Page 12 - DCOM304_INDIAN_FINANCIAL_SYSTEM

Unit 1: Indian Financial System

intermediation and institutions associated with this process are called financial Notes
intermediaries or financial institutions. The top half of Figure 1.3 figures out the flow of
money through process of intermediation. Besides directing the pooled resources into
productive outlets and facilitating the efficient life cycle allocation of physical capital in
its most productive use in the business sector, the financial system makes possible
efficacious separation of ownership from management. This, in turn, enables the efficient
specialisations in production according to the principle of comparative advantage.
1.2.2 Providing Payment System

A financial system provides for effective system of payment for personal, business and
government transactions through array of financial instruments and intermediaries.

1.2.3 Managing Risks

A well-developed, smooth-functioning financial system offers a wide variety of financial
instruments that enable economic agents to pool, price and exchange risk. It provides adequate
mechanism for risk-pooling and risk-sharing for both households and business firms. These
mechanisms are built in hedging, diversification and insurance. While hedging is a technique to
move from a risky asset to riskless assets, diversification provides for pooling and subdividing
risks. Insurance enables the insured to retain the economic benefits of ownership while laying
off the possible losses.
1.2.4 Price Information

Besides facilitating transfer of funds from savers to investors, financial system provides necessary
information that plays significant role in coordinating decentralised decision-making.
Information about existing interest rates and securities not only enable individuals in making
their saving and investment decisions but also aid the managers of business enterprises in
deciding about choice of investment projects and funding thereof.

Self Assessment

Fill in the blanks:

1. A well developed …………………….. provides adequate mechanism for risk-pooling and
risk-sharing for both households and business firms.
2. …………………….. are government securities that have a maturity period of up to one
year.
3. The …………………….. through its conduct of monetary policy influences the different
segments of the Financial Market in varying degrees.

4. …………………….. intervene in the process of transfer of funds.
5. …………………….. primarily perform risk bearing function.
1.3 Nature and Role of Financial System

1. The price in financial markets is known as "rate of interest". Under conditions of perfect
competition, the equality between total expected demand for funds and total planned
supply of funds determines the equilibrium rate of interest.
2. The intervention between authorities in the form of administering interest rates results in
excess demand or excess supply of funds, which in turn requires the official policy of direct
allocation of financial resources.

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