Beyond Banks: A Simple Guide to India Financial Sector

1. Introduction to the Indian Financial System

The Indian Financial System is a complex network of financial institutions, financial markets, financial instruments, and financial services. Its primary role is to mobilize savings from households and other surplus units and channel them towards productive activities like industrial development, infrastructure projects, and commerce. A robust and efficient financial system is the backbone of economic development, facilitating capital formation and ensuring the smooth flow of funds across the economy.

The IFS is broadly classified into two sectors:

  • Organized Sector: Comprises regulators, commercial banks, cooperative banks, NBFCs, and other financial institutions that are regulated and supervised by authorities like the RBI and SEBI.
  • Unorganized Sector: Includes individual moneylenders, indigenous bankers, and chit funds, which are largely outside the regulatory purview of the central authorities.

2. Components of the Indian Financial System

The four main components of the organized financial system are:

  1. Financial Institutions
  2. Financial Markets
  3. Financial Instruments
  4. Financial Services

Let’s delve into each component in detail, focusing on points.

3. Financial Institutions: The Pillars of the System

Financial institutions act as intermediaries that connect savers and borrowers. They are crucial for the efficient allocation of resources in an economy.

A. Banking Institutions

  • Reserve Bank of India: The apex institution and central bank of India. (Detailed functions in Section 4).
  • Commercial Banks: These are the most significant players in the Indian banking system. They are further classified as:
    • Scheduled Commercial Banks (SCBs): Banks listed in the Second Schedule of the RBI Act, 1934. To be included, a bank must have a paid-up capital and reserves of at least ₹5 lakh and satisfy the RBI that its affairs are not being conducted in a manner detrimental to depositors’ interests. SCBs include:
      • Public Sector Banks (PSBs): Majority stake is held by the government (e.g., State Bank of India, Punjab National Bank).
      • Private Sector Banks: Majority stake is held by private individuals or corporations (e.g., HDFC Bank, ICICI Bank, Axis Bank).
      • Foreign Banks: Banks with headquarters in a foreign country and branches in India (e.g., Citibank, HSBC, Standard Chartered).
      • Regional Rural Banks (RRBs): Established to provide credit to rural and agricultural sectors. The ownership is shared between the Central Government (50%), the State Government (15%), and the Sponsor Bank (35%).
    • Non-Scheduled Banks: Banks that are not included in the Second Schedule of the RBI Act, 1934.
  • Co-operative Banks: These banks operate on the principles of cooperation and primarily serve the needs of agriculture and the rural sector, though they also have a presence in urban areas. They have a three-tier structure:
    • State Co-operative Banks (at the apex/state level)
    • Central/District Co-operative Banks (at the district level)
    • Primary Agricultural Credit Societies (at the village level)
  • Differentiated Banks: These are niche banks created to serve specific purposes.
    • Small Finance Banks (SFBs): Provide basic banking services and credit to underserved sections like small farmers, micro-businesses, and the unorganized sector. (e.g., AU Small Finance Bank).
    • Payments Banks: Can accept restricted deposits (currently up to ₹2 lakh) but cannot issue loans or credit cards. They facilitate payments and remittances. (e.g., Airtel Payments Bank, India Post Payments Bank).

B. Non-Banking Financial Companies (NBFCs)

NBFCs are companies registered under the Companies Act that provide financial services similar to banks but do not hold a banking license. A key difference is that NBFCs cannot accept demand deposits. They are regulated by the RBI.

C. Development Financial Institutions (DFIs) / All India Financial Institutions (AIFIs)

These are specialized institutions established to provide long-term finance for specific sectors of the economy. They are crucial for infrastructure and industrial development.

NABARD (National Bank for Agriculture and Rural Development): NABARD is the apex development financial institution in India, responsible for providing and regulating credit and other facilities for the promotion and development of agriculture, small-scale industries, cottage and village industries, handicrafts, and other rural crafts and allied economic activities.

  • Key Points:
    • Establishment: It was established on July 12, 1982, by an Act of Parliament.
    • Recommendation: It was set up based on the recommendations of the B. Sivaraman Committee (also known as CRAFICARD – Committee to Review Arrangements for Institutional Credit for Agriculture and Rural Development).
    • Ownership: It is wholly owned by the Government of India.
    • Headquarters: Mumbai, Maharashtra.
  • Core Functions:
    • Refinancing: This is its most crucial function. NABARD does not lend directly to individuals but provides refinance (funding) to institutions that do, such as Commercial Banks, Regional Rural Banks (RRBs), and Co-operative Banks, enabling them to provide credit for agricultural and rural development.
    • Supervision: It is entrusted with the statutory supervision of Regional Rural Banks (RRBs) and Co-operative Banks to ensure their financial health and proper functioning.
    • Developmental Role: NABARD undertakes a wide range of developmental activities, such as:
      • Promoting the Self-Help Group (SHG)-Bank Linkage Programme, the world’s largest microfinance project.
      • Managing the Rural Infrastructure Development Fund (RIDF), which finances rural infrastructure projects.
      • Supporting financial inclusion and promoting initiatives like the Kisan Credit Card (KCC) scheme.
    • Advisory Role: It acts as a key advisor to the Government of India, the Reserve Bank of India, and state governments on matters related to rural development and agricultural credit.
  • In essence, NABARD is the central pillar supporting the entire rural financial ecosystem in India.

SIDBI (Small Industries Development Bank of India): SIDBI is the principal financial institution for the promotion, financing, and development of the Micro, Small, and Medium Enterprise (MSME) sector in India. It serves as the apex regulatory body for institutions engaged in financing MSMEs.

  • Key Points:
    • Establishment: It was set up on April 2, 1990, through an Act of Parliament (SIDBI Act, 1989).
    • Headquarters: Lucknow, Uttar Pradesh.
    • Primary Mandate: To empower the MSME sector and address its financial and developmental gaps.
  • Core Functions:
    • Indirect Finance (Refinance): SIDBI’s primary function is to provide refinance facilities to Primary Lending Institutions (PLIs) like banks and NBFCs, which in turn provide credit to MSMEs. This enhances the resource position of these institutions for lending to the MSME sector.
    • Direct Finance: SIDBI also provides direct financial assistance to MSMEs through various tailored loan schemes for needs such as technology upgradation, marketing, and business expansion.
    • Development and Promotion: Beyond financing, SIDBI has a strong developmental role. It undertakes initiatives for skill development, entrepreneurship promotion, cluster development, and helps MSMEs become more competitive. It also acts as a nodal agency for various Government of India schemes like Startup India and Stand-Up India.
  • In short, SIDBI is the key enabler for the growth and development of the MSME sector, which is a critical engine for job creation and economic growth in India.

NHB (National Housing Bank):

  • NHB is the apex level financial institution for the housing sector in India. Its primary role is to operate as a principal agency to promote housing finance institutions and to provide financial and other support to such institutions.
  • Key Points:
    • Establishment: It was set up on July 9, 1988, under the National Housing Bank Act, 1987.
    • Ownership: It is 100% owned by the Government of India. (Note: It was a wholly-owned subsidiary of the RBI until 2019).
    • Headquarters: New Delhi.
    • Primary Mandate: To promote a sound, healthy, and cost-effective housing finance system in the country.
  • Core Functions:
    • Promotion and Development: NHB’s main objective is to promote and develop a network of dedicated housing finance institutions (like Housing Finance Companies – HFCs) to serve various regions and income groups.
    • Financing (Refinance): It provides refinance to banks and HFCs for their housing loan portfolios, thereby augmenting the flow of credit to the housing sector.
    • Supervision: NHB is responsible for the supervision of Housing Finance Companies (HFCs). However, the regulatory powers over HFCs were transferred to the Reserve Bank of India (RBI) in 2019.
  • In essence, NHB acts as the leader and primary support system for the housing finance market in India, with a special focus on making housing credit more affordable and accessible.

EXIM Bank (Export-Import Bank of India):

EXIM Bank of India is the country’s premier export finance institution, established to finance, facilitate, and promote India’s international trade. It acts as the principal financial institution for coordinating the work of other institutions engaged in financing the export and import of goods and services.

Key Points:

  • Establishment: It was established on January 1, 1982, under the Export-Import Bank of India Act, 1981.
  • Ownership: It is 100% owned by the Government of India.
  • Headquarters: Mumbai, Maharashtra.
  • Primary Mandate: To provide financial assistance to exporters and importers and to function as the principal institution for matters related to the financing of foreign trade.

Core Functions:

  1. Financing: Provides a wide range of financing programs, including pre-shipment and post-shipment credit, loans to Indian companies for overseas investments, and financing for export-oriented units (EOUs).
  2. Lines of Credit (LOCs): Extends Lines of Credit to overseas financial institutions, regional development banks, and foreign governments to enable buyers in those countries to import developmental and infrastructure projects, goods, and services from India.
  3. Advisory Services: Offers a range of advisory and support services to Indian companies to help them evaluate international risks, exploit export opportunities, and improve their global competitiveness.
  4. Guarantees: Issues guarantees on behalf of Indian exporters to support their project bids and execution abroad.

In essence, EXIM Bank is a crucial catalyst for promoting India’s cross-border trade and investment, serving as a one-stop shop for Indian companies’ international business endeavors.

4. Financial Regulators: The Guardians of Stability

  • Reserve Bank of India (RBI): Established on April 1, 1935, under the RBI Act, 1934.
    • Key Functions (High-Yield for Exams):
      • Monetary Authority: Formulates and implements monetary policy to maintain price stability and ensure an adequate flow of credit.
      • Issuer of Currency: Sole authority to issue currency notes (except one-rupee notes and coins, which are issued by the Ministry of Finance).
      • Banker and Debt Manager to Government: Manages the banking needs of the Central and State governments.
      • Banker’s Bank: Maintains the banking accounts of all scheduled banks and acts as the lender of last resort.
      • Regulator and Supervisor of the Financial System: Prescribes regulations for banking and financial institutions to protect depositors’ interests and ensure financial stability.
      • Manager of Foreign Exchange: Manages the foreign exchange reserves under the FEMA (Foreign Exchange Management Act), 1999.
      • Developmental Role: Promotes functions to support national objectives like financial inclusion.
      • Regulator of Payment and Settlement Systems: Oversees the country’s payment systems (e.g., NEFT, RTGS).

Securities and Exchange Board of India (SEBI):

SEBI is the statutory regulatory body for the securities and commodity markets in India, under the jurisdiction of the Ministry of Finance, Government of India. It is the principal regulator for the Indian capital markets.

Key Points:

  • Establishment: Initially constituted as a non-statutory body on April 12, 1988. It was granted statutory powers on January 30, 1992, through the SEBI Act, 1992.
  • Headquarters: Mumbai, Maharashtra.
  • Primary Mandate: To protect the interests of investors in securities, to promote the development of the securities market, and to regulate the securities market.

Core Functions:

SEBI’s functions are broadly categorized into three types:

  1. Protective Functions: These are aimed at protecting the interests of investors and include checking price rigging, prohibiting insider trading, promoting fair practices, and creating awareness and educating investors.
  2. Regulatory Functions: These functions are performed to regulate the business in stock exchanges. They include registering and regulating market intermediaries (like brokers, merchant bankers), registering and regulating mutual funds, regulating the takeover of companies, and conducting inquiries and audits of stock exchanges.
  3. Developmental Functions: These include activities to develop the securities market, such as training intermediaries, promoting self-regulatory organizations, and facilitating the introduction of new products and technologies in the market.

Key Powers:

SEBI is vested with significant powers to ensure the orderly functioning of the market:

  • Quasi-Legislative: It can draft regulations.
  • Quasi-Judicial: It can conduct inquiries, pass rulings, and impose penalties.
  • Quasi-Executive: It can conduct investigations and take enforcement actions.

In essence, SEBI acts as the watchdog of the Indian capital markets, ensuring they are fair, transparent, and efficient for both issuers and investors.

Insurance Regulatory and Development Authority of India (IRDAI):

IRDAI is an autonomous, statutory body tasked with regulating and promoting the insurance and re-insurance industries in India. It is the apex regulatory body for the insurance sector.

Key Points:

  • Establishment: It was constituted as a statutory body in 1999 and commenced operations in April 2000, following the recommendations of the Malhotra Committee. It was established under the Insurance Regulatory and Development Authority Act, 1999 (IRDA Act, 1999).
  • Jurisdiction: It operates under the jurisdiction of the Ministry of Finance, Government of India.
  • Headquarters: Hyderabad, Telangana.
  • Primary Mandate: To protect the interests of the holders of insurance policies, to regulate, promote, and ensure the orderly growth of the insurance industry.

Core Functions:

  1. Registration and Regulation: Issues, renews, modifies, or cancels registration certificates for insurance and re-insurance companies in India.
  2. Policyholder Protection: Safeguards the rights of policyholders, especially in areas like claim settlement, nomination, and policy terms. It provides a grievance redressal mechanism.
  3. Ensuring Financial Soundness: Regulates the investment of funds by insurance companies and mandates the maintenance of solvency margins to ensure they can meet their claim obligations.
  4. Regulation of Intermediaries: Specifies the code of conduct and qualifications for insurance intermediaries like agents and brokers to ensure professionalism in the industry.

In essence, IRDAI acts as the guardian of the Indian insurance sector, ensuring that insurance companies operate in a fair, transparent, and financially sound manner, with the primary focus on protecting the policyholder.

Pension Fund Regulatory and Development Authority (PFRDA):

PFRDA is the statutory regulatory body for the pension sector in India. It is responsible for the promotion, development, and regulation of pension funds to ensure old-age income security for subscribers.

Key Points:

  • Establishment: Established initially as an interim authority in 2003. It was given statutory status through the PFRDA Act, 2013.
  • Jurisdiction: It is a statutory body that functions under the Ministry of Finance, Government of India.
  • Headquarters: New Delhi.
  • Primary Mandate: To promote old-age income security by establishing, developing, and regulating pension funds, and to protect the interests of subscribers.

Core Functions:

  1. Regulation and Development: Regulates pension funds and the intermediaries involved (e.g., Pension Fund Managers, Central Recordkeeping Agency). It works to ensure the orderly growth of the pension sector.
  2. Subscriber Protection: Safeguards the interests of subscribers of pension schemes through a transparent and fair regulatory framework. It also establishes a robust grievance redressal mechanism.
  3. Administering Pension Schemes: PFRDA is the primary regulator for major national pension schemes, including:
    • National Pension System (NPS): A voluntary, defined-contribution retirement savings scheme for government employees, private-sector employees, and all citizens of India.
    • Atal Pension Yojana (APY): A government-backed pension scheme targeted at workers in the unorganized sector.
  4. Promotion and Education: Undertakes steps to educate subscribers and the general public on the importance of pension and retirement planning.

In essence, PFRDA is the guardian of India’s pension system, working to create a financially secure future for retirees across the country.

5. Financial Markets: The Arenas of Trade

This is where financial instruments are traded.

  • Money Market:
    • Purpose: A market for short-term funds, with maturity ranging from overnight to one year. It deals with managing short-term liquidity needs.
    • Key Instruments (Very Important for Exams):
      • Call/Notice Money: Very short-term borrowing between banks (1-14 days).
      • Treasury Bills (T-Bills): Short-term debt instruments issued by the Government of India. They are zero-coupon bonds issued at a discount and redeemed at face value. Issued in three tenors: 91-day, 182-day, and 364-day.
      • Commercial Paper (CP): An unsecured promissory note issued by corporates to raise short-term funds.
      • Certificate of Deposit (CD): A time deposit with a bank, which is negotiable and can be traded in the secondary market.
  • Capital Market:
    • Purpose: A market for long-term funds (maturity > 1 year). It facilitates capital formation for companies and the government.
    • It is divided into:
      • Primary Market: Where new securities are issued for the first time. Also known as the New Issues Market. Methods include:
        • Initial Public Offering (IPO): A private company offers shares to the public for the first time.
        • Follow-on Public Offering (FPO): An already listed company issues additional shares to the public.
        • Rights Issue: New shares are offered to existing shareholders.
      • Secondary Market: Where existing securities are bought and sold. This market provides liquidity to investors. The Stock Exchange (e.g., BSE, NSE) is the most important part of the secondary market.

6. Key Concepts & Reforms for Banking Exams

  • Priority Sector Lending (PSL): An RBI directive for banks to lend a specific portion of their funds to crucial sectors of the economy. The overall target for SCBs is 40% of their Adjusted Net Bank Credit (ANBC). Categories include Agriculture, MSMEs, Export Credit, Education, Housing, Social Infrastructure, and Renewable Energy.
  • Basel Norms: International banking supervision accords that prescribe a set of minimum capital requirements for banks.
    • Basel III: The current framework focuses on making banks more resilient to financial stress by increasing the quality and quantity of capital, strengthening liquidity standards, and introducing a leverage ratio. The minimum Capital Adequacy Ratio (CAR) to be maintained by scheduled commercial banks in India is 9% (plus a Capital Conservation Buffer of 2.5%), which is higher than the international norm of 8%.
  • Insolvency and Bankruptcy Code (IBC), 2016: A landmark reform that provides a time-bound process for resolving insolvency of companies and individuals. The goal is to maximize the value of assets and promote entrepreneurship. The Corporate Insolvency Resolution Process (CIRP) is a key feature.
  • Payment and Settlement Systems:
    • NEFT (National Electronic Funds Transfer): An electronic fund transfer system that operates in half-hourly batches, available 24×7.
    • RTGS (Real-Time Gross Settlement): A system for continuous, real-time settlement of high-value fund transfers (minimum ₹2 lakh).
    • IMPS (Immediate Payment Service): An instant, 24×7 interbank electronic fund transfer service.
    • UPI (Unified Payments Interface): An instant real-time payment system developed by NPCI that allows peer-to-peer and person-to-merchant transactions.