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Historical Evolution of the Indian Financial System

The Indian financial system has a rich historical lineage that traces back to the period before independence.

Pre-independence Period (Pre-1947)

During this time, the financial system was rudimentary, with few formal institutions. Indigenous banking was prevalent, including community lending, pawnbroking and moneylending. In 1935, the Reserve Bank of India (RBI) was established, which was a significant milestone in the evolution of the formal financial system.

Post-independence Period (1947-1991)

Post-independence, the focus was on developing a robust financial system to support India's economic growth. Nationalisation of major banks in 1969 and 1980 marked a major turning point. Insurance companies were also nationalised, and the Unit Trust of India was established as the first mutual fund in 1963.

Liberalisation and Reforms Era (1991-Present)

Post-1991, financial liberalisation and structural reforms were initiated to make the financial system more competitive and efficient. New institutions like SEBI were established for regulating the securities market. The licensing of private and foreign banks, introduction of new financial instruments, and emergence of fintech companies revolutionised the financial system.

Growth of Indian Financial System

The Indian financial system has seen exponential growth, characterised by the emergence of diverse financial institutions, markets, services and instruments. The two main facets of this growth include:

Expansion of Financial Institutions

In the banking sector, a shift from a 'class' to a 'mass' banking approach has led to the expansion of banking services across the length and breadth of the country. The growth of non-banking financial companies (NBFCs), mutual funds, pension funds, and insurance companies has also been remarkable.

Development of Financial Markets

India's financial markets have also witnessed substantial growth. The securities market, consisting of the stock and bond markets, has become more vibrant and efficient. The entry of private sector players and foreign institutional investors (FIIs) has significantly increased market liquidity and depth.

Functions of Indian Financial System

The financial system plays a crucial role in an economy. Its primary functions include:

  1. Resource Allocation: It facilitates the transfer of funds from surplus sectors (savers) to deficit sectors (borrowers), ensuring optimum utilisation of resources.

  2. Risk Management: By offering a variety of financial products like insurance and derivatives, the system enables individuals and businesses to manage risks.

  3. Liquidity Provision: It offers mechanisms to convert assets into cash quickly, ensuring liquidity in the economy.

  4. Payment System: It provides a framework for facilitating transactions, contributing to the smooth functioning of the economy.

  5. Policy Implementation: Through the central bank's monetary policy, the financial system aids in achieving macroeconomic goals like price stability and economic growth.

In conclusion, the Indian financial system, with its diverse institutions and markets, has grown dynamically over the years, fuelled by socio-economic changes, policy reforms and technological advancements. Its crucial functions in resource allocation, risk management, liquidity provision and facilitating payments underline its integral role in supporting India's economic growth and stability.

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