2011

Thoth Vipin Srinath

[INDIAN FINANCIAL SYSTEM]

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

Chapter 1 Financial System In finance, the financial system is the system that allows the transfer of money between savers and borrowers. It comprises a set of complex and closely interconnected financial institutions, markets, instruments, services, practices, and transactions. Financial systems are crucial to the allocation of resources in a modern economy. They channel household savings to the corporate sector and allocate investment funds among firms; they allow inter-temporal smoothing of consumption by households and expenditures by firms; and they enable households and firms to share risks. These functions are common to the financial systems of most developed economies. Yet the form of these financial systems varies widely. Institutions in Financial System The main players are the global institutions, such as International Monetary Fund and Bank for International Settlements, national agencies and government departments, e.g., central banks and finance ministries, private institutions acting on the global scale, e.g., banks and hedge funds, and regional institutions, e.g., the Eurozone. Governments act in various ways as actors in the GFS, primarily through their finance ministries: they pass the laws and regulations for financial markets, and set the tax burden for private players, e.g., banks, funds and exchanges. They also participate actively through discretionary spending. They are closely tied (though in most countries independent of) to central banks that issue government debt, set interest rates and deposit requirements, and intervene in the foreign exchange market.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

Players active in the stock-, bond-, foreign exchange-, derivatives- and commoditiesmarkets, and investment banking, including: Commercial banks Hedge funds and Private Equity Pension funds Insurance companies Mutual funds Sovereign wealth funds

Markets In economics, a financial market is a mechanism that allows people to buy and sell (trade) financial securities (such as stocks and bonds), commodities (such as precious metals or agricultural goods), and other fungible items of value at low transaction costs and at prices that reflect the efficient-market hypothesis. In finance, financial markets facilitate: The raising of capital (in the capital markets) The transfer of risk (in the derivatives markets) The transfer of liquidity (in the money markets) International trade (in the currency markets)

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 includes the stock market (equity securities) and the bond market (debt). Financial regulators, such as the UK's Financial Services Authority (FSA) or the U.S. Securities and Exchange Commission (SEC), oversee the capital markets in their designated

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

jurisdictions to ensure that investors are protected against fraud, among other duties. In India SEBI does the similar role. Capital markets may be classified as primary markets and secondary markets a) Primary Market: 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 typically done through a syndicate of securities dealers. The process of selling new issues to investors is called underwriting. In the case of a new stock issue, this sale is an initial public offering (IPO). Dealers earn a commission that is built into the price of the security offering, though it can be found in the prospectus. Primary markets create long term instruments through which corporate entities borrow from capital market. Features of primary markets are: 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). 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 primary market performs the crucial function of facilitating capital formation in the economy. The new issue market does not include certain other sources of new long term external finance, such as loans from financial institutions. Borrowers in

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

the new issue market may be raising capital for converting private capital into public capital; this is known as "going public." The financial assets sold can only be redeemed by the original holder.

Methods of issuing securities in the primary market are: Initial public offering; Rights issue (for existing companies); Preferential issue.

b) Secondary Market: The secondary market, also called aftermarket, is the financial market where previously issued securities and financial instruments such as stock, bonds, options, and futures are bought and sold. In the secondary market, securities are sold by and transferred from one investor to another. It is therefore important that the secondary market be highly liquid (originally, the only way to create this liquidity was for investors and speculators to meet at a fixed place regularly; this is how stock exchanges originated).

The secondary market for a variety of assets can vary from loans to stocks, from fragmented to centralized, and from illiquid to very liquid. The major stock exchanges are the most visible example of liquid secondary markets - in this case, for stocks of publicly traded companies. Exchanges such as the BSE, NYSE and NASDAQ provide a centralized, liquid secondary market for the investors who own stocks that trade on those exchanges.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

Money Markets The money market is a component of the financial markets for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames. Trading in the money markets involves Treasury bills, commercial paper, bankers' acceptances, certificates of deposit, federal funds, and short-lived mortgage- and asset-backed securities. It provides liquidity funding for the global financial system. Types of Money Market Instruments in India Money market instruments provide for borrowers' short-term needs and gives needed liquidity to lenders. The types of money market instruments are treasury bills, repurchase agreements, commercial papers, certificate of deposit, and banker's acceptance.

a) Treasury Bills (T-Bills): Treasury bills began being issued by the Indian government in 1917. They are short-term instruments issued by the Reserve Bank of India. They are one of the safest money market instruments because they are risk free, but the returns from this instrument are not very large. The primary as well as the secondary markets circulate this instrument. They have 3-month, 6-month and 1-year maturity periods. T-bills are issued with a separate price from their face value. The face value is achieved upon maturity, as is the interest earned on the buy value. The buy value is set by a bidding process in auctions.

b) Repurchase Agreements: Repurchase agreements are also known as repos. They are short-term loans that buyers and sellers agree to sell and repurchase. As of 1992, repo transactions are allowed only between RBI-approved securities such as state and central government securities, T-bills, PSU bonds, FI bonds and corporate bonds. Repurchase agreements are sold by sellers with a promise of purchasing them back at a given price and on a given date in the future. The buyer will also purchase the

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

securities and other instruments in the repurchase agreement with a promise of selling them back to the seller.

c) Commercial Papers: Commercial papers are promissory notes that are unsecured and issued by companies and financial institutions. They are issued at a discounted rate of their face value. They have a fixed maturity of 1 to 270 days. They are issued for financing of inventories, accounts receivables, and settling short-term liabilities or loans. Commercial papers yield higher returns than T-bills. They are usually issued by companies with strong credit ratings, as these instruments are not backed by collateral. They are usually issued by corporations to raise working capital and are actively traded in the secondary market. Commercial papers were first issued in the Indian money market in 1990.

d) Certificate of Deposit: A certificate or deposit is a short-term borrowing note, like a promissory note, in the form of a certificate. It enables the bearer to receive interest. It has a maturity date, a fixed rate of interest and a fixed value. It usually has a term between 3 months and 5 years. The funds cannot be withdrawn on demand, but it can be liquidated on payment of a penalty. The returns are higher than T-bills as the risk is higher. Returns are based on an annual percentage yield (APY) or annual percentage rate (APR). In APY, interest is gained by compounded interest calculation, whereas in APR simple interest calculation is done to calculate the return. The certificate of deposit was first introduced to the money market of India in 1989.

e) Banker's Acceptance: A banker's acceptance is a short-term investment plan created by a company or firm with a guarantee from a bank. It is a guarantee from the bank that a buyer will pay the seller at a future date. A good credit rating is required by the company or firm drawing the bill. The terms for these instruments are usually 90

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

days, but this period can vary between 30 and 180 days. Companies use the acceptance as a time draft for financing imports, exports and other trade

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

Chapter 2 Commercial Banks Commercial banks are banking institutions which accept deposits from the public and grant short-term loans and advances to their customers. In India, there are nationalised (public sector) commercial banks as well as private sector banks which are corporate organisations. The largest commercial bank is the State Bank of India which was established in 1955 under a special Act. The main source of income of commercial banks is the difference between the interest they charge on loans and the interest they allow on deposits. Commercial banks generally grant short-term loans repayable within one year. But they also meet the medium-term and long-term requirements of business enterprises. Besides accepting deposits and lending money, commercial banks provide other services such as issue of bank drafts, travellers cheques and letters of credit, collection of bills, dividends and interest safe keeping of valuables, transfer of money from one place to another, payment of insurance premium etc. Functions of Banks The functions of commercial banks are divided into two categories: a) Primary functions, and b) Secondary functions including agency functions.

Primary functions: The primary functions of a commercial bank include: a) Accepting deposits: The most important activity of a commercial bank is to mobilise deposits from the public. People who have surplus income and savings find it convenient to deposit the amounts with banks. Depending upon the nature of deposits, funds deposited with bank also earn interest. Thus, deposits with the bank grow along with the interest earned. If the rate of interest is higher, public are

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

motivated to deposit more funds with the bank. There is also safety of funds deposited with the bank. b) Granting loans and advances: The second important function of a commercial bank is to grant loans and advances. Such loans and advances are given to members of the public and to the business community at a higher rate of interest than allowed by banks on various deposit accounts. The rate of interest charged on loans and advances varies depending upon the purpose, period and the mode of repayment. The difference between the rate of interest allowed on deposits and the rate charged on the Loans is the main source of a banks income. i. Loans: A loan is granted for a specific time period. Generally, commercial banks grant short-term loans. But term loans, that is, loan for more than a year, may also be granted. The borrower may withdraw the entire amount in lump sum or in instalments. However, interest is charged on the full amount of loan. Loans are generally granted against the security of certain assets. A loan may be repaid either in lump sum or in instalments. ii. Advances: An advance is a credit facility provided by the bank to its customers. It differs from loan in the sense that loans may be granted for longer period, but advances are normally granted for a short period of time. Further the purpose of granting advances is to meet the day to day requirements of business. The rate of interest charged on advances varies from bank to bank. Interest is charged only on the amount withdrawn and not on the sanctioned amount.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

Structure of Commercial Banks

Sources of Funds a) Current Account: Also called demand deposit, current deposit can be withdrawn by the depositor at any time by cheques. Businessmen generally open current accounts with banks. Current accounts do not carry any interest as the amount deposited in these accounts is repayable on demand without any restriction.The Reserve bank of India prohibits payment of interest on current accounts or on deposits upto 14 Days or less except where prior sanction has been obtained. Banks usually charge a small amount known as incidental charges on current deposit accounts depending on the number of transaction.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

b) Savings Account: Savings deposit account is meant for individuals who wish to deposit small amounts out of their current income. It helps in safe guarding their future and also earning interest on the savings. A saving account can be opened with or without cheque book facility. There are restrictions on the withdrawls from this account. Savings account holders are also allowed to deposit cheques, drafts, dividend warrants, etc. drawn in their favour for collection by the bank. To open a savings account, it is necessary for the depositor to be introduced by a person having a current or savings account with the same bank. c) Fixed Deposit: The term Fixed deposit means deposit repayable after the expiry of a specified period. Since it is repayable only after a fixed period of time, which is to be determined at the time of opening of the account, it is also known as time deposit. Fixed deposits are most useful for a commercial bank. Since they are repayable only after a fixed period, the bank may invest these funds more profitably by lending at higher rates of interest and for relatively longer periods. The rate of interest on fixed deposits depends upon the period of deposits. The longer the period, the higher is the rate of interest offered. The rate of interest to be allowed on fixed deposits is governed by rules laid down by the Reserve Bank of India. d) Recurring Deposits are gaining wide popularity these days. Under this type of deposit, the depositor is required to deposit a fixed amount of money every month for a specific period of time. Each instalment may vary from Rs.5/- to Rs.500/- or more per month and the period of account may vary from 12 months to 10 years. After the completion of the specified period, the customer gets back all his deposits along with the cumulative interest accrued on the deposits. e) Banks have introduced several deposit schemes to attract deposits from different types of people, like Home Construction deposit scheme, Sickness Benefit deposit scheme, Children Gift plan, Old age pension scheme, Mini deposit scheme, etc.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

Factors Affecting Liquidity of Banks 1. Statutory requirements: The extent of liquid reserves held by banks depends on the statutory requirements of the Central Bank (i.e. the RBI) According to RBI, commercial banks have to maintain a certain CRR(cash Reserve Ratio ) and SLR (statutory liquid ratio) Higher CRR and SLR result in lower liquidity. 2. Banking Habits of the people: The nature of the economy has an impact on the banking habits of the people. In developing countries, cheque transactions are confined to business. Individuals depend more on cash transactions. Hence, the need for liquidity is comparatively higher. 3. Monetary transactions: The number and magnitude of monetary transactions determine the liquidity of banks. Higher monetary transaction leads to higher liquidity. 4. Nature of Money market: In case of fully developed money markets, banks buy and sell securities easily. Therefore, liquidity requirement is lower. 5. Structure of banking system: Branch banking system requires lower liquidity since cash reserves can be centralized in the head office. Unit Banking System requires higher degree of liquidity. 6. Number and size of Deposits: The number and sized of deposits influence the liquidity of banks. Increase in the number & size of deposits will require higher liquidity. 7. Nature of Deposits: Deposits trade with the banks are of various types like time deposits, demand deposits, short term deposits, etc. larger demand deposits /short term deposits need higher liquidity 8. Liquidity Policies of other banks: Various banks may function in the same area. So, liquidity policies of other banks also have an impact on the liquidity of a bank to build goodwill among depositors.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

Asset Structure of Commercial Bank This includes a) Cash Balances: amount of available cash that a management decides to maintain in cash planning, to avoid or cover up cash shortfalls resulting from mismatch between cash inflows and outflows during an accounting period. b) Money at Call: A short-term loan that does not have a set repayment schedule, but is payable immediately and in full upon demand. Money-at-call loans give banks a way to earn interest while retaining liquidity. Investors might use money at call to cover a margin account. The interest rate on such loans is called the call-loan rate. c) Short Term Bills: These include Treasury bills or any other investment made by the bank in a government security with a maturity less than 1 year. d) Loans And Advances: (explained previously) e) Misc Investments Profitability of Banks 1. Amount of working funds: Funds deployed by a bank in profitable assets are the working funds of the bank. Profitability of a business is directly proportionate to the amount of working funds deployed by the bank. 2. Cost of funds: Cost of funds are the expenses incurred on obtaining funds from various sources in the form of share capital, reserves, deposits, and borrowings. Thus, it generally refers to interest expenses. Lower the cost of funds, higher the profitability. 3. Yield on funds: The funds raised by the bank through various sources are deployed in various assets. These assets yield income in the form of interest. So, higher the interest, greater the profitability. 4. Spread: Spread is defined as the difference between the interest received (interest income) and the interest paid (interest expense). Higher spread indicates more efficient financial intermediation and higher net income. Thus, higher spread leads to higher profitability.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

5. Operating Costs: Operating costs are the expenses incurred in the functioning of the bank. Excluding cost of funds, all other expenses are operating costs. Lower operating costs give rise to greater profitability of the banks. 6. Risk cost: This cost is associated to the probable annual loss on assets. They include provisions made towards bad debts and doubtful debts. Lower risk costs increase the profitability of banks. 7. Non interest income: It is the income derived from non financial assets and services; it includes commission & brokerage on remittance facility, rent of locker facility, fees for underwriting and financial guarantees, etc. This income adds to the profitability of banks. 8. Level of technology: Use of upgraded technology normally leads to decline in the operating costs of banks. This improves the profitability of banks. 9. Level of Non performing assets (NPAs): The profitability of a bank is inversely related to the level of NPAs. Hence, over the years, the NPAs of commercial banks have greatly declined. 10. Level of competition: Increase in competition generally leads to higher operating costs. This leads to lower profitability.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

Chapter 3 IDBI The Industrial Development Bank of India Limited (IDBI) is one of India's leading public sector banks and 4th largest Bank in overall ratings. RBI categorised IDBI as an "other public sector bank". 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 1392 ATMs, 833 branches including one overseas branch at DIFC, Dubai and 555 centers including two overseas centres at Singapore & Beijing. Objectives of IDBI The main objectives of IDBI are to serve as the apex institution for term finance for industry in India. Its objectives include a) Co-ordination, regulation and supervision of the working of other financial institutions such as IFCI , ICICI, UTI, LIC, Commercial Banks and SFCs. b) Supplementing the resources of other financial institutions and thereby widening the scope of their assistance. c) Planning, promotion and development of key industries and diversifications of industrial growth. d) Devising and enforcing a system of industrial growth that conforms to national priorities. Function of IDBI The IDBI has been established to perform the following functionsa) To grant loans and advances to IFCI, SFCs or any other financial institution by way of refinancing of loans granted by such institutions which are repayable within 25 year. b) To grant loans and advances to scheduled banks or state co-operative banks by way of refinancing of loans granted by such institutions which are repayable in 15 years.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

c) To grant loans and advances to IFCI, SFCs, other institutions, scheduled banks, state co-operative banks by way of refinancing of loans granted by such institution to industrial concerns for exports. d) To discount or rediscount bills of industrial concerns. e) To underwrite or to subscribe to shares or debentures of industrial concerns. f) To subscribe to or purchase stock, shares, bonds and debentures of other financial institutions. g) To grant line of credit or loans and advances to other financial institutions such as IFCI, SFCs, etc. h) To grant loans to any industrial concern. i) To guarantee deferred payment due from any industrial concern. j) To guarantee loans raised by industrial concerns in the market or from institutions. k) To provide consultancy and merchant banking services in or outside India. l) To provide technical, legal, marketing and administrative assistance to any industrial concern or person for promotion, management or expansion of any industry. m) Planning, promoting and developing industries to fill up gaps in the industrial structure in India. n) To act as trustee for the holders of debentures or other securities.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

State Financial Corporations A Central Industrial Finance corporation was set up under the industrial Finance corporations Act, 1948 in order to provide medium and long term credit to industrial undertakings which fall outside normal activities of commercial banks. The State governments expressed their desire that similar corporations be set up in states to supplement the work of the Industrial financial corporation. State governments also expressed that the State corporations be established under a special statue in order to make it possible to incorporate in the constitutions necessary provisions in regard to majority control by the government, guaranteed by the State government in regard to the payment principal. In order to implement the views Expressed by the State governments the State Financial Corporation bill was introduced in the Parliament. Objectives of SFCs The state governments wished that similar corporations should be set up in their states to supplement the work of industrial financial corporation. The intention is that the State corporations will confine to financing medium and small scale industrial and will , as far as possible consider only such access which are outside the perview of industrial fianc corporation. Functions of SFCs a) Project advisory and Finance AS a catalyst in small scale industrial growth the SFCs provide the following services: i. ii. Investment appraisal Project conceptualization and related services, including guidance in relation to selection of projects, preparation of feasibility studies, capital structuring, techno economic feasibility, financial engineering, project management design etc. iii. Credit Syndication including assistance in legal documentation etc. Documentation of various project documents

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

b) Placement of debt equity including design of the structure of instruments, placement of instruments with financial institutions, bank etc. c) Assist in organizational structural changes like : Analysis of operational performance Study of existing organizational structure Study of the existing statures and rules and regulations Market analysis with respect to products Review of domestic and international scenario Valuation of fixed assets and inventory Advising on formation of new entity Preparation of relevant agreements / legal documents.

d) Industry Research / Information Services: A dedicated research team looking at both macros level issues as well as sector specific, industry research. e) A full fledged legal cell comprising of experienced professional with expertise in handling cases of diverse nature, offer legal help services . The services rendered by this unit comprise investigations and preparations of title reports, besides advisory services in respect of matters under dispute where an independent consultant view is required. LIC The Life Insurance Corporation of India (LIC) is the largest state-owned life insurance company in India, and also the country's largest investor. It is fully owned by the Government of India. It also funds close to 24.6% of the Indian Government's expenses. It has assets estimated of 9.31 trillion (US$206.68 billion). It was founded in 1956 with the merger of more than 200 insurance companies and provident societies. Headquartered in Mumbai, financial and commercial capital of India, the Life Insurance Corporation of India currently has 8 zonal Offices and 101 divisional offices located in different parts of India, at least 2048 branches located in different cities and towns of India

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

along with satellite Offices attached to about some 50 Branches, and has a network of around 1.2 million agents for soliciting life insurance business from the public. Objectives of LIC a) Spread Life Insurance widely and in particular to the rural areas and to the socially and economically backward classes with a view to reaching all insurable persons in the country and providing them adequate financial cover against death at a reasonable cost. b) Maximize mobilization of people's savings by making insurance-linked savings adequately attractive. c) Bear in mind, in the investment of funds, the primary obligation to its policyholders, whose money it holds in trust, without losing sight of the interest of the community as a whole; the funds to be deployed to the best advantage of the investors as well as the community as a whole, keeping in view national priorities and obligations of attractive return. d) Conduct business with utmost economy and with the full realization that the moneys belong to the policyholders. e) Act as trustees of the insured public in their individual and collective capacities. f) Meet the various life insurance needs of the community that would arise in the changing social and economic environment. g) Involve all people working in the Corporation to the best of their capability in furthering the interests of the insured public by providing efficient service with courtesy. h) Promote amongst all agents and employees of the Corporation a sense of participation, pride and job satisfaction through discharge of their duties with dedication towards achievement of Corporate Objective.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

Functions of LIC a) To carry on capital redemption business, annuity certain business or reinsurance business in so far as such reinsurance business relating to life insurance business; b) To invest the funds of the corporation in such manner as the corporation may think fit and to take all such steps as may be necessary or expedient for the protection or realisation of any investment; including the taking over of and administering any property offered as security for the investment until a suitable opportunity arises for its disposal; c) To acquire, hold and dispose of any property for the purpose of its business; d) To transfer the whole or any part of the life insurance business carried on outside india to any other person or persons, if in the interest of the corporation it is expedient so to do; e) To advance or lend money upon the security of any movable or immovable property or otherwise; f) To borrow or raise any money in such manner and upon such security as the corporation may think fit; g) To carry on either by itself or through any subsidiary any other business in any case where such other business was being carried on by a subsidiary of an insurer whose controlled business has been transferred to and vested in the corporation by this act; h) To carry on any other business which may seem to the corporation to be capable of being conveniently carried on in connection with its business and calculated directly or indirectly to render profitable the business of the corporation; and i) To do all such things as may be incidental or conducive to the proper exercise of any of the powers of the corporation. j) In the discharge of any of its functions the corporation shall act so far as may be on business principles.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

EXIM Bank Export-Import Bank of India is the premier export finance institution of the country, set up 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. Since its inception, Exim Bank of India has been both a catalyst and a key player in the promotion of cross border trade and investment. Commencing operations as a purveyor of export credit, like other Export Credit Agencies in the world, Exim Bank of India has, over the period, evolved into an institution that plays a major role in partnering Indian industries, particularly the Small and Medium Enterprises, in their globalisation efforts, through a wide range of products and services offered at all stages of the business cycle, starting from import of technology and export product development to export production, export marketing, preshipment and post-shipment and overseas investment. Objectives of EXIM Bank a) For providing financial assistance to exporters and importers, and for functioning as the principal financial institution for coordinating the working of institutions engaged in financing export and import of goods and services with a view to promoting the countrys international trade b) Shall act on business principles with due regard to public interest Functions of EXIM Bank a) Corporate Banking Group which handles a variety of financing programmes for Export Oriented Units (EOUs), Importers, and overseas investment by Indian companies. b) Project Finance / Trade Finance Group handles the entire range of export credit services such as supplier's credit, pre-shipment Agri Business Group, to spearhead the initiative to promote and support Agri-exports. The Group handles projects and export transactions in the agricultural sector for financing.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

c) Small and Medium Enterprise: The group handles credit proposals from SMEs under various lending programmes of the Bank. d) Export Services Group offers variety of advisory and value-added information services aimed at investment promotion. e) Export Marketing Services Bank offers assistance to Indian companies, to enable them establish their products in overseas markets. f) Besides these, the Support Services groups, which include: Research & Planning, Corporate Finance, Loan Recovery, Internal Audit, Management Information Services, Information Technology, Legal, Human Resources Management and Corporate Affairs Mutual Funds An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money mangers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus. Objectives of Mutual Funds a) Diversification: Investors are often advised that they shouldn't "put all their eggs in one basket." Investors who have too high of a percentage of their assets in one or two stocks can be severely affected if one of the companies goes belly-up. Most financial experts say investors should have at least 15 stocks in their portfolios. It takes a lot of time and effort to keep up with that many companies. Conversely, mutual funds hold a number of stocks, which gives investors instant diversification and protects them from a sharp decline in any one holding.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

b) Growth: Some mutual fund investors are looking for rapid growth in the value of their funds. Stocks have historically offered the best long-term returns of any asset class, though it can be an up-and-down ride. Stock funds that are labelled "growth" typically invest in companies with bright prospects, while "value" funds target stocks that seem inexpensive compared with the company's earnings. c) Income: Other fund investors care more about receiving income from their investments. Numerous stock funds invest in companies with high dividend payouts. Bond funds also can provide steady income, as can funds that invest in real estate investment trusts, or REITs. All these income-focused funds pass the yields along to their investors, usually on a monthly or quarterly basis. Yields of 3 percent to 7 percent are often available with income-oriented mutual funds.

d) International Exposure: Some large international firms offer their shares on U.S. markets, but others don't. For example, individual investors can have a hard time getting access to shares in the fast-growing Chinese market. But internationalfocused mutual funds have an easier time investing in these shares. Because half the world's corporate value is outside the U.S., it's important to have some exposure to overseas stocks, and mutual funds are the easiest way to get this.

e) Low Fees: Stock picking can be expensive thanks to broker commissions, but many "no-load" mutual funds are available that don't charge investors anything. Many other funds charge investors less than 1 percent a year for operational fees. Investors looking for especially inexpensive funds might consider index funds, which charge fees as low as 0.1 percent per year. These funds usually hold every stock or bond in a given asset class, which offers tremendous diversification at a low cost.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

Functions of Mutual Funds a) Professional Management: Experience and training count for a lot in the world of investments. It is a world where not knowing the right pricing convention can cost you a couple thousand dollars in a few seconds. The key to mutual fund performance and one of its main functions for passive investors is the fact it is a hands-off investment. The fund is professionally managed by money managers and a dedicated research team. b) Diversification: One perk to professional management is diversification, which serves a risk mitigation function for mutual funds. The more diversified your portfolio, the more you can mitigate the risk of losing your original investment value. Another way to say this is, "Don't put all your eggs in one basket." c) Affordability: Affordability is a key consideration for most mutual fund investors. The majority of those who invest in mutual funds do not have huge estates to invest and only small amounts to contribute on a monthly basis. Being able to pay into an investment on a monthly basis provides the mutual fund greater access to a larger investment community. d) Liquidity: In addition to affordability, mutual fund shares can be easily redeemed (provided redemption fees or back-end funds are not excessive). Increased liquidity contributes to lowering the overall level of risk of investing in anything that is not as liquid as cash.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

Chapter 4 RBI The Reserve Bank of India is the central banking institution of India and controls the monetary policy of the rupee as well as US$300.21 billion (2010)of currency reserves. The institution was established on 1 April 1935 during the British Raj in accordance with the provisions of the Reserve Bank of India Act, 1934 and plays an important part in the development strategy of the government. It is a member bank of the Asian Clearing Union. Organization of RBI 1. Board of Directors: The Reserve Bank's affairs are governed by a central board of directors. The board is appointed by the Government of India in keeping with the Reserve Bank of India Act.

Appointed/nominated for a period of four years Constitution: o Official Directors Full-time : Governor and not more than four Deputy Governors o Non-Official Directors Nominated by Government: ten Directors from various fields and one government Official Others: four Directors - one each from four local boards

Functions: General superintendence and direction of the Bank's affairs 2. Local Boards

One each for the four regions of the country in Mumbai, Calcutta, Chennai and New Delhi

Membership: consist of five members each appointed by the Central Government for a term of four years

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

Functions: a) To advise the Central Board on local matters and to represent territorial and economic interests of local cooperative and indigenous banks; b) To perform such other functions as delegated by Central Board from time to time.

3. Financial Supervision: The Reserve Bank of India performs this function under the guidance of the Board for Financial Supervision (BFS). The Board was constituted in November 1994 as a committee of the Central Board of Directors of the Reserve Bank of India. The Board is constituted by co-opting four Directors from the Central Board as members for a term of two years and is chaired by the Governor. The Deputy Governors of the Reserve Bank are ex-officio members. One Deputy Governor, usually, the Deputy Governor in charge of banking regulation and supervision, is nominated as the Vice-Chairman of the Board. Some of the initiatives taken by BFS include: Restructuring of the system of bank inspections Introduction of off-site surveillance, Strengthening of the role of statutory auditors and Strengthening of the internal defences of supervised institutions.

The Audit Sub-committee of BFS has reviewed the current system of concurrent audit, norms of empanelment and appointment of statutory auditors, the quality and coverage of statutory audit reports, and the important issue of greater transparency and disclosure in the published accounts of supervised institutions.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

Functions of RBI 1. Monetary Authority:

Formulates, implements and monitors the monetary policy. Objective: maintaining price stability and ensuring adequate flow of credit to productive sectors.

2. Regulator and supervisor of the financial system:

Prescribes broad parameters of banking operations within which the country's banking and financial system functions.

Objective: maintain public confidence in the system, protect depositors' interest and provide cost-effective banking services to the public.

3. Manager of Foreign Exchange

Manages the Foreign Exchange Management Act, 1999. Objective: to facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India.

4. Issuer of currency:

Issues and exchanges or destroys currency and coins not fit for circulation. Objective: to give the public adequate quantity of supplies of currency notes and coins and in good quality.

5. Developmental role

Performs a wide range of promotional functions to support national objectives.

6. Related Functions

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

Banker to the Government: performs merchant banking function for the central and the state governments; also acts as their banker.

Banker to banks: maintains banking accounts of all scheduled banks.

Monetary Policy of RBI 2010-2011

Repo rate and Reverse repo rate increased by 25 bps to 5.25% and 3.75% respectively, with immediate effect. Impact: Repo is the rate at which banks borrow from RBI and Reverse Repo is the rate at which banks deploy their surplus funds with RBI. Both these rates are used by financial system for overnight lending and borrowing purposes. An increase in these policy rates imply borrowing and lending costs for banks would increase and this should lead to overall increase in interest rates like credit, deposit etc. The higher interest rates will in turn lead to lower demand and thereby lower inflation. The move was in line with market expectations

Cash reserve ratio (CRR) increased by 25 bps to 6.00%, to apply from fortnight beginning from 24 April 2010. Impact: When banks raise demand and time deposits, they are required to keep a certain percent with RBI. This percent is called CRR. An increase in CRR implies banks would be required to keep higher percentage of fresh deposits with RBI. This will lead to lower liquidity in the system. Higher liquidity leads to asset price inflation and also leads to build up of inflationary expectations. Before the policy, market participants were divided over CRR. Some felt CRR should not be raised as liquidity would be needed to manage the government borrowing program, 3-G auctions and credit growth. Others felt CRR should be increased to check excess liquidity into the system which was feeding into asset price inflation and general inflationary expectations. Some in the second group even advocated a 50 bps hike in CRR. By increasing the rate by 25 bps, RBI has signalled that though it wants to tighten liquidity it also wants to keep ample liquidity to meet the outflows. Governors statement added that in 2010-11, despite lower budgeted borrowings, fresh issuance will be around Rs 342300 cr compared to Rs 251000 cr last year.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

RBIs Domestic Outlook for 2010-11 Table 1: RBIs Indicative Projections (All Fig In %, YoY) 2009-10 targets 2009-10 2010-11 targets

(Jan 10 Policy) Actual Numbers (Apr 10 Policy) GDP 7.5 Expected at 7.2 8 by CSO Inflation (based on 8.5 9.9 with an

upward bias 5.5

WPI, for March end) Money Supply (March 16.5 end) Credit (March end) Deposit (March end) Source: RBI 16 17 17 17.1 20 18 17.3 17

Growth: RBI revised its growth forecast upwards for 2010-11 at 8% with an upward bias compared to 2009-10 figure of 7.5%. It said Indian economy is firmly on the recovery path. RBIs business outlook survey shows corporates are optimistic over the business environment. Growth in industrial sector and services has picked up in second half of 2009-10 and is expected to continue. The exports and import sector has also registered a strong growth. It is important to note that RBI has placed the growth under the assumption of a normal monsoon. India could have achieved a near 8% growth in 2009-10 itself, if monsoons were better. Table 2 looks at growth forecasts of Indian economy for 2010-11 by various agencies.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

Table 2:Projections of GDP Growth by various agencies for 2010-11 (in %, YoY) 2009-10 RBI 7.5 with 2010-11 an 8 with an upward bias 8.2

upward bias PMs Council Ministry of Finance IMF Asian Development Bank OECD 7.2 6.7 7.2 6.1 Economic Advisory 7.2

8.5 (+/- 0.25) 8 8.2 7.3 8.5

RBIs Survey of Professional 7.2 Forecasters

Inflation: RBIs inflation projection for March 11 is at 5.5% compared to FY March-10 estimate of 8.5% with an upward bias (the final figure was at 9.9%). RBI said inflation is no longer driven by supply side factors alone. First WPI non-food manufactured products (weight: 52.2 per cent) inflation, increased sharply from (-) 0.4%in November 2009, to 4.7% in March 2010. Fuel price inflation also surged from (-) 0.7 per cent in November 2009 to 12.7% in March 2010. Further, contribution of non-food items to overall WPI inflation, which was negative at (-) 0.4% in November 2009 rose sharply to 53.3% by March 2010. So, overall demand pressures on inflation are also beginning to show signs. These movements were visible in March 2010 itself, pushing RBI to increase rates before the official policy in April 2010.

Monetary Aggregates: RBI has increased the projections of all three monetary aggregates for 2010-11. These projections have been made consistent with higher expected growth in 2010-11. Higher growth will lead to more demand for credit. Then management of

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

government borrowing program will remain a challenge as well. High growth coupled with the borrowing program will need higher financial resources. Therefore, projections for money supply, credit and deposit are raised to 17%, 20% and 18% respectively.However, higher growth in money supply would also lead to build up of higher inflation and inflationary expectations There are various measures to calculate money supply. Each measure can be classified by placing it along a spectrum between narrow and broad monetary aggregates. Narrow money includes most acceptable and liquid forms of payment like currency and bank demand deposits. Broad money includes narrow money and other kinds of bank deposits like time deposits, post office savings account etc. Our exchange rate policy is not guided by a fixed or pre-announced target or band. Our policy has been to retain the flexibility to intervene in the market to manage excessive volatility and disruptions to the macroeconomic situation. Recent experience has underscored the issue of large and often volatile capital flows influencing exchange rate movements against the grain of economic fundamentals and current account balances. There is, therefore, a need to be vigilant against the build-up of sharp and volatile exchange rate movements and its potentially harmful impact on the real economy. Policy Stance The policy stance remains unchanged from January 2010 policy. Table 3: Comparing RBIs Policy Stance October 2009 Policy

January 2010 Policy

April 2010 Policy inflation Anchor inflation

Watch inflation trend and Anchor

be prepared to respond expectations, while being expectations, while being swiftly and effectively

prepared

to

respond prepared

to

respond

Monitor liquidity to meet

appropriately, swiftly and appropriately, swiftly and

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

credit productive

demands sectors

of effectively to further build- effectively to further buildwhile up of inflationary pressures. up of inflationary pressures.

securing price and financial Actively manage liquidity to Actively manage liquidity to stability ensure that the growth in ensure that the growth in

Maintain interest

monetary rate

and demand for credit by both demand for credit by both private and public the private and public

regime the

consistent with price and sectors is satisfied in a non- sectors is satisfied in a nonfinancial stability, and disruptive way. disruptive way.

supportive of the growth Maintain an interest rate Maintain an interest rate process regime consistent with regime consistent with price, output and financial price, output and financial stability. stability.

Source: RBI

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

NABARD (National Bank for Agriculture and Rural Development) NABARD is set up as an apex Development Bank with a mandate for facilitating credit flow for promotion and development of agriculture, small-scale industries, cottage and village industries, handicrafts and other rural crafts. It also has the mandate to support all other allied economic activities in rural areas, promote integrated and sustainable rural development and secure prosperity of rural areas. In discharging its role as a facilitator for rural prosperity NABARD is entrusted with a) Providing refinance to lending institutions in rural areas b) Bringing about or promoting institutional development and c) Evaluating, monitoring and inspecting the client banks Besides this pivotal role, NABARD also: a) Acts as a coordinator in the operations of rural credit institutions b) Extends assistance to the government, the Reserve Bank of India and other organizations in matters relating to rural development c) Offers training and research facilities for banks, cooperatives and organizations working in the field of rural development d) Helps the state governments in reaching their targets of providing assistance to eligible institutions in agriculture and rural development e) Acts as regulator for cooperative banks and RRBs. Functions of NABARD a) To provide cheap credit & other facilities to small & marginal farmers, landless agricultural labourers, artisans and small entrepreneurs engaged in productive activities. b) To develop the rural economy of the country by liberal Financial assistance to agriculture, trade &commerce, industries & other productive enterprises in the rural

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

c) To inculcate banking habit among the people and mobilize their saving for accentuating the economic growth of the rural areas. d) To provide employment to educated youths of the rural areas e) To bring down the cost of rural banking SEBI It was formed officially by the Government of India in 1992 with SEBI Act 1992 being passed by the Indian Parliament. SEBI is headquartered in the business district of Bandra-Kurla complex in Mumbai, and has Northern, Eastern, Southern and Western regional offices in New Delhi, Kolkata, Chennai and Ahmadabad. Controller of Capital Issues was the regulatory authority before SEBI came into existence; it derived authority from the Capital Issues (Control) Act, 1947. Organization structure Upendra Kumar Sinha was appointed chairman on 18 February 2011 replacing C. B. Bhave. The Board comprises

Name

Designation

Upendra Kumar Sinha Chairman

M. S. Sahoo

Whole-Time Member

Dr K.M. Abraham

Whole Time Member

Prashant Saran

Whole Time Member

CA. T. V. Mohandas Pai Director, Infosys

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

Dr. Thomas Mathew

Joint Secretary, Ministry of Finance

V. K. Jairath

Member Appointed

Anand Sinha

Deputy Governor, Reserve Bank of India

Functions of SEBI 1. Regulatory Function a) Registration of brokers and sub-brokers and other players in the market b) Registration of collective investments schemes and Mutual Funds c) Regulation of stock exchanges and other self-regulatory organisations (SRO) merchant banks etc d) Prohibition of all fraudulent and unfair trade practices e) Controlling Insider Trading and takeover bids and imposing penalties for such practices 2. Development Functions a) Investor education b) Training of intermediaries. c) Promotion of fair practices and Code of conduct for all S.R.O.s d) Conducting Research and Publishing information useful to all market participants

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

Chapter 5 E-Services Online banking solutions have many features and capabilities in common, but traditionally also have some that are application specific. The common features fall broadly into several categories 1. Transactional (e.g., performing a financial transaction such as an account to account transfer, paying a bill, wire transfer, apply for a loan, new account, etc.) a) Payments to third parties, including bill payments and telegraphic/wire transfers b) Funds transfers between a customer's own transactional account and savings accounts c) Investment purchase or sale d) Loan applications and transactions, such as repayments of enrolments

2. Non-transactional (e.g., online statements, cheque links, chat) a) Viewing recent transactions b) Downloading bank statements, for example in PDF format c) Viewing images of paid cheques d) Financial Institution Administration e) Management of multiple users having varying levels of authority f) Transaction approval process Debit Cards A debit card (also known as a bank card or check card) is a plastic card that provides the cardholder electronic access to his or her bank account/s at a financial institution. Some cards have a stored value against which a payment is made, while most relay a message to the cardholder's bank to withdraw funds from a designated account in favor of the payee's designated bank account. The card can be used as an alternative payment method to cash

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

when making purchases. In some cases, the cards are designed exclusively for use on the Internet, and so there is no physical card. In many countries the use of debit cards has become so widespread that their volume of use has overtaken or entirely replaced the check and, in some instances, cash transactions. Like credit cards, debit cards are used widely for telephone and Internet purchases. However, unlike credit cards, the funds paid using a debit card are transferred immediately from the bearer's bank account, instead of having the bearer pay back the money at a later date. Debit cards usually also allow for instant withdrawal of cash, acting as the ATM card for withdrawing cash and as a check guarantee card. Merchants may also offer cashback facilities to customers, where a customer can withdraw cash along with their purchase. Credit Cards A credit card is a small plastic card issued to users as a system of payment. It allows its holder to buy goods and services based on the holder's promise to pay for these goods and services. The issuer of the card creates a revolving account and grants a line of credit to the consumer (or the user) from which the user can borrow money for payment to a merchant or as a cash advance to the user. A credit card is different from a charge card: a charge card requires the balance to be paid in full each month. In contrast, credit cards allow the consumers a continuing balance of debt, subject to interest being charged. A credit card also differs from a cash card, which can be used like currency by the owner of the card. Most credit cards are issued by banks or credit unions.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

Electronic Fund Transfer An electronic funds transfer (EFT) is a process whereby money is transferred from one place to another electronically. Computers are used to process payments in a variety of ways. The EFT procedure is a quick and efficient way to transfer money from one account to another. EFT is used millions of times a day the world over. If you are earning a salary, your cash may be placed into your bank account by EFT. You can then withdraw money from an automated teller or use your debit card to pay for goods and services. Using your debit card in a store to pay for goods is another example of EFT. EFT has simplified the money transferring process. Once money has been paid into an account using this procedure, it should be available immediately. Some banks and processes may hold up the transfer of funds in order to verify and process the transfer. One of the biggest EFT tools available on the Internet is Paypal. Using the Paypal site, people can shop, move money to bank accounts, buy, sell, and request money directly from their bank accounts. The advent of Paypal has been responsible in creating thousands of small and large online businesses. Another advantage of EFT is that currency is automatically calculated when funds are being transferred around the world. The currency and exchange rate from one country to another can be automatically worked out, and the money can be deposited into an account. EFT is both time saving and, in most cases, reliable. MICR Magnetic Ink Character Recognition, or MICR, is a character recognition technology used primarily by the banking industry to facilitate the processing of cheques. The technology allows computers to read information (such as account numbers) off printed documents. Unlike barcodes or similar technologies, however, MICR codes can be easily read by humans.

Indian Financial System

For 3rd Semester B.Com Vipin Srinath

MICR characters are printed in special typefaces with a magnetic ink or toner, usually containing iron oxide. As a machine decodes the MICR text, it first magnetizes the characters in the plane of the paper. Then the characters are passed over a MICR read head, a device similar to the playback head of a tape recorder. As each character passes over the head it produces a unique waveform that can be easily identified by the system. The use of magnetic printing allows the characters to be read reliably even if they have been overprinted or obscured by other marks, such as cancellation stamps and signature.