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Q) Explain in detail the role and importance of financial institutions and banks in the emerging new environment of privatization

and globalization in India?

Ans) Banking system and the Financial Institutions play very significant role in the economy. First and foremost is in the form of catering to the need of credit for all the sections of society. The modern economies in the world have developed primarily by making best use of the credit availability in their systems. An efficient banking system must cater to the needs of high end investors by making available high amounts of capital for big projects in the industrial, infrastructure and service sectors. At the same time, the medium and small ventures must also have credit available to them for new investment and expansion of the existing units. Rural sector in a country like India can grow only if cheaper credit is available to the farmers for their short and medium term needs.

Credit availability for infrastructure sector is also extremely important. The success of any financial system can be fathomed by finding out the availability of reliable and adequate credit for infrastructure projects. Fortunately, during the past about one decade there has been increased participation of the private sector in infrastructure projects.

The banks and the financial institutions also cater to another important need of the society i.e. mopping up small savings at reasonable rates with several options. The common man has the option to park his savings under a few alternatives, including the small savings schemes introduced by the government from time to time and in bank deposits in the form of savings accounts, recurring deposits and time deposits. Another option is to invest in the stocks or mutual funds.

In addition to the above traditional role, the banks and the financial institutions also perform certain new-age functions which could not be thought of a couple of decades ago. The facility of internet banking enables a consumer to access and operate his bank account without actually visiting the bank premises. The facility of ATMs and the credit/debit cards has revolutionized the choices available with the customers. The banks also serve as alternative gateways for making payments on account of income tax and online payment of various bills like the telephone, electricity and tax. The bank customers can also invest their funds in various stocks or mutual funds straight from their bank accounts. In the modern day

economy, where people have no time to make these payments by standing in queue, the service provided by the banks is commendable.

While the commercial banks cater to the banking needs of the people in the cities and towns, there is another category of banks that looks after the credit and banking needs of the people living in the rural areas, particularly the farmers. Regional Rural Banks (RRBs) have been sponsored by many commercial banks in several States. These banks, along with the cooperative banks, take care of the farmer-specific needs of credit and other banking facilities.

Future Till a few years ago, the government largely patronized the small savings schemes in which not only the interest rates were higher, but the income tax rebates and incentives were also in plenty. The bank deposits, on the other hand, did not entail such benefits. As a result, the small savings were the first choice of the investors. But for the last few years the trend has been reversed. The small savings, the bank deposits and the mutual funds have been brought at par for the purpose of incentives under the income tax. Moreover, the interest rates in the small savings schemes are no longer higher than those offered by the banks.

Banks today are free to determine their interest rates within the given limits prescribed by the RBI. It is now easier for the banks to open new branches. But the banking sector reforms are still not complete. A lot more is required to be done to revamp the public sector banks. Mergers and amalgamation is the next measure on the agenda of the government. The government is also preparing to disinvest some of its equity from the PSU banks. The option of allowing foreign direct investment beyond 50 per cent in the Indian banking sector has also been under consideration.

Banks and financial intuitions have played major role in the economic development of the country and most of the credit- related schemes of the government to uplift the poorer and the under-privileged sections have been implemented through the banking sector. The role of the banks has been important, but it is going to be even more important in the future. Financial institutions play an extremely important role in economic development. Financial institutions cater to important needs of society such as taking care of small savings at reasonable rates. Everyday working men and women have the option of putting their savings

into a number of alternatives such as Government small saving schemes, deposits into a saving account provided by their bank, recurring, deposits, time deposits and also the alternative option of investing in mutual funds or stocks.

Financial institutions also undertake modern functions that could not have been done 20 years or so ago. The relatively new invention of Internet banking allows customers to access their saving and current accounts, manage their money and even make payments without ever having to set foot in the banks building. This and ATMs have completely revolutionized the way that people can access their money. Online payments can also be made which saves the customers time and energy. In the modern day economy when people with hectic lifestyles dont have the time to stand in payment queues all day, financial institutions can only be commended for providing this convenient way of payment.

Financial institutions must also offer an extremely efficient service by developing themselves to make the best use of the credit in their systems. A decent financial institution must make sure that they cater to the all the needs of investors by making high amounts of capital for the big and expensive projects that are being undertaken by the industrial and service sectors. Although it is not just the big people that the financial institutions need to be backing. The small companies and independent businesses must also have credit backing them if they are to expand and grow for the good of the countrys economy. This makes the subject of credit availability by financial institutions an extremely important issue. Financial institutions, which are immensely important to the smooth functioning of a society, have certain functions of their own, which accentuates their role in the society, consolidating their significance to an extensive extent.

The first function of financial institutions is the transformation of assets, which are acquired through markets, into a wider and more preferable form, which becomes their liability this function is performed mainly by financial intermediaries, which is undeniably the most important category of financial institutions.

Also financial institutions are involved in exchanging of assets on behalf of their customers. Other than that, exchanging of assets for their own personal accounts is also part of their job.

Furthermore, financial institutions create financial assets for their customers and sell those assets to other market participants for a definite emolument. In addition to all these functions, financial institutions are also involved in providing investment advice to market participants and managing the portfolios of market participants.

OVERVIEW OF ROLE OF BANKS IN THE ECONOMY

1. Capital Formation: The significance of DFIs lies in their making available the means to utilize savings generated in the economy, thus helping in capital formation. Capital formation implies the diversion of the p r o d u c t i v e c a p a c i t y o f t h e e c o n o m y t o t h e m a k i n g o f c a p i t a l g o o d s w h i c h i n c r e a s e s f u t u r e productive capacity. The process of Capital Formation involves three distinct but interdependent activities, viz., saving financial intermediation and investment. However, poor country/economy may be, there will be a need for institutions which allow such savings, as are currently forthcoming, to be invested conveniently and safely and which ensure that they are channeled into the most useful purposes. A well-developed financial structure will therefore aid in the collections and disbursements of investible funds and thereby contribute to the capital formation of the economy. Indian capital market although still considered to be underdeveloped has been recording impressive progress during the postinterdependence period.

2. Support to the Capital Market: The basic purpose of DFIs particularly in the context of a developing economy, is to accelerate t h e p a c e o f e c o n o m i c d e v e l o p m e n t b y i n c r e a s i n g c a p i t a l f o r m a t i o n , i n d u c i n g i n v e s t o r s a n d entrepreneurs, sealing the leakages of material and human resources by careful allocation thereof, undertaking development activities, including promotion of industrial units to fill the gaps in the industrial structure and by ensuring that no healthy projects suffer for want of finance and/or technical services. Hence, the DFIs have to perform financial and development functions on finance functions, there is a provision of adequate term finance and in development functions there include providing of foreign currency loans, underwriting of shares and debentures of industrial concerns, direct subscription

to equity and preference share capital, guaranteeing of deferred payments, conducting techno-economic surveys, market and investment research and rendering of technical and administrative guidance to the entrepreneurs.

3. Rupee Loans: Rupee loans constitute more than 90 per cent of the total assistance sanctioned and disbursed. T h i s s p e a k s e l o q u e n t l y o n D F I s o b s e s s i o n w i t h t e r m l o a n s t o t h e n e g l e c t o f o t h e r f o r m s o f assistance which are equally important. Term loans supplemented by other forms of assistance had naturally put the borrowers, most of whom are small entrepreneurs, on to a heavy burden of d e b t - s e r v i c i n g . S i n c e term finance is just one of the inputs but not everything for the entrepreneurs, they had to search for other sources and their abortive efforts to secure other forms of assistance led to sickness in industrial units in many cases.

4. Foreign Currency Loans: Foreign currency loans are meant for setting up of new industrial projects as also for expansion, diversification, modernization or renovation of existing units in cases where a portion of the loan was for financing import of equipment from abroad and/or technical know-how, in special cases.

5. Subscription to Debentures and Guarantees: Regarding guarantees, it is well-known that when an entrepreneur purchases some machinery or fixed assets or capital goods on credit, the supplier usually asks him to furnish some guarantee to ensure payment of installments by the purchaser at regular intervals. In such a case, DFIs can act as guarantors for prompt of installments to the supplier of such machinery or capital under a scheme called Deferred Payments Guarantee.

6. Assistance to Backward Areas: Operations of DFIs in India have been primarily guided by priorities as spelt out in the Five-Y e a r P l a n s . T h i s i s r e f l e c t e d i n t h e l e n d i n g p o r t f o l i o a n d p a t t e r n o f f i n a n c i a l a s s i s t a n c e o f development financial institutions under different schemes of financing. Institutional finance to projects in backward areas is extended on concessional terms such as lower interest rate, longer moratorium period, extended repayment schedule and relaxed norms in respect of promoters contribution and

debt-equity ratio. Such concessions are extended on a graded scale to units in industrially backward districts, classified into the three categories of A, B and c depending upon the degree of their backwardness. Besides, inst itutions have introduced schemes for extending term loans for project/area-specific infrastructure development. Moreover, in recent years, development banks in India have launched special programmes for intensive development of industrially least developed areas, commonly referred to as the No -industry Districts (NIDs) which do not have any large-scale or medium-scale industrial project. Institutions have initiated industrial potential surveys in these areas.

7. Promotion of New Entrepreneurs: Development banks in India have also achieved a remarkable success in creating a new class of entrepreneurs and spreading the industrial culture to newer areas and weaker sections of the society. Special capital and seed Capital schemes have been introduced to provide equity type of assistance to new and technically skilled entrepreneurs who lack financial resources of their own even to provide promoters contribution in view of long-term benefits to the society from the emergence of a new class of entrepreneurs. Development banks have been actively involved in the entrepreneurship development programmes and in establishing a set of institutions which i d e n t i f y a n d t r a i n p o t e n t i a l e n t r e p r e n e u r s . A g a i n , t o m a k e a v a i l a b l e a p a c k a g e o f s e r v i c e s encompassing preparation of feasibility of reports, project reports, technical and management c o n s u l t a n c y etc. at a reasonable cost, institutions have sponsored a chain of 16 T e c h n i c a l Consultancy organizations covering practically the entire country. Promotional and development functions are as important to institutions as the financing role. The promotional activities like carrying out industrial potential surveys, identification of potential entrepreneurs, conducting entrepreneurship development programmes and providing technical c onsultancy services have contributed in a significant manner to the process of industrialization and effective utilization of industrial finance by industry. IDBI has created a special technical assistance fund to support its various promotional activities. Over the years, the scope of promotional activities has expanded to include programmes for up gradation of skill of State level development banks and other i n d u s t r i a l p r o m o t i o n a g e n c i e s , c o n d u c t i n g s p e c i a l s t u d i e s o n i m p o r t a n t i s s u e s c o n c e r n i n g industrial development,

encouraging voluntary agencies in implementing their programmes for the uplift of rural areas, village an cottage industries, artisans and other weaker sections of the society.

8. Impact on Corporate Culture: The project appraisal and follo w-up of assisted projects by institutions through various instruments, such as project monitoring and report of nominee directors on the Boards of directors of assisted units, have b e e n m u t u a l l y r e w a r d i n g . T h r o u g h m o n i t o r i n g o f a s s i s t e d projects, the institutions have been able to better appreciate the problems faced by industrial units. It also has been possible for the corporate managements to recognize the fact that interests o f t h e a s s i s t e d u n i t s a n d t h o s e o f i n s t i t u t i o n s d o n o t c o n f l i c t b u t c o i n c i d e . O v e r t h e y e a r s , institutions have succeeded in infusing a sense of constructive partnership with the corporate sector. Institutions have been going through a continuous process of learning by doing and are e f f e c t i n g i m p r o v e m e n t s i n t h e i r s ys t e m s a n d p r o c e d u r e s o n t h e b a s i s o f t h e i r c u m u l a t i v e experience. The promoters of industrial projects now develop ideas into specific projects more carefully and prepare project reports more systematically. Institutions insist on more critical evaluation of technical feasibility demand factors, marketing strategies and project location and on application of modern techniques of discounted cash flow, internal rate of return, economic rate of return etc., in assessing the prospects of a project. This has produced a favorable impact on the process of decision-making in the corporate seeking financial assistance from institutions. In fact, such impact is not continued to projects assisted by them but also spreads over to projects financed by the corporate sector on its own. The association of institutions in the management of corporate bodies has considerably facilitated the process of progressive professionalism of the corporate management. Institutions have been a b l e t o c o n v i n c e the corporate managements to appropriately re -orient their o r g a n i z a t i o n a l structure, personal policies and planning and control systems. In many cases, institutions have s u c c e s s f u l l y i n d u c t e d e x p e r t s o n t h e B o a r d s o f a s s i s t e d c o m p a n i e s . A s p a r t o f t h e i r p r o j e c t follow-up work and through their nominee directors, institutions have also been able to bring about progressive adoption of modern management techniques, such as corporate planning and p e r f o r m a n c e b u d g e t i n g i n t h e a s s i s t e d u n i t s . T h e

progressive professionalism of industrial management in India re flects o n e o f t h e m a j o r q u a l i t a t i v e c h a n g e s b r o u g h t a b o u t b y t h e institutions.

CONCLUSION: The banking system in India has undergone significant changes during last 16 years. There have been new banks, new instruments, new windows, new opportunities and, along with all this, new challenges. While deregulation has opened up new vistas for banks to augment incomes, it has a l s o e n t a i l e d g r e a t e r c o m p e t i t i o n a n d consequentl y greater risks. India adopted prudential measures aimed at i m p a r t i n g s t r e n g t h t o t h e b a n k i n g s ys t e m a n d e n s u r i n g i t s s a f e t y a n d soundness, through greater transparency, accountability a n d p u b l i c c r e d i b i l i t y . Banking sector reform has been unique in t h e w o r l d i n t h a t i t c o m b i n e s a c o m p r e h e n s i v e reorientation of competition, regulation and ownership in a non-disruptive and cost-effective manner. Indeed banking reform is a good illustration of the dynamism of the public sector in managing the overhang problems and the pragmatism of public policy in enabling the domestic and foreign private sectors to compete and expand. There has been no banking crisis in India. The Government took steps to reduce its ownership in nationalized banks and inducted private ownership but without altering their public sector character. The underlying rationale of this a p p r o a c h is to assure that the salutary features of public sector banking were not l o s t i n t h e transformation process. On account of healthy market value of the banks shares, the capital infusion into the banks by the Government has turned out to be profitable for the Government.

Submitted By: Prachi Gupta (03215903911)

Amit Jang Bahadur (03315903911)

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