Financial Institutions in India – Types | Structure | Functions

Financial institutions in India are key components of the country's financial system, functioning as intermediaries between savers and borrowers to facilitate the flow of funds and ensure economic stability. These institutions are broadly classified into two categories: Depository Institutions and Non-Depository Institutions.

Table of Contents

1. Introduction
2. Depository Institutions (Banking Institutions)
3. Commercial Banks (Retail Banking)
4. Cooperative Banks
5. Structure of Cooperative Banking in India
6. Non-Depository Institutions (Non-Banking Institutions)
7. Development Financial Institutions
8. Insurance Companies
9. Mutual Funds
10. Non-Banking Financial Companies (NBFCs)
11. Summary

Check out Taxmann's Financial Markets & Institutions which offers a comprehensive exploration of Indian financial systems, covering money and capital markets, banking, insurance, NBFCs, etc. Authored by Dr Vinod Kumar & Manmeet Kaur, it explains complex concepts in accessible language, supported by examples, figures, and tables. Aligned with NEP/UGCF, the book reflects the latest reforms by RBI, SEBI, and IRDA while addressing contemporary topics like digital banking, venture capital, and financial stability. Each chapter features clear learning outcomes, summary points, end-of-chapter exercises, and past exam papers for thorough exam preparation. It is an essential resource for B.Com. (Hons.), B.Com., BBA, MBA students, and finance professionals seeking an in-depth understanding of the financial ecosystem.

1. Introduction

One of the vital components of our financial system is financial institutions, which function as regulators and intermediaries between borrowers and savers in any economy. Financial Institutions in India are categorised into two categories. The first category pertains to the financial intermediaries, and the second pertains to regulatory institutions.

The regulators are allocated with the job of regulating all the constituents of the Indian financial sector. These regulatory institutions are accountable for upholding the transparency and the national interest in the functioning of the institutions under their regulation. The regulatory bodies of the financial institutions in India are as follows: Ministry of Finance (MOF), Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI), Insurance Regulatory Development Authority (IRDA), and Pension Fund Regulatory and Development Authority (PFRDA).

The Intermediaries include the banking (Depository Institutions) and non-banking (Non-Depository) financial institutions. These institutions mobilise funds through deposits and investments from savers and allocate these funds as creditors to borrowers. So, they channel funds from surplus units to deficit units, which is instrumental in effectively and efficiently utilising financial resources. Consequently, they help in economic development through capital formation. Financial institutions process monetary transactions, including business and private loans, customer deposits, and investments. They are crucial to the financial intermediation procedure, through which financial institutions transfer money from those who save funds to those who borrow funds. Let’s understand the classification of Financial Institutions about sources of funds generated through the following flowchart:

Financial Institutions can be categorised as Depository Institutions and Non-Depository Institutions.

• Depository institutions are financial organizations that mobilize savings from retail consumers through time deposits and demand deposits, e.g., savings accounts and current accounts, known as time deposits and fixed deposits, called demand deposits. These institutions are also called Retail banking institutions in India, which take deposits from the public and extend credit in retail loans and term loans to traders, industry, and farmers.
• Non-depository financial institutions are also called Non-Banking institutions in India as these institutions cannot raise deposits from the public in the form of savings and fixed deposit accounts like retail banks. They raise funds through bonds, shares, venture capital, and loans from the government to extend credit to industry and agriculture for long-term tenure. They also invest their funds in Govt. securities, company share capital, and other investment avenues. All DFIs, NBFCs, Mutual funds, pension funds, provident funds, Merchant Banks, Stock Broking firms, and Insurance Companies are called Non-Depository Institutions. Now, we will go into detail to learn more about these two institutions.

2. Depository Institutions (Banking Institutions)

A depository institution is a financial organisation that takes deposits and transfers the deposits into financing activities. These are primarily known as Scheduled Commercial/Retail banks and Scheduled Cooperative Banks in India. They are regulated in India through the Reserve Bank of India, which regulates the money market of the Indian financial system. These institutions can acquire deposits from the public after getting a license from RBI to operate as banking companies in India, which is why they are called depository Institutions.

Since these Commercial and Cooperative Banks are listed in the Schedule of the Reserve Bank of India Act of 1934, they are called scheduled banks. The financing functions of depository financial institutions mainly involve lending funds for mortgage loans, commercial loans, and real estate loans. The deposits create a liability for the depository financial institutions—the credits they give come under the asset side.

3. Commercial Banks (Retail Banking)

Commercial banks play a significant role in the financial sector of the modern economy. The banking sector is the growth engine for a growing economy. They are vital in deploying deposits and credit transfers to different sections of the economy.

The Banking Companies Act of 1949 defines a banking company as

“accepting for lending or investment of deposit money from the public, repayable on demand or otherwise and with drawable by cheque, drafts, and order or otherwise.”

Modern commercial banks are recognised as universal banks today as they deal with traditional deposit and lending functions and provide all kinds of financial services, including fee- and non-fee-based instruments. Hitherto, these banks used to offer short-term loans for working capital financing, but now they provide project finance. The primary functions of banks are opening accounts like savings, current and recurring deposits, and lending in the form of overdrafts, cash credit accounts, retail loans, and term loans. Other ancillary functions are safe deposit lockers, Demat account services, bullion selling, stock broking services, utility bills payment services, bank guarantee facility, wealth advisory, letter of credit facility, foreign exchange, transfer of funds, gift cheques, merchant banking, collection of Govt. taxes, salary disbursement of clients, bills discounting (hundi) and cash management services.

Scheduled Commercial banks can be further categorised into four kinds of banks in India in terms of ownership and registration: Public sector banks, Private sector banks, foreign banks, and regional rural banks. There are 81 scheduled commercial banks-26 public sector banks, 21 in the private sector, and 34 foreign banks in India.

4. Cooperative Banks

Cooperative Banks in our country have become an essential part of the Financial Inclusion initiative. Their success is attributable to the failure of commercial banks to fund and support the needs of small business owners and ordinary people outside the formal banking net. Cooperative banks helped overcome the vital market imperfections and serviced the poorer layers of society. The Cooperative Credit Societies Act of 1904 started the process of setting up Cooperative Credit Societies in both rural and urban areas. The Cooperative Societies Act, 1912 created a premise for non-credit societies and central cooperative organisations.

Indian cooperative structures are one of the most extensive networks in the world, having more than 200 million members. It has about 67% penetration in villages and funds 46% of the total rural credit.

5. Structure of Cooperative Banking in India

The structure of the cooperative network in our country can be classified into two broad categories of Banks:

1. Urban Co-operative Banks
2. Rural Co-operatives Credit Institutions

5.1 Urban Cooperatives

Urban Cooperatives can be further classified into scheduled and non-scheduled. Again, both categories are categorised into multi-state and single-state. Most of these banks fall under the non-scheduled and single-state categories.

• RBI supervises the banking activities of Urban Cooperative Banks.
• Registration and Management activities are handled by the Registrar of Cooperative Societies (RCS).

5.2 Rural Cooperatives

The rural cooperatives are further classified into short-term and long-term structures. The short-term cooperative banks are three-tiered and function in multiple states. These are:

• State Cooperative Banks – They operate at the top level in states
• District Central Cooperative Banks – They operate at the district levels
• Primary Agricultural Credit Societies – They operate at the rural or lowest level.

Chart VIII.1: Structure of Cooperative Credit Institutions in India (As of end-March 2010) SCARDBs: State Cooperative Agriculture and Rural Development Banks. PCARDB: Primary Cooperative Agriculture and Rural Development Banks. Note: (1) Figure in parentheses indicates the number of institutions at the end of March 2010 for UCBs and at the end of March 2009 for rural cooperative credit institutions. (2) For rural cooperatives, the number of banks refers to reporting banks.

Source: https://www.rbi.org.in/

Cooperative Banks were expected to encourage saving at the grassroots level and make credit available to those not served by traditional banks. Because they were local, they were also supposed to know the local business environment better and thus assist in the community’s economic development. However, it is also a fact that, as a class, cooperative banks are operationally weak. Multiple failures have been getting management ineptitude to the front repeatedly, and many cooperative banks are family-run banks with poor corporate governance records; political interference and influence are widespread, and the regulatory framework within which they function does not permit active supervision by RBI. Moreover, rural cooperative banks are suffering from significant problems related to fund availability and debt quality. Cooperative banks face a two-front challenge in the developing business atmosphere where banking is gradually becoming a function of technology and intelligent operations. Inside, they have to change how they operate drastically and externally, and they need to compete with new entities like small finance banks and new-age MFIs who envisage leveraging advanced technologies to win customers. It is an uphill task for cooperative banks to stay in competition.

6. Non-Depository Institutions (Non-Banking Institutions)

Non-depository financial institutions are financial intermediaries that cannot accept deposits but pool the payments in the form of premiums or contributions from many people and either invest in them or provide credit to others. Hence, non-depository organisations play a vital role in the economy. These non-depository institutions are occasionally mentioned as the hidden banking system because they look like banks as financial intermediaries but cannot lawfully take deposits. Therefore, their regulation is less rigorous, which permits some non-depository institutions, such as NBFCs, to take more risks to earn higher revenues. These institutions accept the public’s funds because they offer other services than just the payment of interest. They can spread the financial risk of individuals over a big group or provide investment services for greater returns or a future income.

Non-depository institutions comprise insurance companies, pension funds, securities firms, development financial institutions, mutual funds, and finance companies. These institutions provide specific financial services to the public like insurance services, hedging services, stock broking services, capital issuance services, venture capital finance, consumer finance, under-writing, factoring, leasing, hire purchase, microfinance, investment advisory, and pension funds management services through different financial instruments. These corporations are called Non-Banking Financial Companies (NBFCs) as they provide retail and corporate financial services similar to those provided by banking institutions. Still, they have not been provided a license by RBI to operate as a Banking entity in India. However, these companies fulfil the non-banking financial needs of corporate and retail consumers, which ensures higher returns for investors. These NBFCs are significant investors in the stock market and the govt. Securities market, in addition to commercial banks.

7. Development Financial Institutions

A DFI is “an institution sponsored or supported by the Government mainly to provide development finance to one or more sectors or sub-sectors of the economy. Thus, the primary stress of a DFI is on long-term finance and on support for activities or sectors of the economy where the risks may be more complex than that the ordinary financial system is keen to accept. DFIs may also play a significant role in encouraging equity and debt markets by:

• selling their shares and bonds,
• serving the aided enterprises float or place their securities, and
• selling from their portfolio of investments. The financial institutions in India were established under the robust control of both Central and State Governments. All India financial institutions can be categorised under the following heads according to their economic importance:

1. 1. All-India Development Banks
   2. Specialised Financial Institutions
   3. Investment Institutions
   4. State-level Institutions
   5. Other Institutions

Some of the development financial institutions set up under the different acts of parliament are IFCI, 1948; ICICI, 1956; IDBI, 1964; IIBI, 1971; SIDBI, 1990; IDFC, 1997; EXIM bank, 1982; NABARD, 1982; LIC, 1956; GIC, 1973; UTI, 1964 and TFCI, 1989.

8. Insurance Companies

Insurance companies safeguard their clients from the financial distress caused by unanticipated events, such as accidents or premature death. They pool the small premiums of the insured to pay the more significant claims to those with losses. The premium payments are regular, while the losses are irregular in timing and amount. An insurance company can earn profit because it can accurately estimate the payment of claims over a large group by using statistics. It can invest its surplus for greater returns, which helps lower premiums to be competitive. The insurance industry of India has 53 insurance companies, of which 24 are in the life insurance business, and 29 are in the general insurance sector. Life Insurance Corporation (LIC) is the single public sector company among the life insurers. Besides that, there are only six public sector insurers among the non-life insurers. In addition, there is a single national re-insurer, General Insurance Corporation of India. The primary regulator for insurance in India is the Insurance Regulatory and Development Authority of India (IRDAI), which was set up in 1999 under the government legislation known as the Insurance Regulatory and Development Authority Act, 1999. Six public sector insurers in the general insurance sector comprise two specialised insurers: Agriculture Insurance Company Ltd. for Crop Insurance and Export Credit Guarantee Corporation of India for Credit Insurance.

9. Mutual Funds

A mutual fund is a professionally managed investment trust that collects money from many investors to buy securities to form a portfolio on behalf of the investor, and the investor is allotted units in return for investment in that mutual fund. A mutual fund scheme is usually operated by an Asset Management Company (AMC) that carries together a set of people and invests their money in stocks, bonds, and other financial instruments on their behalf. Each Scheme is associated with NAV, called Net Asset Value, which states the market value of one unit of a specific mutual fund scheme. These units can be bought or cashed as required at the fund’s Net Asset Value (NAV). AMFI is the advisory organisation that issues recommendations for the operations and management of mutual fund schemes by mutual fund companies in India. SEBI is the regulator of India’s mutual fund sector. The main advantage of investing through a mutual fund is that it provides small investors with a reach for professionally managed, diversified portfolios of equities, bonds, and other instruments, which would be pretty hard to make with a small amount of wealth. There are various schemes based on the nature of securities in a scheme’s portfolio, e.g., Equity-oriented funds, Income Funds, Hybrid/Balanced funds, Index Funds, and sectoral Funds. There are 46 Mutual Funds Companies in India as of June 2016.

10. Non-Banking Financial Companies (NBFCs)

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 2013 of India, involved in the trade of loans and advances, procurement of shares, stock, and bonds, hire-purchase, insurance business, or chit business. Still, it does not involve any institution whose primary business involves agriculture, industrial activity, or the sale, purchase, or erection of immovable property. The functioning and operations of NBFCs are controlled by the Reserve Bank of India (RBI) within the structure of the Reserve Bank of India Act, 1934 (Chapter III B) and its instructions. Under the Act, it is obligatory for an NBFC to register with the RBI as a deposit-accepting company.

Types of NBFCs in India are as follows:

• Asset Finance Company (AFC) – An AFC is a company which is a financial organization carrying on as its primary business the financing of physical assets assisting productive/economic, such as automobiles, tractors, lathe machines, generator sets, earth moving and material handling equipment, moving on own power and general purpose industrial machines. The primary business for this purpose is restricted as a collective of financing real/physical assets assisting economic activity. The rising income is not less than 60% of its total assets and revenue.
• Investment Company (IC) – IC means any company a financial institution carries on as its main business the procurement of securities.
• Loan Company (LC) – LC means any financial institution whose primary business is giving finance, whether by advancing loans or advances or otherwise, for any action other than its own (excluding any equipment leasing or hire-purchase finance activity).
• Infrastructure Finance Company (IFC) – IFC is a non-banking finance organization (a) that transfers at least 75 per cent of its total assets in infrastructure loans, (b) has the least Net Owned Funds of ` 300 crore, (c) has the least credit rating of ‘A’ or same (d) and a CRAR of 15%.

The deposit insurance scheme of Deposit Insurance and Credit Guarantee Corporation (DICGC) is not accessible to investors of NBFCs, unlike in the case of banks. NBFC cannot receive demand deposits. In terms of Section 45-IA of the RBI Act, 1934, no NBFC can start or hold on business of a non-banking financial institution without a) attaining a certificate of registration from the Bank and without having a Net Owned Funds of ` 25 lakhs (` Two crores since April 1999). Although Housing Finance Companies, Merchant Banking Companies, Stock Exchanges, Companies engaged in the business of stock-broking/sub-broking, Venture Capital Fund Companies, Nidhi Companies, Insurance companies, and Chit Fund Companies are NBFCs they have been excused from the obligation of registration under Section 45-IA of the RBI Act, 1934 subject to definite situations.

11. Summary

Financial Institutions in India are categorised into two categories. The first category pertains to the financial intermediaries, and the second pertains to regulatory institutions.

The regulatory bodies of the financial institutions in India are as follows: Ministry of Finance (MOF), Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI), Insurance Regulatory Development Authority (IRDA), and Pension Fund Regulatory and Development Authority (PFRDA). The Intermediaries include the banking (Depository Institutions) and non-banking (Non-Depository) financial institutions.

Depository institutions are those financial organizations that mobilize savings from retail consumers through time deposits and demand deposits, e.g., savings accounts and current accounts, known as time deposits and fixed deposits, named demand deposits.

Non-depository financial institutions are also called Non-Banking institutions in India as these institutions cannot raise deposits from the public in the form of savings and fixed deposit accounts like retail banks.

A depository institution is a financial organisation that takes deposits and transfers the deposits into financing activities. These are primarily known as Scheduled Commercial/Retail banks and Scheduled Cooperative Banks in India.

Scheduled Commercial banks can be further categorised into four kinds of banks in India in terms of ownership and registration: Public sector banks, Private sector banks, foreign banks, and regional rural banks.

The structure of the cooperative network in our country can be classified into two broad categories of Banks—Urban Cooperative Banks and Rural Cooperatives Credit Institutions

Non-depository institutions comprise insurance companies, pension funds, securities firms, development financial institutions, mutual funds, and
finance companies.

A DFI is an institution sponsored or supported by the Government mainly to provide development finance to one or more sectors or sub-sectors of the economy.

Insurance companies safeguard their clients from the financial distress caused by unanticipated events, such as accidents or premature death. They pool the small premiums of the insured to pay the more significant claims to those with losses.

A mutual fund is a professionally managed investment trust that collects money from many investors to buy securities to form a portfolio on behalf of the investor. The investor is allotted units in return for investment in that mutual fund.

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 2013 of India, involved in the trade of loans and advances, procurement of shares, stock, and bonds, hire-purchase, insurance business, or chit business. Still, it does not involve any institution whose primary business involves agriculture, industrial activity, or the sale, purchase, or erection of immovable property.