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Indian Economic Policy

Notes Finally, the government needs funds to meet its expenditure on goods and services (revenue
expenditure) and finance its development programmes (capital expenditure).

The Structure of the Financial System
The financial system of India refers to the system of borrowing and lending of funds or the demand
for and the supply of funds of all individuals, institutions, companies and of the Government.
Commonly, the financial system is classified into :
(a) Industrial finance : Funds required for the conduct of industry and trade;
(b) Agricultural finance : Funds needed and supplied for the conduct of agriculture and allied
activity;
(c) Development finance : Funds needed for development; actually it includes both industrial
finance and agricultural finance; and
(d) Government finance : Relates to the demand for and supply of funds to meet Government
expenditure.
India’s financial system includes the many institutions and the mechanism which affects the generation
of savings by the community, the mobilisation of savings and the effective distribution of the savings
among all those who demand the funds for investment purposes. Broadly, therefore, the Indian
financial system is composed of :
(a) The banking system, the insurance companies, mutual funds, investment funds and other
institutions which promote savings among the public, collect their savings and transfer them to
the actual investors; and
(b) The investors in the country composed of individual investors, industrial and trading companies
and the government—these enter the financial system as borrowers.
Apart from these two broad categories of institutions which promote savings on the one side and
investment on the other, there are certain other essential institutions of the Indian financial system
which are actually facilitators.
The Function of the Indian Financial System : Promotion of Capital Formation

The Indian financial system performs a crucial role in economic development of India through saving
investment process, also known as capital formation. It is for this reason that the financial system is
sometimes called the financial market. The purpose of the financial market is to mobilise savings
effectively and allocate the same efficiently among the ultimate users of funds, viz., investors.
A high rate of capital formation is an essential condition for rapid economic development. The process
of capital formation depends upon :
(a) Increase in savings, that is, the resources that would have been normally used for consumption
purposes, should be released for other purposes;
(b) Mobilisation of savings—domestic savings collected by banking and financial institutions and
placed at the disposal of actual investors; and
(c) Investment proper, which is the production of capital goods.
The third stage or process is the real capital formation but this stage cannot arise or exist without the
first two processes. Thus, the general public should save and be prepared to release real resources
from consumption goods to capital goods. The savings of the people should mobilised by banking
and financial institutions. Finally, the savings of the people should be made available to investors to
produce capital goods. All these three steps or processes, though independent of each other, are
necessary for accumulation of capital. The importance of banking and financial institutions in the
capital formation process arises because those who save and those who invest in India are generally
not the same persons or institutions. The financial institutions and the banks act as intermediaries to
bring the savers and investors together.

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