The Indian Financial System

Presented By
Sashi Prakash (108)
Seema Nagwani (110)
Shrividya Ganesh (119)
Srinivasan Masti (126)
Theagarajan Thanikachalam(131)
Vrinda Mohan (141)
 Financial System
• Financial markets of any country consists of
financial markets, financial intermediaries and
financial instruments.

Flow of funds

Seekers of funds Suppliers of funds

Flow of financial services

 Functions of Financial System:

1. Payment system
2. Pooling of funds
3. Transfer of resources
4. Managing uncertainty and controlling risk.
5. Price information for decentralized decision
making.
6. Dealing with incentive problem
 Financial Intermediaries
• Commercial Banks (led by SBI)
• Financial Institutions
• Insurance Companies
• Mutual Funds
• NBFC
• Non Banking Financial Services companies
 Capital Market
• A capital market is a market for securities (debt or
equity), where business enterprises (companies)
and governments can raise long-term funds.
• It is defined as a market in which money is
provided for periods longer than a year, as the
raising of short-term funds takes place on other
markets (e.g., the money market).
• The capital market include s the stock market
(equity securities) and the bond market (debt).
• Capital markets may be classified as primary
markets and secondary markets.
Capital Market
 Functions of Capital Market
• Mobilization of Savings : Capital market is an important
source for mobilizing idle savings from the economy. It
mobilizes funds from people for further investments in
the productive channels of an economy. In that sense it
activate the ideal monetary resources and puts them in
proper investments.

• Capital Formation : Capital market helps in capital

formation. Capital formation is net addition to the
existing stock of capital in the economy. Through
mobilization of ideal resources it generates savings; the
mobilized savings are made available to various
segments such as agriculture, industry, etc.
• Provision of Investment Avenue : Capital market raises
resources for longer periods of time. Thus it provides an
investment avenue for people who wish to invest resources
for a long period of time. It provides suitable interest rate
returns also to investors.
• Speed up Economic Growth and Development : Capital
market enhances production and productivity in the national
economy. As it makes funds available for long period of time,
the financial requirements of business houses are met by the
capital market.
• Proper Regulation of Funds : Capital markets not only helps in
fund mobilization, but it also helps in proper allocation of
these resources. It can have regulation over the resources so
that it can direct funds in a qualitative manner.
• Continuous Availability of Funds : Capital market is
place where the investment avenue is continuously
available for long term investment.

• The lack of an advanced and vibrant capital market

can lead to underutilization of financial resources
• There are 3 primary types of capital markets efficiencies:
• Weak: where the information from past patterns and historical
stock prices are reflected in current security prices. Only a trained
analyst who can discern this public information, to uncover
potential aspects, can benefit from such capital markets.

• Semi-strong: where current security prices are indicative of all

available public information. In this situation only those capital
markets traders who have access to non-public information can
gain maximum profits.

• Strong: where all information (even insider company information)

is integrated into current security prices. In this situation since all
information is accessible by everyone no trader can make extra
profit from such capital markets .
 Money Market

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 Financial Markets
• Money Market- for short-term funds (less than
a year)
– Organized (Banks)
– Unorganized (money lenders, chit funds, etc.)

• Capital Market- for long-term funds

– Primary Issues Market
– Stock Market
– Bond Market

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 Money/ Corporate Sec. market
Call Money
Short notice
Term Money
Commercial Paper
Certificates of Deposits
Money Market Mutual Funds Primary Market consists of:
Commercial Bills Public Corporate, Existing Stock holders other entiti
Treasury Bills .
Inter Corporate Funds Handles Instruments like:
Stock / Shares/Debentures/Units/Bonds/Warrant

Collective Instruments like:

Venture Capital Funds, Global depository receipt
Capital Markets
Foreign currency convertible Bonds
1.Primary
2.Secondary

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 Organised Money Market
• Call money market
• Bill Market
– Treasury bills
– Commercial bills
• Bank loans (short-term)
• Organised money market comprises RBI,
banks (commercial and co-operative)

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 Purpose of the money market
• Banks borrow in the money market to:
– Fill the gaps or temporary mismatch of funds
– To meet the CRR and SLR mandatory requirements
as stipulated by the central bank
– To meet sudden demand for funds arising out of
large outflows (like advance tax payments)

• Call money market serves the role of

equilibrating the short-term liquidity position of
the banks
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 Money Market Instruments
• Certificates of Deposit
• Commercial Paper
• Inter-bank participation certificates
• Inter-bank term money
• Treasury Bills
• Bill rediscounting
• Call/notice/term money
• CBLO
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 Certificates of Deposit
• CDs are short-term borrowings in the form of UPN issued by
scheduled banks and are freely transferable by endorsement
and delivery.
• CDs are issued by Banks to meet their short term
requirements.
• Introduced in 1989
• Maturity of not less than 7 days and maximum up to a year.
FIs are allowed to issue CDs for a period between 1 year and
up to 3 years
• Subject to payment of stamp duty under the Indian Stamp
Act, 1899
• Issued to individuals, corporations, trusts, funds and
associations
• They are issued at a discount rate freely determined by the
market/investors
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 Commercial Papers
• Short-term borrowings by corporates, financial institutions,
primary dealers from the money market
• CPs are issued by corporate borrowers to meet their working
capital requirement
• Can be issued in the physical form (Usance Promissory Note)
or demat form
• Introduced in 1990
• When issued in physical form are negotiable by endorsement
and delivery and hence, highly flexible
• Issued subject to minimum of Rs. 5 lacs and in the multiple of
Rs. 5 lacs after that
• Maturity is 7 days to 1 year
• Unsecured and backed by credit rating of the issuing company
• Issued at discount to the face value

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 E.T.12-11-07
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 Bill Market
• Treasury Bill market- Also called the T-Bill market
– These bills are short-term liabilities (91-day, 182-day,
364-day) of the Government of India
– It is an IOU of the government, a promise to pay the
stated amount after expiry of the stated period from
the date of issue
– They are issued at discount to the face value and at the
end of maturity the face value is paid
– The rate of discount and the corresponding issue price
are determined at each auction
– RBI auctions 91-day T-Bills on a weekly basis, 182-day
T-Bills and 364-day T-Bills on a fortnightly basis on
behalf of the central government
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 Bonds
• A bond is nothing more than a loan for which
you are the lender.
• The organization that sells a bond is known as
the issuer. You can think of a bond as an IOU
given by a borrower (the issuer) to a lender
(the investor).
 Bonds
• The interest rate is often referred to as the
coupon.
• The date on which the issuer has to repay the
amount borrowed (known as face value) is
called the maturity date
Coupon (The Interest Rate)
The coupon is the amount the bondholder
will receive as interest payments.
It's called a "coupon" because sometimes
there are physical coupons on the bond
that you tear off and redeem for interest.
However, this was more common in the
past. Nowadays, records are more likely
to be kept electronically.
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 Govt Bonds
• In general, fixed-income securities are classified
according to the length of time before
maturity. These are the three main categories:
• Bills - debt securities maturing in less than one
year.
• Notes - debt securities maturing in one to 10
years.
• Bonds - debt securities maturing in more than
10 years.
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 Call money market
• Is an integral part of the Indian money market
where day-to-day surplus funds (mostly of
banks) are traded.
• The loans are of short-term duration (1 to 14
days). Money lent for one day is called ‘call
money’; if it exceeds 1 day but is less than 15
days it is called ‘notice money’. Money lent for
more than 15 days is ‘term money’
• The borrowing is exclusively limited to banks,
who are temporarily short of funds.
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 Call money market
• Call loans are generally made on a clean basis- i.e. no
collateral is required
• The main function of the call money market is to
redistribute the pool of day-to-day surplus funds of
banks among other banks in temporary deficit of
funds
• The call market helps banks economise their cash
and yet improve their liquidity
• It is a highly competitive and sensitive market
• It acts as a good indicator of the liquidity position

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 Call Money Market Participants
• Those who can both borrow and lend in the
market – RBI (through LAF), banks and primary
dealers
• Once upon a time, select financial institutions
viz., IDBI, UTI, Mutual funds were allowed in
the call money market only on the lender’s side
• These were phased out and call money market
is now a pure inter-bank market (since August
2005)

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 Trading in call Money market
• There are no brokers in the call money market
and trading is done over the counter
• Settlement is done between the participants
through the current account maintained with
the RBI
• Currently, there are 98 commercial banks,
3,000 co-operative banks and 17 PDs who
are borrowing and lending in the market,
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 Money Market Instruments
• Money market instruments are those which
have maturity period of less than one year.
• The most active part of the money market is
the market for overnight call and term money
between banks and institutions and repo
transactions
• Call money/repo are very short-term money
market products

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 Market Repos
• Repo is the rate at which RBI infuses liquidity through
purchase of government securities
• Repo (repurchase agreement) instruments enable
collateralized short-term borrowing through the selling of
debt instruments
• A security is sold with an agreement to repurchase it at a
pre-determined date and rate
• Reverse repo is the process of absorption of liquidity
from the system through sale of government papers .
• Reverse repo is a mirror image of repo and reflects the
acquisition of a security with a simultaneous
commitment to resell
• A repo is essentially a short-term interest-bearing loan
against collateral
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 Collateralised Borrowing and Lending
Obligation (CBLO)
• Operationalised as money market instruments by the in
2003
• Follows an anonymous, order-driven and online trading
system
• On the lenders side main participants are mutual funds,
insurance companies.
• Major borrowers are nationalised banks, PDs and non-
financial companies
• The average daily turnover in the CBLO segment increased
from Rs. 515 crore (2003-04) to Rs. 32, 390 crore (2006-07)
CBLO Segment clocked the highest volume of
Rs. 80,60. 9.75 Crores on June 12, 2009
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 Collateralized Borrowing and
Lending Obligation (CBLO)
• CCIL introduced a new product Collateralised
Borrowing and Lending Obligation (CBLO) in
January, 2003.
• The product was introduced with a definite
objective, which was to provide an alternative
avenue for managing short term liquidity for
the market players who have been restricted
and/or being phased out of call money market.

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 CBLO
• It is an obligation by borrower to return
money as a future date
• Securities are held in custody with CCIL( The
Clearing Corp of India Ltd )
• Members- Banks, FIs,Insurance Cos, Mutual
Funds,Primary Dealers,NBFCs,Non Govt
PF,Corporates.
• Members to open SGL a/c with CCIL

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 CBLO
• It is a money Market Instrument. No
restriction on min denomination or lock in
period for its secondary market
• Maturity- 1 day to 1 year
• Rate - As decided by market participants
• Borrowing Limit- As decided by CCIL at the
beginning of the day taking in to a/c securities
deposited by the borrowers

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 CBLO
• Market players used to borrow funds from the
CBLO market, which was available at 3.5-4 per
cent and put the money in reverse repo, where
it earned around 6 per cent. However, now
with CBLO rates going up, there is no such
incentive( position as of April 08 ).
• CBLO is the money market for non-banking
entities to lend and borrow funds for daily
requirement.
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 Category wise Turnover
In CBLO

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 Developments in Money Market
• Prior to mid-1980s participants depended heavily on
the call money market
• The volatile nature of the call money market led to
the activation of the Treasury Bills market to reduce
dependence on call money
• Emergence of market repo and collateralized
borrowing and lending obligation (CBLO) instruments
• Turnover in the call money market declined from Rs.
35,144 crore in 2001-02 to Rs. 14,170 crore in 2004-
05 before rising to Rs. 21,725 crore in 2006-07

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 Why do companies need to issue shares to
the public?
• Most companies are usually started privately by their
promoter(s). However, the promoters' capital and the
borrowings from banks and financial institutions may
not be sufficient for setting up or running the business
over a long term. So companies invite the public to
contribute towards the equity and issue shares to
individual investors. The way to invite share capital from
the public is through a 'Public Issue'. Simply stated, a
public issue is an offer to the public to subscribe to the
share capital of a company. Once this is done, the
company allots shares to the applicants as per the
prescribed rules and regulations laid down by SEBI
Primary Market
 Primary Markets
• The primary market is that part of the capital
markets that deals with the issuance of new
securities. Companies, governments or public
sector institutions can obtain funding through the
sale of a new stock or bond issue.
• This is the market for new long term equity capital.
The primary market is the market where the
securities are sold for the first time. Therefore it is
also called the new issue market (NIM).
 Features of Primary Market
• In a primary issue, the securities are issued by the
company directly to investors.
• The company receives the money and issues new security
certificates to the investors.
• Primary issues are used by companies for the purpose of
setting up new business or for expanding or modernizing
the existing business.
• The new issue market does not include certain other
sources of new long term external finance, such as loans
from financial institutions. Borrowers in the new issue
market may be raising capital for converting private
capital into public capital; this is known as "going public."
 Difference between public issue
and private placement
• When an issue is not made to only a select set
of people but is open to the general public and
any other investor at large, it is a public issue.
But if the issue is made to a select set of people,
it is called private placement. As per Companies
Act, 1956, an issue becomes public if it results in
allotment to 50 persons or more. This means an
issue can be privately placed where an
allotment is made to less than 50 persons
Various Issues In Primary Market
 Rights Issue
• A rights issue is a way in which a company can sell
new shares in order to raise capital. Shares are
offered to existing shareholders in proportion to
their current shareholding, respecting their pre-
emption right
• The price at which the shares are offered is usually
at a discount to the current share price, which gives
investors an incentive to buy the new shares — if
they do not, the value of their holding is diluted.
 Preferential issue
• A Preferential issue is an issue of shares or of
convertible securities by listed companies to a select
group of persons under Section 81 of the Companies
Act, 1956 which is neither a rights issue nor a public
issue. This is a faster way for a company to raise
equity capital. The issuer company has to comply
with the Companies Act and the requirements
contained in the Chapter pertaining to preferential
allotment in SEBI guidelines which inter-alia include
pricing, disclosures in notice etc.
 Initial Public Offer
• A company's new offering is placed on the
primary market through an initial public offer.
• An Initial Public Stock Offering(IPO) is simply
an "offering" or "flotation," when a company
(called the issuer) issue Common stocks or
shares to the public for the first time. It can be
issued by small, young companies as well as by
large privately-owned companies
 Initial Public Offer contd..
• The sale of an IPO takes place in several forms. Some
Common Methods are:
•Best Efforts Contract: In the best efforts contract the
underwriter agrees to sell as many shares as possible at
the agreed-upon price.
•Firm Commitment Contract: In the firm commitment
contract the underwriter guarantees the sale of the
issued stock at the agreed-upon price. For the issuer, it
is the safest but the most expensive type of the
contracts, since the underwriter takes the risk of sale.
 Initial Public Offer contd..
• All or None Contract: Under the all-or-none contract the
underwriter agrees either to sell the entire offering or to
cancel the deal.
• Bought Deal: A bought deal occurs when an underwriter,
such as an investment bank or a syndicate, purchases
securities from an issuer before a preliminary prospectus is
filed. The investment bank (or underwriter) acts as principal
rather than agent and thus actually "goes long" in the
security. The bank negotiates a price with the issuer.
• Self Distribution of Stock: The company itself involves into
Stock Distribution however this cant be done when the
volumes are large
Initial Public Offer contd..
• A large IPO is usually underwritten by a
“syndicate” of investment banks led by one
or more major investment banks . Upon
selling the shares, the underwriters keep a
commission based on a percentage of the
value of the shares sold (called the gross
spread). Usually, the lead underwriters, i.e.
the underwriters selling the largest
proportions of the IPO, take the highest
commissions—up to 8% in some cases .
However, should the Underwriters not be
able to find enough investors, they will have
to hold some securities themselves.
 Initial Price
• A company that is planning an IPO appoints lead managers
to help it decide on an appropriate price at which the shares
should be issued. There are two ways in which the price of
an IPO can be determined: either the company, with the
help of its lead managers, fixes a price or the price is arrived
at through the process of book building.
• Book building refers to the process of generating, capturing
and recording investor demand for shares during an IPO (or
other securities during their issuance process) in order to
support efficient price discovery. Usually, the issuer
appoints a major investment bank to act as a major
securities underwriter or book runner
 Risk in Primary Markets
• As the saying goes, A known Devil is much better than an
Unknown Devil.
• It is highly risky and also much more riskier than secondary
market.
• It is highly risky hope that the differential premium existing in the
secondary market does not vanish before fresh shares find their
way to the market.
• One such example can be seen as that happened in 2005 between
India Info line, which made an IPO, and Jindal Polyfilms that made
a subsequent public offer.
• Though both the offerings came out at the same time, JPFL
suffered with its investors not able to do anything apart from
seeing their vanishing premiums whereas India Info line came out
with flying colors
SECONDARY MARKETS
 What are secondary markets?
• A market where investors purchase securities or assets
from other investors, rather than from issuing
companies themselves
Ex: NYSE, NASDAQ, BSE, NSE etc

• In any secondary market trade, the cash proceeds go

to an investor rather than to the underlying
company/entity directly.

• In the secondary market only basic forces like supply

and demand determine the price of the security.
Classification Of Secondary Markets

SECONDARY MARKETS

DEALER MARKET
AUCTION MARKET Eg: Over The
Eg: Stock Market Counter(OTC)
AUCTION MARKETS:
A market in which buyers enter competitive bids and
sellers enter competitive offers at the same time. The
price a stock is traded represents the highest price that
a buyer is willing to pay and the lowest price that a
seller is willing to sell at. Matching bids and offers are
then paired together and the orders are executed. 

Brokers acting for buyers compete against each other on the exchange floor, as
brokers acting for sellers do, to get the best price. While the trading can be quite
intense, it is orderly because the participants adhere to exchange rules.

DEALER MARKETS:
A market where traders specializing in particular commodities buy and sell
assets for their own accounts. In this type of trading environment, the buyers
and sellers make use of their own resources in order to conduct trading.

Securities dealers who make use of a dealer market are often referred to as
Market Makers
 Stock Exchanges
• Securities and Exchange Board of India (SEBI), provides a
trading platform, where buyers and sellers can meet to
transact in securities.
• Electronic trading platform: Demat accounts
• Indian stock exchange allows a member broker to perform
following activities:
–Act as an agent,
–Buy and sell securities for his clients and charge
commission for the same,
–Act as a trader or dealer as a principal,
–Buy and sell securities on his own account and risk.
• At present, there are twenty one recognized stock exchanges
in India, main ones being BSE and NSE.
BSE(Bombay Stock Exchange)
• Historically an open outcry floor
trading exchange.
• Now an electronic trading system.
• Operational from 8 a.m. to 5:30 p.m.
• Most popular index : SENSEX
• Top Brokers include: HDFC
Securities, ICICI Securities etc.
NSE(National Stock Exchange)
• Professionally managed national market for shares,
PSU bonds, debentures & government securities.
• Fully automated screen based system that provides
higher degree of transparency .
• Largest in India by daily turnover and number of
trades, for both equities and derivative trading
• Operational from 9 a.m. to 3:30 p.m.
• Key index is the S&P CNX Nifty, known as the NSE
NIFTY
OTCEI(Over The Counter Exchange
of India)
• First screen based nationwide stock exchange
in India.
• OTCEI was promoted by a consortium of
financial institutions.
• Enables the listing of Small and Medium-sized
companies.
• Sponsorship
Products in the Secondary Market
• Shares
• Mutual Funds
• Index ETFs
• Government Securities (G-Secs)
• Debentures
• Bonds
• Derivatives
 Derivatives
• Derivative is a product whose value is derived
from the value of one or more basic variables,
called underlying
• Types of Derivatives:
• Forwards
• Futures
• Options
• Warrants
• Interest rate derivatives
• Commodity derivatives
 REGULATORY AUTHORITIES

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 SEBI (Securities and Exchange Board of India)

• Set up in 1988, as part of the SC(R) Act 1956.

• The first regulator under the SC(R)A, 1956 was the
CCI.
• Regulator of anything that is exchange–traded.
• SEBI can set regulatory policy, carry out
implementation as well as has the power to enforce
regulatory rules and impose punishment on wrong-
doing.
• Grievances and appeals to SEBI rulings are heard by
the Securities Appellate Tribunal.
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 RBI (Reserve Bank of India)
• Set up under the RBI Act, 1935.
• Regulator of deposit-taking agencies.
• Regulator for debt, foreign exchange markets.
• Securities infrastructure for debt, foreign
exchange markets.
• Payments system.
• Investment banker for the government.
• Central bank.
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 FMC (Forward Markets Commission)
• Flows from the FC(R) Act 1952.
• Regulator of commodity derivative markets, commodity
derivative brokers.
• FMC regulation is in the form of policy
• recommendation rather than implementation (which is
done by the DCA) or enforcement/punitive action
(which is done by the police).
• Plays a role in the development of commodity derivative
markets.
• Is an arm of Department of Consumer Affairs.

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 MoF (Ministry of Finance)
• Plays a role in creating regulators.
• Prior to the reforms of the nineties, played the
role of supervisor of rules and regulations.
• Legislative work.
• Big picture policy questions that go beyond
the agenda of any one regulator.
• Conflict of interest: owner of many finance
companies.

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HLCC (High Level Coordination Committee)

• Co-ordination between regulators.

• Members:
– Governor, RBI
– Chairman, SEBI
– Chairman, IRDA
– Finance Secretary, MoF

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Thank You