asset classes.

Implications of Financial Intermediaries

1. Due to financial intermediaries firms have been able to resort increasingly to

bond and stock markets to obtain funds while households could begin to
diversify their portfolios out of bank deposits into securities, mutual funds and
derivatives.
2. Credit flow in the economy increases due to sourcing of borrowers and
extension of credit facilities by banks and NBFCs.
3. Risks in the financial system and economy goes down due to credit screening
by credit unions and risk diversification by mutual funds.
4. Cost of credit goes down for genuine borrowers and bank funds available
easily for business growth
5. Increase in a country’s GDP
6. Employment opportunity rises as financial advising, banking, credit
counselling, insurance advising, brokerage services and mutual funds are
opening up new market segments.
7. The equity markets get a good support from the domestic institutions when
the FII withdraws which stabilises the markets and reduces market risk.
8. The monetary policy to stabilise rates and strike a harmony between growth
and inflation becomes effective when it is transmitted through the financial
intermediaries.

Registration of Financial Intermediaries

The SEBI regulates various intermediaries in the primary and secondary markets
through various regulations framed for respective intermediary. These regulations
allow the SEBI to inspect the functioning of these intermediaries and collect
registration/renewal fees from them. The registrations remain valid for a period
of time and needs to renewed from time to time.

The banks receive licences from RBI and any capital market linked financial
intermediary needs license from SEBI.

The process is initiated by an application made as per norms specified by SEBI.

Along with the application financial documents, disclosures and other specified
requirements are to be submitted. The same will be verified and accordingly will
be accepted or rejected within a specified time period. The disclosures should not
state any false statements or suppress any fact. The certificate of registration is
issued subject to conditions that any changes in its status or constitution or other
conditions must be approved by the certificate issuing authority.