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The financial system in India comprises of financial institutions, financial markets, financial

instruments and services. The Indian financial system is characterised by its two major segments -
an organised sector and a traditional sector that is also known as informal credit market. Financial
intermediation in the organised sector is conducted by a large number of financial institutions which
are business organisations providing financial services to the community. Financial institutions
whose activities may be either specialised or may overlap are further classified as banking and non-
banking entities. The Reserve Bank of India (RBI) as the main regulator of credit is the apex
institution in the financial system. Other important financial institutions are the commercial banks
(in the public and private sector), cooperative banks, regional rural banks and development banks.
Non-bank financial institutions include finance and leasing companies and other institutions like LIC,
GIC, UTI, Mutual funds, Provident Funds and even Post Offices. The financial market is of course,
dominated by the banks, which contribute close to 80% of the total capital in the market.

Recognising the critical nature of the financial sector prompted the Government to set up two
Committees on the Financial System (Narasimham Committees) in 1991 and 1998 to examine all
aspects relating to the structure, organisation, functions and procedures of the financial system. The
deliberations of the Committees were guided by the demands that would be placed on the financial
system by the economic reforms taking place in the real sectors of the economy and by the need to
introduce greater competition through autonomy and private sector participation in the financial
sector. Despite the fact that the bulk of the banks were and are likely to remain in the public sector,
and therefore with virtually zero risk of failure, the health and financial credibility of the banking
sector was an issue of paramount importance to the Committees.

Narasimham Committees After liberalization in 1991, recognising the evolving needs of


the sector, the Finance Ministry of Government of India (GOI) set up various committees
with the task of analysing India's banking sector and recommending legislation and
regulations to make it more effective, competitive and efficient. Two such expert
Committees were set up under the chairmanship of M. Narasimham. They submitted their
recommendations in the 1990s in reports widely known as the Narasimham Committee-I
(1991) report and the Narasimham Committee-II (1998) Report. These recommendations
not only helped unleash the potential of banking in India, they are also recognised as a
factor towards minimising the impact of global financial crisis starting in 2007.
o Recommendations - Greater autonomy was proposed for the public sector banks in
order for them to function with equivalent professionalism as their international
counterparts. For this the panel recommended that recruitment procedures,
training and remuneration policies of public sector banks be brought in line with the
best-market-practices of professional bank management. Secondly, the committee
recommended GOI equity in nationalized banks be reduced to 33% for increased
autonomy. It also recommended the RBI relinquish its seats on the board of
directors of these banks. As such the committee recommended a review of
functions of banks boards with a view to make them responsible for enhancing
shareholder value through formulation of corporate strategy and reduction of
government equity.
o Most of the recommendations were accepted although some recommendations like
reduction in Government's equity to 33%, the issue of greater professionalism and
independence of the board of directors of public sector banks are still awaiting
Government follow-through and implementation.

Let us discuss the important Financial Institutions of India now

I. The Reserve Bank of India


The Reserve Bank of India (RBI) is India's central banking institution, which controls the
monetary policy of the Indian rupee. It was established on 1 April 1935 during the British Raj
in accordance with the provisions of the Reserve Bank of India Act, 1934. It was set up on
the recommendation of the Hilton Young Committee. The share capital was divided into
shares of 100 each fully paid, which was entirely owned by private shareholders in the
beginning. Following India's independence in 1947, the RBI was nationalised in the year
1949.
The RBI plays an important part in the development strategy of the Government of India. It
is a member bank of the Asian Clearing Union. The general superintendence and direction
of the RBI is entrusted with the 21-member-strong Central Board of Directorsthe
Governor (currently Duvvuri Subbarao), four Deputy Governors, two Finance Ministry
representatives, ten government-nominated directors to represent important elements
from India's economy, and four directors to represent local boards headquartered at
Mumbai, Kolkata, Chennai and New Delhi. Each of these local boards consists of five
members who represent regional interests, as well as the interests of co-operative and
indigenous banks.
o The Asian Clearing Union (ACU), with headquarters in Tehran, Iran, was established
on December 9, 1974 at the initiative of the United Nations Economic and Social
Commission for Asia and the Pacific (ESCAP). The primary objective of ACU, at the
time of its establishment, was to secure regional co-operation as regards the
settlement of monetary transactions among the members of the Union and to
provide a system for clearing payments among the member countries on a
multilateral basis. It has 9 members, including India.
II. Commercial Banks

Banks are institutions which accept deposits and make use of those deposits. Banks in India are
generally classified into

Public Sector Banks


Private Sector Banks
Cooperative Banks
Regional Rural Banks
Foreign Banks
The banking system comprises of scheduled banks (banks that are listed under the Second
Schedule of the RBI Act, 1934). Unscheduled banks form a very small component (function in
the form of Local Area Bank). In order to be included under this schedule of the RBI Act,
banks have to fulfil certain conditions such as having a paid up capital and reserves of at
least 0.5 million and satisfying the Reserve Bank that its affairs are not being conducted in a
manner prejudicial to the interests of its depositors. Scheduled banks are further classified
into commercial and cooperative banks, with the basic difference in their holding pattern.
Cooperative banks are cooperative credit institutions that are registered under the
Cooperative Societies Act and work according to the cooperative principles of mutual
assistance. Perhaps the single most important event in the history of Indian Banking post-
independence was nationalization of private banks. Although nationalization happened in
1969, it was not that the government had not controlled banking before that.
The Government of India nationalised the Imperial Bank of India in 1955, with the Reserve Bank of
India taking a 60% stake, and renamed it the State Bank of India. SBI is the biggest commercial
bank in India.

In 2008, the government took over the stake held by the Reserve Bank of India in SBI.
SBI has been ranked 285th in the Fortune Global 500 rankings of the world's biggest
corporations for the year 2012.
As in December 2012, it had assets of US$501 billion and 15,003 branches, including 157
foreign offices making it the largest banking and financial services company in India by
assets.
Earlier SBI had seven associate banks, all of which had belonged to princely states until the
government nationalised them between October 1959 and May 1960. There has been a
proposal to merge all the associate banks into SBI to create a "mega bank" and streamline
the group's operations. The first step towards unification occurred in August 2008 when
State Bank of Saurashtra merged with SBI, reducing the number of associate state banks
from seven to six. Then in June 2009 the SBI board approved the absorption of State Bank
of Indore.
SBI has five associate bank as of today:
i State Bank of Bikaner & Jaipur
ii State Bank of Hyderabad
iii State Bank of Mysore
iv State Bank of Patiala
v State Bank of Travancore
III. Industrial Development Bank of India (IDBI)

IDBI Bank Limited is a developmental financial service company headquartered Mumbai. RBI has
categorised IDBI as an "other public sector bank" the only bank in this category, treated at par
with other nationalized banks. It was established in 1964 by an Act of Parliament to provide
credit and other facilities for the development of the fledgling Indian industry. It is currently
10th largest development bank in the world in terms of reach with 1594 ATMs, 1000 branches
including one overseas branch at DIFC, Dubai and 678 centers including two overseas centres at
Singapore & Beijing.

IV. Industrial Finance Corporation of India (IFCI)

At the time of independence in 1947, India's capital market was relatively underdeveloped.
Although there was significant demand for new capital, there was a dearth of providers.
Merchant bankers and underwriting firms were almost non-existent. And commercial banks
were not equipped to provide long-term industrial finance in any significant manner. It is against
this backdrop that the government established the Industrial Finance Corporation of India (IFCI)
on July 1, 1948, as the first Development Financial Institution (DFI) in the country to cater to
the long-term finance needs of the industrial sector. The newly-established DFI was provided
access to low-cost funds through the central bank's Statutory Liquidity Ratio or SLR which in turn
enabled it to provide loans and advances to corporate borrowers at concessional rates.

This arrangement continued until the 1990s when it was recognized that there was need for
greater flexibility to respond to the changing financial system. It was also felt that IFCI should
directly access the capital markets for its funding needs. It is with this objective the constitution
of IFCI was changed in 1993 from a statutory corporation to a company under the Indian
Companies Act, 1956. Subsequently the name of the company was also changed to 'IFCI Limited '
with effect from October 1999.

IFCI has fulfilled its original mandate as a DFI by providing long term financial support to
all segments of Indian Industry. It has also been chiefly instrumental in translating the
government's development priorities into reality. Until the establishment of ICICI in
1956, IFCI remained solely responsible for implementation of the government's
industrial policy initiatives. Its contribution to the modernization of Indian Industry,
export promotion, import substitution, entrepreneurship development, pollution
control, energy conservation and generation of both direct and indirect employment is
noteworthy.
V. Export - Import Bank of India (Exim Bank)

Export-Import Bank of India is the premier export finance institution of the country, established
in 1982 under the Export-Import Bank of India Act 1981. Government of India launched the
institution with a mandate, not just to enhance exports from India, but to integrate the countrys
foreign trade and investment with the overall economic growth. The Bank extends lines of credit
to overseas financial institutions, foreign governments and their agencies, enabling them to
finance imports of goods and services from India on deferred credit terms. Exim Banks lines of
Credit obviate credit risks for Indian exporters and are of particular relevance to SME exporters.

In 2010, at the behest of Government of India, Exim Bank extended a Line of Credit
(LOC) of USD 1 billion to the Government of Bangladesh, for financing goods and
services including project exports from India into Bangladesh. The USD 1 billion is the
largest ever Exim Bank's GOI-supported LOC to any country.

VI. Industrial Reconstruction Bank of India (IRBI) now (Industrial Investment Bank of India)

The Industrial Investment Bank of India is a 100% government of India-owned financial


investment institution. It was established in 1971 by resolution of the Parliament of India.
The bank was headquartered at Kolkata and has presence in New Delhi, Mumbai, Chennai,
Bengaluru, Ahmedabad and Guwahati.
The Industrial Reconstruction Corporation of India Ltd., set up in 1971 for rehabilitation of
sick industrial companies, was reconstituted as Industrial Reconstruction Bank of India in
1985 under the IRBI Act, 1984. With a view to converting the institution into a full-fledged
development financial institution, IRBI was incorporated under the Companies Act 1956, as
Industrial Investment Bank of India Ltd. (IIBI) in March 1997. IIBI offers a wide range of
products and services, including term loan assistance for project finance, short duration non-
project asset-backed financing, working capital/other short-term loans to companies, equity
subscription, asset credit, equipment finance and investments in capital market and money
market instruments.
VII. National Bank for Agriculture and Rural Development (NABARD)

National Bank for Agriculture and Rural Development (NABARD) is an apex development bank in
India having headquarters based in Mumbai and other branches are all over the country. The
Committee to Review Arrangements for Institutional Credit for Agriculture and Rural
Development (CRAFICARD), set up by the Reserve Bank of India (RBI) under the Chairmanship of
B. Sivaraman, conceived and recommended the establishment of the National Bank for
Agriculture and Rural Development (NABARD). It was established on 12 July 1982 by a special
act by the parliament and its main focus was to uplift rural India by increasing the credit flow
for elevation of agriculture & rural non-farm sector. It has been accredited with "matters
concerning policy, planning and operations in the field of credit for agriculture and other
economic activities in rural areas in India".

RBI sold its stake in NABARD to the Government of India, which now holds 99% stake
VIII. Small Industries Development Bank of India (SIDBI)

Small Industries Development Bank of India (SIDBI), set up on April 2, 1990 under an Act of
Indian Parliament, is the Principal Financial Institution for the Promotion, Financing and
Development of the Micro, Small and Medium Enterprise (MSME) sector and for Co-ordination
of the functions of the institutions engaged in similar activities.

The business domain of SIDBI consists of Micro, Small and Medium Enterprises (MSMEs), which
contribute significantly to the national economy in terms of production, employment and
exports. MSME sector is an important pillar of Indian economy as it contributes greatly to the
growth of Indian economy with a vast network of around 3 crore units, creating employment of
about 7 crore, manufacturing more than 6,000 products, contributing about 45% to
manufacturing output and about 40% of exports, directly and indirectly. In addition, SIDBI's
assistance also flows to the service sector including transport, health care, tourism sectors etc.

IX. National Housing Bank (NHB)

The National Housing Bank (NHB) is a state owned bank and regulation authority in India,
created on July 8, 1988 under section 6 of the National Housing Bank Act (1987). The
headquarters is in New Delhi. The institution, owned by the Reserve Bank of India, was
established to promote private real estate acquisition. The NHB is regulating and re-financing
social housing programs and other activities like research and IT-initiatives, too.
X. Unit Trust of India (UTI)
Unit Trust of India was a financial organization in India, created by the UTI Act passed by the
Parliament in 1964. For more than two decades it remained the sole vehicle for investment in
the capital market by the Indian citizens. In mid- 1980s public sector banks were allowed to
open mutual funds. The real vibrancy and competition in the MF industry came with the setting
up of the regulator SEBI and its laying down the MF Regulations in 1993.UTI maintained its pre-
eminent place till 2001, when a massive decline in the market indices and negative investor
sentiments after Ketan Parekh scam created doubts about the capacity of UTI to meet its
obligations to the investors. This was further compounded by two factors; namely, its flagship
and largest scheme US 64 was sold and re-purchased not at intrinsic NAV but at artificial price
and its Assured Return Schemes had promised returns as high as 18% over a period going up to
two decades.
Fearing a run on the institution and possible impact on the whole market Government came out
with a rescue package and change of management in 2001.Subsequently, the UTI Act was
repealed and the institution was divided into two parts.
UTI Mutual Fund was created as a SEBI registered fund like any other mutual fund.
The assets and liabilities of schemes where Government had to come out with a bail-out
package were taken over directly by the Government in a new entity called Specified
Undertaking of UTI (SUUTI).
o SUUTI, created in 2002 after the then UTI was wound up, owns strategic stakes
in three listed blue-chip entities: ITC (11.54%), Axis Bank (23.6%) and L&T
(8.3%).
o Besides, SUUTI also owns significant stakes in unlisted companies such as the
Stock Holding Corporation of India (SHCIL), in which it owns 16.96% that is
valued at about Rs300 crore.
o The government is planning to en-cash these holdings which are worth over Rs
40,000 crore, as part of its efforts at meeting the fiscal deficit target by
divestment.
XI. Life Insurance Corporation of India (LIC)

Life Insurance Corporation of India (LIC) is the largest insurance group and investment company
in India. Its a state-owned where Government of India has 100%stake. LIC also funds close to
24.6% of the Indian Government's expenses. It has assets estimated of 13.25 trillion (US$240
billion). It was founded in 1956 with the merger of 245 insurance companies and provident
societies(154 life insurance companies,16 foreign companies & 75 provident companies).

XII. General Insurance Corporation of India (GIC)

GIC of India (GIC Re) is the sole reinsurance company in the Indian insurance market with over
three decades of experience. GIC has its registered office and headquarters in Mumbai. The
entire general insurance business in India was nationalised by the Government of India (GOI)
through the General Insurance Business (Nationalisation) Act (GIBNA) of 1972. 55 Indian
insurance companies and 52 other general insurance operations of other companies were
nationalized through the act.

The General Insurance Corporation of India (GIC) was formed in pursuance of Section 9(1) of
GIBNA. It was incorporated on 22 November 1972 under the Companies Act, 1956 as a private
company limited by shares.

Reinsurance is insurance that is purchased by an insurance company from one or more


other insurance companies (the "reinsurer") as a means of risk management, sometimes
in practice including tax mitigation and other similar reasons. The ceding company and
the reinsurer enter into a reinsurance agreement which details the conditions upon
which the reinsurer would pay a share of the claims incurred by the ceding company.
The reinsurer is paid a "reinsurance premium" by the ceding company, which issues
insurance policies to its own policyholders.
o The reinsurer may be either a specialist reinsurance company, which only
undertakes reinsurance business, or another insurance company.
o For example, assume an insurer sells 1000 policies, each with a $1 million policy
limit. Theoretically, the insurer could lose $1 million on each policy totalling up
to $1 billion. It may be better to pass some risk to a reinsurer as this will reduce
the ceding company's exposure to risk.

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