Overview of Indian Financial System

 The financial system of a country is an important tool for economic development of the country
as it helps in the creation of wealth by linking savings with investments. It facilitates the flow of
funds from the households (savers) to business firms (investors) to aid in wealth creation and
development of both the parties.

 There are four main constituents of the financial system as follows:

1. Financial Services – Banking, Foreign Exchange, Investment, Insurance and others

(advisory, etc.)
2. Financial Assets/Instruments – Call Money (14 Days), Term Money (>14 days), Treasury
Bills (<1 year), Certificate of Deposit and Commercial Paper.
3. Financial Markets – Corporate Securities market, Government Securities market, Long-
Term Loan market.
4. Financial Intermediaries - A financial intermediary is an institution which connects the
deficit and surplus money. The best example of an intermediary is a bank which
transforms the bank deposits to bank loans.
o Depository Institutions - These are banks and credit unions that collect money
from the public and use that money to advance loans to financial customers.
o Non-Depository institutions -  These are brokerage firms, insurance and mutual
funds companies that cannot collect money deposits but can sell financial
products to financial customers.
Type of Banks

Reserve Bank of India

 RBI established on April 1, 1935 under RBI ACT 1934 (recommendations of John Hilton Young
Commission 1926 – called Royal Commission on Indian Currency & Finance), is the central bank of
the country & was nationalized w.e.f 01st Jan 1949. Its central office is in Mumbai.

 Functions of RBI-
1. Issuance of Currency

2. Banker to Govt

3. Bankers‘ bank

4. Controller of Banks

5. Controller of credit

6. Maintenance of external value

 Monetary Policy

1. Repo Rate: Repo rate is the rate of interest which is levied on Short-Term loans taken by
commercial banks from RBI. Whenever the banks have any shortage of funds they can
borrow it from RBI.
 2. Reverse Repo Rate: This is exact opposite of Repo rate. Reverse repo rate is the rate at
which commercial banks charge on their surplus funds with RBI. RBI uses this tool when it
feels there is too much money floating in the banking system.

3. SLR Rate: Statutory Liquidity Ratio is the amount a commercial bank needs to maintain in
the form of cash, or gold or Govt. approved securities (Bonds) before providing credit to its
customers. It is determined as the %age of total Net Demand & Time Liabilities (NDTL).

4. Bank Rate: It is defined in Sec 49 of RBI Act 1934 as the ̳standard rate at which RBI is
prepared to buy or rediscount bills of exchange or other commercial papers eligible for
purchase under this act‘.

5. Cash Reserve Ratio: CRR refers to the ratio of bank‘s cash reserve balances with RBI with
reference to the bank‘s net demand & time liabilities to ensure the liquidity & solvency of
the scheduled banks.

6. MSF: It was introduced w.e.f. May 09, 2011, by RBI. Eligibility: Scheduled Commercial Banks
having Current Account & SGL Account with RBI. Amount: 1% of NDTL

Commercial Banks

1. Commercial bank is an institution that accepts deposit, makes business loans and offer
related services to various like accepting deposits and lending loans and advances to general
customers and business man.
2. These institutions run to make profit. They cater to the financial requirements of industries
and various sectors like agriculture, rural development, etc. it is a profit making institution
owned by government or private of both.

Public Sector Banks

1. Currently there are 21 Nationalised banks in India. The public sector accounts for 75 percent
of total banking business in India and State Bank of India is the largest commercial bank in
terms of volume of all commercial banks.

Foreign Banks

1. A foreign bank with the obligation of following the regulations of both its home and its host
countries. Loan limits for these banks are based on the capital of the parent bank, thus
allowing foreign banks to provide more loans than other subsidiary banks.
2. Foreign banks are those banks, which have their head offices abroad. CITI bank, HSBC,
Standard Chartered etc. are the examples of foreign bank in India. Currently India has 36
foreign banks.

Regional Rural Bank (RRB)

1. The government of India set up Regional Rural Banks (RRBs) on October 2, 1975. The banks
provide credit to the weaker sections of the rural areas, particularly the small and marginal
farmers, agricultural labourers, and small entrepreneurs. There are 82 RRBs in the country.
NABARD holds the apex position in the agricultural and rural development. 
Co-operative Bank

1. Co-operative bank was set up by passing a co-operative act in 1904. They are organised and
managed on the principal of co-operation and mutual help. The main objective of co-
operative bank is to provide rural credit.

Banking Sector Reforms In India

Basel Norms

 Stefan Ingves, Governor of Sveriges Riks bank (SWEDEN), is the Chairman of the Basel
Committee.

 Basel III or Basel 3 released in December, 2010 is the third in the series of Basel Accords.
These accords deal with risk management aspects for the banking sector.

 According to Basel Committee on Banking Supervision "Basel III is a comprehensive set of

reform measures, developed by the Basel Committee on Banking Supervision, to strengthen
the regulation, supervision & risk management of the banking sector".
Basel 3 measures aim to:

a)  Improve the banking sector's ability to absorb shocks arising from financial & economic
stress, whatever the source

b)  Improve risk management & governance

c)  Strengthen banks' transparency & disclosures .

 Three Pillars of Basel III

1. Minimum Regulatory Capital Requirements based on Risk Weighted Assets (RWAs)

2. Supervisory Review Process:

3. Market Discipline

 Important facts related to BASEL III

1. Capital Conservation Buffers to RWAs--2.50%

2. Leverage Ratio--3.00%

3. Countercyclical Buffer--0% to 2.50%

4. Core Tier 1 Capital to RWAs – 5%

5. Tier 1 Capital to RWAs – 6%

 6. Minimum Ratio of common equity to RWAs – 4.5 % to 7%

7. Minimum Ratio of Total Capital to RWAs – 10.5%

NPA

 It means once the borrower has failed to make interest or principal payments for 90 days,
the loan is considered to be a non-performing asset.

 The asset portfolio of bank is required to be classified as

1. Standard asset is one that does not disclose any problems & which does not carry more
than normal risk attached to the business.

2. An asset which has been classified as NPA for a period not exceeding 12 months is
considered as sub- standard asset.

3. Doubtful asset is one which has remained NPA for a period exceeding 12 months.

4. An asset which is considered uncollectible & loss has been identified by the bank or
internal or external auditors or the RBI inspection & the loss has not been written off is
regarded as loss asset.

FINANCIAL MARKETS – TOPIC 8 ----Page N0 – 8

FINANCIAL INSTITUTIONS

 Topic 34----Page no -2

 Topic 28-----Page 20

 Page 16- Important Terms Related to Mutual Fund

Financial Regulatory Bodies

The Indian financial system is regulated by five major regulatory bodies, they are:

 RBI as an apex monetary institution: 

Established in April, 1935 in Calcutta, the Reserve Bank of India (RBI) later moved to Mumbai
in 1937. After its nationalization in 1949, RBI is presently owned by the Govt. of India. It has
19 regional offices, majorly in state capitals, and 9 sub-offices. It is the issuer of the Indian
Rupee. RBI regulates the banking and financial system of the country by issuing broad
guidelines and instructions.
 Role of RBI
1. Control money supply
2. Monitor key indicators like GDP and inflation
3. Maintain people’s confidence in the banking and financial system by providing
tools such as ‘Ombudsman’
4. Formulate monetary policies such as inflation control, bank credit and interest
rate control 
 SEBI as a regulatory body for the securities market:

Securities Exchange Board of India (SEBI) was established in 1988 but got legal status in 1992
to regulate the functions of securities market to keep a check on malpractices and protect
the investors. Headquartered in Mumbai, SEBI has its regional offices in New Delhi, Kolkata,
Chennai and Ahmedabad.

Role of SEBI
1. Protect the interests of investors through proper education and guidance
2. Regulate and control the business on stock exchanges and other security
markets
3. Stop fraud in capital market
4. Audit the performance of stock market

 Insurance Regulatory and Development Authority of India (IRDAI)

o IRDAI is an autonomous apex statutory body for regulating and developing the
insurance industry in India. It was established in 1999 through an act passed by the
Indian Parliament. Headquartered in Hyderabad, Telangana, IRDA regulates and
promotes insurance business in India.

 Forward Market Commission of India (FMC)

o Headquartered in Mumbai, FMC is a regulatory authority governed by the Ministry
of Finance, Govt. of India. It is a statutory body, established in 1953 under the
Forward Contracts (Regulation) Act, 1952. The commission allows commodity
trading in 22 exchanges in India. The FMC is now merged with SEBI.

 Pension Fund Regulatory and Development Authority (PFRDA)

o Established in October 2003 by the Government of India, PFRDA develops and
regulates the pension sector in India. The National Pension System (NPS) was
launched in January 2004 with an aim to provide retirement income to all the
citizens. The objective of NPS is to set up pension reforms and inculcate the habit of
saving for retirement amongst the citizens.