Financial System

The word ‘System’ means an ordered, organized and comprehensive assembly of facts, principles or components relating to a particular field and working for a specified purpose.  A financial system is a system which deal with the finance which basically means money thus a financial system forms an Integral Part of any Modern Economy.

The term ‘financial system’ represents a set of closely held financial institutions, financial services and financial instruments or Claims.

Basic requirements for a Financial System

There are three basic requirements of a financial system which is mandatory to make the financial system function smoothly and efficiently. Following are the three requirements:

1. Efficient Monetary System – This indicates an efficient medium for exchange of goods and services.
2. Facilities for the creation of the capital – To meet the demands of the economy capital is needed which needs to be generated. The capital generated is necessary to undertake the production activities. The financial system helps to meet such demands by mobilizing the savings of the surplus units to the demanding units.
3. Efficient financial markets – The financial markets and methodologies facilitate the process of transfer of resources and the conversion of financial claims into money.

Thus we can see that financial market plays a very important role in the financial system and has a direct relationship with the same and is also connected indirectly to the economy as well.

Segments of Financial System

The financial system is segmented into two parts namely the organized and the unorganized system as mentioned below:

1. Organized system – It represents the structured or nationalized banking. It includes the national banks, co-operative banks and the development banks which are set by the government through various bills and regulations passed. It also includes the private sector and the whole system is monitored or controlled/governed by the Government/RBI. This sector basically has a code of conduct or guidelines laid, which is to be adhered.
2. Unorganized system– It comprises of individual money lenders, pawn brokers and traders, etc. who are in general, not monitored by any regulatory body such as the RBI and neither has any guidelines to follow as such.

Investor’s Consideration

Following are the key points which are taken into consideration by an investor before investing money in any investment instrument:

1. Risk
2. Liquidity
3. Returns
4. Tax Planning
5. Cash Flows
6. Simplicity

1. Risk – The one of the most important and the primary consideration for the investor will be the safety of the funds lent out. Every investment option will have an element of risk with it as it is investment in a market of uncertainties.
2. Liquidity – Liquidity is the second thought for the investor. An Investor will give due consideration to liquidity of the instrument, which depends mainly on the secondary market.
3. Returns – The sole motto of making an investment is to get returns on it. An investor’s motive will always be to maximize the ROI which is Return on Investment.The investor generally expects to earn a return which has the ability to compensate for the risk exposure taken by the investor by investing in the security.
4. Tax Planning – Tax planning is yet again an important factor on which every investment made is dependent. Investors always want to minimize the Tax he/she has to pay. Thus the  investors invest in the securities that offer tax incentives, as the post-tax returns are significant to them and this is the reason why the investors gives a primary thought for the instruments which would yield them Tax benefits.
5. Cash flows – Any investment is made only when the investor is having a surplus amount of fund to invest in the instruments i.e., the cash inflow is maximum with the investor. Thus the investment decision of the investor will also depend on the period for which the surplus funds are available to him for investment.
6. Simplicity – The salient features of the instrument should be easy to understand by the investor and should not have any sort of discrepancies, flaws or hidden meanings in it. This transparency along with the simplicity is utmost important for the investor to make the right decisions.

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