Unit 1: Financial system overview
Indian Financial System notes · PTU syllabus (MCOP201-18)
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Unit summary
The financial system channels savings into investment and keeps money moving through the economy. This unit covers the meaning, nature, scope, role and functions of the financial system, its components, the evolution and growth of the Indian financial system, its regulatory framework, and an overview of financial sector reforms.
After this unit you can
- Define the financial system and explain its nature, role and functions
- Describe the components of the Indian financial system
- Trace the evolution and growth of the Indian financial system
- Explain the regulatory framework and financial sector reforms
PTU syllabus topics
- Meaning
- nature
- scope
- role
- functions and components of the financial system
- evolution and growth of the Indian financial system
- regulatory framework
- overview of financial sector reforms in India
Financial institutions
Banks, NBFCs, insurers
Financial markets
Money, capital, forex, derivatives
Financial instruments
Bills, bonds, shares
Financial services
Merchant banking, rating, leasing
Regulators
RBI, SEBI, IRDAI, PFRDA
Topic 1
Meaning, nature and functions of the financial system
The financial system is the network of financial institutions, markets, instruments, services and regulators that facilitates the transfer of funds from surplus units (savers) to deficit units (borrowers).
- Nature: intermediation between savers and investors; deals in claims (financial assets); interconnected; regulated; dynamic.
Mobilisation of savings
Deposits, insurance, mutual funds
Allocation of capital
To productive uses
Payment system
Clearing and settlement — UPI, RTGS
Liquidity
Secondary markets
Risk management
Insurance, derivatives, diversification
Price discovery
Interest rates, share prices
Information
Reduces information asymmetry
Monetary policy transmission
- Role in economic development: capital formation, efficient allocation, entrepreneurship, financial inclusion, infrastructure funding, stability.
Topic 2
Components of the financial system
Financial institutions
Banking — commercial, co-operative, RRBs, SFBs, payments banks; non-banking — NBFCs, insurers, mutual funds, pension funds, DFIs
Financial markets
Money market, capital market (primary and secondary), debt, equity, derivatives, forex
Financial instruments
Deposits, T-bills, CPs, CDs, bonds, shares, units, derivatives
Financial services
Merchant banking, leasing, credit rating, factoring, depository, broking
Regulators
RBI, SEBI, IRDAI, PFRDA, IFSCA
Participants
Banks, NBFCs, insurers, stock exchanges
Moneylenders, indigenous bankers, chit funds (unregistered)
Regulation
Regulated by RBI, SEBI etc.
Little or no regulation
Cost of credit
Lower
Very high interest
Documentation
Formal
Informal
Topic 3
Evolution and growth of the Indian financial system
- 1Pre-1951
Unorganised, private banks, limited industrial finance; RBI 1935
- 21951–1990 (planning era)
DFIs (IFCI 1948, ICICI 1955, IDBI 1964), UTI 1964, LIC 1956, bank nationalisation 1969/1980, administered interest rates, directed credit
- 31991 onwards (reforms)
Deregulation, SEBI statutory (1992), NSE (1994), private banks, depositories (1996), insurance opened (2000)
- 42014 onwards (digital and inclusive)
PMJDY, UPI (2016), IBC (2016), GST, payments and small finance banks, account aggregators, GIFT City IFSC
- Indicators of growth: bank credit and deposits, market capitalisation (India among the world's top five equity markets), mutual fund AUM over ₹70 lakh crore, insurance penetration, digital payments volume.
Topic 4
Regulatory framework
| Regulator | Established | Regulates |
|---|---|---|
| Reserve Bank of India | 1935 (RBI Act 1934) | Banks, NBFCs, money market, forex market, payment systems, government securities market |
| SEBI | 1988 (statutory 1992) | Stock exchanges, intermediaries, listed companies, mutual funds, AIFs, REITs/InvITs, commodity derivatives (since 2015) |
| IRDAI | 1999 (IRDA Act) | Insurance companies and intermediaries |
| PFRDA | 2003 (statutory 2013) | NPS and pension funds |
| IFSCA | 2020 | Financial services in International Financial Services Centres (GIFT City) |
| NHB / NABARD / SIDBI | Statutory DFIs | Housing finance (now RBI-regulated HFCs), rural and MSME refinance |
- Coordination: Financial Stability and Development Council (FSDC), chaired by the Union Finance Minister (2010).
Topic 5
Financial sector reforms
Banking
Narasimham Committees — lower CRR/SLR, prudential norms, CAR, entry of private banks, deregulated interest rates
Capital market
SEBI statutory, free pricing of issues, NSE screen trading, dematerialisation, T+1 settlement, FPI regime
Insurance and pensions
Malhotra Committee, IRDA, private and foreign insurers, NPS
Debt and money markets
Auctioned T-bills, LAF, repo market, corporate bond market development
Resolution
SARFAESI, IBC, bank recapitalisation, NARCL
Digital
UPI, Aadhaar e-KYC, account aggregators, CBDC (e₹)
- Future challenges: credit to MSMEs, deepening the corporate bond market, financial inclusion quality, cyber security, climate risk, regulation of fintech and digital lending.
Key terms
- Financial system
- Network of institutions, markets, instruments, services and regulators channelling funds
- Financial intermediation
- Transfer of funds from savers to borrowers through institutions
- FSDC
- Financial Stability and Development Council
- Development financial institution
- Specialised institution providing long-term finance
- Financial inclusion
- Access to affordable financial services for all
Quick revision
- Functions: savings mobilisation, allocation, payments, liquidity, risk, price discovery.
- Components: institutions, markets, instruments, services, regulators.
- Phases: pre-1951 → planning era → reforms 1991 → digital era.
- Regulators: RBI, SEBI, IRDAI, PFRDA, IFSCA; FSDC coordinates.
- Reforms in banking, capital markets, insurance, debt markets, resolution, digital.
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.Define the financial system.
- Q2.State four functions of the financial system.
- Q3.Distinguish organised and unorganised financial sectors.
- Q4.What is the FSDC?
- Q5.Name the regulators of the Indian financial system.
- Q6.State any three financial sector reforms since 1991.
Long-answer questions
- Q1.Explain the nature, role and functions of the financial system.
- Q2.Explain the components of the Indian financial system.
- Q3.Trace the evolution of the Indian financial system.
- Q4.Explain the regulatory framework and financial sector reforms in India.
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