HS-524 : Housing Finance

Assignment - 1

Indian Financial System

Submitted by: Chetna Godiyal

222109209
M.Plan (Housing) 2nd Sem
Introduction
India's financial system consists of a complex network of financial institutions, regulatory agencies, financial products and services. Some features can be
listed as –
• It plays an important role in the functioning of the economy by allowing the transfer of resources from savers to investors.
• It mobilizes and wisely distributes the country's scarce resources.
• It facilitates the expansion of financial institutions and markets
• Plays a key role in capital formation
• It is also concerned with the Provision of funds
Broadly, it can be classified into formal and informal financial systems.

1. Formal Financial System

The formal financial system comprises of network of banks, other financial and investment institutions and a range of financial instruments. It has 4 major
components:
• Financial Institutions
• Financial Markets
• Financial Instruments
• Financial Services

2. Informal Financial System

• The informal financial system comprises of moneylenders, indigenous bankers, lending pawn brokers, landlords, traders etc.
• The structure of informal financial market is extremely heterogeneous.
 Formal Financial System: Financial Institutions
• Financial institutions serve as mediators between investors and
borrowers, allowing the financial system to run smoothly.
• They mobilize surplus unit savings and invest them in productive
activities with a higher rate of return.
• Financial institutions also offer assistance to individuals, businesses,
and governments on a variety of issues ranging from restructuring to
diversification strategies.
• They offer a wide range of services to firms looking to raise funds through
the stock market or elsewhere.
• Financial institutions are sometimes known as financial intermediaries
because they serve as a link between savers and borrowers by gathering
funds and lending them to borrowers.
• Mutual funds and investing institutions like ICICI, collect deposits and
lend them to borrowers, acting as financial middlemen.

1. Financial Institutes

A financial institution acts as a middleman between consumers and the capital or debt markets, providing banking and investment services. They are
financial market participants. They are companies that deal with financial resources. They are middlemen who connect investors and borrowers to ensure the
smooth operation of the financial system. This is or two types:

a) Banking institutes

Banking financial institutions are in the business of taking deposits from the public and making loans. In addition, they provide other services such as
investment banking, foreign exchange, and safe deposit boxes. These institutions are heavily regulated by governments to protect consumers and ensure that
the banking system is stable.
i) Commercial banks

A commercial bank is a type of financial institution that accepts deposits, provides checking account services, makes business, personal,
and mortgage loans, and provides basic financial products to individuals and small businesses such as certificates of deposit (CDs) and
savings accounts. In contrast to an investment bank, most people do their banking at a commercial bank.

Commercial banks

Private sector Banks Public sector banks Foreign banks Regional Rural Banks
Private sector Banks are those Public sector Banks are type Foreign banks are financial Banking Corporation RRBs
whose maximum shares are of financial institute that is institutes that are operating were set by the state
owned by private parties. They state owned by government. overseas within the foreign government and sponsoring
are financially registered as E.g.: country. E.g.: commercial banks with the
companies with limited abilities. • Bank of Baroda • HSBC India idea of rural
E.g.: • State Bank of India • DBS Bank development. E.g.:
• Axis Bank • Indian Overseas Bank • Bank of America  Madhya Pradesh Gramin
• HDFC Bank • Central bank of India • Australia and New Bank
• Dhana Lakshmi bank • Canara Bank • Zealand Banking Group Ltd.  Mizoram Rural Bank
• Catholic Syrian Bank • Union Bank of India • National Australia  Odisha Gramya bank
• City Union Bank • Punjab National Bank • Bank Westpac  Assam Gramin Vikash Bank
• Federal Bank
• Jammu & Kashmir Bank
• Karnataka Bank
ii) Corporative banks

Co-operative banks are financial entities with a group of people. This means that the customer of a cooperative bank should be a member of
it as well as its owner also. They have limited capital and can do banking with other Banks. These banks also provide a wide range of
regular banking and financial services.
Corporative banks

Primary Cooperative Central Co-operative State Co-operative Banks Land Development Banks
Credit Society Banks
The State Cooperative Bank These are organized in three tiers,
The primary cooperative These are the federations of is a federation of Central namely, State, Central and Primary
credit society is an primary credit societies in a cooperative banks and acts as level, meet the long term credit
association of borrowers district. These banks finance a watchdog of the cooperative requirements of farmers for
and non-borrowers member societies within the banking structure in the State. developmental purposes, viz,
residing in a particular limits of the borrowing Its funds are obtained from purchase of equipment like pump
locality. The funds of capacity of societies. They share capital, deposits, loans sets, tractors and other machineries,
the society are derived also conduct all the business and overdrafts from the reclamation of land, fencing, digging
from the share capital of a joint-stock bank Reserve Bank of India. The up new wells and repairs of old wells
and deposits of members State Co-operative Banks etc. Land Development Banks are
and loans from Central lend money to central cooperative institutions and they grant
Co-operative banks. cooperative banks and loans on the security of mortgage of
primary societies and not immovable property of the farmers.
directly to farmers.
b) Non-banking institutes

i. Organised
The non-banking financial institutions mobilize the financial resources directly or indirectly from people. These companies can be
categorized into investment companies, housing companies, leasing companies, hire purchase companies, etc.
Development Institutes: IDBI, ICICI, IFCI, IRBI, HUDCO, PROVIDENT FUNDS
Investment Institutes: LIC GIC MUTUAL FUNDS

ii. Un-Organized
These include consumer finance companies, leasing companies, housing finance companies, merchant banking companies, credit rating
agencies etc.

2. Financial Markets

Financial markets include any marketplace where securities are traded, such as the stock market, bond market, currency market, and
derivatives market, to name a few. Financial markets are necessary for capitalist economies to function properly. Financial markets are
critical to the smooth operation of capitalist economies because they allocate resources and create liquidity for businesses and
entrepreneurs. Buyers and sellers can easily trade their financial holdings thanks to the markets.
Financial markets are of two classifications:

a) Capital market

The capital market is the place where the medium-term and long-term financial needs of business and other undertakings are met by
financial institutions which supply medium and long-term resources to borrowers. These institutions may further be classified into
investing institutions and development banks on the basis of the nature of their activities and the financial mechanism adopted by them.
 Capital market

Stock market/ Equity Primary Markets Derivatives Markets Secondary Markets

market / Share market The primary market is a new A derivative is a contract between The secondary market is a
The stock market is where issue market; it solely deals two or more parties whose value is place where trading takes
investors connect to buy and with the issues of new based on an agreed - upon place for existing securities. It
sell investments — most securities. A place where underlying financial asset (like a is known as stock exchange
commonly, stocks, which are trading of securities is done security) or set of assets (like an or stock market and equities
shares of ownership in a for the first time. The main index). Simply, future markets. markets. There are two types
public company. objective is capital formation e.g.: Chicago Board Options of secondary markets:
for government, institutions, Exchange (CBOE) • auction markets
companies • dealer markets

b) Money market

Money market is concerned with the supply and the demand for investible funds. Essentially, it is a reservoir of short-term funds. Money
market provides a mechanism by which short-term funds are lent out and borrowed; it is through this market that a large part of the financial
transactions of a country are cleared.

The money market is generally expected to perform following three broad functions:
1. To provide an equilibrating mechanism to even out demand for and supply of short term funds.
2. To provide a focal point for Central bank intervention for influencing liquidity and general level of interest rates in the economy.
3. To provide reasonable access to providers and users of short-term funds to fulfill their borrowing and investment requirements at an
efficient market clearing price.
Treasury Bill: Promissory Note
• A treasury bill is an instrument of short-term borrowing by the • Promissory notes are legally binding whether the note is
government. secured by collateral or based only on the promise of
• Issued by RBI in behalf of central government. repayment.
• Issue period ranges from 14-365 days • One party to pay to another party, a definite sum of money by
• 3 different maturity periods, which are, 91 days T-Bills, 182 days demand or at a specified future date.
T- Bills, 1 year T – Bills. • Issue period is for 3 years.

Banker’s Acceptance Commercial Bill:

• A Banker's Acceptance or BA is basically a document promising • A Bill of exchange to find the working capital requirements of
future payment which is guaranteed by a commercial bank. business firms.
• Issue period ranges from 30-180 days • The seller of goods draws the bill and buyer accepts it.
• Once accepted it becomes, trade bill.
Certificate of Deposit (CD)
• A fixed asset or savings certificate with fixed maturity date and Call Money:
fixed rate of interest. • A Short-term finance repayable on demand the funds are
• Usually given by commercial banks and financial institutes. borrowed and lent for 1 day
• Issue period ranges from 7-365 days by banks and 1 - 3 year by • Interest rate paid on call money loans are called call rates.
other financial institutes. • Issue period is for 1 day.

Commercial Paper: Notice Money:

• A short term unsecured promissory note, negotiable and • Borrowing and lending in unsecured funds for a period of 14
transferable by delivery with a fixed maturity period. days excluding overnight borrowing/lending, without any
• It is issued by corporates and Financial Institutes. collateral security.
• Issue period ranges from 7 to 270 days • Issue period ranges from 1 - 14 days
Term Money:
• Borrowing and lending in unsecured funds for period exceeding 14 days and up to one year.
• Issue period ranges from 15-365 days

Repurchase Agreement (REPO):

• They are a formal agreement between two parties, where one party sells a security to another, with the promise of buying it back at a later
date from the buyer.
• Issued by RBI or RBI approved authorities
• Issue period is over 48 hrs

Bonds:
• A bond is loan from an investor to a borrower such as a company or government.
• The borrower uses the money to fund its operations, and the investor receives interest on the investment.
• There are five main types of bonds: Treasury, savings, agency, municipal, and corporate.
• Each type of bond has its own sellers, purposes, buyers, and levels of risk vs. return.

Shares:
• A share is a percentage of ownership in a company or a financial asset. Investors who hold shares of any company are known as
shareholders.
• Common shares enable voting rights and possible returns through price appreciation and dividends.
• Preferred shares do not offer price appreciation but can be redeemed at an attractive price and offer regular dividends.

Debenture:
• A debenture is a type of debt instrument that is not backed by any collateral and usually has a term greater than 10 years.
• It has obligation to repay the sum at a specified rate and also carrying an interest.
• It is one of the methods of raising the loan capital of the company. e.g.: Treasury bills
3. Financial Instruments

A financial instrument is defined as a contract between individuals/parties that holds a monetary value. They can either be created, traded,
settled, or modified as per the involved parties' requirement. In simple words, any asset which holds capital and can be traded in the market
is referred to as a financial instrument. Cheques, shares, stocks, bonds, futures, and options contracts are all examples of financial
instruments. Financial instruments are classified into three types: cash instruments, derivative instruments, and foreign exchange
instruments.

i. Cash Instruments

Cash instruments are financial instruments whose values are directly influenced by market conditions. There are two types of cash
instruments:

• Securities: A security is a monetary-valued financial instrument that is traded on the stock market. A security represents ownership of a
portion of a publicly traded company on the stock exchange when purchased or traded.
• Loans and deposits: Deposits and loans are both considered cash instruments because they represent monetary assets with a contractual
agreement between the parties.

ii. Derivative Instruments

Derivative instruments are financial instruments whose values are determined by the underlying assets, which include resources, currency,
bonds, stocks, and stock indexes. Synthetic agreements, forwards, futures, options, and swaps are the five most common types of
derivatives instruments. This is covered in greater detail further down.
iii. Foreign Exchange Instruments

Foreign exchange instruments are financial instruments that are traded on the foreign exchange market and primarily consist of currency
contracts and derivatives. In terms of currency agreements, they are classified into three types.

• Spot:
A currency agreement in which the actual exchange of currency occurs no later than the second working day following the agreement's
original date. The term "spot" refers to currency exchange that occurs "on the spot" (limited timeframe).
• Outright Forwards:
A currency agreement in which the actual exchange of currency occurs "forwardly" and before the agreed-upon date. It is useful in cases of
frequently changing exchange rates.
• Currency Swap:
A currency swap is the simultaneous purchase and sale of currencies with different specified value dates.

4. Financial Services

Commercial banks are the heart of our financial system. They make funds available through their lending and investing activities to
borrowers - individuals, business firms, and governments. In doing so, they facilitate both the flow of goods and services from producers to
consumers and the financial activities of governments. Commercial banks have been referred to as 'department stores of finance’ as they
provide a wide variety of financial services. Commercial banks in India have set up subsidiaries to provide capital market related services,
recruitment banking merchant banking etc.

Types of financial service : Fund based (or asset based) and Fee based
Fund based or asset-based services include the following:

a) Hire purchase and consumer credit:

A leasing option is hire buy. A hire purchase agreement is one in which things are acquired and sold on the basis of payment in
instalments. The things are only handed over to the customer. He is not granted possession of anything. Only once the final instalment is
paid does he become the owner. The seller has the authority to repossess the items if the customer fails to pay any instalment. Each
payment also includes interest.

b) Mutual funds:

Mutual funds are investment vehicles that pool people's money and invest it in a mix of corporate and government securities. Mutual fund
operators actively manage this portfolio of securities, earning income from dividends, interest, and capital gains. Eventually, the profits
are distributed to mutual fund shareholders.

c) Bill discounting:

Finance businesses provide bill discounting, which is an enticing fund-based financial service. A time bill (payable after a set period) does
not require the bearer to wait until maturity or the due date. If he needs money, he may work out a deal with his banker to get a reduction
on the cost. After subtracting a specified amount, the banker credits the customer's account with the net amount (discount). As a
consequence, the bank purchases the bill and debits the bill amount less the discount from the customer's account. On the due date, the
drawee pays payment to the banker. If he fails to pay, the banking will seek reimbursement from the client who reduced the payment.
d) Equipment leasing/lease financing:

A lease is an arrangement in which a business acquires the right to use a capital item, such as machinery, in return for a predetermined
charge known as lease rents. The lessee is the individual (or entity) who gets the right. The asset is not provided to him as a gift. Only the
right to utilize the asset is granted to him. The lessor is the individual (or corporation) who gives the right.

e) Venture capital:

The term "venture capital" simply refers to money set aside to fund new company endeavours. It comprises lending money to start-up
companies. It's a bet on a high-risk enterprise that promises a high rate of return. Venture capital, in a nutshell, is long-term risk capital in the
form of equity funding.

f) Insurance services:

Insurance is a two-sided agreement. One party is the insured, while the other is the insurer. The individual whose life or property is covered
by the insurance is known as the insured. The insurer is the name given to the insurance firm. In other terms, the insurance company is the
entity that assures the insured's risk. As a result, insurance is a legally binding agreement between the insurer and the insured.

Fee Based Services

a) Credit rating:

A rating agency's expert opinion on the relative willingness and ability of a debt instrument's issuer to meet financial obligations on time and
in full. It assesses an issuer's ability and willingness to repay both interest and principal over the term of the rated instrument. It is an
assessment of a company's financial and business prospects. In a nutshell, credit rating is the assessment of a company's creditworthiness by
an independent organization.
b) Stock broking:

Stock broking has emerged as a professional advisory service in recent years. A stock broker is a registered member of a stock exchange.
He buys, sells, or trades stocks/securities. In order to act as a broker, every stock broker must be registered with SEBI. As a member of a
stock exchange, he must follow its rules, regulations, and bylaws.

c) Loan syndication:

A loan syndication arrangement is one in which a group of banks collaborate to provide funds for a single loan. A loan syndication is a
group of banks consisting of 10 to 30 banks that collaborate to provide funds, with one of the banks serving as the lead manager. This lead
bank is chosen by corporate enterprises based on their trust in the lead manager. A large loan cannot be made by a single bank. As a result,
a number of banks band together to form a syndicate. This is referred to as loan syndication. As a result, loan syndication is similar to
consortium financing.

d) Merchant banking:

Merchant banking is primarily concerned with providing non-fund-based services such as arranging funds rather than providing them. The
merchant banker is merely an intermediary. Its primary function is to move capital from those who own it to those who require it.