(a) Explain the key classification of the Indian financial system. Make a diagram that depicts the entire financial system and…

(a) Classification of the Indian financial system

The financial system is the network of institutions, markets, instruments and services that moves savings from surplus units (households) to deficit units (firms and government), prices and spreads risk, and provides payment services. It is classified as follows.

1. Formal (organised) and informal (unorganised) sectors

• Formal sector: regulated by RBI, SEBI, IRDAI, PFRDA and IFSCA under the Ministry of Finance, with the Financial Stability and Development Council (FSDC) for co-ordination.
• Informal sector: moneylenders, indigenous bankers, pawnbrokers, chit funds and hundi operators, outside regular supervision and usually charging high rates.

2. Components of the formal system

• Financial institutions. Banking institutions (scheduled commercial banks, regional rural banks, co-operative banks, small finance and payments banks) create credit. Non-banking institutions include development finance institutions (NABARD, SIDBI, EXIM Bank, NaBFID), NBFCs, mutual funds, insurance companies and pension funds.
• Financial markets. The money market deals in funds for up to one year (call money, T-bills, commercial paper, certificates of deposit, repo, TREPS). The capital market deals in long-term funds and has a primary market for new issues and a secondary market (stock exchanges) for trading. Foreign exchange and derivatives markets complete the picture.
• Financial instruments. Primary securities (shares, debentures, bonds) are issued by the ultimate users of funds; secondary securities (deposits, mutual fund units, insurance policies, pension accounts) are issued by intermediaries. They are also classified by maturity into short-term and long-term.
• Financial services. Fund-based services include leasing, hire purchase, factoring and venture capital; fee-based services include merchant banking, credit rating, depository, broking, payments (UPI) and advisory services.

3. Diagram of the system

The system works as a chain: savers deposit with banks or buy securities, intermediaries and markets pool and transform these funds by maturity and risk, and users invest them in productive assets; returns flow back as interest, dividends and capital gains. Regulators keep each segment sound, and the growth of the formal sector (Jan Dhan accounts, UPI, demat accounts) has steadily reduced reliance on the informal sector.

(b) Growth of insurance under IRDAI: trends and policy

IRDAI, set up under the IRDA Act, 1999, replaced the state monopoly with a regulated, competitive market. It licenses insurers, approves products, sets solvency margins, protects policyholders and promotes penetration, which is why private and standalone health insurers have grown quickly. Its stated goal is "Insurance for All by 2047".

Emerging trends in life insurance

• A shift towards pure protection (term plans) and annuity and pension products, alongside unit-linked plans.
• Digital sale and servicing, insurtech partnerships and electronic policies (e-insurance accounts); Bima Sugam, an online marketplace for buying and servicing policies, is being rolled out.
• Bancassurance and wider distribution through the Bima Vahak and Bima Vistaar model for rural and low-income customers.

Emerging trends in health insurance

• Fastest-growing segment, led by standalone health insurers and retail family floater policies.
• Customer-friendly rules from 2024: no upper age limit for buying health insurance, a shorter moratorium period (five years), and cashless claim settlement to be completed within three hours of the discharge request.
• Wider cover for OPD, mental illness, AYUSH treatment and wellness benefits; data-based and usage-based pricing.

Government policy initiatives

• FDI in insurers was raised from 26% to 49% (2015) and 74% (2021); the Sabka Bima Sabki Raksha (Amendment of Insurance Laws) Act, 2025 allows up to 100% FDI.
• From 22 September 2025, premiums on individual life and health insurance policies are exempt from GST, lowering their cost.
• Social security schemes: PMJJBY (life cover), PMSBY (accident cover) and the Atal Pension Yojana for low-income households.
• Ayushman Bharat PM-JAY provides ₹5 lakh hospital cover per family, extended in 2024 to all citizens aged 70 and above regardless of income.
• Tax incentives under Sections 80C and 80D (old regime) encourage life and health cover.

Penetration is still low (about 4% of GDP), and mis-selling, low claim-settlement ratios in some segments and rising medical inflation remain concerns, so growth has to be matched by stronger consumer protection.

(c) Working capital management in a manufacturing firm

Definition. Working capital management is the planning and control of current assets and current liabilities so that the firm always has enough liquidity to run production smoothly while not tying up excess funds that earn little. Gross working capital is total current assets; net working capital is current assets minus current liabilities.

Key components

• Inventories: raw materials, work-in-progress, finished goods and stores.
• Trade receivables: credit sales awaiting collection.
• Cash and cash equivalents, including short-term investments.
• Current liabilities: trade payables, outstanding expenses and short-term borrowings, which finance part of the current assets.

The operating cycle (raw material to finished goods to receivables to cash) decides how much working capital is needed.

Why inventory management matters more than cash management in a manufacturing firm

• Inventory is usually the largest current asset, so small improvements release large amounts of cash.
• Inventory directly decides production continuity and customer service: a stock-out stops the line, while excess stock raises carrying, obsolescence and storage costs.
• Tools such as EOQ, ABC and VED analysis, reorder levels, JIT and vendor-managed inventory reduce the cash conversion cycle, so cash needs fall as a result.
• Cash management (cash budgets, Baumol and Miller-Orr models, investing surplus funds) is largely the outcome of how well inventory and receivables are managed.

Cash management is not unimportant: it ensures solvency and returns on idle funds. But in a manufacturing firm, cash is freed or locked up mainly through inventory, which makes inventory management the more strategic of the two.