Financial Institutions & Markets

Unit 1: Introduction
Prof. Avanish Goel
Financial System and its
Components
Objectives
• Learn the concept of Indian financial system;
• Explain the key elements related to Indian financial system;
• Discuss the nature and functions of Indian financial system;
• Understand role of financial system and financial instruments;
• Understand components of Indian financial system.
• To have overview of role and segments of financial markets
Introduction to Financial System
• The financial system of a country is an important tool for economic development
of the country, as it helps in creation of wealth by linking savings with
investments.
• It facilitates the flow of funds form the households (savers) to business firms
(investors) to aid in wealth creation and development of both the parties.
• The financial system of a country is concerned with:
• Allocation and Mobilization of savings
• Provision of funds
• Facilitating the Financial Transactions
• Developing financial markets
• Provision of legal financial framework
• Provision of financial and advisory services
• According to Robinson, the primary function of a financial system is “to provide a
link between savings and investment for creation of wealth and to permit
portfolio adjustment in the composition of existing wealth”
Financial System
• ‘Financial system’ is a broader term which brings under its fold the financial
markets and the financial institutions which support the system.
• The major assets traded in the financial system are money and monetary assets.
• The responsibility of the financial system is to mobilise the savings in the form of
money and monetary assets and invest them to productive ventures.
• An efficient functioning of the financial system facilitates the free flow of funds
to more productive activities and thus promotes investment.
• The financial system provides the intermediation between savers and investors
and promotes faster economic development
Importance of Indian Financial System
• It accelerates the rate and volume of savings through provision of various
financial instruments and efficient mobilization of savings
• It aids in increasing the national output of the country by providing funds
to corporate customers to expand their respective business
• It protects the interests of investors and ensures smooth financial
transactions through regulatory bodies such as RBI, SEBI etc.
• It helps economic development and raising the standard of living of people
• It helps to promote the development of weaker section of the society
through rural development banks and co-operative societies
• It helps corporate customers to make better financial decisions by
providing effective financial as well as advisory services
• It aids in Financial Deepening and Broadening
Functions of Indian Financial System
• Provision of Liquidity: The provision of liquidity is one of the primary functions of financial
system. It states the ability of meeting the obligations as and when they are required. In other
words, it states the ability of converting the assets into liquid cash without any loss.
• Mobilization of savings: Savings are done by millions of people. But amount saved are of no use
unless they are mobilized into financial assets, whether currency, bank deposits, post office savings
deposits, life insurance policies, mutual funds bonds or equity shares. It is the function of financial
institutions, a sub division of financial system to mobilize the savings from the saver or investment
group.
• Small Savings to big investment: Financial system acts as an intermediary in transforming the
mobilized fund of savings to the big investments. It channelizes small savings fund received from
the savings group to the industries to investments.
• Maturity Transformation function: It is also one of the intermediary functions of financial
system. The financial institutions receive the saving fund from the depositors for a particular tenure
and lend the same fund to the required people on term basis.
Functions of Indian Financial System …
• Risk Transformation function: The financial system also does a function of risk transformation. The
small savers are usually risk averse, who doesn’t want to invest their small saving fund in the risky
ventures. Hence the financial institutions take the responsibility of transforming their risk in investing
their funds in profitable and safe venture by bearing the risk.
• Payment function: The financial system offers a very convenient mode of payment for goods and
services. The cheque system and credit card system are the easiest methods of payment in the
economy. The cost and time of transactions are considerably reduced. The payment mechanism is now
being increasingly made through electronic means.
• Pooling of funds: A financial system provides a mechanism for pooling of funds to invest in large
scale enterprises.
• Monitor Corporate performance: A financial system not only helps in selecting the projects to be
funded but also motivates the various stakeholders of the financial system to monitor the performance
of the investment.
Functions of Indian Financial System …
• Provide price related information: Financial markets provide information which enables the
investors to make an informed decision about whether to buy, sell or hold a financial asset. This
information dissemination facilitates valuation of financial assets.
• Information function: Financial markets disseminate information for enabling participants to
develop informed opinion about investment, disinvestment, reinvestment or holding a particular
asset.
• Transfer function: A financial system provides a mechanism for the transfer of resources across
geographic boundaries.
• Reformatory function: A financial system, undertakes the functions of developing, introducing
innovative financial assets/instruments. Services and practices and restructuring the existing assets,
services etc., to cater to the emerging needs of borrowers and investors. I.e. financial engineering
and reengineering.
• Other functions: It assists in the selection of projects to be financed and also reviews performance
of such projects periodically. It also promotes the process of capital formation by bringing together
the supply of savings and the demand for investible funds.
FINANCIAL CONCEPTS
• An understanding of the financial system requires an understanding of the
following important concepts:
1. Financial assets / instruments
2. Financial intermediaries.
3. Financial markets.
4. Financial instruments.
Structure of Indian Financial System/Components
of Indian Financial System
Components of Financial system
Financial System – Components
• The financial system consists of the Central Bank (RBI), as the apex financial
institution, other regulatory authorities, financial institutions, markets,
instruments, a payment and settlement system, a legal framework and
regulations.
• The financial system carries out the vital financial intermediation function of
borrowing from surplus units and lending to deficit units.
• The legal framework and regulators are needed to monitor and regulate the
financial system.
• The payment and settlement system is the mechanism through which
transactions in the financial system are cleared and settled.
1. Regulatory Authorities
2. Financial Institutions
3. Financial Markets
4. Financial Instruments
5. Payment and Settlement Infrastructure.
Regulators – RBI / SEBI / IRDA
Regulatory Authorities
• Reserve Bank of India (RBI)
• The regulation and supervision of banking institutions is mainly governed by the
Companies Act, 1956, Banking Companies (Acquisition and Transfer of
Undertakings) Act, 1970/1980, Bankers’ Books Evidence Act, Banking Secrecy Act
and Negotiable Instruments Act, 1881.
• The regulation and supervision of finance companies is done by the Banking
Regulation Act, 1949 which governs the financial sector.
• Individual Institutions are regulated by Acts like:
1. State Bank of India Act, 1954
2. The Industrial Development Bank (Transfer of Undertaking and Repeal) Act, 2003
3. The Industrial Finance Corporation (Transfer of Undertaking and Repeal) Act, 1993
4. National Bank for Agriculture and Rural Development Act
5. National Housing Bank Act
6. Deposit Insurance and Credit Guarantee Corporation Act.
Regulatory Authorities …
• Securities and Exchange Board of India (SEBI)
• The Securities and Exchange Board of India (SEBI)– Regulator of
the financial markets in India that was established on 12th April
1988.
• The Securities and Exchange Board of India was made a statutory
body on April 12, 1992 in accordance with the provisions of the
Securities and Exchange Board of India Act, 1992 to protect the
interests of investors in securities and to promote the
development of, and to regulate the securities market and for
matters connected therewith or incidental thereto.
Role of SEBI
• Issuers of securities
• These are entities in the corporate field that raise funds from various sources
in the market. This organization makes sure that they get a healthy and
transparent environment for their needs.
• Investor
• Investors are the ones who keep the markets active. This regulatory authority
is responsible for maintaining an environment that is free from malpractices
to restore the confidence of the general public who invest their hard-earned
money in the markets.
• Financial Intermediaries
• These are the people who act as middlemen between the issuers and
investors. They make the financial transactions smooth and safe.
Objectives of SEBI
• Protection to the investors
• The primary objective of SEBI is to protect the interest of people in the stock
market and provide a healthy environment for them.
• Prevention of malpractices
• This was the reason why SEBI was formed. Among the main objectives,
preventing malpractices is one of them.
• Fair and proper functioning
• SEBI is responsible for the orderly functioning of the capital markets and
keeps a close check over the activities of the financial intermediaries such as
brokers, sub-brokers, etc.
Functions of SEBI
• The main primary three functions are-

1. Protective Function
2. Regulatory Function
3. Development Function
Functions of SEBI
Protective Functions
• These functions are performed by SEBI to protect the interest of
investors and other financial participants.
1. Checking price rigging
2. Prevent insider trading
3. Promote fair practices
4. Create awareness among investors
5. Prohibit fraudulent and unfair trade practices
Functions of SEBI
Regulatory Functions
• These functions are basically performed to keep a check on the
functioning of the business in the financial markets.
1. Designing guidelines and code of conduct for the proper functioning of
financial intermediaries and corporate.
2. Regulation of takeover of companies
3. Conducting inquiries and audit of exchanges
4. Registration of brokers, sub-brokers, merchant bankers etc.
5. Levying of fees
6. Performing and exercising powers
7. Register and regulate credit rating agency
Functions of SEBI
Development Functions
• This regulatory authority performs certain development functions
also that include but they are not limited to-
1. Imparting training to intermediaries
2. Promotion of fair trading and reduction of malpractices
3. Carry out research work
4. Encouraging self-regulating organizations
5. Buy-sell mutual funds directly from AMC through a broker
Regulatory Authorities …
• Insurance Regulatory and Development Authority (IRDA)
• Section 14 of IRDAI Act, 1999
• Insurance Regulatory and Development Authority regulates and
supervises the insurance industry-insurance companies and their
agents and insurance brokers to protect the interests of the
policyholders, to regulate, promote and ensure orderly growth of
the insurance industry and for matters connected therewith or
incidental thereto.
Functions of IRDA
• To safeguard the policyholder’s interest while ensuring a fair and just
treatment.
• To have a fair regulation of the insurance industry while ensuring
financial soundness of the applicable laws and regulations.
• To frame regulations periodically so that there is no ambiguity in the
insurance industry.
Role and importance of IRDA in the insurance
sector
• To protect the policyholder’s interests.
• To help speed up the growth of the insurance industry in an orderly fashion, for the benefit of the
common man.
• To provide long-term funds to speed up the nation’s economy.
• To promote, set, enforce and monitor high standards of integrity, fair dealing, financial soundness and
competence of the insurance providers.
• To ensure genuine claims are settled faster and efficiently.
• To prevent malpractices and fraud, the IRDA has set up a grievance redress forum to ensure the
policyholder is protected.
• To promote transparency, fairness and systematic conduct of insurance in the financial markets.
• To build a dependable management system to make sure high standards of financial stability are
followed by insurers.
• To take adequate action where such high standards are not maintained.
• To ensure the optimum amount of self-regulation of the industry.
Features & Benefits of IRDA
• Acts as a regulator for the insurance industry.
• Protects the policyholder’s interests.
• Rules and regulations are framed by the apex body under Section
114A of the Insurance Act, 1938.
• It is entrusted under the Insurance Act to grant the certificate of
registration to new insurance companies to operate in India.
• Oversees the insurance industry’s activities to ensure sustained
development of insurers and policyholders.
Financial Institutions
Financial Institutions
• The financial system consists of many financial institutions. While most of them
are regulated by the Reserve Bank, there are some which it manages just
indirectly.
• Institutions regulated by the Reserve Bank of India
1. Nationalised Commercial Banks
2. Specialised Banks
3. Registered Finance Companies
4. Registered Finance Leasing Establishments
5. Micro-finance Institutions.
• Institutions not regulated by the Reserve Bank of India
• Certain financial institutions are not regulated by the Reserve Bank of India.
• These include securities firms, investment banks and mutual funds which come under the
purview of the SEBI, Insurance Companies and Insurance Brokers which are regulated by the
IRDA, etc.
Financial Institutions
• Financial institutions are intermediaries of financial markets which
facilitate financial transactions between individuals and financial
customers.
• It simply refers to an organization (set-up for profit or not for profit) that
collects money from individuals and invests that money in financial assets
such as stocks, bonds, bank deposits, loans etc.
• There can be two types of financial institutions:
1. Banking Institutions or Depository institutions – These are banks and credit
unions that collect money from the public in return for interest on money deposits
and use that money to advance loans to financial customers.
2. Non- Banking Institutions or Non-Depository institutions – These are brokerage
firms, insurance and mutual funds companies that cannot collect money deposits
but can sell financial products to financial customers.
Financial Institutions …
• Financial Institutions may be classified into three categories
1. Regulatory – It includes institutions like SEBI, RBI, IRDA etc. which
regulate the financial markets and protect the interests of investors.
2. Intermediaries – It includes commercial banks such as SBI, PNB etc.
that provide short term loans and other financial services to
individuals and corporate customers.
3. Non – Intermediaries – It includes financial institutions like
NABARD, IDBI etc. that provide long-term loans to corporate
customers.
Financial Markets
• The Financial Market, which is the market for credit and capital, can be
divided into the Money Market and the Capital Market.
1. The Money Market is the market for short-term interest-bearing assets.
• Examples: 1. Treasury bills, 2. Commercial paper, 3. Certificates of deposits
• The major task of the Money Market is to facilitate the liquidity management in the
economy.
2. The Capital Market is the market for trading in medium-long-term assets.
• Examples: 1. Treasury bonds, 2. Private debt securities (bonds and debentures) 3.
Equities (shares)
• The main purpose of the Capital Market is to facilitate the raising of long-term funds.
• The main issuers in the
1. Money Market are the Government, banks and private companies, while the main
investors are banks, insurance companies and pension and provident funds.
2. Capital Market are the Government, banks and private companies, while the main
investors are pension and provident funds and insurance companies.
Financial Markets …
• The Financial Market can also be classified according to instruments,
such as –
• Debt market
• Equity market.
• The debt market is also known as the Fixed Income Securities Market
and its segments are the Government Securities Market (Treasury
bills and bonds) and the Private Debt Securities Market (commercial
paper, private bonds and debentures).
Financial Markets …
• Another distinction can also be drawn between primary and secondary
markets.
• The Primary Market is the market for new issues of shares and debt
securities,
• The Secondary Market is the market in which existing securities are traded.
• The Reserve Bank of India through its conduct of monetary policy
influences the different segments of the Financial Market in varying
degrees.
• The Reserve Bank's policy interest rates have the greatest impact on a
segment of the Money Market called the inter-bank call money market and
a segment of the Fixed Income Securities Market, i.e. the Government
Securities Market.
FINANCIAL ASSETS / INSTRUMENTS
• A financial asset is one which is used for production or consumption or for
further creation of assets
• In any financial transaction, there should be a creation or transfer of financial asset.
• One must know the distinction between financial assets and physical assets. For example,
X purchases land and buildings, or gold and silver. These are physical assets since they
cannot be used for further production. Many physical assets are useful for consumption
only.
• The objective of investment decides the nature of the asset. For instance, if a building is
bought for residence purposes, it becomes a physical asset. If the same is bought for
hiring, it becomes a financial asset.
• Financial assets include cash deposits, checks, loans, accounts receivable, letter of
credit, bank notes and all other financial instruments that provide a claim against
a person/financial institution to pay either a specific amount on a certain future
date or to pay the principal amount along with interest.
Classification of Financial assets
• Marketable assets –
• Marketable assets are those which can be easily transferred from one person to another without
much hindrance. Examples: Shares of Listed Companies, Government Securities, Bonds of
Public Sector Undertakings, etc.
• Non-marketable assets –
• If the assets cannot be transferred easily, they come under this category. Examples: Bank
Deposits, Provident Funds, Pension Funds, National Savings Certificates, Insurance Policies, etc.
Financial Instruments
1. Deposits
2. Loans
3. Treasury Bills and Bonds
4. Repurchase Agreements
5. Commercial Paper
6. Corporate Bonds and Debentures
7. Asset-backed Securities (Secured Debentures)
8. Warrants
9. Shares
10. Financial Derivatives
Deposits
• Deposits are sums of money placed with a financial institution, for credit to a customer's
account.
• There are three types of deposits — demand deposits, savings deposits and fixed or time
deposits.
1. Demand deposits are mainly used for transaction purposes and for the safekeeping of
funds. Funds can be withdrawn on demand. Demand deposits do not earn interest.
2. Savings deposits earn interest, which may be calculated on a daily, weekly, monthly or
annual basis. Funds may be withdrawn from savings accounts at any time.
3. Fixed or time deposits are funds placed at financial institutions for a specified period
or term. Fixed/time deposits earn a higher rate of interest than savings deposits.
Fixed/time deposits can be for short, medium or long term. Funds can only be
withdrawn before the maturity date with prior notice and a penalty may be imposed
Loans
• A loan is a specified sum of money provided by a lender, usually a
financial institution, to a borrower on condition that it is repaid,
either in installments or all at once, on agreed dates and at an agreed
rate of interest.
• In most cases, financial institutions require some form of security for
loans.
Treasury Bills and Bonds
• Treasury bills are government securities that have a maturity period of up to one year.
• Treasury bills are issued by the central monetary authority (the RBI), on behalf of the
Government of India.
• Treasury bills are issued in maturities of 91 days, 182 days and 364 days.
• Treasury bills are zero coupon securities and are sold at a discount to face value, which is
paid at maturity.
• The difference between the purchase price and the face value is the interest income to
the owner.
• Treasury bills are considered liquid assets as they can be easily sold in the secondary
market and converted to cash.
• Treasury bonds are medium and long-term government securities and are issued in
maturities ranging from 2 years to 20 years.
• Treasury bills and bonds are guaranteed by the Government and are the safest of all
investments, as they are default risk free.
• Treasury bills and bonds are tradable securities which are sold by auction to Primary
Dealers, who in turn market the securities to the public.
Repurchase Agreements
• Repurchase agreements (Repo) are arrangements involving
transaction between two parties that agree to sell and repurchase the
same security.
• Under repurchase agreement, the seller sells the specified securities
to the buyer with an agreement to repurchase the same at a mutually
decided future date and price.
• Such kind of transaction between parties approved by RBI and in
securities (Treasury Bills, Central/State Govt. securities) as approved
by RBI.
Commercial Paper
• Commercial Papers (CPs) are short-term, non-collateralised
(unsecured) debt securities issued by private sector companies to
raise funds for their own use, by banks and other financial
intermediaries.
• CPs are generally issued by creditworthy (high-rated) institutions in
large denominations and have additional bank guarantees of
payment.
• CPs are usually sold at a discount, although some are interest bearing.
Corporate Bonds and Debentures
1. Corporate bonds are medium or long-term securities of private sector
companies which obligate the issuer to pay interest and redeem the principal
at maturity.
Corporate bonds that are not backed by a specific asset are called debentures.
2. Debentures are medium or long term, interest-bearing bonds issued by private
sector companies, banks and other financial institutions that are backed only
by the general credit of the issuer.
• Debentures are usually issued by large, well-established institutions. The holders of
debentures are considered creditors and are entitled to payment before shareholders in the
event of the liquidation of the issuing company.
a) Convertible Debentures are debentures issued with an option to debenture holders to
convert them into shares after a fixed period. A convertible debenture is a type of
debenture or commercial loan that gives the choice to the lender to take stock or shares in
the company, as an alternative to taking the repayment of a loan. Convertible debentures
are either partially or fully convertible.
b) Non-convertible Debentures are debentures issued without conversion option. The total
amount of the debenture will be redeemed by the issuing company at the end of the
specific period.
Asset-backed Securities (Secured Debentures)
• Asset-backed Securities (ABS) are bonds collateralized (secured) by
mortgages, loans, or other receivables.
• Typically, the issuing institution sells mortgages, loans, instalment
credit, credit card or other receivables to a trust or a Special Purpose
Vehicle (SPV) that in turn sells ABSs to the public.
• ABSs are interest- bearing instruments and are often enhanced
through the use of guarantees or insurance.
Warrants
• Warrants can be described as a derivative security that gives the
holder the right to purchase securities (usually equity) from the issuer
at a specific price within a certain time frame.
• Warrants are frequently attached to bonds or preferred stock as a
sweetener, allowing the issuer to pay lower interest rates or
dividends.
• They can be used to enhance the yield of the bond, and make them
more attractive to potential buyers.
• Warrants can also be used in private equity deals.
Financial Services
• Financial services refer to services provided by the finance industry.
• Among these organizations are banks, credit card companies,
insurance companies, consumer finance companies, stock brokerages,
investment funds and some government sponsored enterprises.
• Financial services can be defined as the products and services offered
by institutions like banks of various kinds for the facilitation of various
financial transactions and other related activities in the world of
finance like loans, insurance, credit cards, investment opportunities
and money management as well as providing information on the
stock market and other issues like market trends.
Financial Services
• Financial Services are concerned with the design and delivery of
financial instruments and advisory services to individuals and
businesses within the area of banking and related institutions,
personal financial planning, leasing, investment, assets, insurance etc.
• It involves provision of a wide variety of fund/asset based and non-
fund based/advisory services and includes all kinds of institutions
which provide intermediate financial assistance and facilitate financial
transactions between individuals and corporate customers.
FINANCIAL INTERMEDIARIES
Financial intermediaries
• DEFINITION
• Financial intermediaries hold a very important role in the flow of money in the financial world.
• The assistance of a financial intermediary is needed by companies who want somebody to act as a
middle man in raising money from the investors.
• Meeting up between these two parties are often very difficult without the help of financial
intermediaries
TYPES OF FINANCIAL INTERMEDIARIES
• INSURANCE COMPANY
• MUTUAL FUNDS COMPANIES
• NON BANKING FINANCE COMPANIES
• INVESTMENT BROKERS
• INVESTMENT BANKERS
• ESCROW COMPANIES
• PENSION FUNDS
• COLLECTIVE INVESTMENT SCHEME
INSURANCE COMPANIES
• Insurance companies concentrate on fulfilling the insurance needs of the community ,
both for life and non life insurance.
• These companies offer products that allow investors to select the kind of policies to suit
their financial planning needs.
• These companies also offer policies for funding a child’s education and marriage, and
providing a steady income for the aged through annuities and pensions
MUTUAL FUNDS
• Mutual funds (MFs) organisations satisfy the needs of individuals investors through
pooling resources from a large number with similar investments goals and risks appetite.
• The resource collected are invested in the capital and money market securities.
• The returns are distributed to investors optimising the return for the investors.
NON BANKING FINANCE COMPANIES
• NBFCs are commonly knows as finance companies and are corporate bodies, which
concentrate mainly on lending activities in a well defined area.
INVESTMENT BROKERS
• The main duty of investment brokers is to transact the security sales.
• There are discount brokers and full-service brokers.
• They provide an opportunity online for some individuals to promote their trades.
• Aside from that they can also solicit valuable investment advice to some clients who may
need it that time
INVESTMENT BANKERS
• The main duty of this financial intermediary is to increase monetary amounts of
companies through stocks and bonds.
• Since conducting stock offerings and issuing bonds is so expensive, investment bankers
focuses on how they can help the firm to earn more capital
ESCROW COMPANIES
• This is the type of financial intermediary that is built for the very purpose.
• These companies acts like an unconcerned party that will hold instructions for execution
as well as the grounds agreed for it.
PENSION FUND
• A pension fund is any plan, fund, or scheme which provides retirement income.
• Pension funds are important to shareholders of listed and private companies.
• They are especially important to the stock market where large institutional investors
dominate.
TYPES OF PENSION FUND
• OPEN VS. CLOSED PENSION FUNDS
• OPEN PENSION FUNDS - Open pension funds support at least one pension plan with no restriction on membership while
closed pension funds support only pension plans that are limited to certain employees

• CLOSE PENSION FUNDS

• Closed pension funds are further subclassified into:

• Single employer pension funds

• Multi-employer pension funds

• Related member pension funds

• Individual pension funds

• PUBLIC VS. PRIVATE PENSION FUND

• A public pension fund is one that is regulated under public sector law while a private pension fund is regulated under
private sector law.
COLLECTIVE INVESTMENT SCHEME
• A collective investment scheme is a way of investing money alongside
other investors in order to benefit from the inherent advantages of working
as part of a group.
• These advantages include an ability to
• hire a professional investment manager, which theoretically offers the prospects of better
returns and/or risk management
• benefit from economies of scale - cost sharing among others
• diversify more than would be feasible for most individual investors which, theoretically, reduces
risk
ADVANTAGES OF FINANCIAL INTERMEDIARIES
• Cost advantage over direct lending/borrowing
• Market failure protection the conflicting needs of lenders and borrowers are reconciled,
preventing market failure
• Risk transformation
• Access to Financial Market and funds and better safe and secure returns
Globalization of Financial Markets
Global Financial System – An Overview
• Functions of Financial Market
• Price Discovery
• Liquidity
• Cost of Transactions (saver search & information costs)
• Transfer of savings from one sector to other
• Reflects as Barometer for economic growth
• Financial Assets
• Treasury Bonds
• Debt
• Equity
• Commercial Paper/Debentures etc.
• Euro Bonds.
• Gold/Silver
• Cross Border Bonds /instruments.
GLOBAL FINANCIAL SYSTEMS
• IBRD (World Bank) Long-Term Capital Assistance
• IFCI To finance PRIVATE enterprises in the form of loans & equity
• IDA Affiliate of World Bank Soft – Loan window of the Bank. Mainly for
developing & under-developed nations. Re-payment period upto 50 years
Govt. & Private, both, eligible.
• MIGA Multilateral Investment Guarantee Agency – an affiliate of World
(1988) Bank Provides guarantee for investment in needy countries.
• ECAFE (Economic Commission for Asia & Far East) promote investment in
Asia & Far East and also finance priority area. Also co-ordinates with U.N.
agencies. 19
International Banking
• International banking relates to financial intermediaries that bid for
time deposits and make loans in the offshore market.
• It is an unregulated market involving greater risk.
• It is a wholesale segment of lending and deposit activity
• International banking brings together borrowers and lenders from
same country or different countries
• They are substitutes for the domestic banking system
Major Functions of International Banking
1. Facilitate imports and exports of their clients – trade financing
2. Arrange for foreign exchange – cross-border transactions and foreign
investments
3. Assist in hedging exchange rate risk.
4. Trade foreign exchange products for their own account
5. Borrow and lend in the Eurocurrency market
6. Participate in international loan syndicate – lending to MNCs- project
financing and to sovereign governments – economic development
7. Participate in underwriting of Eurobonds and foreign bonds issues.
8. Provide consultancy and advice on hedging strategies, interest rate and
currency swap financing and international cash management services
Roles & Functions of RBI
Contents
• Roles & Functions of RBI – Introduction
• Preamble Of The RBI
• Organizational Structure of RBI:
• Functions of RBI in Indian Banking System
• The RBI’s Role In Current Scenario
• RBI’s Role in Economic Development
• RBI’s Role in Promoting Schemes And Policies
• Supervisory Functions of RBI
• Prohibitory Functions of RBI
• RBI Functions – General Terms
Introduction
• India is one of the fastest growing economies in the world, with a
population over 1.3 Billion, has become the hub for global investment.
• There are various factors that influence and control Indian economy, one
such being,
• The RBI, one of the oldest institution behind the success of our economy.
• The RBI is the guardian of Indian economy and because of it, growth in
Exports, FOREX, Capital Markets and other sectors of the economy are all
taking place at a healthy rate. It plays a pivotal role in strengthening,
developing and diversifying the country’s economic and financial structure.
• It is the apex bank in the Indian Banking System.
Structure Of The Indian Banking System
1. Reserve banks of India.
2. Indian Scheduled Commercial Banks.
• State Bank of India and its associate banks.
• Twenty nationalized banks.
• Regional rural banks.
• Other scheduled commercial banks.
3. Foreign Banks
4. Non-scheduled banks.
5. Co-operative banks.
• The Reserve Bank of India (RBI) is India’s Central banking institution, which
controls the monetary policy of the Indian rupee.
• The Reserve Bank of India was established on April 1, 1935, in accordance with
the provisions of the Reserve Bank of India Act, 1934.
• It was initially privately owned and managed but since nationalisation in 1949,
the Reserve Bank is fully owned by the Government of India.
Preamble Of The RBI
• The Preamble of the Reserve Bank of India describes the basic Functions of
Reserve Bank of India as:
“to regulate the issue of Bank notes and keeping of reserves with a view to
securing monetary stability in India and generally to operate the currency
and credit system of the country to its advantage; to have a modern
monetary policy framework to meet the challenge of an increasingly
complex economy, to maintain price stability while keeping in mind the
objective of growth.”
• The Preamble of the Reserve Bank of India describes the basic functions of
the Reserve Bank as:
1. Regulating the issue of Banknotes
2. Securing monetary stability in India
3. Modernising the monetary policy framework to meet economic challenges
RBI as an Organization
• The RBI has four zonal offices at:
1. Chennai
2. Delhi
3. Kolkata
4. Mumbai
• It has 22 regional offices and 11 Sub-offices
Organizational Structure of RBI
• The Reserve Bank’s affairs are governed by a central board of
directors. The board is appointed by the Government of India for a
period of four years.
• Full-time officials: Governor and not more than four Deputy
Governors. The current Governor of RBI is Mr. Shaktikanta Das.
• There are 4 Deputy Governors, Mr B.P. Kanungo, N. S. Vishwanathan,
M. K. Jain.
• Nominated by Government: ten Directors from various fields and two
government officials
• Others: four Directors – one each from four local boards.
RBI
Organizational
Hierarchy
Legal Framework
• The Reserve Bank of India comes under the purview of the following
Acts:
1. Reserve Bank of India Act, 1934
2. Public Debt Act, 1944
3. Government Securities Regulations, 2007
4. Banking Regulation Act, 1949
5. Foreign Exchange Management Act, 1999
6. Securitization and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002
7. Credit Information Companies(Regulation) Act, 2005
8. Payment and Settlement Systems Act, 2007
Functions of RBI in Indian Banking System
1. Monetary Authority: It decides how much money is needed to be supplied to
the economy in order to stabilize the exchange rate, maintaining good balance
of payment, attain Finanancial stability, control inflation, strengthening the
core banking system.
2. The issuer of currency: It has the sole authority in India to issue currency. It
also takes action to control the circulation of fake currency.
3. The issuer of Banking License: As per Sec 22 of Banking Regulation Act, a bank
cannot start functioning without obtaining license from the Reserve Bank Of
India.
4. Banker’s to the Government: It acts as banker both to the central and the state
governments. It provides short term credit. It manages all new issues of
government loans, servicing the government debt outstanding and nurturing
the market for government’s securities. It advises the government on banking
and financial subjects.
Functions of RBI in Indian Banking System
5. Banker’s Bank: RBI is the bank of all banks in India as it provides the loan
to banks/bankers, rediscount the bills of banks and accept the deposit of
banks.
6. Lender of last resort: The banks can borrow from the RBI by keeping
eligible securities as collateral at the time of need or crisis.
7. Banker and debt manager of government: RBI keeps deposits of
Governments without charging any interest, receives and makes the
payment, carry exchange remittances, and help to float new loans and
manage public debt, it also acts as an advisor to Government.
8. Money supply and Controller of Credit: To control demand and supply of
money in Economy by Open Market Operations, Credit Ceiling, etc. RBI
has to match the credit requirements of the rest of the banking system. It
needs to maintain price stability and a high rate of economic growth.
Functions of RBI in Indian Banking System
9. Act as clearinghouse: For the settlement of banking transactions, RBI
manages 14 clearing houses. It facilitates the exchange of instruments
and processing of payment instructions.
10. Manager of foreign exchange: It acts as a custodian of FOREX. It
administers and enforces the provision of Foreign Exchange
Management Act (FEMA), 1999. RBI buys and sells foreign currency to
maintain the exchange rate of Indian rupee v/s foreign currencies.
11. Regulator of Economy: It controls the money supply in the system,
monitors different key indicators like GDP, Inflation, etc.
12. Managing Government securities: RBI administers investments in
institutions when they invest specified minimum proportions of their
total assets/liabilities in government securities.
Functions of RBI in Indian Banking System
13. Regulator and Supervisor of Payment and Settlement systems: The
Payment and Settlement systems Act of 2007 (PSS Act) gives RBI
oversight authority for the payment and settlement systems in the
country. RBI focuses on the development and functioning of safe, secure
and efficient payment and settlement mechanisms.
14. Developmental Role: This role includes the development of the quality
of banking system in India and ensuring that credit is available to the
productive sectors of the economy. It provides a wide range of
promotional functions to support national objectives. It also includes
establishing institutions designed to build the country’s financial
infrastructure. It also helps in expanding access to affordable financial
services and promoting financial education and literacy
Functions of RBI in Indian Banking System
15. Publisher of monetary data and other data: RBI maintains and provides all
essential banking and other economic data, formulating and critically
evaluating the economic policies in India. RBI collects, collates and publishes
data regularly.
16. Exchange manager and controller: RBI represents India as a member of the
International Monetary Fund [IMF]. Most commercial banks are authorized
dealers of RBI
17. Banking Ombudsman Scheme: RBI introduced the Banking Ombudsman
Scheme in 1995. Under this scheme, the complainants can file their complaints
in any form, including online and can also appeal to the RBI against the awards
and the other decisions of the Banking Ombudsman
18. Banking Codes and Standards Board of India: To measure the performance of
banks against Codes and standards based on established global practices, the
RBI set up the Banking Codes and Standards Board of India (BCSBI).
Functions of RBI in Indian Banking System
19. Fair Practices Codes For Lenders:- RBI formulated the Fair Practices Code for Lenders
which was communicated to banks to safeguard the interest of the borrowers. All the
banks are supposed to follow the codes formulated by RBI.
20. Miscellaneous Functions: The RBI collects, collates and publishes all monetary and
banking data regularly in its weekly statements in the RBI Bulletin (monthly) and in the
Report on Currency and Finance.
21. Provision of Industrial Finance: Rapid industrial growth is the key to the development
of the economy. Providing adequate and timely credit to small, medium and large
industry is very important. The RBI has played a pivotal role in setting up special
financial institutions such as IDBI Ltd, ICICI and EXIM BANK etc.
22. Provisions of Training: The RBI has always tried to provide essential training to the
staff of the banking industry. The RBI has set up the bankers’ training colleges at
several places. National Institute of Bank Management i.e NIBM, Bankers Staff College
i.e BSC and College of Agriculture Banking i.e CAB are few to mention
The RBI’s Role In Current Scenario
• The role of RBI in Indian economy has changed according to the scenario in
the country.
• In April 2019 the RBI took the monetary policy decision to lower its
borrowing rate to 6%.
• This was the second rate cut for 2019 and is expected to have a positive
impact on the borrowing rate across the credit market more substantially.
• Prior to April, credit rates in the country have remained relatively high,
despite the central bank’s positioning, which has been limiting borrowing
across the economy.
• The central bank must also grapple with a slightly volatile inflation rate that
is projected at 2.4% in 2019, 2.9% to 3% in the first half of 2020, and 3.5%
to 3.8% in the latter half of 2020.
RBI’s Role in Economic Development
• RBI’s role in the economy is pivotal as it makes or breaks the
economy. Below mentioned are the areas where RBI plays an
important role
1. Development of banking system
2. Development of financial institutions
3. Development of backward areas
4. Bringing Economic stability
5. Facilitating Economic growth
6. Preparing Proper interest rate structure
RBI’s Role in Promoting Schemes And Policies
• Introducing schemes and policies which benefit the public as well as
the government is one of the important function of RBI. Below
mentioned are the sector RBI prioritizes for economic development
1. Promotion of commercial banking
2. Promotion of cooperative banking
3. Promotion of industrial finance
4. Promotion of export finance
5. Promotion of credit guarantees
6. Promotion of differential rate of interest scheme
7. Promotion of credit to priority sections including rural & agricultural sector
8. Promotion of credit to weaker sections
Supervisory Functions of RBI
1. Providing license to banks & keeping a control on the number of
new branches
2. Doing periodical inspection of banks
3. Controlling Non-Bank Financial Institutions: The Non- Bank Financial
Institutions are not influenced by the working of a monitory policy.
RBI has a right to issue directives to the NBFIs regarding their
functioning.
4. Implementation of the Deposit Insurance Scheme: In order to
protect the deposits of small depositors, RBI work to implement the
Deposit Insurance Scheme in case of a bank failure. (For bank
deposits below 2 Lakh.)
Prohibitory Functions of RBI
1. It cannot provide any direct financial assistance to any industry,
trade or business
2. It cannot purchase its own share
3. It cannot purchase shares of any commercial and industrial
undertaking
4. It cannot purchase any immovable property
5. It cannot give loans on the security of shares and property
RBI Functions – General Terms
• Monetary policy: refers to the use of regulatory tools under the
control of the RBI in order to regulate the availability, cost and use of
money and credit.
• Cash Reserve Ratio (CRR): Banks are required to hold a certain
proportion of their deposits in the form of cash with RBI. RBI uses
CRR either to drain excess liquidity from the economy or to release
additional funds needed for the growth of the economy.
• Statutory Liquidity Ratio (SLR): SLR is the amount that commercial
banks are required to maintain in the form of gold or government
approved securities before providing credit to the customers.
RBI Functions – General Terms
• Repo Rate: The rate at which the RBI loans out money to commercial banks is called
Repo Rate. Whenever banks face limitation of funds they can borrow from the RBI,
against securities. If the RBI increases the Repo Rate, borrowing becomes quite
expensive for banks and vice versa. As a tool to control inflation, RBI increases the Repo
Rate, making it more expensive for the banks to borrow from the RBI with a view to
restricting the availability of money. Similarly, the RBI will do the exact opposite in a
deflationary environment.
• Reverse Repo Rate: The rate at which the RBI is willing to borrow from the commercial
banks is called reverse repo rate. If the RBI increases the reverse repo rate, it means that
the RBI is willing to offer good interest rate to banks to deposit their money with the RBI.
This results in a decrease in the amount of money available for banks customers as banks
prefer to deposit their money with the RBI as it guarantees higher security. This naturally
leads to a higher rate of interest which the banks will demand from their customers for
lending money to them.
• The Repo Rate and the Reverse Repo Rate are important tools with which the RBI can
control the availability and the supply of money in the economy.
RBI Functions – General Terms
• Fiscal Policy: It is related to direct taxes and government spending. When direct
taxes increases and spending of government increases than the disposable
Income of the people reduces and hence the demand reduces.
• On the basis of an assessment of the current and evolving macroeconomic
situation at its meeting today, the Monetary Policy Committee (MPC) decided to
keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged
at 5.15 percent.
• Consequently, the reverse repo rate under the LAF remains at 4.90 percent, and
the marginal standing facility (MSF) rate and the Bank Rate at 5.40 percent.
• The decision of the MPC is consistent with a neutral stance of monetary policy in
consonance with the objective of achieving the medium-term target for
consumer price index (CPI) ination of 4 percent within a band of +/- 2 percent
while supporting growth.
Securities and Exchange Board of
India (SEBI)
Concept of SEBI
• SEBI was established in the year 1992

• The three main objectives of SEBI are to –

• Protect the interest of the investors
• Promote the development of securities
• Regulate the securities market
Function of SEBI
• The function preformed by the SEBI are –

• Regulates the business of stock exchanges

• Regulates the working of Stock Brokers, Sub-brokers, Share transfer agents,
merchant bankers, etc
• Prohibits unfair trade practices in the stock exchanges
• Promotes education and training of investors and intermediaries
Organization of SEBI
• The different departments of SEBI are –
• Primary Department – It has the responsibility of looking after the policy
matters related to the primary market
• Issue Management Department – It has the responsibility of looking after the
issuing of new shares
• Secondary Market Department – It has the responsibility of looking after the
market process of the shares in the secondary market
• Institutional Investment Department – It has the responsibility of looking
after the MF, FII, DII, HNI, mergers & acquisitions, etc
SEBI’s role in Primary Market
For protecting the interest of the investors in the primary market, SEBI performs various
important roles, which are as follows –
• Entry Norms – The SEBI has tightened the entry norms for the companies entering the
capital market
• Promotor’s Contribution – The SEBI regulates the contribution of the promoters by fixing
the minimum limit for their contribution made to the capital issue
• Disclosure - The draft prospectus is made as a public document in order to promote
transparency
• Book Building – SEBI accepts book building as one of the modes of public issue and
issues guidelines for book building mode
• Allotment of Shares - The SEBI makes proportionate allotment of shares in order to
protect the interest of small investors to the primary market
• Market Intermediaries – The Merchant Bankers are licensed by SEBI to carry out their
operations in primary market
SEBI’s Role in Secondary Market
SEBI has initiated a number of reforms in the secondary market for making it more
attractive to the investors. Some of these major reforms are –
• Governing Board – SEBI has recommended the governing board of the stock
exchanges
• Infrastructure – In order to sophisticate the shares trading, SEBI has permitted all
the stock exchanges to expand their online screen-based trading terminals
• Settlement – Rolling settlement has been introduced
• Debt Market Segment – SEBI has permitted the debt market instruments to be
traded in the stock exchanges
• Price Stabilization – A separate division has been setup by SEBI to look after the
price movements of shares in the market
• Delisting – The norms of delisting of shares has been tightened by SEBI
• Brokers – SEBI has laid down a code of conduct for the brokers / Sub-brokers
Mutual Funds and SEBI
To ensure a smooth functioning of the MF, SEBI has laid down the following
regulations –
• Disclosure Norms – The companies in their disclosure forms (Prospectus) must
include all the information about the functioning and nature of the mutual funds
• Investments – SEBI has tightened the various norms of investments of mutual
funds so that the investments can get a better rate of return
• Accountability – SEBI has issued directives that proper books of accounts must be
maintained related to investments made by mutual funds
• Dividend – The amount of dividend must not be less than 90% of the profits
earned during the year
• Management – Members of the management must have a great deal of
experience, professional competence and financial soundness in all their business
transactions
SEBI and Foreign Institutional Investment (FII)
• The FII’s is an entity that is established outside India and proposes to
make investments in India
• A large inflow and outflow of FII’s has a significant bearing on the
stock price movement
• SEBI in order to regulate the flow of FII’s in the stock market has
issued the following directives –
• An Individual must hold a certificate granted by SEBI, is S/He has to deal in
securities as a FII
• The individual under the provision of Foreign Exchange Regulation Act (FERA),
1973 has to take permission in order to make investments in India
• A custodian has to be appointed by FII’s to deal in the securities and reporting
Critical Review of SEBI
SEBI has made a great deal of progress in regulating the exchange
market. However there are certain areas which need attention of SEBI.
These are –
• Disclosures
• Settlement
• Capital adequacy
• Single Authority
NON BANKING FINANCE COMPANIES
(NBFC’S)
What is NBFC?
• A Non-Banking Financial Company (NBFC) is a company registered
under the Companies Act, 1956 and is engaged in the business of
Loans , Advances, Acquisition of shares/stock/bonds/debentures/
securities issued by Government or local authority or other securities
of like marketable nature, Leasing, Hire-purchase, Insurance business,
Chit business.
• A non-banking institution which is a company and which has its
principal business of receiving deposits under any scheme or
arrangement or any other manner, or lending in any manner is also a
non-banking financial company (Residuary non-banking company).
HISTORICAL BACKGROUND
• The Reserve Bank of India Act, 1934 was amended on 1st December,
1964 by the Reserve Bank Amendment Act, 1963 to include
provisions relating to non-banking institutions receiving deposits and
financial institutions.
• With a view to review the existing framework and address these
shortcomings, various committees were formed and reports were
submitted by them.
THE COMMITTEES
• James Raj Committee (1974)
• It was formed by the Reserve Bank of India in 1974.
• Suggested for a ban on Prize chit and other schemes.
• Based on these suggestions, the Prize Chits and Money
• Circulation Schemes (Banning) Act, 1978 was enacted.
• Dr. A.C. Shah Committee (1992)
• Agenda for reforms in the NBFC sector.
• Wide ranging recommendations covering
• compulsory registration of large sized NBFCs,
• prescription of prudential norms for NBFCs
• more statutory powers to Reserve Bank for better regulation of NBFCs.
THE COMMITTEES
• Vasudev Committee (1998)
• RBI should consider measures for easing the flow of credit frombanks to
NBFCs
• Consider prescribing a suitable ratio as between secured and unsecured
deposits for NBFCs.
• Appointment of depositors’ grievance redressal authorities with specified
territorial jurisdiction.
• A separate instrumentality for regulation and supervision of NBFCs under the
aegis of the RBI should be set up, so that there is a great focus in regulation
and supervision of the NBFC sector.
NBFC’s Versus Bank’s
BANKS NBFCS
Definition Banking is acceptance of deposits NBFC are companies carrying financial
withdraw able by cheque or demand; NBFC business
cannot accept demand deposits
Scope of business Scope of business of the bank is limited by There is no bar on NBFC carrying activity
sec 16(1) of BR Act other then financial activity.
Major limitation on Business No non banking activity are carried. Cannot provide checking facilities.
Foreign investment Up to 74% is allowed to private sector bank Up to 100% is allowed

Need for a license License norms are tightly controlled and It is comparatively much easier to get a
generally it is perceived to be quite difficult registration as an NBFC.
to get a license for a bank
Regulations BR Act and RBI Act lay down the stringent Much lesser control over NBFC
control over the bank.
SLR/CRR requirements Banks are covered by SLR/CRR requirements NBFCs have to maintain a certain ratio of
deposits in specified securities; no such
requirement for
Non depository companies
REGULATIONS
• In terms of Section 45-IA of the RBI Act, 1934, it is mandatory that every NBFC
should be registered with RBI to commence or carry on any business of non-
banking financial institution.
• NBFC have to maintain 10 and 15 per cent of their deposits in liquid assets
effectively from January 1 and April 1,1998, respectively.
• All NBFCs are not entitled to accept public deposits. Only those NBFCs holding a
valid Certificate of Registration with authorization to accept Public Deposits can
accept/hold public deposits.
• The deposit with NBFCs are not insured.
• The repayment of deposits by NBFCs is not guaranteed by RBI.
• The NBFCs having assets size of Rs.500 crore and above but not accepting public
deposits are required to submit quarterly return on important financial
parameters of company.
REGULATIONS
• They have to create reserve fund and transfer not less than 20 per
cent of their net deposits to it every year.
• The NBFCs are allowed to accept/renew public deposits for a
minimum period of 12 months and maximum period of 60 months.
They cannot accept deposits repayable on demand.
• NBFCs cannot offer interest rates higher than the ceiling rate
prescribed by RBI from time to time.
• They have to obtain a minimum credit rating from anyone of the
three credit rating agencies.
• NBFCs cannot offer gifts/incentives or any other additional benefit to
the depositors.
Role of NBFCs
• Development of sectors like Transport & Infrastructure
• Substantial employment generation
• Help & increase wealth creation
• Broad base economic development
• Major thrust on semi-urban, rural areas & first time buyers / user.
• To finance economically weaker sections
Services Provided by NBFC
• Loans and credit facilities
• Private education funding
• Retirement planning
• Trading in money market
• Underwriting stocks and shares
• Helps in managing portfolios of stocks and shares
• Provide advice on merger and acquisition
IMPORTANCE OF NBFCs
• In the present economic environment it is very difficult to cater need of society
by Banks alone so role of Non Banking Finance Companies and Micro Finance
Companies become indispensable.
• The role of NBFCs as effective financial intermediaries has been well recognised
as they have inherent ability to take quicker decisions, assume greater risks, and
customise their services and charges more according to the needs of the clients.
• At present, NBFCs in India have become prominent in a wide range of activities
like hire-purchase finance, equipment lease finance, loans, investments, etc.
• To help in developing the large number of industries as well as entrepreneur in
different sectors of different areas.
• To cover all the areas which is being untouched or uncovered by RBI or other FCIs.
Types of NBFCs registered under RBI
MUTUAL BENEFIT FINANCIAL COMPANY (MBFC)
• Nidhis or Mutual Benefit Finance Companies are one of the oldest forms of non-financial
companies. It is a company structure in which the company's owners are also its clients.
• That is, the mutual company's profits are distributed to its participating customers each year
in proportion to their individual exposures to the company.
• Many insurance companies are structured as mutual companies.
• Some of the important objectives of Nidhis are to enable the members to save money, to
invest their savings and to secure loans at favorable rates of interest.
• They work on the principles of complete mutuality of interest and are generally well-
managed.
• The Government has granted certain concessions under Section 620A of the Companies Act,
1956.
• Primarily regulated by Department of Company Affairs (DCA) under the directions /
guidelines issued by them under Section 637 A of the Companies Act, 1956.
• The Government of India constituted an Expert Committee in March 2000 (Chairman: Shri
P.Sabanayagam)
INVESTMENT COMPANY
• Investment Company is any financial intermediary whose principal
business is that of buying and selling of securities.
• It is a company whose main business is holding securities of other
companies purely for investment purposes.
• The investment company invests money on behalf of its shareholders
who in turn share in the profits and losses.
• Example : Mutual Fund Companies
EQUIPMENT LEASING COMPANY
• Equipment leasing company is any financial institution whose principal
business is that of leasing equipments or financing of such an activity.
• Leasing
• Leasing is a process by which a firm can obtain the use of a certain fixed
assets for which it must pay a series of contractual, periodic, tax deductible
payments.
• The lessee is the receiver of the services or the assets under the lease
contract and the lessor is the owner of the assets. The relationship between
the tenant and the landlord is called a tenancy, and can be for a fixed or an
indefinite period of time (called the term of the lease). The consideration for
the lease is called rent.
• Example: Shriram Transport Finance Corporation
Advantages of Leasing Company
• 100% financing
• Flexibility
• Restrictive provisions absent
• Quick Finance
• Cost
• Risk management
Disadvantages of Leasing Company
• A net lease may shift some or all of the maintenance costs onto the
tenant.
• If circumstances dictate that a business must change its operations
significantly, it may be expensive or otherwise difficult to terminate a
lease before the end of the term.
• If the business is successful, lessors may demand higher rental
payments when leases come up for renewal.
• If the value of the business is tied to the use of that particular
property, the lessor has a significant advantage over the lessee in
negotiations.
HIRE-PURCHASE COMPANY
• Any financial intermediary whose principal business relates to hire
purchase transactions or financing of such transactions.
• A method of buying goods through making installment payments over
time.
• Under a hire purchase contract, the buyer is leasing the goods and does
not obtain ownership until the full amount of the contract is paid.
• Hire purchase combines elements of both a loan and a lease. You reach an
agreement with the dealer to pay an initial deposit, typically anything
between 10% and 50%, and then pay off the balance in monthly
installments over an agreed period of time.
• At the end of this period, the product is yours.
PROS & Cons
• The main advantage of a hire purchase agreement is that you can buy
something you couldn’t otherwise afford.
• Your monthly payments are effectively secured against your car – and this
has both pros and cons.
• Positively, this means you’re more likely to secure finance than you would
be by shopping around for an unsecured loan as the lender has some
‘security’ in the form of your car – this is often reflected in better interest
rates.
• On the downside however, you must be sure you can keep up with
payments or the lender will have the right to repossess the vehicle.
• For most however, this is a safer form of finance than a regular secured
loan – which puts your house at jeopardy if you can’t meet repayments.
• Interest rates can be high.
LOAN COMPANY
• Loan company means any financial institution whose principal
business is that of providing finance, whether by making loans or
advances or otherwise for any activity other than its own (excluding
any equipment leasing or hire-purchase finance activity).
• A loan is a type of debt. Like all debt instruments, a loan entails the
redistribution of financial assets over time, between the lender and
the borrower.
Types of loans
• Secured : A secured loan is a loan in which the borrower pledges some
asset (e.g. a car or property) as collateral.
• Unsecured : Unsecured loans are monetary loans that are not secured
against the borrower's assets.
• Credit card debt
• Personal loans
• Bank overdrafts
• Corporate bonds (may be secured or unsecured)
• Demand: Demand loans are short term loans that are typical in that they
do not have fixed dates for repayment and carry a floating interest rate
which varies according to the prime rate.
• They can be "called" for repayment by the lending institution at any time.
Demand loans may be unsecured or secured.
MISCELLANEOUS NON-BANKING COMPANIES
(MNBCS)
• MNBCs are mainly engaged in the Chit Fund business.
• Conducting or supervising as a promoter, by which the company enters into
an agreement with a specified number of subscribers that every one of
them shall subscribe a certain sum in instalments over a definite period
and that every one of such subscribers shall in turn, as determined by lot or
by auction or by tender or in such manner as may be provided for in the
arrangement, be entitled to the prize amount.
• The Chit Fund companies have been exempted from all the core provisions
of Chapter IIIB of the RBI Act including registration.
• In terms of Miscellaneous Non-Banking Companies (RB) Directions, the
companies can accept deposits up to 25 per cent and 15 per cent from
public and shareholders, respectively, for a period of 6 months to 36
months, but cannot accept deposits repayable on demand/notice.
RESIDUARY NON-BANKING COMPANIES
(RNBCS)
• Company which receives deposits under any scheme or arrangement,
by whatever name called, in one lumpsum or in instalments by way of
contributions or subscriptions or by sale of units or certificates or
other instruments, or in any manner are called RNBCs.
• RNBCs are a class of NBFCs which cannot be classified as equipment
leasing, hire purchase, loan, investment, nidhi or chit fund companies,
but which tap public savings by operating various deposit schemes.
• The deposit acceptance activities of these companies are governed by
the provisions of Residuary Non Banking Companies (Reserve Bank)
Directions, 1987
HOUSING FINANCE
• The shelter sector of the Indian financial system remained utterly
• underdeveloped till 1980.
• The lack of adequate institutional supply of credit for house building was the main gap in
the process of financial development in India.
• The Indian housing industry is highly fragmented, with the unorganized sector,
comprising small builders and contractors, accounting for over 70% of the housing units
constructed and the organized sector accounting for the rest.
• The organized sector comprises large builders and government or government affiliated
entities.
• Banks now control 40% of this market and continue to show explosive growth.
• Finance for housing is provided in the form of mortgage loans.
• The suppliers of house mortgage loans in India are : HUDCO, SHFSs, central and state
governments, HDFC, Commercial Banks, LIC (Jeevan Kutir & Jeevan Niwas) and NHB.
Top 10 NBFCs in India
• HDFC
• Power Finance Corporation
• Reliance Capital
• Infrastructure Development Finance Company
• Rural Electricity Corp.
• Shree Global
• Shriram Transport Finance
• Bajaj Holdings
• M & M Financials
• Muthoot Finance
Money Markets
What is Money Markets
• As per RBI definitions “ A market for short terms financial assets that are
close substitute for money, facilitates the exchange of money in primary
and secondary market”.
• The money market is a mechanism that deals with the lending and
borrowing of short term funds (less than one year).
• A segment of the financial market in which financial instruments with high
liquidity and very short maturities are traded.
• It doesn’t actually deal in cash or money but deals with substitute of cash
like trade bills, promissory notes & govt papers which can converted into
cash without any loss at low transaction cost.
• It includes all individual, institution and intermediaries.
Features of Money Market
• It is a market purely for short-terms funds or financial assets called near
money.
• It deals with financial assets having a maturity period less than one year
only.
• In Money Market transaction can not take place formal like stock exchange,
only through oral communication, relevant document and written
communication transaction can be done.
• Transaction have to be conducted without the help of brokers.
• It is not a single homogeneous market, it comprises of several submarket
like call money market, acceptance & bill market.
• The component of Money Market are the commercial banks, acceptance
houses & NBFC (Non-banking financial companies).
Objectives of Money Market
• To provide a parking place to employ short term surplus funds.
• To provide room for overcoming short term deficits.
• To enable the central bank to influence and regulate liquidity in the
economy through its intervention in this market.
• To provide a reasonable access to users of short-term funds to meet
their requirement quickly, adequately at reasonable cost.
Importance of Money Market
• Development of trade & industry.
• Development of capital market.
• Smooth functioning of commercial banks.
• Effective central bank control.
• Formulation of suitable monetary policy.
• Non inflationary source of finance to government.
Participants in Money Market
• Reserve Bank of India
• Scheduled Commercial Banks
• Non-Scheduled Commercial Banks
• Foreign Banks
• State, District and Urban Cooperative Banks
• Discount and Finance House of India (DFHI)
• Securities Trading Corporation of India (STCI)
• Primary Dealers (PDs)
• Satellite Dealers (SDs)
• Financial institutions such as LIC, UTI, GIC, NABARD, IDBI, IFCI, ICICI
Instruments termed as money market instruments
• Certificate of Deposit (CD)
• Commercial Paper (CP)
• Inter Bank Participation Certificates
• Inter Bank term Money
• Treasury Bills
• Bill Rediscounting
• Call/ Notice/ Term Money
Call/Notice Money
• Call Money – Overnight one day borrowing
• Notice Money – period upto 14 days
• Balances very short term liquidity requirements
• No collateral requirement
• Mainly used to meet CRR requirements
Term Money
• Term money market is where funds with maturity from 15 days to one
year are borrowed and lent without collateral.
• Two distinct policy measures were taken to activate the term money
market.
• First, term money of original maturity between 15 days and 1 year was
exempted from CRR in August 2001.
• Second, no limits were stipulated for transactions in term money market
unlike those under call/notice money market.
Commercial Paper (CP)
• Commercial Papers are short term borrowings by Corporates, FIs,
from Money Market.
• Features
• Commercial Papers when issued in Physical Form are negotiable by
endorsement and delivery and hence highly flexible instruments
• Issued subject to minimum of Rs 5 lakhs and in the multiples of Rs. 5 Lac
thereafter,
• Maturity is 15 days to 1 year
• Unsecured and backed by credit of the issuing company
• Can be issued with or without Backstop facility of Bank / FI
Eligibility Criteria CP
• Any private/public sector co. wishing to raise money through the CP
market has to meet the following requirements:
• Tangible net-worth not less than Rs 4 crore - as per last audited statement
• Should have Working Capital limit sanctioned by a bank / FI
• Credit Rating not lower than B2 or its equivalent - by Credit Rating Agency
approved by Reserve Bank of India.
• Board resolution authorizing company to issue CPs
• Commercial Papers can be issued in both physical and demat form.
• Commercial Papers are issued in the form of discount to the face value.
• Commercial Papers are short-term unsecured borrowings by reputed
companies that are financially strong and carry a high credit rating.
Cash Deposits (CD)
• CDs are short-term borrowings in the form of Promissory Notes having a maturity of not
less than 15 days up to a maximum of one year.
• CD is subject to payment of Stamp Duty under Indian Stamp Act, 1899
• They are like bank term deposits accounts. Unlike traditional time deposits these are
freely negotiable instruments and are often referred to as Negotiable Certificate of
Deposits
• Features of CD
• All scheduled banks (except RRBs and Co-operative banks) are eligible to issue CDs
• Issued to individuals, corporations, trusts, funds and associations
• They are issued at a discount rate freely determined by the issuer and the market/investors.
• Freely transferable by endorsement and delivery. At present CDs are issued in physical form (UPN)
• These are issued in denominations of Rs.5 Lacs and Rs. 1 Lac thereafter.
• Bank CDs have maturity up to one year. Minimum period for a bank CD is fifteen days.
• Financial Institutions are allowed to issue CDs for a period between 1 year and up to 3 years.
Repo and a Reverse Repo
• A Repo deal is one where eligible parties enter into a contract with
another to borrow money against at a pre-determined rate against
the collateral of eligible security for a specified period of time.
• The legal title of the security does change. The motive of the deal is
to fund a position.
• Though the mechanics essentially remain the same and the contract
virtually remains the same, in case of a Reverse Repo deal the
underlying motive of the deal is to meet the security / instrument
specific needs or to lend the money.
• Indian Repo Market is governed by Reserve Bank of India.
Meaning of Repo
• It is a transaction in which two parties agree to sell and repurchase
the same security. Under such an agreement the seller sells specified
securities with an agreement to repurchase the same at a mutually
decided future date and a price
• The Repo/Reverse Repo transaction can only be done at Mumbai
between parties approved by RBI and in securities as approved by RBI
(Treasury Bills, Central/State Govt securities).
Uses of Repo
• It helps banks to invest surplus cash
• It helps investor achieve money market returns with sovereign risk.
• It helps borrower to raise funds at better rates
• An SLR surplus and CRR deficit bank can use the Repo deals as a
convenient way of adjusting SLR/CRR positions simultaneously.
• RBI uses Repo and Reverse repo as instruments for liquidity
adjustment in the system
Treasury bills (T-Bills)
• A class of Central Government Securities
• T-Bills are issued by Government of India against their short term
borrowing requirements with maturities ranging between 14 to 364
days.
• Banks, Primary Dealers, State Governments, Provident Funds,
Financial Institutions, Insurance Companies, NBFCs, FIIs (as per
prescribed norms), NRIs & OCBs (Overseas Corporate Body ) can
invest in T-Bills.
T-bills Type
• T-Bills are for different maturities - 14-day, 28 days, 91 days, 182
days and 364 days.
• T-Bills are issued at a discount-to-face value. For example a Treasury
bill of Rs. 100.00 face value issued for Rs. 91.50 gets redeemed at the
end of it's tenure at Rs. 100.00.
• 91 days T-Bills are auctioned under uniform price auction method
where as 364 days T-Bills are auctioned on the basis of multiple price
auction method.
Primary Dealers
• Primary Dealers can be referred to as Merchant Bankers to Government of
India, comprising the first tier of the government securities market.
Satellite Dealers work in tandem with the Primary Dealers forming the
second tier of the market to cater to the retail requirements of the market.
• These were formed during the year 1994-96 to strengthen the market
infrastructure and put in place an improvised and an efficient secondary
government securities market trading system and encourage retailing of
Government Securities on large scale.
• The role of Primary Dealers is to
• commit participation as Principals in Government of India issues through bidding in
auctions
• provide underwriting services
• offer firm buy - sell / bid ask quotes for T-Bills & dated securities
• Development of Secondary Debt Market
What are ‘Gilt edged’ securities?
• The term government securities encompass all Bonds & T-bills issued
by the Central Government, state government.
• These securities are normally referred to, as "gilt-edged" as
repayments of principal as well as interest are totally secured by
sovereign guarantee.
• Gilt Securities are issued by the RBI on behalf of the Government of
India. Being sovereign paper, gilt securities carry absolutely no risk of
default.
What are G-Secs?
• These can be referred to as certificates issued by Government of India
through the Reserve Bank acknowledging receipt of money in the
form of debt, bearing a fixed interest rate (or otherwise) with
interests payable semi-annually or otherwise and principal as per
schedule, normally on due date on redemption
• G-Secs are usually referred to as risk free securities. However, these
securities are subject to only one type of risk i.e., interest-rate risk.
Subject to changes in the over all interest rate scenario, the price of
these securities may appreciate or depreciate.
G-Secs
• G-Secs are issued by the Reserve Bank of India on behalf of the Government of
India.
• These form a part of the borrowing program approved by the parliament in the
‘union budget’.
• G- Secs are normally issued in dematerialized form (SGL). When issued in the
physical form they are issued in the multiples of Rs. 10,000/-.
• Normally the dated Government Securities, have a period of 1 year to 20 years.
Government Securities when issued in physical form are normally issued in the
form of Stock Certificates.
• The transfer does not require stamp duty. The G-Secs cannot be subjected to lien.
Hence, is not an acceptable security for lending against it. Some Securities issued
by Reserve Bank of India like 8.5% Relief Bonds are securities specially notified &
can be accepted as Security for a loan.
Type of new G-Secs issued by GOI
• Earlier, the RBI used to issue straight coupon bonds ie bonds with a stated
coupon payable periodically.
• In the last few years, new types of instruments have been issued. These are
• Inflation linked bonds: These are bonds for which the coupon payment in a
particular period is linked to the inflation rate at that time - the base coupon rate is
fixed with the inflation rate (consumer price index-CPI) being added to it to arrive at
the total coupon rate.
• FRBs or Floating Rate Bonds comes with a coupon floater, which is usually a margin
over and above a benchmark rate.
• Zero coupon bonds: These are bonds for which there is no coupon payment. They
are issued at a discount to face value with the discount providing the implicit interest
payment. In effect, zero coupon bonds are like long duration T - Bills.
State government securities (State Loans –SDL)
• SDLs are issued by the respective state governments but the RBI coordinates
the actual process of selling these securities.
• Each state is allowed to issue securities up to a certain limit each year. The
planning commission in consultation with the respective state governments
determines this limit.
• Generally, the coupon rates on state loans are marginally higher than those of
GOI-Secs issued at the same time.
• State Loans qualify for SLR status
• Interest payment and other modalities are similar to GOI-Secs.
• No stamp duty is payable on transfer for State Loans as in the case of GOI-
Secs. In general, State loans are much less liquid than GOI-Secs.
Auction
• Auction is a process of calling of bids with an objective of arriving at
the market price.
• It is basically a price discovery mechanism.
• There are several variants of auction.
• Auction can be price based or yield based.
French Auction System
• After receiving bids at various levels of yield expectations, a particular
yield level is decided as the coupon rate.
• Auction participants who bid at yield levels lower than the yield
determined as cut-off get full allotment at a premium.
• The premium amount is equivalent to price equated differential of
the bid yield and the cut-off yield.
• Applications of bidders who bid at levels higher than the cut-off levels
are out-right rejected. This is primarily a Yield based auction.
Dutch Auction Price
• This is identical to the French auction system as defined above.
• The only difference being that the concept of premium does not exist.
• This means that all successful bidders get a cut-off price of Rs. 100.00
and do not need to pay any premium irrespective of the yield level
bid for.
Private Placement
• After having discovered the coupon through the auction mechanism,
if on account of some circumstances the Government / Reserve Bank
of India decides to further issue the same security to expand the
outstanding quantum, the government usually privately places the
security with Reserve Bank of India.
• The Reserve Bank of India in turn may sell these securities at a later
date through their open market window albeit at a different yield.
Risk Exposure in Money Market Instruments
• Interest Rate risk
• Re-investment risk
• Default risk
• Inflation Risk
Interest Rate risk
• Interest rate risk, market risk or price risk are essentially one and the
same. These are typical of any fixed coupon security with a fixed
period-to-maturity.
• This is on account of an inverse relation between price and interest.
As interest rates rise, the price of a security will fall.
• However, this risk can be completely eliminated incase an investor's
investment horizon identically matches the term of the security.
Re-investment risk
• This risk is again akin to all those securities, which generate
intermittent cash flows in the form of periodic coupons.
• The most prevalent tool deployed to measure returns over a period of
time is the yield-to-maturity (YTM) method.
• The YTM calculation assumes that the cash flows generated during
the life of a security is re-invested at the rate of the YTM.
• The risk here is that the rate at which the interim cash flows are re-
invested may fall thereby affecting the returns.
Default risk
• This kind of risk in the context of a Government security is always zero.
• However, these securities suffer from a small variant of default risk i.e.,
maturity risk.
• Maturity risk is the risk associated with the likelihood of the
government issuing a new security in place of redeeming the existing
security.
• In case of Corporate Securities it is referred to as Credit Risk.
Inflation Risk
• The risk that arises due to the inflationary effect is known as inflation
risk/purchasing power risk.
• All money market instruments are exposed to this risk.
• However, considering the short-term nature of the money market
instruments, their level of exposure to this inflation risk can be
minimal when compared with other long-term instruments