The Structure of Financial Markets in India

11 min read • Published 18 November 2022
Written by Piyush Mohta
How Indian Financial Market is Structured?

Financial market is a term that denotes any place where the exchange and trading of financial assets, including stocks, bonds, commodities, forex, etc., takes place. It provides a platform where those in need of funds can easily find those who are looking for returns on their investments. The state of financial marketplaces in a country plays a crucial role in determining the state of its economy. 

This article discusses everything about the structure of financial markets in India

What Are Financial Markets?

Like regular markets are places where buying and selling of goods occur, financial markets serve the same purpose for financial instruments. 

Financial markets provide an avenue for individuals and institutions to participate in the trading of securities. This includes stocks, bonds, commodities, money market instruments, forex, derivatives, etc. Every country has at least one financial market for each of these financial instruments, though they may be different in size.

The stock market is an example of financial markets where participants trade stocks. Similarly, investors can buy or sell bonds on the bond market. There is also a money market, where individuals and institutions deal with securities with short-term maturities and high liquidity. 

These markets play an essential role in the smooth functioning of a country’s economy. Having efficient financial markets enables anyone in need of capital to conveniently access it.Informational transparency is crucial in ensuring that market prices reflect the intrinsic value of assets.

India’s financial markets feature different types of monetary institutions and many new market participants. Banks have the majority of the monetary value of the country’s financial system. All Indian markets are regulated by the Reserve Bank of India (RBI), the country’s central bank and the Securities and Exchange Board of India (SEBI), the capital market regulator.

How Are Financial Markets Structured in India?

To broadly classify the structure of financial markets in India, you must first understand the two main financial markets: money markets and capital markets. While money markets deal with short-term liquid securities, capital markets usually deal with medium-term and long-term securities. 

There are also other types of financial markets based on parameters like delivery timing, maturity, type of claims, etc. In the following sections, you will see the structure of India’s financial markets:

  1. Money market

Money markets are marketplaces that deal with highly liquid and low-risk instruments. In these markets, participants trade money market instruments such as Treasury Bills (T-Bills), certificates of deposits, commercial papers, overnight securities, etc. These securities have maturities of one year or less.  

These assets are characterised by high liquidity, short-term maturity periods, low risks of loss or volatility and low-interest rates. They are mostly used by companies and large institutional investors like government bodies and financial institutions for wholesale trades.

Although the returns from these assets are limited, they offer a high degree of safety due to their liquidity and short tenures. Moreover, money markets offer a large variety of instruments to choose from. For market participants who require funds, this market is a reliable source of cash.

  1. Capital market

Capital markets are venues where entities that require capital can access it from suppliers who have excess funds. It is a broad term that includes stock markets, bond markets, currency markets and forex markets. The stock market and the bond market are the two most popular capital markets.

Suppliers in the capital market include financial institutions and investors who have extra capital to invest. Entities looking for capital include companies, government bodies and individual borrowers. The capital market’s function is to provide a platform where buyers and sellers can come to terms and exchange securities. 

The capital market can be divided into two categories- The primary market and the secondary market. These are discussed in more detail below.

  1. Primary market 

Also known as New Issue Market, this is where a company issue securities for the first time. Companies use this marketplace to raise capital to help them fund their business endeavours. They issue securities in the primary market in the form of shares, bonds and IPOs (Initial Public Offerings).

  1. Secondary market 

Shares that have already been issued in the primary markets are traded in the secondary markets. Unlike primary markets, where securities move from companies to investors, in the second market, securities are traded among investors. Also, the value of securities tends to change as per their demand and supply. Stocks, Futures, Options, bonds, etc., are some of the financial instruments traded in the secondary markets.

Other Types of Financial Markets

Other than money markets and capital markets, the following are some more types of financial markets:

  • Banking Market

The banking market is another important component under the structure of Indian financial markets. It consists of both banks and non-banking financial institutions.

The banking market comprises scheduled commercial banks, small finance banks, payment banks and cooperative banks. The Reserve Bank of India (RBI) is India’s central bank and regulates our banking sector.

This system’s primary purpose is to collect funds from the general public and lenders with surplus money and offer them credits. Banks offer credit in loans to individuals or businesses that need capital. 

  • Pension market

Another pillar in the structure of financial markets in India is the pension market. This marketplace assists people looking for financial security during their old age. It shelters and allows senior citizens who do not fall under the umbrella of pension schemes to get retirement benefits.

  • Insurance market

Insurance markets are another growing part of the structure of Indian financial markets. People tend to purchase insurance policies like motor or health insurance to safeguard themselves financially in case of a mishap or financial obligations. 

Insurance markets are experiencing positive growth due to growing financial literacy amongst the masses. Therefore, policies such as health insurance, annuity plans, travel insurance and motor insurance are high in demand today.

  • Foreign exchange market

Foreign exchange, or Forex, carries the highest liquidity in the Indian financial market. This is because people can easily deal with currencies in the forex markets.

Every country has their foreign exchange market that is connected online. Traders on foreign exchanges use various trading strategies to benefit from the fluctuating exchange rates of different currencies.

  • Commodity market

The commodity market deals with trading raw materials like oil, pulses, rice, coffee and tea. You can further classify commodity markets into hard and soft commodities.

Hard commodities comprise natural resources and minerals like coal, gold, oil and rubber. Soft commodities include livestock and agricultural products like tea, wheat, sugar, meat, soybean, etc.

In commodity exchanges, traders engage mainly in future contracts instead of trading. Future contracts are an arrangement between traders wherein they decide upon selling or purchasing commodities for a pre-decided period. Spots contracts and options contracts are also sometimes used.

To trade in commodities in India, one must go to one of the following commodity exchanges. 

  • Multi Commodity Exchange (MCEX)
  • Indian Commodity Exchange (ICEX)
  • Bombay Stock Exchange (BSE)
  • National Commodity and Derivative Exchange (NCDEX)
  • National Stock Exchange (NSE)

What Are the Instruments of the Money Market?

Money market instruments are short-term financing instruments that assist government bodies, businesses, and corporations in raising their financial liquidity. These securities can be easily converted to cash, and they fulfill the short-term need of the borrowers.

These instruments are unsecured debt contracts with fixed return rates and high credit ratings. This implies that their issuers have a low probability of defaulting on their obligations. Hence, businesses opt for money market instruments to satisfy their short-term capital needs. 

When discussing the structure of the Indian financial markets, the following are the different types of money market instruments one must know:

  • Call  and notice money 

When banks lend or borrow money for a short period to maintain their daily cash flow, the fund is called call money. For example, banks may lend or borrow call money for a day.

Whereas banks or financial institutions can borrow or lend funds for more than 14 days without collateral, it is known as notice money.

  • Repo

Repurchase agreements or repo are a contract wherein a buyer promises to resell a security back to the seller in future. This contract also binds a seller to repurchase the same bond from a buyer after a certain tenure.

The cost price of these funds depends on repo rates subject to market volatility. Trading of government securities occurs using repurchase agreements. 

  • Treasury Bills

Treasury Bills or T-Bills are another important money market instrument in the finance market of India. Central governments issue Treasury Bills when they need funds to fulfil short-term requirements.

When the entire face value has been paid, the government provides the security at a discount rate. This allows investors to make capital gains. Treasury Bills do not generate interest but can be easily sold at face value. This acts as a perk for investors who are looking for low-risk investment options.

The fact that the Central Government backs T-Bills, they have almost negligible chances of defaulting. Thus, these Treasury Bills become an optimum investment option for new investors.  

  • Commercial papers

Companies and businesses issue commercial papers to generate funds for their short-term capital requirements.

Moreover, commercial papers are unsecured instruments. This implies that usually, large-cap funds with a good market reputation issue them. 

  • Banker’s acceptance

These are popular money market instruments in the structure of financial markets in India. 

A banker’s acceptance is an agreement which the bank signs to promise they will repay the borrowed money to companies. Then, borrowers must repay the funds usually within 30 to 180 days.

Why Is the Structure of Indian Financial Markets So Important?

We have a proper structure for the Indian financial market for the following reasons:

  • Having a well-designed structure helps sellers and buyers know where to invest and borrow to gain the most returns.
  • With different types of financial markets, it becomes a–stop–shop for all forms of investment options.
  • It provides a large ground for individuals, businesses, debtors and investors to participate in the broader market.

Who Regulates Financial Markets in India?

The financial market structure in India is monitored and regulated by some important governing bodies of high stature. They also monitor whether participants abide by trading rules and act against defaulters.

Following are the governing bodies that regulate trading in financial markets in India.

  • Reserve Bank of India

All banks are financial institutions expected to abide by all guidelines set by RBI to operate in the Indian financial market.

  • Insurance Regulatory and Development Authority (IRDA) 

This body acts as the chief governor of all insurance companies and their intermediaries in India.

  • Securities and Exchange Board of India (SEBI)

SEBI is responsible for regulating Indian capital markets, including primary and secondary capital markets. 

What Are the Differences between Capital Markets and Money Markets?

As stated earlier, money and capital markets are two major classifications of the structure of Indian financial markets. However, both these markets differ from each other in many ways.

Regarding tenure, trading in money markets takes place for a short period, usually less than one year. After that, traders opt for capital markets for long-term investments.

Central banks, chit funds, banks and companies are the primary participants of money markets. Capital markets comprise insurance companies, stock exchanges, mutual funds, individual investors and underwriters.

Money markets are highly liquid. Therefore, businesses opt for money markets when they are in instant need of funds. On the other hand, capital markets are less liquid as they usually deal with long-term investments.

Furthermore, owing to money market’s short-term maturity and high liquidity, they are low-risk investment options for novice investors. On the other hand, capital markets are comparatively high-risk investment options for investors due to their long-term maturity period. However, one can get the opportunity to earn significantly higher returns.

Final Word

Financial markets follow a certain structure to maintain the economy of a country. The structure of financial markets in India is made in a way that promotes savings, business activities, investment and proper utilisation of resources. Having a robust financial system is essential for a country’s economic growth.

Frequently Asked Questions

What is the main purpose of financial markets?

Financial markets act as a place where people with surplus funds can sell them to people who require funds. Like every other marketplace, traders interact, sell and purchase financial products in a financial market.

How do capital markets work?

Buyers of debts and securities interact with investors ready to take a risk and lend them securities. Brokerage companies are pivotal in bridging the gap between borrowers and investors.

Who are the intermediaries under capital markets?

Brokers, stock exchange and investment bankers are some examples of intermediaries for the capital market. They help fund sellers and buyers communicate and reach an agreement.

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Piyush Mohta

Credit Principal
CA with 10+ years of experience in Banking in SME and wholesale/start-up lending. Previously worked with UC inclusive, TATA capital, Kotak Bank. Underwritten/Managed loan book of 2500 Cr+

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