FINANCIAL INSTITUTIONS

Financial Institutions

 “A financial institution is an institution

that provides financial services for its
clients or members.”

 Act as financial intermediaries.

 OBJECTIVE OF FINANCIAL
INSTITUTIONS
 To transform financial assets acquired through the market and
constitute them into a different, and more widely preferable, type of
asset-which becomes their liability. This is the function performed by
financial intermediaries, the most important type of financial institution.

 To exchange financial assets on behalf of customers.

 To exchange of financial assets for their own accounts.

 To assist in the creation of financial assets for their customers, and

then selling those financial assets to other market participants.

 To provide investment advice to other market participants.

 To manage the portfolios of other market participants.

Examples of financial
institutions
 Banks
 Stock Brokerage Firms
 Non Banking Financial Institutions
 Building Societies
 Asset Management Firms
 Credit Unions
 Insurance Companies
FUNCTIONS OF FINANCIAL
INSTITUTIONS
Financial institutions offer various types of transformation services :

 Liability-Asset transformation - They issue claims to their

customers that have characteristics different from those of their own
assets. For example, banks accept deposits as liability and convert
them into assets such as loans.
 Size- transformation – They choose and manage portfolios whose
risk and return they alter by applying resources to acquire better
information and to reduce or overcome transaction costs. They
provide large volumes of finance on the basis of small deposits or
unit capital.
 Risk–transformation - They distribute risk through diversification
and thereby reduce it for savers as in the case of mutual funds.
 Maturity transformation – They offer savers alternate forms of
deposits according to their liquidity preferences, and provide
borrowers with loans of requisite maturities.
Classification
Financial
Institutions

Intermediaries Regulators

Banking

Non-banking
IMPORTANCE OF
FINANCIAL INSTITUTIONS
 Financial intermediaries convert the money
given by savers to investment by borrowers,
such as banks, UTI, NBFIs, etc.
 Non-intermediaries give loans but do not
collect deposits or funds from savers.
 Regulators watch the markets, players and
modes of transactions.
 Regulators design the market system,
create and enforce regulations and rules for
the market.
FINANCIAL
INTERMEDIARIES
Financial intermediaries are a special group of
financial institutions that obtain funds by issuing claims to
market participants and use these funds to purchase financial
assets. Intermediaries transform funds they acquire into
assets that are more attractive to the public. By doing so,
financial intermediaries do one or more of the following:

 Provide maturity intermediation

 Provide risk reduction via diversification at lower cost
 Reduce the cost of contracting and information processing
 Provide a payments mechanism.
What is a Bank ?
 A bank as an institution which accepts
deposits from the public and in turn
advances loans by creating credit. It is
different from other financial
institutions in that they cannot create
credit though they may be accepting
deposits and making advances.
Functions of Banks
 Primary Functions
 Acceptance of deposits
 Lending money
 Making investments
 Borrowing money
Functions of Banks
 Agency Functions
 Collection and payment of cheques
 Collection and payment of bills
 Remittance of funds
 Collections of government taxes
 Undertaking administration of estates
as executors and trustees
Functions of Banks
 General Utility Functions
 Issues of guarantees, letters of credit,
cheques, credit and debit cards
 Dealing with bullion, foreign exchange,
merchant banking, safe custody of
articles, etc,
OVERVIEW OF IMPORTANT
FINANCIAL INSTITUTIONS
 There are various kinds of financial institutions
performing their role in financial intermediation and
infrastructural development, differing on the basis of
their inception and operations. Broadly, the existing
financial institutions may be classified as
 (a) All India institutions like Industrial Development
Bank of India (lDBI), Industrial Finance Corporation
of India (IFCI) etc.,
 (b) Regional/State level institutions like the State
Financial Corporation (SFC)
 (c) Other Institutions like DICGC etc.
Industrial Finance Corporation
of India

 The Industrial Finance Corporation of India (IFCI) ,

the first All-India term-lending institution was set up
in 1948 with the primary objective of providing
medium and long-term credit to industry.

 It is headquartered in New Delhi.

 The sources of funds for IFCI are Paid-up capital,

reserves, repayment of loans, market borrowings,
loans from the Government of India, advances from
the Industrial Development Bank of India and
foreign lines of credit from KfW (West Germany),
BFCE (France), ODA(UK) and others.
IFCI -Functions
Functions :
 The main functions of IFCI are
 To provide various kinds of financial services to the industries.
 Primarily, its services focus on project finance as it provides
assistance to all viable industrial projects above Rs.50m.
 IFCI provides assistance industrial concerns for their new
projects, expansion, diversification and modernization schemes.
 Loans are generally extended for a period of 5-7 years with a
moratorium of 2-3 years. Loans are extended both in rupee and
foreign currency.
 Loans are provided after a detailed project appraisal.

Future :
 In order to tap on the other financial services that offer greater
scope for the corporation, IFCI is diversifying into bill
discounting, trade bills important financing and working capital
financing.
Industrial Credit and
Investment Corporation of India
 The Industrial and Investment Corporation of India (ICICI) was
founded in 1955.

 It is owned and financed mainly by the private sector.

 It is headquartered in Bombay.

 It provides assistance to units in the private sector, particularly to

meet their foreign exchange requirements.

 The resources of ICICI consist of Paid-up capital, reserves,

repayment of loans, market borrowings, loans from the
Government of India, advances from the Industrial Development
Bank of India, market borrowings and foreign lines of credit from
World Bank, USAID, KFW, UK government and others.
 Industrial Development Bank of
India
 The Industrial Development Bank of India (IDBI) was established in
1964 as a subsidiary of the Reserve Bank of India.

 Industrial Development Bank of India (IDBI) is the largest financial

institution in India, with assets at the end of 1999 approximating to
Rs.600 billion.

 It is headquartered in Bombay.

 This apex financial institution in India, is also the 10th largest

development bank in the world.

 The resources of IDBI consist of Paid-up capital, reserves, repayment

of loans, market borrowings both within and outside the country,
temporary credit from the Reserve Bank of India, foreign lines of
credit from the World Bank, ADB and others.
Role of IDBI
 Planning, promoting and developing industries to fill
the gaps in the industrial sector.
 Co-coordinating the working of institutions engaged
in such activities and assisting in their development.
 Providing technical and administrative assistance
for promotion, management or expansion of
industry.
 Undertaking market and investment research and
techno-economic studies to contribute to the
development of industry.
 IDBI - Operations
 IDBI initially provided long-term assistance to industries such as textiles, fertilizers,
chemicals products and machinery. The assistance was mainly in the form of long-
term loans or in the form of project lending.

 In 1964, IDBI also began a role in assisting the State Finance Corporations (SFCs) of
various states.

 By 1965, IDBI entered into rediscounting of -machinery bills to promote the sale of
indigenous machinery on deferred payment basis.

 Subsequently, IDBI entered into finanancing exports on a different payment basis, till
the time Export- Import (Exim) Bank of India was formed in 1982.

 In 1986, IDBI created a Small Industries Development Fund (SIDF) to provide a

special focus to the needs of the small scale sector. This fund is intended to provide
financial inputs catered to the specific needs of the small scale sector.

 Through the late ’80s and the early ’90s IDBI played a significant role in the
development of financial markets - it played a major role in setting up of the Stock
Holding Corporation of India Limited (SHCIL)
Non Banking Financial
Institutions [NBFC]
 NBFCs help to bridge the credit gaps
in several sectors which traditional
institution are unable to fulfill.
 NBFCs are more flexible in their
operations and quick in decision-
making.
Activities of NBFCs

Fund-Based Activities Fee-Based Activities

1. Equipment leasing 1. Issue Management
2. Hire Purchase 2. Portfolio Management
3. Bill discounting 3. Corporate Counseling
4. Loan and Investment
5. Venture Capital 4. Project Counseling
6. House Finance 5. Arranging Foreign Collaboration
7. Factoring 6. Advising on acquisitions
&mergers
8. Equity Participant 7. Advising on Capital restructuring
9. Short-term loans
10. Inter-Corporate Loans
Life Insurance Corporation of
India
 The Life Insurance Corporation of India (LIC) came into being in 1955 after
the nationalization and merger of about 250 independent life insurance
societies.

 It is headquartered in Bombay.

 The primary activity of LIC is to carry on life insurance business, but it has
gradually developed into an important all-india financial institution which
provides substantial support to industry.

 It works in close liaison with the other all-india financial institutions in

providing finance directly and in helping industrial concerns by its
underwriting support.

 Thanks to its massive resources, LIC is one of the two largest institutional
investors in the country. By law it is required to invest 25 percent of its funds
in government securities and a further 25 percent in “approved securities”.
General Insurance Corporation

 The General Insurance Corporation (GIC) was

founded when the management of general insurances
business in india was taken over by the government in
1971 and subsequently nationalized in 1973.

 It is headquartered in Bombay.

 In addition to investing in “socially-oriented” sectors,

where the bulk of its inevitable resources are required
to be Invested, GIC provides substantial assistance to
industrial projects by way of term loans, subscription
to equity capital and debentures, and underwriting of
securities.
Unit Trust of India

 The Unit Trust of India (UTI) was set up in 1964 with the principal
objective of mobilizing public savings and channeling them into
productive corporate investments.

 UTI raises its resources primarily through the sale small

denomination units.

 UTI subscribes to industrial securities and also purchases

outstanding securities in the secondary market, in its investment
activity.

 UTI is naturally governed by considerations of yield and security

as it has an obligation to earn a responsible rate of return for its
unit holders in its various schemes, without exposing them to
undue risks. UTI has emerged as one of the two largest
institutional investors in India.
State Financial Corporations

 The State Financial Corporation (SFC), set up under

the State Financial Corporations Act, 1951, render
assistance to medium and small scale industries to
their respective states.

 Their shareholders are the respective state

governments, IDBI, insurance companies, credit
cooperatives, and private shareholders.

 The financial resources of SFCs consist of Paid-up

capital, reserves, market borrowings, refinance from
IDBI and borrowings from the Reserve Bank of India
and the Government of India.
State Industrial and
Development Corporations
 The state Industrial and Development Corporations (SIDCs), were set up by
the state Governments during the 1960s to serve as catalytic agents in the
industrialization process of their respective states.

 Presently almost every state has an SIDC which is fully owned by the
respective state government. In addition to providing term finance to
industry, SIDCs perform a variety of other functions.

 In particular, their role in sponsoring joint sector projects with the

participation of private entrepreneurs need to be emphasized.

 The major resources of the SIDCs are

 Paid-up capital reserves

 Market borrowings
 Loans from the government.
 In addition, SIDCs get funds from IDBI under its refinancing scheme.
Direct Financial Assistance

Financial institutions provide direct financial

assistance in the following ways:

 Rupee term loans

 Foreign Currency term loans
 Subscription to equity shares
 Seed capital – Money used for the initial
investment in a project or start-up company,for
proof of concept or market research or product
development. Also called as seed money or seed
financing.
Indirect Financial
Assistance
Besides providing direct financial assistance,
financial institutions extend help to industrial
units in obtaining finance/credit through the
following ways:
 Deferred Payment guarantee - A deferred payment
guarantee is a contract under which a bank promises to pay the
supplier the price of machinery supplied by him on deferred terms,
in agreed installments with stipulated interest in the respective due
dates, in case of default in payment there of by the buyer.
 Guarantee for foreign currency loans
 Underwriting
Advantages of financial
institutions
 Reduction of information and transaction
costs
 Grant long-term loans
 Provide liquid claims and pool risks.
 Financial intermediaries economize costs of
borrowers and lenders.
 Banks are set up to mobilize savings of
many small depositors, which are insured.
 Investment strategy
Nature of Liabilities of financial institutions
 The nature of their
Liability type Amount of Timing of
liabilities determines cash outlay cash outlay
the investment strategy
Type I Known Known
pursued by all financial
institutions. The
liabilities of all financial Type II Known Uncertain
institution will generally
fall into one of the four
Type III Uncertain Known
types shown in the
adjacent Table :
Type IV Uncertain Uncertain
Conclusion
 Thus, it can be concluded that a financial
institution is that type of an institution, which
performs the collection of funds from private
investors and public investors and utilizes
those funds in financial assets. The
functions of financial institutions are not
limited to a particular country, instead they
have also become popular in abroad due to
the growing impact of globalization.