Tag: NEP 2020 Notes

NBFCs (Non Banking Financial Companies) play an important role in promoting inclusive growth in the country, by catering to the diverse financial needs of bank excluded customers. Further, NBFCs often take lead role in providing innovative financial services to Micro, Small, and Medium Enterprises (MSMEs) most suitable to their business requirements. NBFCs do play a critical role in participating in the development of an economy by providing a fillip to transportation, employment generation, and wealth creation, bank credit in rural segments and to support financially weaker sections of the society. Emergency services like financial assistance and guidance is also provided to the customers in the matters pertaining to insurance.

NBFCs are financial intermediaries engaged in the business of accepting deposits delivering credit and play an important role in channelizing the scarce financial resources to capital formation. They supplement the role of the banking sector in meeting the increasing financial needs of the corporate sector, delivering credit to the unorganized sector and to small local borrowers. However, they do not include services related to agriculture activity, industrial activity, sale, purchase or construction of immovable property. In India, despite being different from banks, NBFC are bound by the Indian banking industry rules and regulations.

NBFC focuses on business related to loans and advances, acquisition of shares, stock, bonds, debentures, securities issued by government or local authority or other securities of like marketable nature, leasing, hire-purchase, insurance business, chit business.

The banking sector would always be the most important sector in the field of business because of its credibility in supporting manufacturing, infrastructural development and even being the backbone for the common man’s money. But despite this, the role of NBFCs is critical and their presence in a country would only boost the economy in the right direction.

Game Changers

• Size of sector: The NBFC sector has grown considerably in the last few years despite the slowdown in the economy.
• Growth: In terms of year-over-year growth rate, the NBFC sector beat the banking sector in most years between 2006 and 2013. On an average, it grew 22% every year. This shows, it is contributing more to the economy every year.
• Profitability: NBFCs are more profitable than the banking sector because of lower costs. This helps them offer cheaper loans to customers. As a result, NBFCs’ credit growth; the increase in the amount of money being lent to customers is higher than that of the banking sector with more customers opting for NBFCs.
• Infrastructure Lending: NBFCs contribute largely to the economy by lending to infrastructure projects, which are very important to a developing country like India. Since they require large amount of funds, and earn profits only over a longer time-frame, these are riskier projects and deters banks from lending. In the last few years, NBFCs have contributed more to infrastructure lending than banks.
• Promoting inclusive growth: NBFCs cater to a wide variety of customers – both in urban and rural areas. They finance projects of small-scale companies, which is important for the growth in rural areas. They also provide small-ticket loans for affordable housing projects. All these help promote inclusive growth in the country.

NBFCs aid economic development in the following ways

• Mobilization of Resources: It converts savings into investments
• Capital Formation: Aids to increase capital stock of a company
• Provision of Long-term Credit and specialised Credit
• Aid in Employment Generation
• Help in development of Financial Markets
• Helps in Attracting Foreign Grants
• Helps in Breaking Vicious Circle of Poverty by serving as government’s instrument

Cash and liquidity management is a sub-function of treasury management that aims to convert sales to available cash as soon as possible and at the lowest processing cost.

It’s a crucial component in treasury operations; operations which are concerned with maximising the benefits of surplus funds and minimising the cost of shortfalls through careful investment and considered borrowing.

Individuals and businesses have a wide range of offerings available across the financial marketplace to help with all types of cash management needs. Banks are typically a primary financial service provider for the custody of cash assets. There are also many different cash management solutions for individuals and businesses seeking to obtain the best return on cash assets or the most efficient use of cash comprehensively.

Cash Management Involve:

Cash management deals with all aspects of working capital management and involves many different tasks. The roles and responsibilities of this department include:

• Forecasting the cash requirements of the business and preparing budgets.
• Establishing necessary banking relationships and providing working capital finance security.
• Managing the credit collection.
• Ensuring that shortfalls are avoided or minimised and that the business can always meet its financial obligations.
• Releasing trapped cash
• Extracting liquidity from working capital
• Releasing working capital

Functions of cash management

In an ideal scenario, an organization should be able to match its cash inflows to its cash outflows. Cash inflows majorly include account receivables and cash outflows majorly include account payables.

Practically, while cash outflows like payment to suppliers, operational expenses, payment to regulators are more or less certain, cash inflows can be tricky. So the functions of cash management can be explained as follows:

Inventory management

Higher stock in hand means trapped sales and trapped sales means less liquidity.  Hence, an organization must aim at faster stock out to ensure movement of cash.

Receivables Management

An organization raises invoices for its sales. In these cases, the credit period for receiving the cash can range between 30 – 90 days. Here, the organization has recorded the sales but has not yet received cash for the transactions. So the cash management function will ensure faster recovery of receivables to avoid a cash crunch.

If the average time for recovery is shorter, the organization will have enough cash in hand to make its payments. Timely payments ensure lesser costs (interests, penalties) to the organization. Receivables management also includes a robust mechanism for follow-ups. This will ensure faster recovery and it will also assist the business to predict bad debts and unforeseen situations.

Payables Management

While receivables management is one of the primary areas in the cash management function,  payables management is also important. Payables arise when the organization has made purchases on credit and needs to make payments for the same within a fixed time. 

An organization can take short-term credit from banks and financial institutions. However, these credit facilities come at a cost and therefore, an organization must ensure that they maintain a good liquidity position; this will help in timely repayments of debts.

Forecasting

While planning investments, the managers need to be very careful as they need to plan for future contingencies and also ensure profitability. For this, they must use efficient forecasting and management tools. When the cash inflows and outflows are efficiently managed it gives the firm good liquidity.

Short-term investments

Avoiding cash crunch, insolvency and ensuring financial stability are the main criterias of cash management. But it is equally important to invest the surplus cash in hand wisely. Despite being a liquid asset, idle cash does not generate any returns. While investing in short-term investments an organization must ensure liquidity and optimum returns.

Therefore, this decision needs to be taken with prudence.  Here, the quantum/amount of investment needs to be calculated and decided carefully. This caution is necessary because an organization cannot invest all the available funds. Businesses need to reserve cash for contingencies (cash in hand) too.

Other functions

Cash management also includes monitoring the bank accounts, managing electronic banking, pooling and netting of assets, etc. So the cash management for treasury can also be a core function. Although for large corporates this function is managed by softwares, small businesses have to monitor it manually and ensure liquidity at all times.

To add, large businesses have access to credit facilities at competitive rates. For small businesses that access is not available.  Therefore cash management is vital for them. However, even large corporations need to monitor their systems time and again to avoid a situation of bankruptcy.

Phases of Cash and Liquidity Management

The first phase of cash and liquidity management involves maximising liquidity through releasing and centralising cash. The second phase involves maximising the returns on any cash surplus in the concentrated cash pool or minimising the cost of funding any shortfalls. Together, both phases work to increase the profitability of the business.

Releasing Trapped Cash

As the name suggests, trapped cash is simply cash that is trapped in one location and can’t be moved to the centralised treasury. This occurs when there are regulations and constraints which limit cross-border money movement something which is often seen in emerging markets. This blog explains in more detail what these in-country restrictions include.

As we mentioned earlier, the difficult and important job of releasing trapped cash falls to the cash and liquidity management function. Fortunately, there are several methods that can be used to do this intercompany transfers, transfer pricing, and payment of dividends to name a few and companies will typically explore various avenues in their efforts to do this.

Local financial authorities in many countries have banned or blocked the use of these methods, but new techniques are constantly being developed.

Releasing Working Capital

The cash management function is also concerned with releasing working capital which may be tied up in assets like accounts receivables.

In order to do this, they aim to do three things: maximise their DSO (Days Sales Outstanding) and minimise their DIO (Days of Inventory) and DPO (Days Payables Outstanding).

We can use these three factors to determine the DCC (Days Cash Conversion) through a simple calculation:

In other words, the goal is to make payments as late as possible, collect payments as early as possible, and keep inventories as tight as possible.

Seasonality and Working Capital

Seasonality can have a huge effect on working capital. During periods of slow sales, there may be a lesser influx of cash which can affect the amount of working capital a business has available.

Similarly, a seasonal surge in sales requires larger inventory stocks, which must be ordered in advance. The cost of increasing inventory stocks may put additional strain on working capital during periods in which there is less available to them.

To combat the negative effects this can have on the profitability of the business, the cash management function must ensure they have accurate annual cash flow forecasts. They can then use this information to set limits for the amount of cash the business must hold back throughout the year and more effectively manage accounts receivable.

If the cash management function fails to effectively anticipate and prevent a shortfall in working capital, they may fall back on short-term financing options.

Bank deposits consist of money placed into banking institutions for safekeeping. These deposits are made to deposit accounts such as savings accounts, checking accounts, and money market accounts. The account holder has the right to withdraw deposited funds, as set forth in the terms and conditions governing the account agreement.

The deposit itself is a liability owed by the bank to the depositor. Bank deposits refer to this liability rather than to the actual funds that have been deposited. When someone opens a bank account and makes cash deposit, he surrenders the legal title to the cash, and it becomes an asset of the bank. In turn, the account is a liability to the bank.

Deposits of banks are classified into three categories:

(1) Demand deposits that is repayable on customers’ demand. These comprise the following:

• Current account deposits
• Savings bank deposits
• Call deposits

(ii) Term deposits that are repayable on maturity dates as agreed between the customers and the banker. These comprise the following:

• Fixed deposits
• Recurring deposits

(iii) Hybrid deposits or flexi deposits, which combine features of demand and term deposits. Lately, these deposits have been introduced by some banks to satisfy customers’ financial needs and convenience and are known by different names in different banks.

Demand and time deposits of a bank constitute its demand and time liabilities that the bank reports every week (on every Friday) to the RBI.

Types of Bank Deposits

Current (Demand Deposit) Account

A current account, also called a demand deposit account, is a basic checking account. Consumers deposit money and the deposited money can be withdrawn as the account holder desires on demand. These accounts often allow the account holder to withdraw funds using bank cards, checks, or over-the-counter withdrawal slips. In some cases, banks charge monthly fees for current accounts, but they may waive the fee if the account holder meets other requirements such as setting up direct deposit or making a certain number of monthly transfers to a savings account.

Savings Accounts

Savings accounts offer account holders interest on their deposits. However, in some cases, account holders may incur a monthly fee if they do not maintain a set balance or a certain number of deposits. Although savings accounts are not linked to paper checks or cards like current accounts, their funds are relatively easy for account holders to access.

In contrast, a money market account offers slightly higher interest rates than a savings account, but account holders face more limitations on the number of checks or transfers they can make from money market accounts.

Call Deposit Accounts

Financial institutions refer to these accounts as interest-bearing checking accounts, Checking Plus, or Advantage Accounts. These accounts combine the features of checking and savings accounts, allowing consumers to easily access their money but also earn interest on their deposits.

Certificates of Deposit/Time Deposit Accounts

Like a savings account, a time deposit account is an investment vehicle for consumers. Also known as certificates of deposit (CD), time deposit accounts tend to offer a higher rate of return than traditional savings accounts, but the money must stay in the account for a set period of time. In other countries, time deposit accounts feature alternative names such as term deposits, fixed-term accounts, and savings bonds.

Mobilization funding provides the capital needed to cover costs before work begins on a project or prior to invoicing. This can include such things as the transfer of both equipment and manpower, the installation of equipment at the project site, personnel lodging and allowance, insurance, and payroll.

Similar to purchase order financing, mobilization funding provides a financial cushion so you are able to keep your projects moving effectively and efficiently from invoice to invoice. This funding option allows contractors to take on larger projects, while giving peace of mind that there will be monetary coverage for materials and labor from start to finish.

• Economy consists of huge number of enterprises and individuals, requirements of all of them differ. Some have surplus cash to save, while some other needs cash.
• Some firms/individuals wants to make good there short term liquidity requirements, some wants money for long term capital investment.
• So distinction can be made as to period for which one intends to lend or borrow. In this sense financial market is categorized into money market and capital markets. In Money market, period involved (for funds movement) is 1 year or less, while in capital markets period is generally more than 1 year.
• As economy of the country grows, highly specialized institutions comes up which caters exclusively to capital needs and banks continues its money market business. These institutions are known as Capital Market intermediaries.
• These are intermediaries like insurance companies, housing finance companies, pension funds, and investment funds etc. which mobilize savings and fund long term investments.
• Financial market is a market where financial instruments are exchanged or traded and helps in determining the prices of the assets that are traded (also called the price discovery process). These facilitate trade in financial assets by providing platform for coming together of buyers and sellers or Borrowers or Lenders.
• Stock exchanges are ‘markets’ (or mandis) where prospective buyer and seller meets and item traded is Shares, debentures, bonds etc. In early days, there was physical interface between two parties; there were mediators in stock exchanges, which for a commission used to negotiate the deal.
• In present times stock markets indicate health of an economy. They are primary means of mobilization of long term savings and investment and fixed capital formation. Further, when volume of trade in markets is significant, it leads to transparent price discovery.
• There are other forms of savings under which small denominations of savings gets together to form significant investment figures. These are mainly Insurance, Provident fund and pension Savings (also called contractual savings). These have an important social security angle, but here focus is on resource mobilization through them.
• These funds have long maturity (repayment) period so they are better placed to cater need of projects with long gestation periods like infrastructure.
• Angel investors who invest in small start-ups or entrepreneurs are another important source of resource mobilization in an economy. Often, angel investors are among an entrepreneur’s family and friends. The capital angel investors provide may be a onetime investment to help the business propel or an ongoing injection of money to support and carry the company through its difficult early stages.
• Insurance: Insurance is service in which individual economic risk is spread over large number of people. Any loss that can be quantified in money can be insured. For e.g. Life Insurance provides risk cover on life of a person. Life cannot be quantified in itself, but economic hardships on survivors of a deceased breadwinner can be undoubtedly quantified in money terms, so this way life insurance can be done.
• Mutual Funds: Different shares in the market carry different kind and degree of risks. So an investors instead of putting all eggs in one basket, diversifies its portfolio. He attempts to minimize his risk and maximize return by investing in both debt and equity and further within equity, he picks up various sectors; infra, textile, IT, Cement, Housing, banking etc.
• Venture Capital (VC) which is a type of private equity, a form of financing that is provided by firms or funds to small, early-stage, emerging firms that are deemed to have high growth potential, or which have demonstrated high growth (in terms of number of employees, annual revenue, or both).
• Venture capital firms or funds invest in these early-stage companies in exchange for equity, or an ownership stake, in the companies they invest in. Venture capitalists take on the risk of financing risky start-ups in the hopes that some of the firms they support will become successful. Thus VC are another important source of resource mobilization in an economy.

Nature of Primary Reserve in Commercial Banks Primary reserve refers to absolutely non-earning liquid assets held by a commercial bank.

It is an aggregate of cash holdings by a bank with itself, the balance with the central bank and the demand deposits (DDs) with other commercial banks.

Primary reserves are the minimum amount of cash required to operate a bank. They include the legal reserves that are deposited with the Central Bank (i.e. RBI in case of India) or other correspondent bank. Cheques that have not been collected are also included in this amount as well. They are kept in order to cover unexpected major withdrawals or runs of withdrawals. They serve as a defence against substantial reduction in liquidity. These reserves must be kept more liquid than secondary reserves, which may be invested in marketable securities such as treasury offerings/bills

Purpose of Primary Reserve:

From the liquidity point of view, the main purpose of primary reserve is not only to play the role of first day to day business needs but also to comply with the obligation imposed on it by law. The other purposes are as follows:

• To maintain sufficient liquidity in the bank with a view to protect it against illiquidity crisis.
• To enable the bank to satisfy the depositors’ claims;
• To perform its expected functions in the community;
• To meet the establishment charges e.g. computerisation, etc.;
• To meet the day to day business needs;
• To comply with the obligation of CRR imposed on it by law.

The primary reserve may be classified into two categories:

• Legal Reserve (CRR with the RBI)
• Working Reserve (Cash holdings with itself and with other banks)

Types:

Legal Reserve: It is the portion of primary reserve which the law requires a bank to maintain. It is calculated on the basis of average deposits outstanding on the bank’s books over a short period, i.e. one or two weeks. Banks deals in public money and attracts public deposits on the promise that deposit holders will get back their money on demand.

The government has the responsibility to ensure sufficient liquidity in the banking system so that the depositors’ claims are met in full, as promised.
There are two main functions of legal reserve:

• Primary Functions: To serve as a powerful tool in the hands of RBI to offset the supply of money; to curve the inflationary pressures; to restrict the lending and investment activities of banks; to take the economy out of depression.
• Regulatory Functions: It regulates the CRR (4%) within the range of 3% to 15% out of total deposits (TDs).

Working Reserve: Since the legal reserve only cannot overcome the illiquidity crisis, banks have to carry cash reserves in excess of the legal minimum reserve in order to meet the depositors’ claims, to satisfy credit needs of the community and to provide protection against the unforeseen withdrawals.

This excess cash reserves held by the banks to fulfill the day to day business needs is designated as working reserve. It consists of:

• Cash in their own vaults and tills
• Demand Deposits (DDs) with other banks
• Excess reserve with the Central Bank (RBI)

There are various factors which influence the level of working reserve which may be categorised into two groups, namely, external factors and internal factors:

External Factors: Refer to environmental factors which exert their influence alike on all banks and which are beyond the control of the bank management.

These are:

• Banking Habit of the People
• Nature of Business Conditions
• Seasonal Factors
• Cash Reserves held by Other Banks
• Existence of Clearing House Arrangements

Internal Factors: are concerned with such factors which are controllable by

• Individual banks. These are:
• Scale of operations of the bank
• Structure of deposits
• Size of deposit accounts
• Ownership of deposit accounts
• Location of banks
• Size of secondary reserves
• Availability and cost of borrowings

Secondary Reserves:

Nature of Secondary Reserves:

The secondary reserves are the aggregate of highly liquid earning assets which can be converted into cash quickly. A commercial bank generally relies on highly liquid earning assets to meet its expected and unexpected financial needs because it cannot afford to hold a larger proportion of funds in the vault for the purpose of maintaining liquidity in the bank with a view to protect it from illiquidity crisis or day to day business needs.

The main purpose of holding the secondary reserve is to provide adequate liquidity to funds without adversely affecting the profitability of a bank. Therefore, it must comprise such assets which yield some income to the bank and at the same time are highly liquid. An asset is said to be highly liquid if it can be converted into cash very quickly without any material loss. The secondary reserves include such assets which fulfill the three conditions of shiftability, low risk and yield.

Secondary reserves must yield income but for the sake of income the liquidity attribute should not be forgone. Keeping in view the three characteristics of the secondary reserve i.e. shiftability, low risk and yield, the following types of assets may be grouped in the category of secondary reserve:

Call loans to stock brokers and commercial banks;

• Short term loans to commercial banks;
• Short term loans against self-liquidating assets or shares of blue chip companies;
• Investment in government securities, treasury bills, bonds, NSCs, NSS, Kisan Vikas Patras, etc.
• Promissory notes of short period maturity;
• Discounting of usance bills eligible for rediscounting from the RBI;
• Short period debentures of companies with a non-questionable credit standing.

Functions of Secondary Reserves in Commercial Banks:

If a commercial bank has a surplus in the primary reserves on account of heavy cash inflows in different accounts, it is invested in the sec. reserve assets so that in times of need they can be converted into cash quickly. They are primarily designed to strengthen bank’s liquidity. The following are the functions of sec. reserves:

• The basic function of sec. reserve is to replenish the primary reserves, while its subsidiary function is to earn a moderate income.
• It helps a banker to trade off successfully between the liquidity and profitability which are the conflicting goals each other for a bank.
• The banker by holding the sec. reserves in a large proportion
  can easily meet the risks/hazards of illiquidity.
• It provides safety to the bank in the event of unexpected heavy withdrawals as a banker can quickly convert the sec. reserve assets into cash.
• It acts as a reservoir for the bank whose gates are opened or closed as the need for funds arises.
• It acts as a second line of defense for the safety of the bank as
  these are easily convertible into cash.

Factors Influencing Secondary Reserves:

A banker must keep in mind both internal and external factors while deciding the level of secondary reserves for his bank, which are as follows:

• External Factors:

National Factors: While planning the sec. reserve requirements, a banker must keep himself update of national developments and assess their impact on deposits and loans. The national factors are as follows:

Prosperity: Lower proportion of funds/TDs in sec. reserves.

Recession: Higher proportion of funds/TDs in sec. reserves.

Political Conditions:

• Uncertain Political Conditions: Larger proportion of funds.
• Normal Political Conditions: Lower proportion of funds.

Taxation Policy:

• Securities: Exempt from tax- Larger proportion of funds in secondary reserves.
• Non-Govt. Securities: Not exempt from tax- Lower proportion of funds in sec. reserves.

Monetary Policy:

If RBI raises present 19%SLR by 2% then the banks will divert their funds from loans and investments to secondary reserves to satisfy this legal requirement.

Supervisory Role:

The objective of supervision as stated in the preamble to the IRDAI Act is “to protect the interests of holders of Insurance policies, to regulate, promote and ensure orderly growth of the Insurance industry”, both Insurance and Reinsurance business. The powers and functions of the Authority are laid down in the IRDAI Act, 1999 and Insurance Act, 1938 to enable the Authority to achieve its objectives.

Section 25 of IRDAI Act 1999 provides for establishment of Insurance Advisory Committee which has Representatives from commerce, industry, transport, agriculture, consume for a, surveyors agents, intermediaries, organizations engaged in safety and loss prevention, research bodies and employees’ association in the Insurance sector are represented. All the rules, regulations, guidelines that are applicable to the industry are hosted on the website of the supervisor and are available in the public domain.

Section 14 of the IRDAI Act, 1999 specifies the Duties, Powers and functions of the Authority. These include the following:

• To grant licenses to (re)Insurance companies and Insurance intermediaries
• To protect interests of policyholders,
• To regulate investment of funds by Insurance companies, professional organisations connected with the (re)Insurance business; maintenance of margin of solvency;
• To call for information from, undertaking inspection of, conducting enquiries and investigations of the entities connected with the Insurance business;
• To specify requisite qualifications, code of conduct and practical training for intermediary or Insurance intermediaries, agents and surveyors and loss assessors
• To prescribe form and manner in which books of account shall be maintained and statement of accounts shall be rendered by insurers and other Insurance intermediaries;

Roles of the IRDAI in the insurance sector:

• IRDAI issues a certificate of registration to the life insurance company and also renews, modifies, withdraws, suspends and cancels the registration.
• The regulatory body secures policyholder’s interests in areas like assigning of policy, nomination by policyholders, insurable interest, settlement of insurance claim, surrender value of the policy, and other terms and conditions applicable to an insurance contract.
• It specifies the requisite qualifications, code of conduct and practical training required for insurance intermediaries and agents.
• IRDAI makes certain that the code of conduct is followed by surveyors and loss assessors.
• The autonomous body promotes efficiency in the conduct of the insurance business.
• It also promotes and regulates professional organisations connected with the insurance and reinsurance business.
• It levies fees and other charges for carrying out the purposes of the IRDAI Act.
• IRDAI carries out functions like inspection, conducting inquiries and investigations, including an audit of the insurers, insurance intermediaries and other organisations involved with the insurance business.
• The rates, advantages, terms and conditions that may be offered by insurers with respect to general insurance business are also controlled and regulated by the regulatory body.
• It also specifies the form and manner in which books of account should be maintained, and the statement of accounts should be rendered by insurers and insurance intermediaries.
• IRDAI monitors the investment of funds by insurance companies and governs the maintenance of the margin of solvency.
• It also judges the disputes between insurers and intermediaries or insurance intermediaries.
• It supervises the functioning of the Tariff Advisory Committee.
• IRDAI specifies the percentage of premium income of the insurer to finance schemes for promoting and regulating professional organisations referred to in clause (f).
• It specifies the percentage of life insurance and general insurance business to be undertaken by the insurer in the rural or social sector.

Financial institutions play a pivotal role in every economy. The central government organization regulates banking and non-banking financial institutions. In addition, these institutions help bridge the gap between idle savings and investment and its borrowers, i.e., from net savers to net borrowers.

Functions of Financial Services

• Promotes Savings: These services provide different types of convenient investment options that can grow people’s savings. A mutual fund is one such good option where people can invest and earn reasonable returns without much risk.
• Raises Fund: Financial services serve as an efficient tool for raising funds in an economy. It provides various financial instruments to individuals, investors, corporations, and institutions where they can invest their money thereby raising funds from them.
• Deployment of Funds: Financial services enable the proper deployment of financial resources into productive means. There are numerous investment avenues and instruments available in the financial market where people can invest their funds for earning income.
• Economic Growth: Financial services help the government in attaining the overall growth of the economy. The government can easily raise both short-term and long term funds for its various needs. It helps in improving overall infrastructural facilities and employment opportunities in a country.
• Minimizes Risk: Risk minimization is an important role played by financial services. These services help in diversifying the risk and protect people against damages by providing insurance policies.
• Proper Utilization of Funds: These intangible services help in efficient allocation of funds. Financial services serve as a means through which peoples invest their ideal lying resources into better investment plans for generating incomes.
• Enables payment system: Financial services have a key role in the proper movement of funds among peoples. It enables peoples to successfully do their payments without any difficulty. Credit cards, debit cards, bill of exchange, and cheque are such financial instruments which facilitate financial transactions.
• Maintains Liquidity: Financial services helps in maintaining sufficient funds in an economy. It links the one who is in need of funds and those who can supply funds as they have sufficient savings. Various services like loans and credit cards enable people to acquire needed funds easily.
• Raises Standard of living: These services play a crucial role in improving the living standards of people. Customers are easily able to purchase costly goods on hire purchase system availing these services. People are able to enjoy the benefits of quality and luxury items.
• Promotes trade: Financial services promote both domestic and foreign trade in a country. Forfaiting and factoring companies in the financial market promote the export of goods to foreign markets and also the sales of products in the domestic market. In addition to this insurance and banking facilities also support trade activities in-country.
• Balanced Regional Development: Financial services helps in the balanced regional development of the country. All the key sectors of the economy such as the primary sector, secondary sector, and tertiary sector are able to acquire the required funds through these services. This results in regional disparities and brings balanced development in a country.
• Improve Employment Opportunities: Generation of employment opportunities is another important function of financial services. Different financial institutions employ a large number of peoples for selling these services. They pay remunerations to their employees out of the profit earned by selling these financial services.

Financial system is a system that facilitates the movement of funds among people in an economy. It is simply a means through which funds are exchanged between investors, lenders, and borrowers.

A financial system is composed of various elements like financial institutions, financial intermediaries, financial markets and financial instruments which all together facilitate the smooth transfer of funds. This system exists at the regional, national and international levels. It is an efficient tool that helps in economic development of a country by linking savings and investments thereby leading to wealth creation.

Nature of Financial institutions

Mobilizes Saving

It helps in allocating ideal lying resources with peoples into productive means. Financial system is the one which obtains funds from savers and provide it to those who are in need of it for various development purposes.

Transfer Funds

Financial system helps in transferring of financial resources from one person to another person. This system includes financial markets, financial intermediaries, financial assets and services which facilitates fund movements in an economy.

Risk Allocation

Diversification of risk in an economy is important feature of financial system. Financial system allocates people’s funds in various sources due to which risk is diversified.

Facilitates Investment

Financial system encourages investment by peoples into different investment avenues. It provides various income-generating investment options to peoples for investing their savings.

Enhances liquidity

Financial system helps in maintaining optimum liquidity in an economy. It facilities free movement of funds from households (savers) to corporates (investors) which ensures sufficient availability of funds.

Role of Financial institutions

Reduces Risk

It aims at reducing the risk by diversifying it among a large number of individuals. Financial system distributes funds among a large number of peoples due to which risk is shared by many peoples.

Brings Savers and Investors Together

Financial system serves as a means of bridging the gap between savings and investment. It acquires money from those with whom it is lying idle and transfers it to those who need it for investing in productive ventures.

Facilitates Payment Mechanism

Financial system provides a payment mechanisms for the smooth flow of funds among peoples in an economy. Buyers and sellers of goods or services are able to perform transactions with each other due to the presence of a financial system.

Assist in Capital Formation

Financial system has an efficient role in the capital formation of the country. It enables big corporates and industries to acquire the required funds for performing or expanding their operations thereby leading to capital formation in the nation.

Improves Standard of living

It raises the standard of living of peoples by promoting regional and rural development of the country. The financial system promotes the development of a weaker sections of society through cooperative societies and rural development banks.

Facilitates Economic Development

Financial system influences the pace of economic growth or development of an economy. It aims at optimum utilization of all financial resources by investing all idle lying resources into useful means which leads to the creation of wealth.