Financial system plays a very important role in the development of the country. It is through the financial system that funds get transferred from funds surplus to funds deficient sectors of the country. The fund surplus parts of the economy essentially include households while fund deficient parts of the economy include businesses and government. The financial system acts as an intermediary through which funds are channelized from one part of the economy to another. Indian Financial System
The financial system in India has progressed from nascence post independence. But, it was only the banking sector which was the sole representative of the financial system in the country. The other components viz. Capital markets, Insurance etc were visibly absent in the early years. Also, the banking sector was strongly controlled by the government. The control became even stronger after the nationalisation of banks in 1969. Infact the successive Governments looked upon the financial system as an easily available mechanism for raising money (Hanson& Kathuria). It’s only in the 80s and the 90s that we saw a flourish in the other segments of the system. There were strict regulations on the interest rates on both the deposit as well as the lending side of the business. However, even with the tight restrictions imposed on the interest rates, the depth of the Indian financial system was comparable with other countries of the world which were considerably higher on the growth curve in terms of the maturity of the markets as well as GDP. The Broad money to GDP ratio in 1980 was as high as 36% comparable to some of the middle income countries (World Bank, 1989). Similar was the case in equity markets as well. The Market capitalisation to GDP ratio in 1985 was almost the same as economy like Korea which had a much higher GDP at that point of time (World Bank, 1989). The Financial system has progressed substantially post the reforms in 1991. We are seeing a flourishing equity market, money market, insurance and banking. Financial intermediaries and financial instruments have become more sophisticated and we are seeing a flourish of domestic and foreign investors willing to invest in financial markets in India.
Segments of Indian Financial System
1. Equity Markets
The capital markets have attained substantial proportion by 1980s. This was a reflection of the growth of Indian companies who saw the need of raising capital in the equity market to meet their growing needs (Joseph et al). However, the market was beset with a number of difficulties especially for investors (Nayak et al). The trading was conducted through a mechanism of open outcry in the BSE since there were no computer terminals at that time. This presented a problem of price transparency and large amount of time being required for transfer of shares from the seller to the buyer. Also, the IPO regulations being governed by the Controller of Capital Market Issues lead to limited price discovery (Hanson & Kathuria). There was a monopoly in the trading market with BSE being the sole national level market. There were number of regional stock exchanges but they reflected a small proportion of trading and majorly saw listing of the local companies. There were very few dealers and also the cost of transaction was very high. The cost has been approximately calculated as close to 5% for a one way transaction (Shah and Thomas). This high cost of transaction and the delay in getting the transaction executed in terms of delivery and payment was a deterrent for retail participation. Government realising these limitations set up NSE in 1993 to break the monopoly of BSE and increase the transparency and efficiency of equity markets. NSE brought about a revolution in retail trading by introduction of computer terminals. There was also establishment of SEBI to ensure the orderly growth of the market. It made several changes in the laws...