Recent Developments in the Financial System- JAIIB Notes

Introduction to Financial System: 

The Indian Financial System is made from various structures such as the banking sector, capital market, money market, regulatory bodies, financial institutions, and financial instruments. There have been timely reforms in the financial sector to make it convenient for the common man. Reforms enable to increase the efficiency of resource utilisation and availability in the Indian economy. The reforms in the financial sector in India had first taken in the year 1991 where various sectors of the economy were opened for the Foreign Financial Institutions. These changes were regarded as privatisation. The financial system has gone through various reforms.  

History of Reforms and Recent Developments in the Financial System

The Indian Government had appointed the committee in 1985 for the Review of the Indian Monetary System. Various measures such as operating in short term money market instruments to enhance the liquidity. The operations were commenced by the Reserve Bank Of India, Public Financial Institutions, and various other financial institutions. In the early 1990s, the Government introduced major reforms in the money market as mentioned below: 

• Interest Rate Deregulation.
• Liquidity Adjustment Facility
• Money Market Mutual Fund (MMMFs)
• Electronic Transactions
• Formation of CCIL
• Development and Encouragement of New Market Instruments such as Commercial Papers, Certificates of Deposits, MMMFs, and many others. 

Reforms were needed since there was excessive micro-regulation and structural that created a barrier in financial innovation and further enhanced the operational and transactional costs. There was an inappropriate level of prudential regulation in the financial system. The underdeveloped debt and money markets and obsolete technological and institutional structures reduced the efficiency of the capital markets and the financial system. Thus, the Government of India had to introduce the reformation process of the financial system to increase the efficiency and effectiveness of the different elements of the financial sector. The major developments of the financial sector introduced by the Indian Government were: 

• Creating effective, efficient, and profit-making financial entities,
• Imparting functional and operational independence to the financial institutions, 
• Developing the banking sector as per the international standards, 
• Allowing foreign direct investment in the private sector in a controlled manner, 
• Encouraging financial stability during the domestic and international crisis, 
• Market determination of interest rates enables the price discovery process that facilitates the allocation of resources efficiently. 

Narasimham Committee: 

The Government of India formed the Narasimham Committee in August 1991, which made various recommendations for changes in the banking sector and capital market. The suggestions were: 

• Asset Quality
• Strengthening the Banking sector
• Structural issues
• Technological upgradation
• Systems and methods in Banks

Reforms were undertaken in Banking Sector: 

A major area of the banking sector is controlled by  Public Sector Banks. The Reserve Bank of India(RBI) has provided licenses to private sector banks, being part of the liberalisation process. The RBI has introduced prudential norms for all the banks. However, it has also deregulated the determination of interest rates for deposit and lending purposes. The developments in the banking sector were: 

• Strengthening of banks’ capital base by providing debt, borrowing from the public through equity issues, and recapitalisation. 
• Introduction of prudential norms,
• Regulation of income recognition, provision for bad and doubtful debts, declaration of non-performing assets, assets classification, recognition of investments as per the market value,
• Licensing of private sector banks and restrictions on the opening of the branches,
• Implementing KYC norms,
• Ensuring of Credibility of customers before the issuance of loans,
• Improvement in Audit norms for Banking Sector,
• The digitalisation of Credit, Deposit, and Payment systems, 

Other operation reforms to revolutionise the credit policy of banks: 

• Removal of in-depth regulations for Maximum Permissible Bank Finance.
• Substantial relaxation of Consortium Regulations
• Shifting of credit delivery to providing of loans from the cash credit system. 

Permission to different entities in the financial sector: 

The Government also allowed the involvement of Public Sector Enterprises, Private Companies, and Non-Banking Finance Companies (NBFCs) with a strong base in the banking sector. The permission to these entities led to an increment in the competition among the banking sector, which in turn contributed to the enhancement of the quality of services provided to the end-user. The inclusion of new segments in the banking sector has increased the participation of the common man in the banking services. The recent developments in the financial system imparted the liberty to the banks to increase and decrease the authorised capital without the restriction on the overall limit. The reforms provided the banks with higher flexibility in conducting their funds raising operations. 

Reformation of Capital Market: 

The financial market which operates for the flow of debt and equity capital is termed as capital market. It channelises the investments made by financial institutions and individual investors by providing the investors with numerous investing options such as financial instruments such as debt bonds, shares, debentures, and many others, which are technically termed as financial securities. The capital market is a decentralised structure whose performance is based on the various aspects that affect the Indian economy. The capital market is divided into three important parts such as bond market, stock market, and money market. 

The capital market has facilitated the trading of financial debts by issuance of shares and units. The capital market deals in Government securities (which are considered safe for investment but with limited returns) and equity and debt issued by other public and private limited entities.  

The Bombay Stock Exchange and National Stock Exchange have witnessed the performance in capital markets for over several years. The establishment of SEBI (Securities and Exchange Board of India) in 1988 got the legal status by the enactment of the SEBI Act, 1992. SEBI has highly regulated capital market activities. The main objective of SEBI is to secure the interest of investors in the securities market and provide assurance for all the matters which are incidental and connected to the securities market. The important functions of SEBI are given as under: 

• To regulate the conduct of stock and other securities market
• To promote the formation of self-regulatory organisations
• To prevent fraudulent and unfair trade practices in the capital market 
• To encourage awareness among investors and provide education to intermediaries for safe conducting of market activities. 
• To restrict insider trading activities.
• To control the major acquisition of securities and companies’ takeover. 

SEBI has assisted in conducting of trading of securities in a protected manner. 

Conclusion: 

Thus, the financial system is the backbone of the Indian economy. Even after the undertaking of numerous reforms, there is still a lot of scope for improvement in the financial sector. The recent developments in the financial system have encouraged the common man to enhance their involvement in the financial system. However, after the reforms of 1991, the financial sector has proceeded on the path of development, which strengthened the Indian economy. 

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