60  Overview of Indian financial system

60.1 Concept of a Financial System

A financial system is “the set of institutions, markets, instruments and services through which savings are mobilised from surplus units and channelled to deficit units of an economy”. It is the circulatory system of the economy — moving funds from those who have them to those who can use them productively. India’s financial system has four pillars: Financial Institutions, Financial Markets, Financial Instruments and Financial Services. The system is regulated by multiple agencies — RBI (banking, money market), SEBI (capital market), IRDAI (insurance), PFRDA (pensions), IFSCA (international centres), MCA (companies). The system has evolved dramatically since the 1991 liberalisation reforms and the Narasimham Committees (1991, 1998).

60.2 Four Pillars of the Financial System

TipFour Pillars of the Financial System
Pillar Working content
Financial Institutions Banks, NBFCs, insurance, pension funds, AIFIs (NABARD, EXIM, SIDBI, NHB), mutual funds
Financial Markets Money market (short-term), Capital market (long-term), Forex, Derivatives, Commodities
Financial Instruments Equity, debt, derivatives, hybrids — call money, T-bills, CP, CD, bonds, shares, futures, options
Financial Services Banking, insurance, broking, depository, advisory, factoring, custodial, credit-rating

60.3 Functions of the Financial System

TipSix Functions of the Financial System
  • Savings mobilisation — collect savings from households and firms.
  • Allocation of capital — channel funds to productive uses.
  • Price discovery — for capital, risk, currency.
  • Liquidity provision — enable conversion of assets into cash.
  • Risk management — pooling, diversification, derivatives.
  • Payment and settlement — clearing transactions.
  • Information generation and dissemination.

60.4 Structure of the Indian Financial System

flowchart TB
  IFS[Indian Financial System] --> FI[Financial Institutions]
  IFS --> FM[Financial Markets]
  IFS --> INS[Financial Instruments]
  IFS --> FS[Financial Services]
  FI --> B[Banks]
  FI --> NB[NBFCs]
  FI --> AIFI[AIFIs<br/>NABARD/EXIM/SIDBI/NHB]
  FI --> MF[Mutual Funds]
  FI --> IP[Insurance / Pension]
  FM --> MM[Money Market]
  FM --> CM[Capital Market]
  FM --> FX[Forex / Derivatives]
    classDef default fill:#003366,color:#ffffff,stroke:#ffcc00,stroke-width:3px,rx:10px,ry:10px;

60.4.1 Banking System

TipIndian Banking Structure
  • Reserve Bank of India (RBI) — central bank; established 1935.
  • Scheduled Commercial Banks (SCBs) — Public Sector Banks (PSBs), Private Sector Banks, Foreign Banks, Regional Rural Banks (RRBs), Small Finance Banks (SFBs), Payments Banks.
  • Cooperative Banks — Urban and Rural Cooperative Banks.
  • All-India Financial Institutions (AIFIs) — NABARD, EXIM Bank, SIDBI, NHB, NaBFID.

60.4.2 Non-Banking Financial Companies (NBFCs)

TipNBFC Categories
  • Asset Finance Companies (AFCs).
  • Loan Companies (LCs).
  • Investment Companies (ICs).
  • Infrastructure Finance Companies (IFCs).
  • Micro-Finance Institutions (NBFC-MFIs).
  • Core Investment Companies (CICs).
  • Housing Finance Companies (HFCs) — now under RBI.
  • Systemically Important NBFCs (NBFC-SI) — asset size ≥ ₹500 cr.

Post-IL&FS crisis (2018), RBI introduced Scale-Based Regulation for NBFCs in 4 tiers: Base, Middle, Upper, Top.

60.5 Financial Markets — Money vs Capital

TipMoney Market vs Capital Market
Dimension Money Market Capital Market
Maturity < 1 year > 1 year
Risk Low Higher
Participants RBI, banks, FIs, corporates Retail, institutional investors
Instruments Call money, T-bill, CP, CD, repo Shares, bonds, debentures
Regulator RBI SEBI
Primary segment Funding Investment

60.5.1 Money Market Instruments

TipMajor Money Market Instruments
  • Call money — overnight inter-bank funds.
  • T-bills — 91, 182, 364 days (Government securities).
  • Commercial Paper (CP) — short-term unsecured corporate paper.
  • Certificate of Deposit (CD) — issued by banks/FIs.
  • Repo and Reverse Repo — RBI’s main liquidity instrument.
  • CBLO / TREPS — Tri-party Repo (CCIL).
  • Cash Management Bills — Government short-term funds.

60.5.2 Capital Market

TipCapital Market Segments
  • Primary market — issue of new securities (IPO, FPO, rights, private placement).
  • Secondary market — trading in already-issued securities (stock exchanges).
  • Equity market (BSE, NSE).
  • Debt market (G-Sec, corporate bond).
  • Derivatives (NSE F&O, currency derivatives).

60.6 Indian Stock Exchanges

TipMajor Indian Stock Exchanges
  • BSE (Bombay Stock Exchange) — oldest in Asia (1875); Sensex index (30 stocks).
  • NSE (National Stock Exchange) — 1992 (operations 1994); Nifty 50 index.
  • MSE (Metropolitan Stock Exchange).
  • Calcutta Stock Exchange (1908) — limited operations.
  • NSE IFSC — at GIFT City (international); USD-denominated trades.

60.7 Indian Financial Regulators

TipIndian Financial Regulators
Regulator Scope Year
RBI Banking, money market, forex, payments 1935
SEBI Securities market, mutual funds, capital market 1988 (statutory 1992)
IRDAI Insurance 1999
PFRDA Pensions / NPS 2003 (statutory 2013)
IBBI Insolvency 2016
IFSCA International Financial Services Centre (GIFT City) 2019
MCA / NFRA / ICAI Companies, accounting, audit Various

60.8 Narasimham Committee Reforms

The two Narasimham Committees (1991 and 1998) laid the blueprint for Indian financial-sector liberalisation.

TipMajor Reform Recommendations
  • Reduction in SLR and CRR.
  • Phasing out of priority-sector lending below floor.
  • Capital adequacy norms (Basel I, II, III).
  • Prudential norms — Income Recognition, Asset Classification, Provisioning (IRAC).
  • Recapitalisation of banks.
  • Asset Reconstruction Companies (post SARFAESI 2002).
  • Consolidation of public-sector banks.
  • Universal banking.
  • Autonomy to banks.
NoteDistractor warning

PYQs often ask: Sensex is the BSE index of 30 stocks; Nifty is NSE index of 50 stocks. Money market < 1 year; Capital market > 1 year.

60.9 Practice Questions

Q 01PillarsEasy

The **four pillars** of a financial system are:

  • AInstitutions, Markets, Instruments, Services
  • BBanks, Insurance, Mutual Funds, RBI
  • CMoney, Capital, Forex, Commodity
  • DSaving, Lending, Borrowing, Trading
View solution
Correct Option: A
**Institutions, Markets, Instruments, Services**.
Q 02RBIEasy

RBI was established in:

  • A1921
  • B1935
  • C1949
  • D1969
View solution
Correct Option: B
**RBI Act 1934 → operational 1 April 1935**.
Q 03Money vs CapitalEasy

Money market deals in instruments of maturity:

  • ALess than 1 year
  • B1-5 years
  • C> 5 years
  • D> 10 years
View solution
Correct Option: A
Money market = **< 1 year**; capital market > 1 year.
Q 04RegulatorsMedium

Match each regulator with its domain:

Regulator Domain
(i) RBI (a) Pension
(ii) SEBI (b) Insurance
(iii) IRDAI (c) Securities market
(iv) PFRDA (d) Banking
  • A(i)-(d), (ii)-(c), (iii)-(b), (iv)-(a)
  • B(i)-(a), (ii)-(b), (iii)-(c), (iv)-(d)
  • C(i)-(c), (ii)-(d), (iii)-(a), (iv)-(b)
  • D(i)-(b), (ii)-(a), (iii)-(d), (iv)-(c)
View solution
Correct Option: A
RBI — banking; SEBI — securities; IRDAI — insurance; PFRDA — pension.
Q 05SensexEasy

Sensex is an index of:

  • A30 stocks on BSE
  • B50 stocks on NSE
  • C100 stocks on BSE
  • D500 stocks on NSE
View solution
Correct Option: A
**BSE Sensex** — 30 stocks (since 1986).
Q 06SEBIMedium

SEBI was given statutory status by:

  • ASEBI Act 1992
  • BSEBI Act 1988
  • CRBI Act 1934
  • DCompanies Act 1956
View solution
Correct Option: A
SEBI **set up 1988**; **statutory 1992** via SEBI Act.
Q 07AIFIMedium

Which is **not** an All-India Financial Institution (AIFI)?

  • ANABARD
  • BEXIM Bank
  • CSIDBI
  • DSBI
View solution
Correct Option: D
SBI is a commercial bank, not an AIFI; AIFIs are NABARD, EXIM, SIDBI, NHB, **NaBFID**.
Q 08NarasimhamMedium

The Narasimham Committees on banking reform were set up in:

  • A1969 and 1980
  • B1991 and 1998
  • C2003 and 2008
  • D2015 and 2020
View solution
Correct Option: B
**N-I 1991** and **N-II 1998**.
Q 09NiftyEasy

Nifty 50 is an index of NSE comprising:

  • A30 stocks
  • B50 stocks
  • C100 stocks
  • D500 stocks
View solution
Correct Option: B
**Nifty 50** — top 50 stocks on NSE.
Q 10RepoMedium

Repo rate is:

  • ARate at which RBI borrows from commercial banks
  • BRate at which RBI lends to commercial banks against securities
  • CInterest on deposit
  • DBank rate
View solution
Correct Option: B
**Repo** — RBI to bank (against G-sec). Reverse repo = opposite.
Q 11IFSCAMedium

IFSCA regulates:

  • AIndian companies
  • BInternational Financial Services Centre at GIFT City
  • CInsurance
  • DMutual funds
View solution
Correct Option: B
**IFSCA 2019** — single regulator for GIFT City IFSC.
Q 12InstrumentsMedium

Which is **not** a money-market instrument?

  • ATreasury bill
  • BCommercial paper
  • CEquity share
  • DCertificate of deposit
View solution
Correct Option: C
Equity is **capital market**, not money market.
Q 13NABARDMedium

NABARD primarily refinances:

  • AIndustrial sector
  • BAgriculture and rural development
  • CExports
  • DSmall industries
View solution
Correct Option: B
**NABARD 1982** — agriculture and rural development.
Q 14SIDBIMedium

SIDBI is the apex institution for:

  • AAgriculture
  • BMSME / small industries
  • CHousing
  • DForeign trade
View solution
Correct Option: B
**SIDBI 1990** — MSME financing.
Q 15EXIMMedium

EXIM Bank finances:

  • AImports
  • BExports and imports of India
  • CInsurance claims
  • DAgriculture
View solution
Correct Option: B
**EXIM 1982** — financing India's foreign trade.
Q 16NaBFIDHard

NaBFID — newest All-India Financial Institution — is mandated for:

  • AMSME
  • BInfrastructure
  • CAgriculture
  • DHousing
View solution
Correct Option: B
**NaBFID 2021** — National Bank for Financing Infrastructure and Development.
Q 17BSEEasy

The oldest stock exchange in Asia is:

  • ANSE
  • BBSE (1875)
  • CTokyo SE
  • DHKEX
View solution
Correct Option: B
**BSE 1875** — oldest in Asia.
Q 18CRRMedium

**CRR** is:

  • ACapital Reserve Ratio
  • BCash Reserve Ratio — banks' reserves with RBI
  • CCredit Risk Ratio
  • DCost Recovery Ratio
View solution
Correct Option: B
**CRR** — % of NDTL banks must keep with RBI in cash.
Q 19SLRMedium

**SLR** is:

  • AStatutory Liquidity Ratio — investment in approved securities
  • BStandard Lending Rate
  • CStatutory Loan Ratio
  • DShort Liquidity Reserve
View solution
Correct Option: A
**SLR** — % of NDTL in cash, gold, approved securities.
Q 20FunctionsMedium

Which is **not** a primary function of a financial system?

  • AMobilising savings
  • BRisk management
  • CProduction of goods
  • DLiquidity provision
View solution
Correct Option: C
Production of goods is real-sector, not financial-system function.

60.10 Quick Recall

ImportantQuick recall
  • Financial system = Institutions + Markets + Instruments + Services.
  • Functions: mobilisation, allocation, price discovery, liquidity, risk mgmt, payment, information.
  • Indian regulators: RBI (1935), SEBI (1988/statutory 1992), IRDAI (1999), PFRDA (2013), IBBI (2016), IFSCA (2019).
  • Markets: Money (< 1 yr, RBI-regulated) vs Capital (> 1 yr, SEBI-regulated).
  • Money-market instruments: Call money, T-bills, CP, CD, Repo/reverse repo, TREPS, CMB.
  • Stock exchanges: BSE 1875 (Sensex 30), NSE 1992-94 (Nifty 50); NSE IFSC at GIFT City.
  • AIFIs: NABARD 1982 (agri/rural), EXIM 1982 (trade), SIDBI 1990 (MSME), NHB (housing), NaBFID 2021 (infra).
  • RBI tools: CRR, SLR, Repo / Reverse repo, OMO, Bank rate, MSF.
  • Narasimham Committees: I (1991), II (1998) — reform blueprint.