FINANCIAL INSTITUTIONS AND SERVICES

Finance Terms
Finance: The proper management of money. Money: The current medium of exchange or means of payment. Credit or Loan: A sum of money to be returned normally with interest.

Classification of finance
1. Public finance
It studies the sources of funds of public authorities such as states, local self-governments and the Central Government. It is concerned with the income and expenditure of public authorities and with the adjustment of one to another.

Contd

Classification of finance
Private finance
An individual Profit-seeking business organizations
External finance (outside sources)
Direct financing (through issuing securities) Indirect financing (through middlemen)

Internal finance (ploughing back of profits) A non-profit organization

Financial system
A set of institutions, instruments and markets which promote savings and channel them to their most efficient use.

Contd

Financial system
Financial Institutions Financial Markets
(Claims, assets, securities)

Financial instruments

Financial Services

Regulatory

Intermediaries

Non-Intermediaries

Others Primary Secondary

Banking

Nonbanking

Organised

Un-organised Short term Medium Term Long Term

Primary

Secondary

Capital Markets Equity Market Debt Market

Money Markets Derivatives Market

Financial Institutions
Banking
These are participate in the economys payments mechanism Their deposit liabilities constitute a major part of the national money supply They can, as a whole, create deposits or credit, which is money

Financial Institutions
Non-Banking
Lend only out of resources put at their disposal by the savers. LIC, UTI, IDBI

Financial Markets
These are the centers or arrangements that provide facilities for buying and selling of financial claims and services. These are classified into
Primary and secondary markets Money and capital markets

Primary and Secondary Markets

Primary Markets
deal in the new financial claims or new securities (new issue markets) these are mobilize savings and they supply fresh or additional capital

Secondary Markets
deal in securities already issued or existing or outstanding. these do not contribute directly to the supply of additional capital

Money and Capital Markets

Both are perform the same function of transferring resources to the producers. Money markets deals short-term claims Capital markets deals long-term claims

Financial Instruments and Services

Financial asset
A sum of money sometime in future (repayment of principal) and/or a period (regular/intervals) payment in the form of interest or dividend.

Financial instruments

Technology in Financial System

Financial Services will be provided by a wide variety of institutions. Small financial service firms will be able to obtain access to the technologies they will require to remain viable. Large number of small, specialized financial service organizations will prevent the few from dominating the market. Networks are permitting electronic fund transfers from the merchants counter. Systems providing access to funds from virtually any place in the Nation and are likely to be in use in the next few years.
Contd

Technology in Financial System

Advanced communication technologies including satellite relays, video cable, fiber optics and cellular radio will find wide application in the financial service industry. Decreasing computer costs will create the opportunity for large numbers of individual consumers and managers of small businesses to take advantage of technology in using financial services. Large computers will be used to support the data bases. Computers that accept voice inputs and recognize fingerprints may become cost effective for financial service delivery.

Financial System instability

Increased cross-border integration and the presence of large international financial institutions facilitate the dissemination of financial shocks across countries. Financial innovation in products and markets, together with the existence of large financial companies facilitate the transmission of financial shocks in domestic financial markets. Strong growth in asset prices and the growing importance of household credit are potential sources of financial instability.

Financial System Stability

Monitoring and analysis of financial system developments Designing and building up financial system safety nets Regulation of the banking system Market Infrastructure Safety Buffers Adoption of Common International Standards Corporate Bonds and Securities Market Risk management Market discipline (through prudential regulation and supervision)

Development Finance Institution (DFI)

It refers to a range of alternative financial institutions including microfinance institutions, community development financial institution and revolving loan funds. These institutions provide a crucial role in providing credit in the form of higher risk loans, equity positions and risk guarantee instruments to private sector investments in developing countries. The purpose of DFIs is to ensure investment in areas where otherwise, the market fails to invest sufficiently.

Subsidies
There are three main forms of subsidies in the operations of DFIs in practice
High level of liquidity; An ability to access technical assistance funds; and Subsidies passed on directly to beneficiaries.

Universal Banking
Universal banking is a combination of Commercial banking, Investment banking, Development banking, Insurance and many other financial activities. It is a place where all financial products are available under one roof. A universal bank is a bank which offers commercial bank functions plus other functions such as Merchant Banking, Mutual Funds, Credit cards, Housing Finance, Auto loans, Retail loans, Insurance, etc.

Advantages of Universal Banking

Investors' Trust Economics of Scale Resource Utilisation Profitable Diversification Easy Marketing One-stop Shopping

Disadvantages of Universal Banking

Different Rules and Regulations Effect of failure on Banking System Monopoly Conflict of Interest

Financial Intermediaries & Financial Innovation

Financial Institutions
Provider of financial services such as
transforming financial assets in terms of maturity of liquidity (these are financial intermediaries) trading financial assets for themselves and others creating financial assets and then selling those assets on the behalf of customers giving professional investment advice to others managing investment portfolios for others

Depository institutions acquire most of their funds through accepting deposits Non depository institutions receive funds from other sources

Role of Financial Intermediaries

Make direct investments by purchasing bonds, stocks or making loans. These are their assets Raise money for these investments by issuing their own financial assets such as deposits, insurance policies, mutual fund shares. These are liabilities for the intermediary and are indirect investments for the investors.

Asset/Liability Management
Not all liabilities of financial intermediaries are created equal! They differ in terms of the certainty of their amount and timing
Type I liabilities: timing and amount are certain
example: bank fixed rate CD. Bank knows how much it owes the depositor and when.

Type II liabilities: amount is certain but timing is not

example: term life insurance policy. Insurance company knows amount of policy but uncertain when the policy holder will die.

Asset/Liability Management
Type III liabilities: amount is not certain but timing is
example: variable rate Certificate of Deposits (CD). Bank knows the maturity date, but the interest owed is not known when the CD is issued.

Type IV liabilities: time and amount are uncertain

example: auto insurance policy. The timing and payout for an auto accident is not known when the policy is issued.

The type of liabilities created by a financial intermediary will determine how they invest their funds (i.e. the type of assets that they hold)

Financial Innovation
What is it?
creation of new financial assets or new ways to use financial assets changing circumstances: increased instability in interest rates, stock prices and exchange rates led to the development of derivative securities advances in technology make new trading strategies feasible competition among institutions for unique products and strategies desire to avoid regulations or tax laws

Why does it happen?

Banking History
In the first half of the nineteenth century, three Presidency Banks were started in Madras, Bombay and Bengal with the financial participation of the government for conducting banking business and issue currency notes. Towards the end of the 19th Century the cash balances of the government were kept in the government treasuries and the government shed its connections with the Presidency Banks.

Contd

Banking History
The Imperial Bank came into existence on the 27th January, 1921 by the Imperial Bank of India Act of 1920. It was established by the amalgamation of the three Presidency Banks. The Imperial Bank was the biggest bank until 1935. Until the establishment of the Reserve Bank of India in 1935, the Imperial Bank performed certain central banking functions, although it was purely a commercial bank. It acted as the sole-banker to the Government.

Introduction
It is the Central Bank of India Established in 1934 under the RESERVE BANK OF INDIA ACT 1934. Its head quarters is in Mumbai (Maharashtra). Its present governor is Duvvuri Subbarao. It has 26 offices in which four are regional offices located in metropolitan cities.

Brief History of RBI

It was set up on the recommendations of the Hilton Young Commission. It was started as share-holders bank with a paid up capital of INR 5 crore. Initially it was located in Kolkata. It moved to Mumbai in 1937. Initially it was privately owned. The govt. had a nominal value of shares of INR 2,20,000. Later on in 1949, the bank was nationalised and is fully owned by the Govt. of India.

Preamble
The Preamble of the Reserve Bank of India describes the basic objectives of the Reserve Bank 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."

Subsidiaries
The Reserve Bank of India has fully-owned four subsidiaries which include National Housing Bank(NHB). Deposit Insurance and Credit Guarantee Corporation of India(DICGC). Bharatiya Reserve Bank Note Mudran Private Limited(BRBNMPL). National Bank for Agriculture and Rural Development (NABARD, 12 July, 1982). The Reserve Bank of India has recently divested its stake in State Bank of India to the Government of India. RBI has also set up some trainning institutions.

Functions of RBI

Monetary functions

Note issue (except one rupee note all other notes are issued) Banker to the government Bankers bank Custodian of foreign reserves Controller of credit

Bank Rate Open market operations Variable reserve requirements (Cash Reserve Requirement & Statutory Liquidity Requirements)

Non-Monetary Functions
Supervisory functions Promotional functions

Banker to the Government

Keeping

the cash balances of the Government as deposits free of

interest.
Receiving Carrying

and making payments on behalf of the Govt.

out the Govts exchange remittances and other banking operations. both Central and State Govts float new loans and mange public debt. ways and means advances to the state and local authorities.

Helping

Making Acting

as advisor to the Govt. on all monetary and banking matters.

Bankers Bank
Apex banking institution Controls the banking activities and credit system in India It provides financial assistance to scheduled banks by rediscounting eligible securities

Custodian of Foreign Reserves

Most of the countries, central bank is with the task of managing their foreign reserves. In India, RBI has maintain the rate of exchange. According to RBI Act, 1934 the bank was required to buy and sell at fixed rates. The bank has licensed several banks as authorized dealers in foreign exchange.

Controller of Credit
Bank Rate
Sec.49 of RBI Act, empowers the Reserve Bank to publish the bank rate from time to time. Standard rate which is prepared to buy or rediscount bills of exchange or other commercial papers eligible for purchase under this act. RBI is able to regulate commercial bank credit and the general credit situation in the country to a certain extent. 9.00% (w.e.f. close of business of 17/04/2012) Decreased from 9.50% to 9.00% which was continuing since 13/02/2012
Contd

Controller of Credit
Open market operations
The purchase and sale of Govt. securities by the RBI from/to the public and bank on its own account. Section 17(8) provides this right to RBI. To provide seasonal finance to commercial banks by purchase of securities from them.

Variable Reserve Requirements

Sec 42 of RBI Act, every bank included in the second schedule shall maintain with the bank an average daily balance, the amount of which shall not be less than 3% of the total demand and time liabilities in India of such bank. The reserve maintained is called Cash Reserve Requirement/Ratio (CRR). According to Sec 24 of Banking Regulation Act, every banking company shall maintain Cash, Gold and Approved securities which shall be less than 25% of business on any day.

Cash Reserve Requirement (CRR)

Every scheduled bank should maintain a minimum balance with RBI. It was 5% on demand deposits and 2% on time deposits. The reserve between 5 and 20% in respect of demand liabilities and 2 and 8% in respect of time liabilities. RBI (amendment) Act 1962 removed the distinction between time and demand liabilities. Then the ratio changed to 3 and 15% for time and demand liabilities. 4.75% (w.e.f. 10/03/2012) -announced on 24/01/2012 Decreased from 5.50% which was continuing since 24/01/2012

Statutory Liquidity Requirement (SLR)

It is another method of influencing the lending policies of commercial banks. RBI is given the power to change the minimum liquidity ratio. Narasimham Committee recommended it was from 25 to 38%. RBI gradually reduced the SLR. 23%(w.e.f. 11/08/2012) announced on 31/07/2012

Non-Monetary Functions
Supervisory Function
RBI Act 1934 & than Banking Regulations Act 1949 have given wide range of powers to RBI to control over commercial banks. The Section 22 of Banking Regulations Act 1949, every bank has to obtain a license from RBI carrying on banking business. Sanction of new branch or a new place of business. It promotes banking habits Extend banking facilities to rural and semi urban areas Establish and promote new specialized financing agencies

Promotional Functions

Indian Organized Money Market

Central Bank

Introduction
It regulates and makes policy relating to monetary management in the country. It is an organ of the government which participates in financial markets in different ways. By issuing of currency notes which is directly and solely under the purview of the Central Bank.

Introduction
By working as the agent and adviser of the Government specifically concerning to the financial matters, such as loans, advances, servicing of debts, etc. By acting as bankers bank in the financial market and it regulates the banking operations in the country. By maintaining adequate foreign exchange reserve for meeting the requirements of foreign trade and servicing of foreign debts.

Functions
Note issue Governments banker, agent and adviser Bankers bank and lender of last resort Custodian of foreign balances of the country Central clearance, settlement and transfer Credit control