Drive: Summer 2016

Program: MBA
Semester: 3rd
Subject Code: MB0036
Subject Name: Financial System and Commercial Banking

Q1. Illustrate the role of Trading System in the Securities Market.

Explain margin trading with examples.

Ans:

Securities market is a component of the wider financial market where securities can be bought and sold between
subjects of the economy, on the basis of demand and supply. Securities markets encompass equity markets, bond
markets and derivatives markets where prices can be determined and participants both professional and non
professionals can meet.

Securities markets can be split into two levels. Primary markets, where new securities are issued and secondary
markets where existing securities can be bought and sold. Secondary markets can further be split into organised
exchanges, such stock exchanges and over-the-counter where individual parties come together and buy or sell
securities directly. For securities holders knowing that a secondary market exists in which their securities may be sold
and converted into cash increases the willingness of people to hold stocks and bonds and thus increases the ability of
firms to issue securities.

There are a number of professional participants of a securities market and these include; brokerages, broker-
dealers, market makers, investment managers, speculators as well as those providing the infrastructure, such
as clearing houses and securities depositories.

A securities market is used in an economy to attract new capital, transfer real assets in financial assets, determine price
which will balance demand and supply and provide a means to invest money both short and long term.

A securities market is a system of interconnection between all participants (professional and nonprofessional) that
provides effective conditions:

to attract new capital by means of issuance new security (securitization of debt),

to transfer real asset into financial asset,

to invest money for short or long term periods with the aim of deriving profitability.

commercial function (to derive profit from operation on this market)

price determination (demand and supply balancing, the continuous process of prices movements guarantees
to state correct price for each security so the market corrects mispriced securities)

informative function (market provides all participants with market information about participants and traded
instruments)

regulation function (securities market creates the rules of trade, contention regulation, priorities determination)
 Transfer of ownership (securities markets transfer existing stocks and bonds from owners who no longer
desire to maintain their investments to buyers who wish to increase those specific investments.

Insurance (hedging) of operations though securities market (options, futures, etc.)

Levels of securities market[edit]

Primary market[edit]
Main article: Primary market

The primary market is that part of the capital markets that deals with the issue 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 a public offering. 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 the new issue market may be raising capital for converting private capital
into public capital; this is known as "going public."

Secondary market[edit]
Main article: Secondary market

The secondary market, also known as the aftermarket, is the financial market where previously issued securities and
financial instruments such as stock, bonds, options, and futures are bought and sold. The term "secondary market" is
also used to refer to the market for any used goods or assets, or an alternative use for an existing product or asset
where the customer base is the second market (for example, corn has been traditionally used primarily for food
production and feedstock, but a "second" or "third" market has developed for use in ethanol production). Stock
exchange and over the counter markets.

With primary issuances of securities or financial instruments, or the primary market, investors purchase these securities
directly from issuers such as corporations issuing shares in an IPO or private placement, or directly from the federal
government in the case of treasuries. After the initial issuance, investors can purchase from other investors in the
secondary market.

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 New York Stock Exchange, Nasdaq and the American
Stock Exchange provide a centralized, liquid secondary market for the investors who own stocks that trade on those
exchanges. Most bonds and structured products trade over the counter, or by phoning the bond desk of ones broker-
dealer. Loans sometimes trade online using a Loan Exchange.

Over-the-counter market[edit]
Main article: Over-the-counter (finance)

Over-the-counter (OTC) or off-exchange trading is to trade financial instruments such as stocks, bonds, commodities
or derivatives directly between two parties. It is contrasted with exchange trading, which occurs via facilities constructed
for the purpose of trading (i.e., exchanges), such as futures exchanges or stock exchanges. In the U.S., over-the-
counter trading in stock is carried out by market makers that make markets in OTCBB and Pink Sheets securities using
inter-dealer quotation services such as Pink Quote (operated by Pink OTC Markets) and the OTC Bulletin Board
(OTCBB). OTC stocks are not usually listed nor traded on any stock exchanges, though exchange listed stocks can be
traded OTC on the third market. Although stocks quoted on the OTCBB must comply with United States Securities and
Exchange Commission (SEC) reporting requirements, other OTC stocks, such as those stocks categorized as Pink
Sheets securities, have no reporting requirements, while those stocks categorized as OTCQX have met alternative
disclosure guidelines through Pink OTC Markets. An over-the-counter contract is a bilateral contract in which two parties
agree on how a particular trade or agreement is to be settled in the future. It is usually from an investment bank to its
clients directly. Forwards and swaps are prime examples of such contracts. It is mostly done via the computer or the
telephone. For derivatives, these agreements are usually governed by an International Swaps and Derivatives
Association agreement.

This segment of the OTC market is occasionally referred to as the "Fourth Market."

The NYMEX has created a clearing mechanism for a slate of commonly traded OTC energy derivatives which allows
counterparties of many bilateral OTC transactions to mutually agree to transfer the trade to ClearPort, the exchange's
clearing house, thus eliminating credit and performance risk of the initial OTC transaction counterparts..

Main financial instruments[edit]

Bond, Promissory note, Cheque a security contains requirement to make full payment to the bearer of cheque,
Certificate of deposit, Bill of Lading (a Bill of Lading is a document evidencing the receipt of goods for shipment issued
by a person engaged in the business of transporting or forwarding goods." ), Stock.

Promissory note[edit]
A promissory note, referred to as a note payable in accounting, or commonly as just a "note", is a contract where one
party (the maker or issuer) makes an unconditional promise in writing to pay a sum of money to the other (the payee),
either at a fixed or determinable future time or on demand of the payee, under specific terms. They differ from IOUs in
that they contain a specific promise to pay, rather than simply acknowledging that a debt exists.

Certificate of deposit[edit]
A certificate of deposit or CD is a time deposit, a financial product commonly offered to consumers by banks, thrift
institutions, and credit unions. CDs are similar to savings accounts in that they are insured and thus virtually risk-free;
they are "money in the bank" (CDs are insured by the FDIC for banks or by the NCUA for credit unions). They are
different from savings accounts in that the CD has a specific, fixed term (often three months, six months, or one to five
years), and, usually, a fixed interest rate. It is intended that the CD be held until maturity, at which time the money may
be withdrawn together with the accrued interest.

Bond[edit]
Bond - an issued security establishing its holder's right to receive from the issuer of the bond, within the time period
specified therein,

its nominal value

 and the interest fixed therein on this value or other property equivalent.

The bond may provide for other property rights of its holder, where this is not contrary to legislation.

Stocks (shares)[edit]
Common shares[edit]

Common shares represent ownership in a company and a claim (dividends) on a portion of profits. Investors get one
vote per share to elect the board members, who oversee the major decisions made by management.Over the long term,
common stock, by means of capital growth, yields higher returns than almost every other investment. This higher return
comes at a cost since common stocks entail the most risk. If a company goes bankrupt and liquidates, the common
shareholders will not receive money until the creditors, and preferred shareholders are paid.

Preferred share[edit]

Preferred share represents some degree of ownership in a company but usually doesn't come with the same voting
rights. (This may vary depending on the company.) With preferred shares investors are usually guaranteed a fixed
dividend forever. This is different than common stock, which has variable dividends that are never guaranteed. Another
advantage is that in the event of liquidation preferred shareholders are paid off before the common shareholder (but still
after debt holders). Preferred stock may also be callable, meaning that the company has the option to purchase the
shares from shareholders at any time for any reason (usually for a premium). Some people consider preferred stock to
be more like debt than equity.

Professional participants[edit]
Professional participants in the securities market - legal persons, including credit organizations, and also citizens
registered as business persons who conduct the following types of activity:

Brokerage shall be deemed performance of civil-law transactions with securities as agent or commission agent
acting under a contract of agency or commission, and also under a power (letter) of attorney for the performance of
such transactions in the absence of indication of the powers of agent or commission agent in the contract.

Dealer activity shall be deemed performance of transactions in the purchase and sale of securities in one's
own name and for one's own account through the public announcement of the prices of purchase and/or sale of
certain securities, with an obligation of the purchase and/or sale of these securities at the prices announced by the
person pursuing such activity.

Activity in the management of securities shall be deemed performance by a legal person or individual
business person, in his own name, for a remuneration, during a stated period, of trust management of the following
conveyed into his possession and belonging to another person, in the interests of this person or of third parties
designated by this person:

1. securities;

2. monies intended for investment in securities;

3. monies and securities received in the process of securities management.

Clearing activity shall be deemed activity in determining mutual obligations (collection, collation and correction
of information on security deals and

preparation of bookkeeping documents thereon) and in offsetting these obligations in deliveries of securities
 Depositary activity shall be deemed the rendering of services in the safekeeping of certificates of securities
and/or recording and transfer of rights to securities

Activity in the keeping of a register of owners of securities shall be deemed collection, fixing, processing,
storage and provision of data constituting a system of keeping the register of security owners

Provision of services directly promoting conclusion of civil-law transactions with securities between
participants in the securities market shall be deemed activity in thearrangement of trading on the securities
market.
Buying on margin is borrowing money from a broker to purchase stock. You can think of it as a loan from
your brokerage. Margin trading allows you to buy more stock than you'd be able to normally.
To trade onmargin, you need a margin account.

Margin trading
Margin trading occurs when investors who purchase stocks on margin borrow part of the
purchase price of the stock from their brokers, and leave purchased stocks with the
brokerage firm in street name because the securities are used as collateral for the loan. The
interest rate of the margin credit charged by the broker is typically 1.5 percent above the rate
charged by the bank making the loan. The bank rate (called the call money rate) is normally
about one percent below the prime rate.
Percentage margin The ratio of the net worth, or equity value of the account to the
market value of the securities.
Maintenance margin The required proportion of your equity to the total value of the
stock. It protects the broker if the stock price declines.
Margin call If the percentage margin falls below the maintenance margin, the broker
issues a margin call requiring the investor to add new cash or securities to the margin
account. If the investor fails to provide the required funds in time, the broker will sell the
collateral stock to pay off the loan.

Example 1
Suppose an entrepreneur initially pays rs. 6,000 towards the purchase of rs. 10,000 worth of
stock (100 shares at 100 per share), borrowing the remaining from the broker. The
maintenance margin is set to be 30 percent. The initial percentage margin is 60 percent. If
the price of the stock falls to rs. 57.14, the value of his stock will be rs. 5,714. Since the loan
is rs. 4,000, the percentage margin now is (5,714 4,000)/5714 = 29.9 percent. The investor
will get a margin call.
When investors acquire stock or other investments on margin, they are increasing the
financial risk of the investment beyond the risk inherent in the security itself. They should
increase their required rate of return accordingly.
Return on margin transaction = (Change in investors equity Interest Commission)/ Initial
investors equity.

Explain the features of Commercial Papers as a money market instrument.

Distinguish between money market and capital market instruments

Meaning and Features:

The money market is a market for short-term instruments that are close substitutes for money.
The short term instruments are highly liquid, easily marketable, with little change of loss. It
provides for the quick and dependable transfer of short term debt instruments maturing in one
year or less, which are used to finance the needs of consumers, business agriculture and the
government. The money market is not one market but is a collective name given to the various
form and institutions that deal with the various grades of near money.

In other words, it is a network of market that are grouped together because they deal in financial
instruments that have a similar function in the economy and are to some degree substitutes from
the point of view of holders.

Thus the money market consists of call and notice market, commercial bills market; commercial
paper market, treasury bills market, inter-bank market and certificates of deposit market. All
these markets are closely interrelated so as to make the money market. It is a wholesale market
where large numbers of financial assets or instruments are traded.

The money market is divided into direct, negotiated, or customers money market and the open
or impersonal money market. In the former, banks and financial firms supply funds to local
customers and also to larger centres such as London for direct lending. In the open money
market, idle funds drawn from all- over the country are transferred through intermediaries to the
New York City market or the London market.

These intermediaries comprise the Federal Reserve Banks in the USA or the Bank of England in
England, commercial banks, insurance companies, business corporations, brokerage houses,
finance companies, state and local government securities dealers. The money market is a
dynamic market in which new money market instruments are evolved and traded and more
participants are permitted to deal in the money market.

Instruments of the Money Market:

The money market operates through a number of instruments.

1. Promissory Note:

The promissory note is the earliest types of bill. It is a written promise on the part of a
businessman today to another a certain sum of money at an agreed future data. Usually, a
promissory note falls due for payment after 90 days with three days of grace. A promissory note
is drawn by the debtor and has to be accepted by the bank in which the debtor has his account,
to be valid. The creditor can get it discounted from his bank till the date of recovery. Promissory
notes are rarely used in business these days, except in the USA.

2. Bill of Exchange or Commercial Bills:

Another instrument of the money, market is the bill of exchange which is similar to the promissory
note, except in that it is drawn by the creditor and is accepted by the bank of the debater. The
creditor can discount the bill of exchange either with a broker or a bank. There is also the foreign
bill of exchange which becomes due for payment from the date of acceptance. The rest of the
procedure is the same as for the internal bill of exchange. Promissory notes and bills of
exchange are known as trade bills.

3. Treasury Bill:

But the major instrument of the money markets is the Treasury bill which is issued for varying
periods of less than one year. They are issued by the Secretary to the Treasury in England and
are payable at the Bank of England. There are also the short-term government securities in the
USA which are traded by commercial banks and dealers in securities. In India, the treasury bills
are issued by the Government of India at a discount generally between 91 days and 364 days.
There are three types of treasury bills in India91 days, 182 days and 364 days.

4. Call and Notice Money:

There is the call money market in which funds are borrowed and lent for one day. In the notice
market, they are borrowed and lent upto 14 days without any collateral security. But deposit
receipt is issued to the lender by the borrower who repays the borrowed amount with interest on
call. In India, commercial banks and cooperative banks borrow and lend funds in this market but
mutual funds and all-India financial institutions participate only as lenders of funds.

5. Inter-bank Term Market:

This market is exclusively for commercial and cooperative banks in India, which borrow and lend
funds for a period of over 14 days and upto 90 days without any collateral security at market-
determined rates.

6. Certificates of Deposits (CD):

Certificates of deposits are issued by commercial banks at a discount on face value. The
discount rate is determined by the market. In India the minimum size of the issue is Rs. 25 lakhs
with the minimum subscription of Rs. 5 lakhs. The maturity period is between 3 months and 12
months.

7. Commercial Paper (CP):

Commercial papers are issued by highly rate companies to raise short-term working capital
requirements directly from the market instead of borrowing from the banks. CP is a promise by
the borrowing company to repay the load at a specified date, normally for a period of 3 months to
6 months. This instrument is very popular in the USA, UK, Japan, Australia and a number of
other countries. It has been introduced in India in January 1990.

Working of the Money Market:

The money market consisting of commercial banks, discount houses, bill brokers, acceptance
houses, non-bank financial houses and the central bank operates through the bills, securities,
treasury bills, government securities and call loans of various types. As the money market
consists of varied types of institutions dealing in different types of instruments, it operates
through a number of sub-markets.

First, the money market operates through the call loan market. It has been defined as a market
for marginal funds, for temporarily unemployed or unemployable funds. In this market the
commercial banks use their un-sued funds to lend for very short periods to bill brokers and
dealers in stock exchange. In developed countries, even big corporations lend their dividends
before distribution to earn interest for a very short period.

The central bank also lends to commercial bank is for very short periods. Such loans are mostly
for a week even for a day or a night and can be recalled at a very short notice. That is why a
short period loan is known as call loan or call money market. Bill brokers and stock brokers who
borrow such funds use them to discount or purchase bills or stocks.

Such funds are borrowed at the call rate which is generally one per cent below the bank rate.
But this rate varies with the volume of funds lent by the bank. If the brokers are asked to pay off
loans immediately, then they are forced to get funds from large corporations and even from the
central bank at high interest rate.

Second, the money market also operates through the bill market. The bill market is the short-
period loan market. In this market, loans are made available to businessmen and the
government by the commercial banks, discount houses and brokers. The instruments of credit
are the promissory notes. Internal bills of exchange and treasury bills.

The commercial banks discount bills exchange, lend against promissory notes or through
advances or overdrafts to the business community. Similarly, the discount houses and bills
brokers lend to businessmen by discounting their bills of exchange before they mature within 90
days. On the other hand, government borrows through the treasury bills from the commercial
banks and non-bank financial institutions. Third, the money market operator through the
collateral loan market for a short period.

The commercial banks lend to brokers and discount houses against collateral bonds, stock,
securities, etc. In case of need, commercial banks themselves borrower from the large banks
and the central bank on the basis of collateral securities.

Finally, the other important sub-market through which the money market operates is the
acceptance market. The merchant bankers accept bills drawn on domestic and foreign traders
whose financial standing is not known. When they accept a domestic or foreign trade bill, they
guarantee its payment at maturity. In recent years, the commercial banks have also stared the
acceptance business.

Capital Markets

Capital markets are perhaps the most widely followed markets. Both the stock and bond markets are closely
followed and their daily movements are analyzed as proxies for the general economic condition of the world
markets. As a result, the institutions operating in capital markets - stock exchanges, commercial banks and all
types of corporations, including nonbank institutions such as insurance companies and mortgage banks - are
carefully scrutinized.

The institutions operating in the capital markets access them to raise capital for long-term purposes, such as for
a merger or acquisition, to expand a line of business or enter into a new business, or for other capital projects.
Entities that are raising money for these long-term purposes come to one or more capital markets. In the bond
market, companies may issue debt in the form of corporate bonds, while both local and federal governments may
issue debt in the form of government bonds. Similarly, companies may decide to raise money by issuing equity on
the stock market. Government entities are typically not publicly held and, therefore, do not usually issue equity.
Companies and government entities that issue equity or debt are considered the sellers in these markets.

The buyers, or the investors, buy the stocks or bonds of the sellers and trade them. If the seller, or issuer, is
placing the securities on the market for the first time, then the market is known as the primary market. Conversely,
if the securities have already been issued and are now being traded among buyers, this is done on the secondary
market. Sellers make money off the sale in the primary market, not in the secondary market, although they do
 have a stake in the outcome (pricing) of their securities in the secondary market.

The buyers of securities in the capital market tend to use funds that are targeted for longer-term investment.
Capital markets are risky markets and are not usually used to invest short-term funds. Many investors access the
capital markets to save for retirement or education, as long as the investors have long time horizons, which
usually means they are young and are risk takers.

Money Market

The money market is often accessed alongside the capital markets. While investors are willing to take on more
risk and have patience to invest in capital markets, money markets are a good place to "park" funds that are
needed in a shorter time period - usually one year or less. The financial instruments used in capital markets
include stocks and bonds, but the instruments used in the money markets include deposits, collateral loans,
acceptances and bills of exchange. Institutions operating in money markets are central banks, commercial banks
and acceptance houses, among others.

Money markets provide a variety of functions for either individual, corporate or government entities. Liquidity is
often the main purpose for accessing money markets. When short-term debt is issued, it is often for the purpose
of covering operating expenses or working capital for a company or government and not for capital
improvements or large scale projects. Companies may want to invest funds overnight and look to the money
market to accomplish this, or they may need to cover payroll and look to the money market to help. The money
market plays a key role in ensuring companies and governments maintain the appropriate level of liquidity on a
daily basis, without falling short and needing a more expensive loan or without holding excess funds and missing
the opportunity of gaining interest on funds.

Investors, on the other hand, use the money markets to invest funds in a safe manner. Unlike capital markets,
money markets are considered low risk; risk-adverse investors are willing to access them with the anticipation that
liquidity is readily available. Older individuals living on a fixed income often use the money markets because of
the safety associated with these types of investments.

Explain the functions of a primary dealer.

Enumerate the role of Cooperative banks.
Primary dealers are registered entities with the RBI who have the license to purchase and sell government
securities. They are entities who buys government securities directly from the RBI (the RBI issues
government securities on behalf of the government), aiming to resell them to other buyers. In this way, the
Primary Dealers create a market for government securities - See more at:

Role and Functions of Primary Dealers

The role of Primary Dealers is to:

(i) commit participation as Principals in Government of India issues through bidding in auctions

(ii) provide underwriting services

(iii) offer firm buy - sell / bid ask quotes for T-Bills & dated securities
(v) Development of Secondary Debt Market

PDs are performing an exceptional role in giving marketability to government securities. the RBI has
elaborated the role of PDs in the following words PDs are expected to play an active role in the G-Sec
market, both in its primary and secondary market segments through various obligations like participating in
Primary auction, market making in G-Sec, predominance of investment in G-Sec, achieving minimum
secondary market turnover ratio, maintaining efficient internal control system for fair conduct of business
etc. A PD is required to have a standing arrangement with RBI based on the execution of an undertaking
and the authorization letter issued by RBI every three years. Undertaking will be based on passing of a
fresh Board resolution by the PD every three years.

As on January 2015, there was 21 Primary Dealers in the country. Most of the PDs are started by
scheduled commercial banks and are registered as NBFCs. Operations of the PDs are subject to prudential
and regulatory guidelines issued by RBI from time to time.

Explain the Asset Liability Management of commercial

banks.
What do you understand by financial inclusion process ?

Banks face several risks such as the risks associated withassets,interest,currency exchange risks. Asset
Liability management(ALM) is at tool to manage interest rate risk and liquidity risk faced by
various banks, other financial services companies .

ALM objectives and scope

The exact roles and perimeter around ALM can vary significantly from one bank (or other financial institutions) to
another depending on the business model adopted and can encompass a broad area of risks.

The traditional ALM programs focus on interest rate risk and liquidity risk because they represent the most prominent
risks affecting the organization balance-sheet (as they require coordination between assets and liabilities).

But ALM also now seeks to broaden assignments such as foreign exchange risk and capital management. According to
the Balance sheet management benchmark survey conducted in 2009 by the audit and consulting
company PricewaterhouseCoopers (PwC), 51% of the 43 leading financial institutions participants look at capital
management in their ALM unit.

The scope of the ALM function to a larger extent covers the following processes:

1. Liquidity risk: the current and prospective risk arising when the bank is unable to meet its obligations as they
come due without adversely affecting the bank's financial conditions. From an ALM perspective, the focus is
on the funding liquidity risk of the bank, meaning its ability to meet its current and future cash-flow obligations
and collateral needs, both expected and unexpected. This mission thus includes the bank liquidity's
benchmark price in the market.

2. Interest rate risk: The risk of losses resulting from movements in interest rates and their impact on future cash-
flows. Generally because a bank may have a disproportionate amount of fixed or variable rates instruments
on either side of the balance-sheet. One of the primary causes are mismatches in terms of bank deposits and
loans.

3. Currency risk management: The risk of losses resulting from movements in exchanges rates. To the extent
that cash-flow assets and liabilities are denominated in different currencies.
 4. Funding and capital management: As all the mechanism to ensure the maintenance of adequate capital on a
continuous basis. It is a dynamic and ongoing process considering both short- and longer-term capital needs
and is coordinated with a bank's overall strategy and planning cycles (usually a prospective time-horizon of 2
years).

5. Profit planning and growth.

6. In addition, ALM deals with aspects related to credit risk as this function is also to manage the impact of the
entire credit portfolio (including cash, investments, and loans) on the balance sheet. The credit risk,
specifically in the loan portfolio, is handled by a separate risk management function and represents one of the
main data contributors to the ALM team.

The ALM function scope covers both a prudential component (management of all possible risks and rules and
regulation) and an optimization role (management of funding costs, generating results on balance sheet position), within
the limits of compliance (implementation and monitoring with internal rules and regulatory set of rules). ALM intervenes
in these issues of current business activities but is also consulted to organic development and external acquisition to
analyse and validate the funding terms options, conditions of the projects and any risks (i.e., funding issues in local
currencies).

Financial Inclusion is the process of ensuring access to appropriatefinancial products and Services
needed by all sections of the society in general and vulnerable groups such as weaker Sections and low
income groups in particular at an affordable cost in a fair and transparent manner by mainstream
institutional

Financial inclusion may be defined as the process of ensuring access to financial services and timely and adequate
credit where needed by vulnerable groups such as weaker sections and low income groups at an affordable cost (The
Committee on Financial Inclusion, Chairman: Dr. C. Rangarajan).
Financial Inclusion, broadly defined, refers to universal access to a wide range of financial services at a reasonable
cost. These include not only banking products but also other financial services such as insurance and equity products (The
Committee on Financial Sector Reforms, Chairman: Dr.Raghuram G. Rajan). Household access to financial services is
depicted in Figure I.
 The essence of financial inclusion is to ensure delivery of financial services which include - bank accounts for savings
and transactional purposes, low cost credit for productive, personal and other purposes, financial advisory services, insurance
facilities (life and non-life) etc.

Why Financial Inclusion ?

Financial inclusion broadens the resource base of the financial system by developing a culture of savings among
large segment of rural population and plays its own role in the process of economic development. Further, by bringing low
income groups within the perimeter of formal banking sector; financial inclusion protects their financial wealth and other
resources in exigent circumstances. Financial inclusion also mitigates the exploitation of vulnerable sections by the usurious
money lenders by facilitating easy access to formal credit.
In rural areas, the Ginis coefficient rose to 0.28 in 2011-12 from 0.26 in 2004-05 and during the same period to an
all-time high of 0.37 from 0.35 in urban areas.

In the Indian context, the term financial inclusion was used for the first time in April 2005 in the Annual Policy
Statement presented by Y.Venugopal Reddy,the then Governor,Reserve Bank of India.[5] Later on, this concept
gained ground and came to be widely used in India and abroad. While recognizing the concerns in regard to
the banking practices that tend to exclude rather than attract vast sections of population, banks were urged to
review their existing practices to align them with the objective of financial inclusion. [5] The Report of the Internal
Group to Examine Issues relating to Rural Credit and Microfinance (Khan Committee) in July 2005 drew
strength from this announcement by Governor Y. Venugopal Reddy in the Annual Policy Statement for 2005-
06 wherein he had expressed deep concern on the exclusion of vast sections of the population from the formal
financial system.[6] In the Khan Committee Report, the RBI exhorted the banks with a view to achieving greater
financial inclusion to make available a basic "no-frills" banking account. The recommendations of the Khan
Committee were incorporated into the mid-term review of the policy (200506). [7] Financial inclusion again
featured later in 2005 when it was used by K.C. Chakraborthy, the chairman of Indian
Bank. Mangalam became the first village in India where all households were provided banking facilities. Norms
were relaxed for people intending to open accounts with annual deposits of less than Rs. 50,000. General
credit cards (GCCs) were issued to the poor and the disadvantaged with a view to help them access easy
 credit. In January 2006, the Reserve Bank permitted commercial banks to make use of the services of non-
governmental organizations (NGOs/SHGs), micro-finance institutions, and other civil society organizations as
intermediaries for providing financial and banking services. These intermediaries could be used as business
facilitators or business correspondents by commercial banks. The bank asked the commercial banks in
different regions to start a 100% financial inclusion campaign on a pilot basis. As a result of the campaign,
states or union territories like Puducherry, Himachal Pradesh and Kerala announced 100% financial inclusion
in all their districts. Reserve Bank of Indias vision for 2020 is to open nearly 600 million new customers'
accounts and service them through a variety of channels by leveraging on IT. However, illiteracy and the low
income savings and lack of bank branches in rural areas continue to be a roadblock to financial inclusion in
many states and there is inadequate legal and financial structure.

The government of India recently announced Pradhan Mantri Jan Dhan Yojna,[8] a national financial inclusion
mission which aims to provide bank accounts to at least 75 million people by January 26, 2015. To achieve
this milestone, its important for both service providers and policy makers to have readily available information
outlining gaps in access and interactive tools that help better understand the context at the district level. MIX
designed the FINclusion Lab India FI workbook[9] to support these actors as they craft strategies to achieve
these goals.

In India, RBI has initiated several measures to achieve greater financial inclusion, such as facilitating no-frills
accounts and GCCs for small deposits and credit. Some of these steps are:

Opening of no-frills accounts: Basic banking no-frills account is with nil or very low minimum balance as
well as charges that make such accounts accessible to vast sections of the population. Banks have been
advised to provide small overdrafts in such accounts.

Relaxation on know-your-customer (KYC) norms: KYC requirements for opening bank accounts were
relaxed for small accounts in August 2005, thereby simplifying procedures by stipulating that introduction by an
account holder who has been subjected to the full KYC drill would suffice for opening such accounts. The
banks were also permitted to take any evidence as to the identity and address of the customer to their
satisfaction. It has now been further relaxed to include the letters issued by the Unique Identification Authority
of India containing details of name, address and Aadhaar number.

Engaging business correspondents (BCs): In January 2006, RBI permitted banks to engage business
facilitators (BFs) and BCs as intermediaries for providing financial and banking services. The BC model allows
banks to provide doorstep delivery of services, especially cash in-cash out transactions, thus addressing the
last-mile problem. The list of eligible individuals and entities that can be engaged as BCs is being widened
from time to time. With effect from September 2010, for-profit companies have also been allowed to be
engaged as BCs. India map of Financial Inclusion by MIX provides more insights on this. [10] In the grass-root
level, the Business correspondents (BCs), with the help of Village Panchayat (local governing body), has set
up an ecosystem of Common Service Centres (CSC). CSC is a rural electronic hub with a computer
connected to the internet that provides e-governance or business services to rural citizens. [11]

Use of technology: Recognizing that technology has the potential to address the issues of outreach and
credit delivery in rural and remote areas in a viable manner,banks have been advised to make effective use of
information and communications technology (ICT), to provide doorstep banking services through the BC
model where the accounts can be operated by even illiterate customers by using biometrics, thus ensuring the
security of transactions and enhancing confidence in the banking system. [11]

Adoption of EBT: Banks have been advised to implement EBT by leveraging ICT-based banking through BCs
to transfer social benefits electronically to the bank account of the beneficiary and deliver government benefits
to the doorstep of the beneficiary, thus reducing dependence on cash and lowering transaction costs.
 GCC: With a view to helping the poor and the disadvantaged with access to easy credit, banks have been
asked to consider introduction of a general purpose credit card facility up to `25,000 at their rural and semi-
urban branches. The objective of the scheme is to provide hassle-free credit to banks customers based on the
assessment of cash flow without insistence on security, purpose or end use of the credit. This is in the nature
of revolving credit entitling the holder to withdraw up to the limit sanctioned.

Simplified branch authorization: To address the issue of uneven spread of bank branches, in December
2009, domestic scheduled commercial banks were permitted to freely open branches in tier III to tier VI
centres with a population of less than 50,000 under general permission, subject to reporting. In the north-
eastern states and Sikkim, domestic scheduled commercial banks can now open branches in rural,semi-urban
and urban centres without the need to take permission from RBI in each case, subject to reporting.

Opening of branches in unbanked rural centres: To further step up the opening of branches in rural areas
so as to improve banking penetration and financial inclusion rapidly, the need for the opening of more bricks
and mortar branches, besides the use of BCs, was felt. Accordingly, banks have been mandated in the April
monetary policy statement to allocate at least 25% of the total number of branches to be opened during a year
to unbanked rural centres.

Explain the legal framework of RBI and its credit control mechanism.
The legal-institutional framework for the delivery of civic services in cities and towns as envisaged in the Constitution
(74th Amendment) Act, 1992 comprises a number of mandatory institutions:

State Election Commission (Article 243K);

Municipalities: Municipal Corporations, Municipal Councils and Nagar Panchayats (Article 243Q);

Wards Committees and other Committees (Article 243R);

State Finance Commission (Article 243I);

District Planning Committee (Article 243ZD); and

Metropolitan Planning Committee (Article 243ZE).

The responsibility for the creation and operationalisation of the legal-institutional framework the aforesaid
institutions and other entities, including para-statals impacting on civic service delivery, however, has been left to the
State Governments.

The mandates of various key institutions as prescribed by the Constitution (74th Amendment) Act 1992 are as
follows:

State Election Commission to superintend, direct and control the preparation of electoral rolls, and conduct
elections to all the rural and Urban Local Bodies (ULBs) [Article 243K(1)];

Municipalities to function as institutions of self-government -prepare plans for economic development and
social justice, perform civic functions and implement schemes as may be entrusted to them by the State
Government, including those related to the Twelfth Schedule [Article 243W(a)];

Wards Committees and Special Committees to take Municipal Government physically closer to the people and
carry out the responsibilities conferred upon them including those in relation to the Twelfth Schedule [Article
243W(b)];

State Finance Commission to review the financial position of the rural and urban local bodies, and to make
recommendations regarding the principles of devolution of resources from the State Government to the local bodies
and the measures needed to improve their finances and functioning [Article 243I(1)];

District Planning Committee to consolidate the plans prepared by the Panchayats and the Municipalities in the
district and to prepare a draft development plan for the district as a whole [Article 243ZD(1)];
 Metropolitan Planning Committee to prepare draft development plan for the Metropolitan area as a whole [Article
243ZE(1)].

3.2 Expenditure & Revenue Assignment

Governance of ULBs (and also rural local bodies) in India has remained a State subject in accordance with the
stipulation of the Seventh Schedule and List II of the Constitution of India. Primarily, designed for a two-tier system,
the Constitution of India has specified the expenditure responsibilities as well as the resource raising domains of the
Union and States through three lists given under Schedule VII. This Schedule spells out the division of functions and
finances into the Union List, the State List and the Concurrent List wherein the Union and the State Governments
have joint jurisdiction. However, the scenario has changed substantially after the 74th Amendment, by which the
ULBs have gained constitutional status and have become an integral part of Indias decentralization strategy.

The 74th Amendment Act envisaged that elected Municipalities function as effective local self-government institutions
preparing and implementing plans for economic development and social justice and discharging civic responsibilities
envisaged in the 12th Schedule (Box 2).

In order to perform these tasks, the urban local bodies have to be financially sound and endowed with commensurate
powers to raise resources. However, while the Constitution specifies the expenditure responsibilities, it has not listed
out the sources of revenue of ULBs. Article 243X of the Constitution only stipulates that a State Legislature may, by
law,

i) authorise a Municipality to levy, collect and appropriate such taxes, duties, tolls and fees in accordance with such
procedure and subject to such limit;

ii) assign to a Municipality such taxes, duties, tolls and fees levied and collected by the State Government for such
purposes and subject to such conditions and limits;

iii) provide for making such grants-in-aid to the Municipalities from the Consolidated Fund of the State and

iv) provide for the constitution of such Funds for crediting all moneys received, respectively, by or on behalf of the
Municipalities and also for the withdrawal of such moneys there from, as may be prescribed by law.

Box 2: Functions of Urban Local Bodies: Twelfth Schedule (Article 243W)

1. Urban Planning including town planning;

2. Regulation of land use and construction of buildings;
3. Planning for economic and social development;
4. Roads and bridges;
5. Water supply for domestic, industrial and commercial purposes;
6. Public health, sanitation conservancy and solid waste management;
7. Fire services;
8. Urban forestry, protection of the environment and promotion of ecological aspects;
9. Safe-guarding the interest of weaker sections of society, including the handicapped and mentally retarded;
10. Slums improvement and upgrading;
11. Urban poverty alleviation;
12. Provision of urban amenities and facilities such as parks, gardens, playgrounds;
13. Promotion of cultural, educational and aesthetic aspects;
14. Burials and burial grounds; cremations, cremation grounds and electric crematoriums;
15. Cattle pounds; prevention of cruelty to animals;
16. Vital statistics, including registration of births and deaths;
17. Public amenities, including street lighting, parking lots, bus stops and public conveniences; and
18. Regulation of slaughter houses and tanneries.

Thus, the 74th Amendment has not clarified a critical area of fiscal federalism, i.e., the matching of resources and
responsibilities. The taxes, duties, charges and fees to be levied by the Municipalities, those to be assigned to them
and the grants-in-aid to be provided to them have been left to the discretion of the State Governments. This has
allowed the fiscal mismatches to continue in the absence of adequate decentralization of resources corresponding to
the decentralization of expenditures envisaged in the Constitution (74th Amendment) Act, 1992.

However, for strengthening the finances of the local governments, as described in Chapter 1, the two positive
features in the Amendments to the Constitution are:
 i) provision for the constitution of State Finance Commissions (SFCs) every five years;
ii) amendment of Article 280 of the Constitution of India by inserting section 3(C).

Article 243(I), inserted into the Constitution by the 73rd Amendment Act, makes it mandatory on the part of the State
Governments to constitute SFCs once every five years to review the financial position of the Panchayats and the
Municipalities.

It may be noted that the role of the State Finance Commission is envisaged to be much broader (as set out
subsequently) than that of the Central Finance Commission, which is primarily related to the distribution of the central
divisible pool of resources among the State Governments. As stated earlier, the Constitutional Amendments also
provide a safeguard regarding the implementation of the recommendations of the SFCs. Article 280 of the
Constitution, under which a CFC is appointed once every five years to assess the financial needs of the State
Governments and to recommend a package of financial transfers from the Centre to the States, has been amended.
It is now mandatory on the part of the CFC to recommend measures to augment the Consolidated Fund of a State to
supplement the resources of the Municipalities in the State on the basis of the recommendations made by the
Finance Commission of the State.

The provision for the establishment of a SFC every five years is an important step toward redressing the fiscal
imbalance of ULBs. The additional responsibility cast upon the CFC, to recommended measures to supplement the
resources of local self-government institutions is a clear acknowledgement of the mismatch between functions and
finances at various tiers of the India federal system

Credit control is an important tool used by Reserve Bank of India, a major weapon of the monetary policy used
to control the demand and supply of money (liquidity) in the economy. Central Bank administers control over
the credit that the commercial banks grant.

Such a method is used by RBI to bring "Economic Development with Stability". It means that banks will not
only control inflationary trends in the economy but also boost economic growth which would ultimately lead to
increase in real national income with stability. In view of its functions such as issuing notes and custodian of
cash reserves, credit not being controlled by RBI would lead to Social and Economic instability in the country

Need for credit control[edit]

Controlling credit in the economy is amongst the most important functions of the Reserve Bank of India. The basic and
important needs of credit control in the economy are-

To encourage the overall growth of the "priority sector" i.e. those sectors of the economy which is recognized
by the government as "prioritized" depending upon their economic condition or government interest. These sectors
broadly totals to around 15 in number.[1]

To keep a check over the channelization of credit so that credit is not delivered for undesirable purposes.

To achieve the objective of controlling inflation as well as deflation.

To boost the economy by facilitating the flow of adequate volume of bank credit to different sectors.

To develop the economy.

Objectives of credit control[edit]

Credit control policy is just an arm of economic policy which comes under the purview of Reserve Bank of India, hence,
its main objective being attainment of high growth rate while maintaining reasonable stability of the internal purchasing
power of money. The broad objectives of credit control policy in India have been-

Ensure an adequate level of liquidity enough to attain high economic growth rate along with maximum utilization of
resource but without generating high inflationary pressure.
 Attain stability in exchange rate and money market of the country.

Meeting the financial requirement during slump in the economy and in the normal times as well.

Control business cycle and meet business needs.

Methods of credit control[edit]

There are two methods that the RBI uses to control the money supply in the economy-

Qualitative method

Quantitative method

During the period of inflation Reserve Bank of India tightens its policies to restrict the money supply, whereas
during deflation it allows the commercial bank to pump money in the economy.

Qualitative method[edit]
By Quality we mean the uses to which bank credit is directed.

For example- the bank may feel that spectators or the big capitalists are getting a disproportionately large share in the
total credit, causing various disturbances and inequality in the economy, while the small-scale industries, consumer
goods industries and agriculture are starved of credit.

Correcting this type of discrepancy is a matter of qualitative credit control.

Qualitative method controls the manner of channelizing of cash and credit in the economy. It is a 'selective method' of
control as it restricts credit for certain section where as expands for the other known as the 'priority sector' depending on
the situation.

Tools used under this method are-

Marginal requirement[edit]

Marginal requirement of loan = current value of security offered for loan-value of loans granted. The marginal
requirement is increased for those business activities, the flow of whose credit is to be restricted in the economy.

e.g.- a person mortgages his property worth Rs. 100,000 against loan. The bank will give loan of Rs. 80,000 only. The
marginal requirement here is 20%.

In case the flow of credit has to be increased, the marginal requirement will be lowered. RBI has been using this method
since 1956.[2]

Rationing of credit[edit]

Under this method there is a maximum limit to loans and advances that can be made, which the commercial
banks cannot exceed. RBI fixes ceiling for specific categories. Such rationing is used for situations when credit flow is to
be checked, particularly for speculative activities. Minimum of"capital: total assets" (ratio between capital and total
asset) can also be prescribed by Reserve Bank of India

Publicity[edit]

RBI uses media for the publicity of its views on the current market condition and its directions that will be required to be
implemented by the commercial banks to control the unrest. Though this method is not very successful in developing
nations due to high illiteracy existing making it difficult for people to understand such policies and its implications.

Direct Action[edit]
Under the banking regulation Act, the central bank has the authority to take strict action against any of the commercial
banks that refuses to obey the directions given by Reserve Bank of India. There can be a restriction on advancing of
loans imposed by Reserve Bank of India on such banks. e.g. RBI had put up certain restrictions on the working of the
Metropolitan co-operative banks. Also the 'Bank of Karad' had to come to an end in 1992.[3]

Moral persuasion[edit]

This method is also known as "moral persuasion" as the method that the Reserve Bank of India, being the apex bank
uses here, is that of persuading the commercial banks to follow its directions/orders on the flow of credit. RBI puts a
pressure on the commercial banks to put a ceiling on credit flow during inflation and be liberal in lending during
deflation.

Quantitative method[edit]

Graph showing variations in the Bank Rate from 19352011 (current year) [4]

By quantitative credit control we mean the control of the total quantity of credit.

For Example- let us consider that the Central Bank, on the basis of its calculations, considers that Rs. 50,000 is the
maximum safe limit for the expansion of credit. But the actual credit at that given point of time is Rs. 55,000(say). Thus it
then becomes necessary for the central bank to bring it down to 50,000 by tightening its policies. Similarly if the actual
credit is less, say 45,000, then the apex bank regulates its policies in favor of pumping credit into the economy.

Different tools used under this method are-

Chart showing effect of increase in bank rate

Bank rate[edit]
Bank rate also known as the discount rate is the official minimum rate at which the central bank of the country is ready
to rediscount approved bills of exchange or lend on approved securities.

Section 49 of the Reserve Bank of India Act 1934, defines Bank Rate as "the standard rate at which it (RBI) is prepared
to buy or re-discount bills of exchange or other commercial paper eligible for purchase under this Act".[5]

When the commercial bank for instance, has lent or invested all its available funds and has little or no cash over and
above the prescribed minimum, it may ask the central bank for funds. It may either re-discount some of its bills with the
central bank or it may borrow from the central bank against the collateral of its own promissory notes.

In either case, the central bank accommodates the commercial bank and increases the latter's cash reserves. This Rate
is increased during the times of inflation when the money supply in the economy has to be controlled.

At any time there are various rates of interest ruling at the market, like the deposit rate, lending rate of commercial
banks, market discount rate and so on. But, since the central bank is the leader of the money market and the lender of
the last resort, al other rates are closely related to the bank rate. The changes in the bank rate are, therefore, followed
by changes in all other rates as the money market.

The graph on the right hand side shows variations in the bank rate since 19352011.

Working of the bank rate

This section will answer how Bank Rate policy operates to control the level of prices and business activity in the country.

Changes in bank rate are introduced with a view to controlling the price levels and business activity, by changing the
demand for loans. Its working is based upon the principle that changes in the bank rate results in changed interest rate
in the market.

Suppose a country is facing inflationary pressure. The central bank, in such situations, will increase the bank rate
thereby resulting to a hiked lending rate. This increase will discourage borrowing. It will also lead to a fall in the business
activity due to following reasons.

Employment of some factors of production will have to be reduced by the business people.
 The manufacturers and stock exchange dealers will have to liquidate their stocks, which they held through
bank loans, to pay off their loans.

The effect of Rise in bank rate by the central bank is shown in the chart (left side). Hence, we can conclude that hike in
Bank Rate leads to fall in price level and a fall in the Bank Rate leads to an increase in price level i.e. they share
an inverse relationship.

SWIFT offers unique message processing services globally. Critically explain the features
and importance of SWIFT.

Founded in Brussels in 1973, the Society for the Worldwide Interbank Financial
Telecommunication (SWIFT) is a co-operative organization dedicated to the promotion and
development of standardized global interactivity for financial transactions. SWIFT's original
mandate was to establish a global communications link for data processing and a common
language for international financial transactions. The Society operates a messaging service for
financial messages, such as letters of credit, payments, and securities transactions, between
member banks worldwide. SWIFT's essential function is to deliver these messages quickly and
securely -- both of which are prime considerations for financial matters. Member organizations
create formatted messages that are then forwarded to SWIFT for delivery to the recipient
member organization. SWIFT operates out of its Brussels headquarters and processes data at
centers in Belgium and the United States.

The Society for Worldwide Interbank Financial Telecommunication (SWIFT) provides a network that
enables financial institutions worldwide to send and receive information about financial transactions in a secure,
standardized and reliable environment. SWIFT also sells software and services to financial institutions, much of it for
use on the SWIFTNet Network, and ISO 9362. Business Identifier Codes (BICs, previously Bank Identifier Codes) are
popularly known as "SWIFT codes".

The majority of international interbank messages use the SWIFT network. As of September 2010, SWIFT linked more
than 9,000 financial institutions in 209 countries and territories, who were exchanging an average of over 15 million
messages per day (compared to an average of 2.4 million daily messages in 1995). [1] SWIFT transports financial
messages in a highly secure way but does not hold accounts for its members and does not perform any form
of clearing or settlement.

SWIFT does not facilitate funds transfer: rather, it sends payment orders, which must be settled by correspondent
accounts that the institutions have with each other. Each financial institution, to exchange banking transactions, must
have a banking relationship by either being a bank or affiliating itself with one (or more) so as to enjoy those particular
business features.

SWIFT is a cooperative society under Belgian law owned by its member financial institutions with offices around the
world. SWIFT headquarters, designed by Ricardo Bofill Taller de Arquitectura are in La Hulpe, Belgium, near Brussels.
The chairman of SWIFT isYawar Shah,[2] originally from Pakistan,[3] and its CEO is Gottfried Leibbrandt, originally from
the Netherlands.[4] SWIFT hosts an annual conference every year, called SIBOS, specifically aimed at the financial
services industry.