The informal financial system consists of: (i) Individual
The Indian financial system can be broadly classified into the formal
(organized) financial system and the informal (unorganized) financial system.
The formal financial system comes under the purview of the Ministry of
Finance (MOF) Reserve Bank of India (RBI), Securities Exchange Board of
India (SEBI) and other regulatory bodies. The informal financial system
(i) Individual money lenders such as neighbors, relatives, land lords,
traders, store owners and so on.
(ii) Groups of persons operating as funds or ‘associations’. These groups
function under a system of their own rules.
(iii) Partnership firms consisting of local brokers, pawn brokers and non
banking financial intermediaries such as finance, investment, chit
In India the spread of banking in rural areas has helped in enlarging the
scope of the formal financial system.
Components of formal financial system
Formal financial system consist of four segments, these are financial
institutions, financial markets, financial instruments and financial services.
Financial institutions are intermediaries that mobilize the savings and facilitate
the allocation of funds in an efficient manner. Financial institutions are
classified as banking and non banking financial institutions. Banking
institutions are creator of credit while non banking financial institutions are
purveyors of credit. In India non banking financial institutions namely the
Development Financial Institutions (DFIs) and Non Banking Financial
Companies (NBFCs) as well as Housing Finance Companies (HFCs) are the
major institutional purveyors of credit.
Financial institutions are further classified as Term Finance Institutions
such as Industrial Development Bank of India (IDBI), Industrial Credit and
Investment Corporation of India (ICICI), Industrial Financial Corporation of
India (IFCI), Small Industries Development Bank of India (SIDBI) and
Industrial Investment Bank of India (IIBI). Specialized finance institutions like
the Export Import Bank of India (EXIM), Tourism Finance Corporation of
India (TFCI), ICICI Venture, Infrastructure Development Finance Company
(IDFC) and sectoral financial institutions such as National Bank for
Agricultural and Rural Development (NABARD) and National Housing Bank
(NHB). Investment institutions in the business of mutual funds (UTI, Public
Sector and Private Sector Mutual Funds) and insurance activity (LIC, GIC and
its subsidiaries) are also classified as financial institutions. There are state level
financial institutions such as State Financial Corporation and State Industrial
Development Corporation (SIDCs) which are owned and managed by the State
Financial markets are a mechanism enabling participants to deal in
financial claims. Money market and capital market are the organized financial
markets in India. Money market is for short term securities while capital
market is for long term securities. Primary market deals in new issues, the
secondary market is meant for trading in outstanding or existing securities.
Financial instrument is a claim against a person or an institution for the
payment at a future date a sum of money or a periodic payment in the form of
interest or dividend. Financial instruments may be primary or secondary
securities. Primary securities are issued by the ultimate borrowers of funds to
the ultimate savers e.g. Bank Deposits, Mutual Fund Units, Insurance Policies,
etc. Financial instruments help the financial markets and the financial
intermediaries to perform the important role of channelising funds from leaders
Financial services include merchant banking, leasing, hire purchase,
credit rating etc. Financial services rendered by the financial intermediaries’
bridge the gap between lack of knowledge on the part of the investors and
increasing sophistication of financial market and instruments.
The four components are interdependent and they interact continuously
with each other. Their interaction leads to the development of a smoothly
functioning financial system