An overview of financial system
An overview of financial system: The institutional framework in the industrially developed nations of the West contrasts sharply with the way the capital market is organized in India. The institutionalization of personal savings through saving vehicles like life insurance, pension and provident funds, unit trusts, and other similar vehicles has largely contributed to the expansion of institutional finance for industry abroad.
Development banks—a collective term for industrial financing organizations established by the government at the national and regional levels—have played a significant role in the establishment of institutional finance for industry in India.
In other words, the heavy dominance of the development banks over the structure of the system of industrial finance in India and the comparatively modest involvement of the traditional channels of financing are notable features.
Because of this, the sector has grown to rely significantly on the development banks for all of its funding needs. Development banks have outgrown their secondary status as financiers in terms of their idea as “gap-fillers” due to their significant role in society. It is unquestionably to their credit that they have been able to direct enough capital into the productive system despite unfavorable investment market conditions.
Term lending is not complete without the thorough, exacting, and thorough appraisal that development banks do. This appraisal raises the standard of projects and assures the effective use of resources. Additionally, their evaluation of initiatives is impersonal and objective.
Due to this, a variety of businesses, particularly young or relatively new businesses in industries, can now get funding. At the current stage of India’s industrialization, the supply of financial assistance to such enterprises is very important. When it comes to their role in promoting and innovating, the development banks’ importance in the industrial financing system is overwhelmingly qualitative rather than purely quantitative.
With the development of a meaningful industrial strategy, the emphasis in financing by development banks is geared so that industrial development would support the fundamental economic goals of balanced regional development, the growth of new entrepreneurial talents and small businesses, and the development of indigenous industrial technology. This would help to contribute to the emergence of a widely-diffused yet viable process of industrialization consistent with the socio-economic objectives.
An overview of financial system
The Indian capital market is actually supported by the development banks.
The enormous importance of development banks in India, notwithstanding their remarkable growth and the industry’s heavy reliance on them as a result, has significant ramifications for the market’s capacity to meet the demands of future accelerated industrial development programmes.
The current industrial capital supply experience distorts our perception of this capability. This “distortion” has two grave measurements.
The first part of this “distortion” concerns the financing system’s actual capacity to handle the escalating demands of a larger corporate sector of the private sector as a result of a faster programme of industrial expansion under the five-year plans.
The transfer of savings to profitable businesses is the foundation for the relevance of capital markets to economic progress. These two related tasks are essential for a functioning capital market.
When viewed in this light, development banks tend to play a rather restricted and partial function, and an industrial finance system as heavily dominated by them as the one in India has undoubtedly failed to expand in line with the expected expansion of the industry.
This is due to the fact that development banks act as financial intermediaries and are effectively distributional agencies since they receive the majority of their funding from sponsors. As a result, there is now a separation between the gathering of savings and their distribution.
This poses a significant challenge to the development of an autonomous financing system in terms of maintaining an equilibrium between the supply and demand for capital funds. These words were used to bring attention to this Indian capital market weakness:
The fact that the system is not organically linked to the ultimate source of funds and relies too heavily on ad hoc allocation from the treasury is a flaw of the current institutional structure with its high dependence on special entities. In order for the distributing mechanism to become increasingly capable of expanding autonomously in response to the needs of the economy on the basis of available savings, links between it and the conventional channels of saving will be desirable.
Development banks’ dominance over the institutional framework of the capital market in India has resulted in yet another severe “distortion” in the form of questionably prudent financial activities. There is a preponderance of debt in the financial structure of business firms because the development banks provided the majority of the cash in the form of term loans.
There is no denying that term loans, as a form of financing, reduce the reliance of investment on volatile stock exchanges, and careful examination of the loan agreement has the effect of encouraging greater financial discipline among borrowers and more effective public control over the private enterprise, but the predominance of debt capital has made the capital structure of borrowing concerns lopsided and unbalanced.
However, it does not justify the unlimited use of debt capital as it is likely to jeopardise the future of the company itself. Development banks’ sympathetic and flexible attitude as public financial institutions in case of defaults arising out of temporary difficulties can, of course, permit a greater use of debt than is warranted by the traditional concept of a sound capital structure.
Securing an organic connection between the distribution mechanism and the eventual pool of community savings is the obvious solution to the issue posed by these distortions.