Capital Markets

Capital markets constitute a vital segment of the financial system, facilitating the mobilisation and allocation of long-term funds for productive investment. In India, capital markets play a crucial role in linking savings with investment, supporting industrial growth, strengthening the banking and financial sectors, and contributing to overall economic development. Their evolution reflects the country’s transition from a regulated, bank-dominated system to a more diversified and market-oriented financial structure.

Concept and Scope of Capital Markets

Capital markets refer to markets where long-term financial instruments such as shares, debentures, bonds, and government securities are issued and traded. They differ from money markets, which deal in short-term funds. The primary function of capital markets is to provide long-term finance to business enterprises, governments, and financial institutions while offering investors opportunities for returns through capital appreciation and income.
In the Indian context, capital markets encompass both the primary market, where new securities are issued, and the secondary market, where existing securities are traded. Together, these markets form an essential component of the broader financial system, complementing banking institutions and non-banking financial intermediaries.

Historical Development in India

The origins of the Indian capital market can be traced back to the late nineteenth century with the establishment of organised stock trading in Bombay. However, for several decades after independence, capital markets remained underdeveloped due to restrictive controls, limited investor participation, and dominance of public sector finance.
During the planned development era, banks and development financial institutions were the principal sources of long-term finance. Capital markets played a relatively secondary role, constrained by controls on pricing, issues, and investment patterns. The Reserve Bank of India exercised indirect influence over capital markets through credit regulation and monetary policy, while direct oversight of securities markets was limited.
The economic reforms initiated in 1991 marked a significant shift. Liberalisation, privatisation, and globalisation led to the expansion and modernisation of capital markets. The establishment of the Securities and Exchange Board of India (SEBI) as a statutory regulator strengthened market discipline, transparency, and investor protection, transforming the Indian capital market into a more robust and internationally integrated system.

Structure of the Indian Capital Market

The Indian capital market has a multi-layered structure comprising institutions, instruments, and participants.
At the institutional level, it includes stock exchanges such as the Bombay Stock Exchange and the National Stock Exchange, along with clearing corporations, depositories, and intermediaries. These institutions provide the infrastructure for trading, settlement, and custody of securities.
In terms of instruments, the market offers equity shares, preference shares, corporate bonds, government securities, mutual fund units, and derivative products. Participants include individual investors, institutional investors, banks, financial institutions, foreign portfolio investors, and corporates.

Relationship between Capital Markets and Banking

The relationship between capital markets and banking in India is both complementary and interdependent. Banks mobilise deposits and provide credit, while capital markets mobilise long-term funds directly from investors. Together, they enhance financial intermediation and support economic growth.
Banks participate in capital markets as issuers, investors, and intermediaries. They raise capital through equity and bond issues, invest in government and corporate securities, and provide services such as underwriting and custodial operations. At the same time, capital markets reduce excessive dependence on bank credit by offering alternative financing avenues to firms, thereby improving financial stability.
Regulatory oversight ensures that banks’ exposure to capital markets remains within prudent limits, protecting depositors and maintaining systemic stability.

Role in Corporate Finance

Capital markets are central to corporate finance in India. They enable companies to raise long-term funds for expansion, modernisation, mergers, and infrastructure projects. Equity financing allows firms to raise risk capital without fixed repayment obligations, while debt instruments provide structured long-term borrowing.
The development of capital markets has reduced the cost of capital, improved access to finance for large and medium enterprises, and enhanced corporate governance through disclosure and listing requirements. Market-based valuation of securities also promotes efficiency and accountability in corporate management.

Contribution to Economic Development

Capital markets contribute to the Indian economy in several important ways. They mobilise household savings into productive investments, support industrialisation, and facilitate infrastructure development. By providing liquidity and price discovery, they encourage investment and entrepreneurship.
A well-functioning capital market also attracts foreign investment, supplementing domestic savings and integrating the Indian economy with global financial markets. The growth of mutual funds and pension funds has broadened investor participation, promoting financial inclusion and long-term savings.
Moreover, capital markets assist the government in financing fiscal deficits through the issuance of securities, reducing reliance on inflationary sources of finance.

Regulatory Framework and Reforms

The regulatory framework governing Indian capital markets has evolved significantly. SEBI regulates market intermediaries, issues guidelines for public offerings, and enforces disclosure norms. Stock exchanges follow strict listing and trading regulations to ensure fair and orderly markets.
Technological reforms, such as electronic trading, dematerialisation of securities, and rolling settlement, have improved efficiency and reduced transaction costs. Risk management mechanisms, including margining systems and surveillance measures, have strengthened market integrity.
Coordination between SEBI and the Reserve Bank of India ensures consistency between capital market regulation and monetary and banking policies.

Challenges and Limitations

Despite significant progress, the Indian capital market faces several challenges. Market participation remains concentrated, with limited involvement of small investors. The corporate bond market is relatively underdeveloped compared to equity markets, restricting long-term debt financing options.
Volatility, information asymmetry, and periodic instances of market manipulation pose risks to investor confidence. Additionally, regional and sectoral imbalances in access to capital persist, particularly for small and emerging enterprises.