SEMINAR REPORT

ON
“INDIAN FINANCIAL SYSTEM”

Submitted to : Submitted by :
MRS. RUPA KHANNA MALHOTRA Yamini Swami
Programme Coordinator MBA (IT)
MBA (IB/IT)

Graphic Era University

Dehradun
 CONTENT

Sl. No. Title of the Chapter Page No.

Acknowledgement 3

Introduction of the Topic 4

Report Profile 5

1. Introduction of Financial System 6

2 Saving and Financial Intermediaries 16

3 Commercial Banking 20

4 Central Banking 24

5 Security Exchange Board Of India 40

6 Financial Services 42

7 Some Important Financial Institution 47

8 Global Crisis Impact on Indian Financial System 54

9 Future Vision of Indian Financial System 64

10 Growth of Indian Financial System 72

Summary and Recommendations 73

Conclusions 75

2
 ACKNOWLEDGEMENT

First of all I thanks to God for showing me the right path and boosting my
morale up to bring the best out of me.

I express my gratitude to Mrs. Manu Sharma(Teacher of DSS) who

guides me in making my presentation and also Mrs. Rupa Khanna Malhotra,
Coordinator MBA (IB/IT) for their inspiring direction in this degree course
programme. My sincere thanks goes to all my teachers those work as a mentor for
me in this semester and entire degree programme also.

I thankful to my family members without their support I am not able to

complete my any life task. I also thanks to my roommates and classmates those
help me to complete this report on time.

I also thankful to the University Library staff, without their support I am

not complete this project perfectly.

Yamini Swami
MBA (IT)

3
 INTRODUCTION OF THE TOPIC
“Finance is the art of passing currency from hand to hand until it
finally disappears.”

A financial system, which is inherently strong, functionally diverse and displays

efficiency and flexibility, is critical to our national objectives of creating a market-driven,
productive and competitive economy. A mature system supports higher levels of
investment and promotes growth in the economy with its depth and coverage. The
financial system in India comprises of financial institutions, financial markets, financial
instruments and services. The Indian financial system is characterised by its two major
segments - an organised sector and a traditional sector that is also known as informal
credit market. Financial intermediation in the organised sector is conducted by a large
number of financial institutions which are business organisations providing financial
services to the community. Financial institutions whose activities may be either
specialised or may overlap are further classified as banking and non-banking entities. The
Reserve Bank of India (RBI) as the main regulator of credit is the apex institution in the
financial system. Other important financial institutions are the commercial banks (in the
public and private sector), cooperative banks, regional rural banks and development
banks. Non-bank financial institutions include finance and leasing companies and other
institutions like LIC, GIC, UTI, Mutual funds, Provident Funds, Post Office Banks etc.

4
 REPORT PROFILE

Objectives Of study: -
The vital objectives of this report are-
 To enhance and sharpens skill.
 To get awareness about changing business environment in financial
system.
 To understand the financial system.

Industry Profile :
India stands on the cusp of the millennium, having largely completed a first phase
of financial sector reforms and in need of a second phase to meet some remaining and
new challenges. The first phase — liberalization of interest rate and directed credit —
began in the early 1990s, hand-in-hand with real sector deregulation. With prices in the
real economy reflecting economic costs more closely and with greater reliance on the
private sector, it naturally became important to move from a financial system that was
largely an arm of public finance carrying out centralized, directed credit allocations to a
system where financial institutions played a much greater role in allocating resources
based on their evaluation of risk and return. Cross-country evidence suggests that the new
approach should contribute to faster overall development.
Giving financial sector institutions a greater role in credit allocations entails many
changes — not just freeing interest rates and credit allocations but giving more attention
to legal, regulatory and supervisory issues and to incentives, an area that often has been
neglected. The changes involve not only individual institutions and sectors of the
financial system, but also intersectoral issues, such as meshing the roles of banks,
development banks and the capital market.

5
 CHAPTER – 1
INTRODUCTION OF FINANCIAL SYSTEM

The economic scene in the post independence period has seen a sea change;
the end result being that the economy has made enormous progress in diverse
fields. There has been a quantitative expansion as well as diversification of
economic activities. The experiences of the 1980s have led to the conclusion that
to obtain all the benefits of greater reliance on voluntary, market-based decision-
making, India needs efficient financial systems.

The financial system is possibly the most important institutional and

functional vehicle for economic transformation. Finance is a bridge between the
present and the future and whether it be the mobilisation of savings or their
efficient, effective and equitable allocation for investment, it is the success with
which the financial system performs its functions that sets the pace for the
achievement of broader national objectives.

Significance and Definition

The term financial system is a set of inter-related activities/services
working together to achieve some predetermined purpose or goal. It includes
different markets, the institutions, instruments, services and mechanisms which
influence the generation of savings, investment capital formation and growth.

Van Horne defined the financial system as the purpose of financial markets
to allocate savings efficiently in an economy to ultimate users either for
investment in real assets or for consumption. Christy has opined that the objective
of the financial system is to "supply funds to various sectors and activities of the
economy in ways that promote the fullest possible utilization of resources without

6
the destabilizing consequence of price level changes or unnecessary interference
with individual desires."

According to Robinson, the primary function of the system is "to provide a

link between savings and investment for the creation of new wealth and to permit
portfolio adjustment in the composition of the existing wealth."
From the above definitions, it may be said that the primary function of the
financial system is the mobilisation of savings, their distribution for industrial
investment and stimulating capital formation to accelerate the process of economic
growth.

The process of savings, finance and investment involves financial institutions,

markets, instruments and services. Above all, supervision control and regulation
are equally significant. Thus, financial management is an integral part of the
financial system. On the basis of the empirical evidence, Goldsmith said that "... a

7
case for the hypothesis that the separation of the functions of savings and
investment which is made possible by the introduction of financial instruments as
well as enlargement of the range of financial assets which follows from the
creation of financial institutions increase the efficiency of investments and raise
the ratio of capital formation to national production and financial activities and
through these two channels increase the rate of growth……"
The inter-relationship between varied segments of the economy are
illustrated below:-

A financial system provides services that are essential in a modern

economy. The use of a stable, widely accepted medium of exchange reduces the
costs of transactions. It facilitates trade and, therefore, specialization in
production. Financial assets with attractive yield, liquidity and risk characteristics
encourage saving in financial form. By evaluating alternative investments and
monitoring the activities of borrowers, financial intermediaries increase the
efficiency of resource use. Access to a variety of financial instruments enables an
economic agent to pool, price and exchange risks in the markets. Trade, the

8
efficient use of resources, saving and risk taking are the cornerstones of a growing
economy. In fact, the country could make this feasible with the active support of
the financial system. The financial system has been identified as the most
catalyzing agent for growth of the economy, making it one of the key inputs of
development

The Organisation of the Financial System in India

The Indian financial system is broadly classified into two broad groups:
i) Organised sector and
ii) unorganised sector.

"The financial system is also divided into users of financial services and
providers.
Financial institutions sell their services to households, businesses and government.
They are the users of the financial services. The boundaries between these sectors
are not always clear cut. In the case of providers of financial services, although
financial systems differ from country to country, there are many similarities.
(i) Central bank
(ii) Banks
(iii) Financial institutions
(iv) Money and capital markets and
(v) Informal financial enterprises.

i) Organised Indian Financial System

The organised financial system comprises of an impressive network of
banks, other financial and investment institutions and a range of financial
instruments, which together function in fairly developed capital and money
markets. Shortterm funds are mainly provided by the commercial and cooperative
banking structure. Nine-tenth of such banking business is managed by twenty-
eight leading banks which are in the public sector. In addition to commercial

9
banks, there is the network of cooperative banks and land development banks at
state, district and block levels. With around two-third share in the total assets in
the financial system, banks play an important role. Of late, Indian banks have also
diversified into areas such as merchant banking, mutual funds, leasing and
factoring.

The organised financial system comprises the following sub-systems:

1. Banking system
2. Cooperative system
3. Development Banking system
(i) Public sector
(ii) Private sector
4.Money markets and
5. Financial companies/institutions.

Over the years, the structure of financial institutions in India has developed
and become broad based. The system has developed in three areas - state,
cooperative and private. Rural and urban areas are well served by the cooperative
sector as well as by corporate bodies with national status. There are more than
4,58,782 institutions channellising credit into the various areas of the economy.

ii) Unorganised Financial System

On the other hand, the unorganised financial system comprises of relatively
less controlled moneylenders, indigenous bankers, lending pawn brokers,
landlords, traders etc. This part of the financial system is not directly amenable to
control by the Reserve Bank of India (RBI). There are a host of financial
companies, investment companies, chit funds etc., which are also not regulated by
the RBI or the government in a systematic manner. However, they are also
governed by rules and regulations and are, therefore within the orbit of the
monetary authorities.

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The Banking System

The structure of the baking system is determined by two basic factors –

economic and legal. The Development of the economy and the spread of banking
habit calls for increasing banking services. The demand for these banking services
affects the banks' structure and organisation. National objectives and aspirations
result in government regulations, which have a profound influence on’ the banking
structure. These regulations are basically of two types. First, regulations which
result in the formation of new banks to meet the specific needs of a group of
economic activities. Secondly, legislation that affects the structure by means of
nationalisation, mergers or liquidation.

RBI
The Reserve Bank of India as the central bank of the country, is at the head
of this group. Commercial banks themselves may be divided into two groups, the
scheduled and the non scheduled.
The commercial banking system may be distinguished into:
A. Public Sector Banks
i) State Bank of India State Bank Group
ii) Associate Bank
iii) 14 Nationalized Banks (1969) Nationalized Banks
iv) 6 Nationalized Banks (1980)
v) Regional Rural Banks Mainly sponsored by Public Sector
Banks
B. Private Sector Banks
i) Other Private Banks;
ii) New sophisticated Private Banks;
iii) Cooperative Banks included in the second schedule;
iv) Foreign banks in India, representative offices, and
v) One non-scheduled banks

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Cooperative Sector
The cooperative banking sector has been developed in the country to
supplant the village moneylender, the predominant source of rural finance, as the
terms on which he made finance available have generally been usurious and
detrimental to the development of Indian agriculture. Although the sector receives
concessional finance from the Reserve Bank, it is governed by the state
legislation. From the point of view of the money market, it may be said to lie
between the organized and the unorganised markets.

Primary cooperative Credit Societies

The primary cooperative credit society is an association of borrowers and
nonborrowers residing in a particular locality. The funds of the society are derived
from the share capital and deposits of members and loans from Central
Cooperative banks. The borrowing power of the members as well as of the society
is fixed. The loans are given to members for the purchase of cattle, fodder,
fertilizers, pesticides, implements etc.

Central Co-operative Banks

These are the federations of primary credit societies in a district. These
banks finance member societies within the limits of the borrowing capacity of
societies. They also conduct all the business of a joint-stock bank.

State Co-operative Banks

The State Cooperative Bank is a federation of Central cooperative banks
and acts as a watchdog of the cooperative banking structure in the State. Its funds
are obtained from share capital, deposits, loans and overdrafts from the Reserve
Bank of India. The State Co-operative Banks lend money to central cooperative
banks and primary societies and not directly to farmers.

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Land Development Banks
The Land Development Banks, which are organized in three tiers, namely,
State, Central and Primary level, meet the long term credit requirements of
farmers for developmental purposes, viz, purchase of equipment like pump sets,
tractors and other machineries, reclamation of land, fencing, digging up new wells
and repairs of old wells etc. Land Development Banks are cooperative institutions
and they grant loans on the security of mortgage of immovable property of the
farmers.

Money Market
Money market is concerned with the supply and the demand for investible funds.
Essentially, it is a reservoir of short-term funds. Money market provides a
mechanism by which short-term funds are lent out and borrowed; it is through this
market that a large part of the financial transactions of a country are cleared. It is
place where a bid is made for short-term investible funds at the disposal of
financial and other institutions by borrowers comprising institutions, individuals
and the Government itself. Thus, money market covers money, and financial
assets which are close substitutes for money. The money market is generally
expected to perform following three broad functions:
(i) To provide an equilibrating mechanism to even out demand for and supply of
short term funds.
(ii) To provide a focal point for Central bank intervention for influencing liquidity
and general level of interest rates in the economy.
(iii) To provide reasonable access to providers and users of short-term funds to
fulfill their borrowing and investment requirements at an efficient market clearing
price.
Capital Market

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The capital market is the place where the medium-term and long-term financial
needs of business and other undertakings are met by financial institutions which
supply medium and long-term resources to borrowers. These institutions may
further be classified into investing institutions and development banks on the basis
of the nature of their activities and the financial mechanism adopted by them.
Investing institutions comprise those financial institutions which garner the
savings of the people by offering their own shares and stocks, and which provide
long-term funds, especially in the form of direct investment in securities and
underwriting capital issues of business enterprises. These institutions include
investment banks, merchant banks, investment companies and the mutual funds
and insurance companies. Development banks include those financial institutions
which provide the sinews of development, i.e. capital, enterprise and know-how,
to business enterprises so as to foster industrial growth.

Liberalisation Of The Financial System

A radical restructuring of the economic system consisting of industrial
deregulation, liberalisation of policies relating to foreign direct investment, public
enterprise reforms, reforms of taxation system, trade liberalisation and financial
sector reforms have been initiated in 1992-93. Financial sector reforms in the area
of commercial banking, capital markets and non-banking finance companies have
also been undertaken. The focus of reforms in the financial markets has been on
removing the structural weaknesses and developing the markets on sound lines.
The money and foreign exchange market reforms have attempted to broaden and
deepen them. Reforms in the government securities market sought to smoothen the
maturity structure of debt, raising of debt at close-to-market rates and improving
the liquidity of government securities by developing an active secondary market.
In the capital market the focus of reforms has been on strengthening the disclosure
standards, developing the market infrastructure and strengthening the risk
management systems at stock exchanges to protect the integrity and safety of the

14
market. Elements of the structural reforms in various market segments are
introduction of free pricing of financial assets such as interest rate on government
securities, pricing of capital issues and exchange rate, the enlargement of the
number of participants and introduction of new instruments. Improving financial
soundness and credibility of banks is a part of banking reforms under. Taken by
the RBI, a regulatory and supervisory agency over commercial banks under the
Banking Companies Regulation Act 1949. The improvement of financial health of
banks is sought to be achieved by capital adequacy norms in relation to the risks to
which banks are exposed, prudential norms for income recognition and provision
of bad debts. The removal of external constraints in norms of pre-emption of
funds, benefits and prudential regulation and recapitalisation and writing down of
capital base are reflected in the relatively clean and healthy balance sheets of
banks. The reform process has, however, accentuated the inherent weaknesses of
public sector dominated banking systems. There is a need to further improve
financial soundness and to measure up to the increasing competition that a fast
liberalising and globalizing economy would bring to the Indian banking system.

In the area of capital market, the Securities and Exchange Board of India
(SEBI) was set up in 1992 to protect the interests of investors in securities and to
promote development and regulation of the securities market. SEBI has issued
guidelines for primary markets, stipulating access to capital market to improve the
quality of public issues, allotment of shares, private placement, book building,
takeover of companies and venture capital. In the area of secondary markets,
measures to control volatility and transparency in dealings by modifying the badla
system, laying down insider regulations to protect integrity of markets, uniform
settlement, introduction of screen-based online trading, dematerialising shares by
setting up depositories and trading in derivative securities (stock index futures).
There is a sea change in the institutional and regulatory environment in the capital
market area.

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 CHAPTER 2
SAVING AND FINANCIAL INTERMEDIATION

Saving
The term saving refers to the activity by which claims to resources, which
might be put to current consumption, are set aside and so become available for
other purposes. It represents the excess of income over current consumption. The
total volume of savings in an economy, therefore, depends mainly upon the size of
its material income and its average propensity to consume, which, in its turn, is
determined by the level and distribution of the incomes, tastes and habits of the
people, their expectations about the future, etc. As the size of the national income
increases, the volume and ratio of savings may generally be expected to rise,
unless the marginal propensity to consume is either equal to, or higher than the
average propensity. This is very likely to be the case in countries where the
standards of living are very low, and where the development policy places a heavy
emphasis on the social objectives of raising the living standards of the poorer
sections of the community, or where the spending habits of the people are strongly
influenced by the "demonstration effect)

Composition of Savings
Total savings are composed of public savings and private saving. Public
savings constitute the savings of the government through normal budgetary
channels and the retained earnings of public enterprises. Private savings includes
household savings and business savings. The house hold sector makes the largest
contribution 77% in 94-95, the public sector – 6.8% and the business sector 16.2%
of the savings of household sector, savings (gross) in the form of physical assets
accounted for 36.1% in 1998-99.

Factors determining saving

16
 The volume of public savings depends largely upon the functions assumed
by the state, the general state of the economy, the tax structure, the fiscal policy of
the government, its pricing and investment policies. Private savings include
household savings and business savings. They occupy, by far, the most important
position in democratic countries. The size of household savings depends on the
capacity and ability and willingness of the people to save, which are influenced by
a multitude of social, psychological and political factors, in addition to the
economic factors, the most important of which are the level and distribution of
income and the general fiscal, monetary and economic policies of the state.

Business savings, in the form of retained savings and depreciations and

other provisions, claim relatively large proportions of the total savings in
developed countries. Such savings are identified generally with corporate savings
because the savings of other forms of business enterprises are not only relatively
small but are not easily distinguishable from household savings. Corporate savings
depend chiefly on the profitability of the enterprises and their policies of the
distribution of dividends, provision for depreciation, etc., and the retention of
current earnings for financial expansion programmes. These, in their turn, are
largely influenced by the general state of the economy (and of industry in
particular), the fiscal policies of the state and expectations about the future).

Gross Domestic Savings

The savings on a gross basis include:
Depreciation at book value in the case of the private corporate sector.
In the case of the household sector, savings in the form of financial assets
without allowing for increase in household liabilities which largely consist of
loans and advances from banks, and
In the case of physical assets of the household sector, the difference in value of
physical assets in terms of gross saving and net saving which was a much as 43.2

17
per cent in 1994-95 (41.9 per cent in 1980-81). This may be largely on account of
depreciation and changes in stocks of unincorporated enterprises which account
for 80 per cent of the savings of the household sector. The gross domestic savings
ratio was 23.4% in 1998-99).

Saving of Household Sector In the form of Gold

For long, gold has been kept out of the financial system. It has been left out
of our savings estimates and purchase of gold is treated as consumption. This is
really going against entrenched custom. Gold hoards which are estimated at $100
billion have to be brought into the mainstream of the financial system. Further, out
of our annual import of $6 billion (400 to 500 tones), 90 per cent goes towards
investment in the form of jewellery. Gold should be treated as a 'hybrid asset' as
the Committee on Capital Account Convertibility (CAC) has termed it. In the
words of the Committee, "Gold is a surrogate for foreign exchange and because of
its special features it is a hybrid between a commodity and a financial asset". The
Committee on CAC recommended that asset." banks should be permitted to
operate freely both in the domestic and international gold markets, sale of gold by
banks and financial institutions (FIs) should be freely allowed to all residents,
banks should be allowed to offer gold denominated deposits and loans and banks
should be allowed to offer deposit schemes akin to gold accumulation plans.

The liberalization of the overall policy regime of gold as recommended by

the Committee is the most far reaching and has a vital impact on our savings and
investment. Its implementation would have enormous impact in terms of growth
as gold can be mobilised for financing investment. Once we accept it as an
instrument for saving, estimates of household savings in the national income
statistics would go up by 10-12 per cent and overall gross saving and net saving
ratios by 1.5 to 1.2 per cent. The inclusion of gold in national income statistics is

18
not suggested just to raise the savings rate. It is in the national interest to put it to
productive use.

Savings of the Household Sector In Financial Assets

The financial assets in the order of their importance in 1998-99 are bank
deposits, provident and pension funds, non-bank deposits, currency, life insurance
fund, claims on government and shares and debentures. The composition of
household sector's savings has been generally in favour of financial assets as
compared to physical assets on account of the higher rates of return on financial
saving, growing financial intermediation and preference of households for less
risky assets like bank deposits, contractional savings and small savings
instruments.

Financial intermediation
The Institutions in the financial market such as Banks & other non banking
financial intermediatory undertakes the task of accepting deposits of money from
the public at large and employing them deposits so pooled in the forms of loans
and investment to meet the financial needs of the business and other class of
society i.e. they collect the funds from surplus sector through various schemes and
channalised then to the deficit sector.
These financial intermediaries act as moblisers of public saving for their
productive utilization. Funds are transferred through creation of financial
liabilities such as bonds and equity shares. Among the financial institutions
commercial banks accounts for more than 64% of the total financial sector assets.
Thus financial intermediation can enhance the growth of economy by pooling
funds of small and scattered savers and allocating then for investment in an
efficient manner by using their in formational advantage in the loan market. They
are the principal moblisers of surplus funds to productive activity and utilize this
funds for capital formation hence promote the growth.

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 CHAPTER 3
COMMERCIAL BANKING

Enhancement of the RBI Act 1935 gave birth to scheduled banks in India,
and some of these banks had already been established around 1881. The
prominent among the scheduled banks is the Allahabad Bank, which was set up in
1865 with European management. The first bank which was established with
Indian ownership and management was the Oudh Commercial Bank, formed in
1881, followed by the Ayodhya Bank in 1884, the Punjab National Bank in 1894
and Nedungadi Bank in 1899. Thus, there were five Banks in existence in the 19 th
century. During the period 1901-1914, twelve more banks were established,
prominent among which were the Bank of Baroda (1906), the Canara Bank
(1906), the Indian Bank (1907), the Bank of India (1908) and the Central Bank of
India (1911).
Thus, the five big banks of today had come into being prior to the
commencement of the First World War. In 1913, and also in 1929, the Indian
Banks faced serious crises. Several banks succumbed to these crises. Public
confidence in banks received a jolt. There was a heavy rush on banks. An
important point to be noted here is that no commercial bank was established
during the First World War, while as many as twenty scheduled banks came into
existence after independence - two in the public sector and one in the private
sector. The United Bank of India was formed in 1950 by the merger of four
existing commercial banks. Certain non-scheduled banks were included in the
second schedule of the Reserve Bank. In view of these facts, the number of
scheduled banks rose to 81. Out of 81 Indian scheduled banks, as many as 23 were
either liquidated or merged into or amalgamated with other scheduled banks in
1968, leaving 58 Indian schedule banks.
It may be emphasized at this stage that banking system in India came to be
recognized in the beginning of 20th century as powerful instrument to influence

20
the pace and pattern of economic development of the country. In 1921 need was
felt to have a State Bank endowed with all support and resources of the
Government with a view to helping industries and banking facilities to grow in all
parts of the country. It is towards the accomplishment of this objective that the
three Presidency Banks were amalgamated to form the Imperial Bank of India.
The role of the Imperial Bank was envisaged as "to extend banking facilities, and
to render the money resources of India more accessible to the trade and industry of
this country, thereby promoting financial system which is an indisputable
condition of the social and economic advancement of India." Until 1935 when
RBI came into existence to play the role of Central Bank of the county and
regulatory authority for the banks, Imperial Bank of India played the role of a
quasi-central bank. It functioned as a commercial bank but at times the
Government used it for regulating the money supply by influencing its policies.

Thus, the role of commercial banks in India remained confined to providing

vehicle for the community's savings and attending to the credit needs of only
certain selected and limited segments of the economy.

Financial services
Commercial banks are the heart of our financial system. They hold the
deposits of millions of persons, governments and business units. They make funds
available through their lending and investing activities to borrowers - individuals,
business firms, and governments. In doing so, they facilitate both the flow of
goods and services from producers to consumers and the financial activities of
governments. They provide a large portion of our medium of exchange and they
are the media through which monetary policy is effected.
These facts obviou51y add up to the conclusion that the commercial
banking system of the nation is important to the functioning of its economy.
Commercial banks playa very important role in our economy; in fact, it is difficult

21
to imagine how our economic system could function efficiently without many of
their services. They are the heart of our financial structure, since they have the
ability, in cooperation with the Reserve Bank of India, to add to the money supply
of the nation and create additional purchasing power. Banks' lending, investments
and related activities facilitate the economic processes of production, distribution
and consumption.

The major task of banks and other financial institutions is to act as

intermediaries, channelling savings into investment and consumption: through
them, the investment requirements of savers are reconciled with the credit needs
of investors and consumers.
If this process of transference is to be carried out efficiently, it is absolutely
essential that the banks are involved. Indeed, in performing their tasks, they realise
important economies of scale: the savings placed at their disposal are employed in
numerous and large transactions adapted to the specific needs of borrowers. In this
way, they are able to make substantial cost savings for both savers and borrowers,
who would otherwise have to make individual transactions with each other.
However, there is more to these economies of scale than just the cost aspect.

Commercial banks have been referred to as 'department stores of finance'

as they provide a wide variety of financial services. In addition to the acceptance
of deposits, lending and investing, they provide a multitude of services, including
transfer of funds, collection, foreign exchange, safe custody, safe deposit locker,
traveller'5 cheque, merchant banking services, credit cards, gift cheques, etc.
Commercial Banks provide various securities related services. Commercial banks
in India have set up subsidiaries to provide capital market related services,
recruitment banking merchant banking etc.

22
 Merchant banking services are activities i.e. counseling corporate clients
who are in need of capital on capital structure, from of capital to be raised, the
terms and conditions of issue underwriting of the issue, timing of the issue &
preparation of prospectus and publicity for grooming the issue for the market.
While providing these services they act as sponsor of issue, render expert advice
on matters pertaining to investment decision, render the services as corporate
counseling and advice on mergers acquisition and reorganization.

23
 CHAPTER 4
CENTRAL BANKING

The pattern of central banking in India was based on the Bank of England.
England had a highly developed banking system in which the functioning of the
central bank as a banker's bank and their regulation of money supply set the
pattern. The central bank's, function as 'a: lender of last resort' was oil the
condition that the banks maintain stable cash ratios as prescribed from time to
time. The effective functioning of the British model depends on an active
securities market where open market operations can be conducted at the discount
rate. The effectiveness of open market operations however depends on the
member banks' dependence on the central bank and the influence it wields on
interest rates. Later models, especially those in developing countries showed that
central banks play an advisory role and render technical services in the field of
foreign exchange, foster the growth of a sound financial system and act as a
banker to government. .

Instruments Of Monetary Control

One of the most important functions of a central bank is monetary
managementregulation of the quantity of money and the supply and availability of
credit for industry, business and trade. !be monetary or credit management
activities of the bank are of two types: general monetary' and credit management
functions-total supply of money and credit and the general level of interest rates.
The central bank relies on two types of instruments.

The direct and the indirect. The direct instruments of monetary control are
reserve requirements, administered interest rates and credit controls; and the
indirect instrument of control is open market operation.

24
Bank rate policy
Bank rate is the rate charged by the central bank for rediscounting first
class bills of exchange and government securities held by Commercial Banks. The
Bank rate policy affects the cost and availability of credit to the Commercial
Banks. When there is inflation the central bank raises the bank rate. This will raise
the cost of borrowing of the Commercial Banks, so they will charge a higher rate
of interest on their loans and advances to the customer. This would lead to
following effects:
i) Rise in market rate of interest
ii) Rise in the cost of borrowing money from the banks
iii) Decline in demand for credit leading, to contraction of credit.
When there is deflation in the economy, the central bank will lower the
bank rate. Opposite trend takes place leading to expansion of credit to the
economy. In short, an increase in the bank rate leads to rise in the rate of interest
and contraction of credit, which in turn adversely affects investment activities and
the economy as a whole. Similarly, a lowering of bank rate will have a reverse
effect. When the bank rate is lowered money market rate falls. Credit becomes

25
cheaper. People borrow, these leads to expansion of credit. This increases
investment, which leads to employment and increase in production. Economy
gradually progresses. In India, the bank rate has been of little significance except
as an indicator of changes in the direction of credit policy. The bank rate was
changed nine times during the period 1951-74, but only thrice during 1975-96. In
1997, it was changed thrice; in 1998 four times, twice in 1999 and once in 2000. It
should become effective in the near future since interest rates have been
deregulated and market determined through the adoption of auction procedure for
treasury bills and government securities. Variations in bank rate have little
significance in a scenario where hardly any rates are linked to it and the amount of
refinance extended to banks at this rate is minimal.

Open Market Operations

The technique of open market operations as an instrument of credit control
is superior to bank rate policy. The need for open market operation was felt only
when the bank rate policy turned out to be a rather weak, instrument of monetary
control. According to some experts, bank rate policy and open market operations
are complementary measures in the area of monetary management. Open market
operation is mainly related to the sale of government securities and during the
busy s4eason, they sell the securities. When commercial banks sell the securities
and when RBI purchases them, The reserve position of the banks is improved and
they can expand their credit to meet growing demands.

Cash Reserve Ratio

The commercial banks have to keep with the central bank a certain
percentage of their deposits in the form of cash reserves. In India initially CRR
was 5 percent. In 1962 RBI was empowered to vary it between 3 to 15 percent
since then it has been increased or decreased a number of times. Increasing the
CRR leads to credit contraction and reducing it will lead to credit expansion.

26
 The CRR is applicable to all scheduled banks including scheduled
cooperative banks and the Regional Rural Banks (RRBs) and non scheduled
banks. However, cooperative banks, RRBs, the non scheduled banks have to
maintain the CRR of only 3 percent and so far it has not been changed the RBI.
The CRR for both the types of Non-Resident Indians (NRI) the RBI. The CRR for
both the types of Non-Resident Indians (NRI) accounts Non-Resident (External)
Rupee Account (NR(E)RA) and Foreign Currency (Non-Resident Accounts
(FCNRA) - was the same as for other types of deposits till 9th April 1982, the
CRR for these accounts was fixed at 3 percent. Subsequently, it was raised from
time to time. For example in July 1988, it was raised from 9.5 percent to 10
percent.

The RBI has powers to impose penal interest rates on banks in respect of
their shortfall in the prescribed CRR). CRR has been reduced to 10 percent in
January 1997 and further to 8 percent (in stages of 0.25 percent per quarter over a
two year period) and inter bank deposits have been exempted from April 1997.

Statutory Liquidity Ratio

Under the Banking Regulation Act (sec 24(2A» as amended in 1962, banks
have to maintain a minimum liquid assets of 25 per cent of their demand and time
liabilities in India. The Reserve Bank has, since 1970, imposed a much higher
percentage of liquid assets to restrain the pace of expansion of bank credit. SLR
was fixed at 31.5 percent of the net domestic and time liabilities (NDTL) on the
base date 30-9-1994; and for any increase in NDTL over the level as on
September 30, 1994, the SLR was fixed at 25 per cent. Inter bank deposits have
been taken out of NDTL in April1997. The overall effective SLR was estimated at
28.2 per cent at the end of March 1995 and reduced to 25 per cent in October
1997. The average investments in Government securities to deposits (lGS-D ratio)

27
actually increased from 25.3% in'1980s to 30.4% in 1990 on account of
introduction of prudential norms which imparted discipline in extending credit and
auctions of government securities at market related rates.

Selective Credit Controls

Selective credit controls have been used by the bank mainly with a view to
restraining excessive speculative stock-building of commodities in short supply
either as a result of a crop shortage or as a result of a fall in the production of
manufactured articles following raw materials shortages, etc. The commodities in
respect of which these articles of consumption or items important for exports are
food grains, oilseeds, jute, cotton textiles and sugar. These controls have taken the
form of objectives to increase the margin requirements, to regulate the size of
credit limit per borrower with a view to ensure maintenance of an aggregate level
of credit against a particular commodity at a certain level which may have
reference to the level of credit maintained in the corresponding period in the past,
etc. Adjustments to suit the needs of the economy in a particular region have also
been incorporated in these controls. Besides exercising control on bank credit
against the security of particular commodities in short supply, the Reserve Bank
has also endeavoured to control excessive borrowing from the banking system by
way of clean advances or against the security of other assets, such as share and
stocks.

The main instruments of selective controls in India are:

(a) Minimum margins (in a secured advance, the "margin" represents a portion of
the value of the security charged to the bank, which is expected to have been paid
for by the borrower out of his own resources) for lending against selected
commodities;
(b) Ceilings on the levels. of credit; and

28
(c) Charging minimum rate of interest on advances against specified commodities.
While the two instruments control the quantum of credit, the third instrument
works as leverage on the cost of credit. On the whole, the banking system in India
has shown a good appreciation of the needs of such controls and has co-operated
quite well. As regards their overall efficiency, the experience in India has been the
same as that of most other countries, namely, that their effectiveness in general is
comparatively limited. Generally, they are successful if employed in combination
with measures of general credit control.

RBI : THE CENTRAL BANK OF INDIA

The central bank of the country is the Reserve Bank of India (RBI). It was
established in April 1935 with a share capital of Rs. 5 crores on the basis of the
recommendations of the Hilton Young Commission. The share capital was divided into
shares of Rs. 100 each fully paid which was entirely owned by private shareholders in the
beginning. The Government held shares of nominal value of Rs. 2,20,000. Before the
establishment of RBI notes were issued by three-presidency banks-Bank of Bengal, Bank
of Madras & Bank of Bombay. After some time these banks were merged into one 1920
and named Imperial bank of India. Till the establishment of RBI this bank was acting as
the central bank. In 1935 the rights and duties of Imperial bank were delegated to RBI.
By that time RBI is issuing and controlling the currency.

The Reserve Bank of India was established on April 1, 1935 in accordance with the
provisions of THE RESERVE BANK OF INDIA ACT, 1934. Though originally
privately owned, since nationalization in 1949, the Reserve Bank is fully owned by the
Government of India The Central Office of the Reserve Bank has been in Mumbai since
inception. The Central Office is where the Governor sits and is where policies are
formulated. Now it has 22 regional offices, most of them in state capitals. The general
superintendence and direction of the Bank is entrusted to Central Board of Directors of
20 members, the Governor and four Deputy Governors, one Government official from
the Ministry of Finance, ten nominated Directors by the Government to give
representation to important elements in the economic life of the country, and four

29
 nominated Directors by the Central Government to represent the four local Boards with
the headquarters at Mumbai, Kolkata, Chennai and New Delhi. Local Boards consist of
five members each Central Government appointed for a term of four years to represent
territorial and economic interests and the interests of co-operative and indigenous banks.

Reserve Bank of India

Scheduled Non-Scheduled
Banks Banks

Scheduled Scheduled
Commercial Banks Cooperative Banks

Public Private Foreign Regional Scheduled Scheduled

sector Sector Banks Rural Urban State
banks Banks Banks Cooperative Cooperative
Banks Banks

Nationalized SBI & its Old Private New Private

Banks Associates Sector Banks Sector Banks

30
 The Reserve Bank of India Act 1934 was commenced on April 1, 1935. The Act,
1934 (II of 1934) provides the statutory basis of the functioning of the Bank.

The Bank was constituted for the need of following:

 To regulate the issue of banknotes
 To maintain reserves with a view to securing monetary stability and
 To operate the credit and currency system of the country to its advantage.

Objectives of the Reserve Bank of India

The Preamble to the Reserve Bank of India Act, 1934 spells out the objectives of
the Reserve Bank as: "to regulate the issue of Bank notes and the keeping of reserves
with a view to securing monetary stability in India and generally to operate the currency
and credit system of the country to its advantage." Prior to the establishment of the
Reserve Bank, the Indian financial system was totally inadequate on account of the
inherent weakness of the dual control of currency by the Central Government and of
credit by the Imperial Bank of India. The Hilton-Young Commission, therefore,
recommended that the dichotomy of functions and division of responsibility for control
of currency and credit and the divergent policies in this respect must be ended by setting-
up of a central bank - called the Reserve Bank of India - which would regulate the
financial policy and develop banking facilities throughout the country. Hence, the
Bank was established with this primary object in view.
Another objective of the Reserve Bank has been to remain free from
political influence and be in successful operation for maintaining financial
stability and credit.
The fundamental object of the Reserve Bank of India is to discharge purely
central banking functions in the Indian money market, i.e., to act as the note-
issuing authority, bankers' bank and banker to government, and to promote the
growth of the economy within the framework of the general economic policy of
the Government, consistent with the need of maintenance of price stability. A

31
significant object of the Reserve -Bank of India has also been to assist the planned
process of development of the Indian economy. Besides the traditional central
banking functions, with the launching of the five-year plans in the country, the
Reserve Bank of India has been moving ahead in performing a host of
developmental and promotional functions, which are normally beyond the purview
of a traditional Central Bank.

Functions
The Reserve Bank of India performs all the typical functions of a good
Central Bank. In addition, it carries out a variety of developmental and
promotional functions attuned to the course of economic planning in the country:
(1) Issuing currency notes, Le., to act as a currency authority.
(2) Serving as banker to the Government.
(3) Acting as bankers' bank and supervisor.
(4) Monetary regulation and management
(5) Exchange management and control.
(6) Collection of data and their publication.
(7) Miscellaneous developmental and promotional functions and activities.
(8) Agricultural Finance.
(9) Industrial Finance
(10) Export Finance.
(11) Institutional promotion

32
 FUNCTIONS OF RBI

MONETARY REGULATOR & MANAGER OF ISSUER OF RELATED

AUTHORITY SUPERVISOR FOREIGN CURRENCY FUNCTION
EXCHANGE Y S

BANKER BANKER TO
TO BANKS GOVERNMENT

Functions of RBI
Monetary Authority:
The RBI is responsible for implementing, formulating and monitoring the monetary
policy of India.
Objective: Keeping this authority in mind the RBI is required to maintain price stability
and ensure adequate flow of credit to productive sectors.

Regulator and supervisor of the financial system:

The Supreme financial body sets down broad parameters of banking operations within
which the country's banking and financial system operates.
Objective: This reasonably helps in maintaining public confidence in the system. It in
turn protects depositors' interest and provides lucrative banking services to the public.

Manager of Exchange Control:

The RBI is responsible for managing the Foreign Exchange Management Act, 1999.
Objective: It is the nodal agency, which facilitates external trade and payment and
promotes orderly development and maintenance of foreign exchange market in India.

Issuer of currency:
It is the only supreme body, which issues and exchanges or destroys currency and coins
not fit for circulation.

33
Objective: This facilitates in giving the public adequate quantity of currency notes and
coins and in good quality.

Developmental role
The RBI since its inception performs a wide range of promotional functions to support
national objectives and generate goodwill among the citizens of the country.

Related Functions

Banker to the Government: The RBI performs merchant banking function for the
central and the state governments and also acts as their banker. The RBI often advises the
Government of the current monetary condition in the state.

Banker to banks: maintains banking accounts of all scheduled banks. The RBI looks
after the functioning of the state banks and grants them license and even cancels the same
on account of fraud practice.

Bank Issue:
Under Section 22 of the Reserve Bank of India Act, the bank has the sole
sight to issue bank notes of all denominations. The notice issued by the Reserve
bank has the following advantages:
(i) It brings uniformity to note issue;
(ii) It is easier to control credit when there is a single agency of note issue
(iii) It keeps the public faith in the paper currency alive;
(iv) It helps in the stabilization of the internal and external value of the
currency
(v) Credit can be regulated according to the needs of the business.
Since 1957 the Reserve Bank of India is required to maintain gold and
foreign exchange reserves of Rs.200 Crores, of which atleast Rs.15 crores should
be in gold. The system of note issue as it exists today is known as the min imum

34
reserve system. The currency notes issued by the Bank arid legal tender every Where in
India without any limit. At present, the Bank issues notes in the following
denominations: Rs. 2, 5, 10, 20, 50 100, and 500. The responsibility of the Bank is not
only to put currency into, or withdraw it from, the circulation but also to exchange notes
and coins of one denomination into those of other denominations as demanded by the
public. All affairs of the Bank relating to note issue are conducted through its Issue
Department.

Banker, Agent and Financial Advisor to the State

As a banker agent and financial advisor to the State, the Reserve Bank performs
the following functions:
(i) It keeps the banking accounts of the government.
(ii) It advances short-term loans to the government and raises loans from the
public
(iii) It purchases and sells through bills and currencies on behalf to the
government.
(iv) It receives and makes payment on behalf of the government:
(v) It manages public debt and
(vi) It advises the government on economic matters like deficit financing price
stability, management of public debts. etc.

Banker to the Banks:

It acts as a guardian for the commercial banks. Commercial banks are required to
keep a certain proportion of cash reserves with the Reserve bank. In lieu of this, the
Reserve bank 0 them various facilities like advancing loans, underwriting securities etc.,
The RBI controls the volume of reserves of commercial banks and thereby determines
the deposits/credit creating ability of the banks. The banks hold a part or all of their
reserves with the RBI. Similarly, in times of their needs, the banks borrow funds from the
RBI. It is, therefore, called the bank of last resort or the lender of last resort.

35
Custodian of Foreign Exchange Reserves
It is the responsibility of the Reserve bank to stabilize the external value of the
national currency. The Reserve Bank keeps golds and foreign currencies as reserves
against note issue and also meets adverse balance of payments with other counties. It also
manages foreign currency in accordance with the controls imposed by the government.

As far as the external sector is concerned, the task of the RBI has the the
following dimensions: (a) to administer the foreign Exchange Control; I) to choose ,the
exchange rate system and fix or manages the exchange rate between the rupee and other
currencies; (c) to manage exchange reserves; (d) to interact or negotiate with the
monetary authorities of the Sterling Area, Asian Clearing Union, and other countries, and
with International financial institutions such as the IMF, World Bank, and Asian
Development Bank.

The RBI is the custodian of the country's foreign exchange reserves, id it is vested
with the responsibility of managing the investment and utilization of the reserves in the
most advantageous manner. The RBI achieves this through buying and selling of foreign
exchange market, from and to schedule banks, which, are the authorized dealers in the
Indian, foreign exchange market. The Bank manages the investment of reserves in gold
counts abroad' and the shares and securities issued by foreign governments and
international banks or financial institutions.

Lender of the Last Resort

At one time, it was supposed to be the most important function of the Reserve
Bank. When Commercial banks fail to meet obligations of their depositors the Reserve
Bank comes [b their rescue As the lender of the last resort, the Reserve Bank assumes the
responsibility of meeting directly or indirectly all legitimate demands for accommodation
by the Commercial Banks under emergency conditions.

36
Banks of Central Clearance, Settlement and Transfer
The commercial banks are not required to settle the payments of their mutual
1000nsactions in cash, It is easier to effect clearance and settlement of claims among
them by making entries in their accounts maintained with the Reserve Bank, The Reserve
Bank also provides the facility for transfer to money free of charge to member banks.

Controller of Credit
In modern times credit control is considered as the most crucial and important
functional of a Reserve Bank. The Reserve Bank regulates and controls the volume and
direction of credit by using quantitative and qualitative controls. Quantitative controls
include the bank rate policy, the open market operations, and the variable reserve ratio.
Qualitative or selective credit control, on the other hand includes rationing of credit,
margin requirements, direct action, moral suasion publicity, etc. Besides the above
mentioned traditional functions, the Reserve Bank also performs some promotional and
supervisory functions. The Reserve Bank promotes the development of agriculture and
industry promotes rural credit, etc. The Reserve Bank also acts as an agent for the
international institutions as I.M.F., I.B.R.D., etc.

Supervisory Functions
In addition to its traditional central banking functions, the Reserve Bank has
certain non- monetary functions of the nature of supervision of banks an promotion of
sound banking in India. The supervisory functions of the RBI have helped a great deal in
improving the methods of their operation. The Reserve
Bank Act, 1934, and I Banking Regulation Act, 1949 have given the RBI wide powers
of:
 Supervision and control over commercial and cooperative banks, relating to
licensing and establishments.
 Branch expansion.
 Liquidity of their assets.
 Management and methods of working, amalgamation reconstruction and
liquidations;

37
  The RBI is authorized to carry out periodical inspections off the banks and to
call for returns and necessary information from them.

Promotional Role
A striking feature of the Reserve Bank of India Act was that it made agricultural
credit the Bank's special responsibility. This reflected the realisation that the country's
central bank should make special efforts to develop, under its direction and guidance, a
system of institutional credit for a major sector of the economy, namely, agriculture,
which then accounted for more than 50 per cent of the national income. However, major
advances in agricultural finance materialized only after India's independence. Over the
years, the Reserve Bank has helped to evolve a suitable institutional infrastructure for
providing credit in rural areas.
Another important function of the Bank is the regulation of banking. All the
scheduled banks are required to keep with the Reserve Bank a consolidated 3 per cent of
their total deposits, and the Reserve Bank has power to increase this percentage up to 15.
These banks must have capital and reserves of not less than Rs.5 lakhs. The accumulation
of these balances with the Reserve Bank places it in a position to use them freely in
emergencies to support the scheduled banks themselves in times of need as the lender of
last resort. To a certain extent, it is also possible for the Reserve Bank to influence the
credit policy of scheduled banks by means of an open market operations policy, that is,
by the purchase and sale of securities or bills in the market. The Reserve bank has
another instrument of control in the form of the bank rate, which it publishes from time to
time.
Further, the Bank has been given the following special powers to control banking
companies under the Banking Companies Act, 1949:
(a) The power to issue licenses to banks operating in India.
(b) The power to have supervision and inspection of banks.
(c) The power to control the opening of new branches.
(d) The power to examine and sanction schemes of arrangement and amalgamation.
(e) The power to recommend the liquidation of weak banking companies.

38
(f) The power to receive and scrutinize prescribed returns, and to call for any other
information relating to the banking business.
(g) The power to caution or prohibit banking companies generally or any banking
company in particular from entering into any particular transaction or transactions.
(h) The power to control the lending policy of, and advances by banking companies or
any particular bank in the public interest and to give directions as to the purpose for
which advances mayor may not be made, the margins to be maintained in respect of
secured advances and the interest to be charged on advances.

39
 CHAPTER 5

SECURITY EXCHANGE BOARD OF INDIA

SEBI is the Regulator for the Securities Market in India. Originally set up by the
Government of India in 1988, it acquired statutory form in 1992 with SEBI Act 1992
being passed by the Indian Parliament.Chaired by C B Bhave, SEBI is headquartered in
the popular business district of Bandra-Kurla complex in Mumbai, and has Northern,
Eastern, Southern and Western regional offices in New Delhi, Kolkata, Chennai and
Ahmedabad.

ORGANIZATION STRUCTURE

Chandrasekhar Bhaskar Bhave is the sixth chairman of the Securities Market

Regulator. Prior to taking charge as Chairman SEBI, he had been the chairman of NSDL
(National Securities Depository Limited) ushering in paperless securities. Prior to his
stint at NSDL, he had served SEBI as a Senior Executive Director. He is a former Indian
Administrative Service officer of the 1975 batch. The Board comprises[2]

Name Designation As per

Mr CB Bhave Chairman SEBI CHAIRMAN (S.4(1)(a) of the SEBI Act, 1992)

FUNCTIONS AND RESPONSIBILITIES

SEBI has to be responsive to the needs of three groups, which constitute the market:

 the issuers of securities

 the investors
 the market intermediaries.

SEBI has three functions rolled into one body quasi-legislative, quasi-judicial and
quasi-executive. It drafts regulations in its legislative capacity, it conducts investigation

40
and enforcement action in its executive function and it passes rulings and orders in its
judicial capacity. Though this makes it very powerful, there is an appeals process to
create accountability. There is a Securities Appellate Tribunal which is a three member
tribunal and is presently headed by a former Chief Justice of a High court - Mr. Justice
NK Sodhi. A second appeal lies directly to the Supreme Court.

SEBI has enjoyed success as a regulator by pushing systemic reforms

aggressively and successively (e.g. the quick movement towards making the markets
electronic and paperless rolling settlement on T+2 basis). SEBI has been active in setting
up the regulations as required under law.

Stock exchange
A stock exchange, (formerly a securities exchange) is a corporation or mutual
organization which provides "trading" facilities for stock brokers and traders, to trade
stocks and other securities. Stock exchanges also provide facilities for the issue and
redemption of securities as well as other financial instruments and capital events
including the payment of income and dividends. The securities traded on a stock
exchange include: shares issued by companies, unit trusts, derivatives, pooled investment
products and bonds. To be able to trade a security on a certain stock exchange, it has to
be listed there. Usually there is a central location at least for recordkeeping, but trade is
less and less linked to such a physical place, as modern markets are electronic networks,
which gives them advantages of speed and cost of transactions. Trade on an exchange is
by members only. The initial offering of stocks and bonds to investors is by definition
done in the primary market and subsequent trading is done in the secondary market. A
stock exchange is often the most important component of a stock market. Supply and
demand in stock markets is driven by various factors which, as in all free markets, affect
the price of stocks

41
 CHAPTER 6
FINANCIAL SERVICES

Financial services refer to services provided by the finance industry. The finance
industry encompasses a broad range of organizations that deal with the management of
money. Among these organizations are banks, credit card companies, insurance
companies, consumer finance companies, stock brokerages, investment funds and some
government sponsored enterprises. As of 2004, the financial services industry represented
20% of the market capitalization of the S&P 500 in the United States.

History of financial services

The term "financial services" became more prevalent in the United States partly
as a result of the Gramm-Leach-Bliley Act of the late 1990s, which enabled different
types of companies operating in the U.S. financial services industry at that time to
merge.Companies usually have two distinct approaches to this new type of business. One
approach would be a bank which simply buys an insurance company or an investment
bank, keeps the original brands of the acquired firm, and adds the acquisition to its
holding company simply to diversify its earnings. Outside the U.S. (e.g., in Japan), non-
financial services companies are permitted within the holding company. In this scenario,
each company still looks independent, and has its own customers, etc. In the other style, a
bank would simply create its own brokerage division or insurance division and attempt to
sell those products to its own existing customers, with incentives for combining all things
with one company.

A "commercial bank" is what is commonly referred to as simply a "bank". The

term "commercial" is used to distinguish it from an "investment bank", a type of financial
services entity which, instead of lending money directly to a business, helps businesses
raise money from other firms in the form of bonds (debt) or stock (equity).

Banking services

The primary operations of banks include:

42
  Keeping money safe while also allowing withdrawals when needed
 Issuance of checkbooks so that bills can be paid and other kinds of payments can
be delivered by post
 Provide personal loans, commercial loans, and mortgage loans (typically loans to
purchase a home, property or business)
 Issuance of credit cards and processing of credit card transactions and billing
 Issuance of debit cards for use as a substitute for checks
 Allow financial transactions at branches or by using Automatic Teller Machines
(ATMs)
 Provide wire transfers of funds and Electronic fund transfers between banks
 Facilitation of standing orders and direct debits, so payments for bills can be
made automatically
 Provide overdraft agreements for the temporary advancement of the Bank's own
money to meet monthly spending commitments of a customer in their current
account.
 Provide Charge card advances of the Bank's own money for customers wishing to
settle credit advances monthly.
 Provide a check guaranteed by the Bank itself and prepaid by the customer, such
as a cashier's check or certified check.
 Notary service for financial and other documents

Other types of bank services

 Private banking - Private banks provide banking services exclusively to high net
worth individuals. Many financial services firms require a person or family to
have a certain minimum net worth to qualify for private banking services. [2]
Private banks often provide more personal services, such as wealth management
and tax planning, than normal retail banks.[3]
 Capital market bank - bank that underwrite debt and equity, assist company deals
(advisory services, underwriting and advisory fees), and restructure debt into
structured finance products.

43
  Bank cards - include both credit cards and debit cards. Bank Of America is the
largest issuer of bank cards.[citation needed]
 Credit card machine services and networks - Companies which provide credit
card machine and payment networks call themselves "merchant card providers".

Foreign exchange services

Foreign exchange services are provided by many banks around the world. Foreign
exchange services include:

 Currency Exchange - where clients can purchase and sell foreign currency
banknotes
 Wire transfer - where clients can send funds to international banks abroad
 Foreign Currency Banking - banking transactions are done in foreign currency

Investment services

 Asset management - the term usually given to describe companies which run
collective investment funds.
 Hedge fund management - Hedge funds often employ the services of "prime
brokerage" divisions at major investment banks to execute their trades.
 Custody services - the safe-keeping and processing of the world's securities trades
and servicing the associated portfolios. Assets under custody in the world are
approximately $100 trillion.[4]

Insurance

 Insurance brokerage - Insurance brokers shop for insurance (generally corporate

property and casualty insurance) on behalf of customers. Recently a number of
websites have been created to give consumers basic price comparisons for
services such as insurance, causing controversy within the industry.[5]
 Insurance underwriting - Personal lines insurance underwriters actually
underwrite insurance for individuals, a service still offered primarily through

44
 agents, insurance brokers, and stock brokers. Underwriters may also offer similar
commercial lines of coverage for businesses. Activities include insurance and
annuities, life insurance, retirement insurance, health insurance, and property &
casualty insurance.
 Reinsurance - Reinsurance is insurance sold to insurers themselves, to protect
them from catastrophic losses.

Other financial services

 Intermediation or advisory services - These services involve stock brokers

(private client services) and discount brokers. Stock brokers assist investors in
buying or selling shares. Primarily internet-based companies are often referred to
as discount brokerages, although many now have branch offices to assist clients.
These brokerages primarily target individual investors. Full service and private
client firms primarily assist execute trades and execute trades for clients with
large amounts of capital to invest, such as large companies, wealthy individuals,
and investment management funds.
 Private equity - Private equity funds are typically closed-end funds, which usually
take controlling equity stakes in businesses that are either private, or taken private
once acquired. Private equity funds often use leveraged buyouts (LBOs) to
acquire the firms in which they invest. The most successful private equity funds
can generate returns significantly higher than provided by the equity markets
 Venture capital is a type of private equity capital typically provided by
professional, outside investors to new, high-potential-growth companies in the
interest of taking the company to an IPO or trade sale of the business.
 Angel investment - An angel investor or angel (known as a business angel or
informal investor in Europe), is an affluent individual who provides capital for a
business start-up, usually in exchange for convertible debt or ownership equity. A
small but increasing number of angel investors organize themselves into angel
groups or angel networks to share research and pool their investment capital.
 Conglomerates - A financial services conglomerate is a financial services firm
that is active in more than one sector of the financial services market e.g. life

45
 insurance, general insurance, health insurance, asset management, retail banking,
wholesale banking, investment banking, etc. A key rationale for the existence of
such businesses is the existence of diversification benefits that are present when
different types of businesses are aggregated i.e. bad things don't always happen at
the same time. As a consequence, economic capital for a conglomerate is usually
substantially less than economic capital is for the sum of its parts.

Financial crime

Fraud within the financial industry costs the UK an estimated £14bn a year and it
is believed a further £25bn is laundered by British institutions.[6]

Market share

The financial services industry constitutes the largest group of companies in the
world in terms of earnings and equity market cap. However it is not the largest category
in terms of revenue or number of employees. It is also a slow growing and extremely
fragmented industry, with the largest company (Citigroup), only having a 3 % US market
share.[7] In contrast, the largest home improvement store in the US, Home Depot, has a
30 % market share, and the largest coffee house Starbucks has a 32 % market share.

46
 CHAPTER 7
SOME IMPORTANT FINANCIAL INSTITUTION

NABARD

National Bank for Agriculture and Rural Development (NABARD) is a

development bank in the sector of Regional Rural Banks in India. It provides and
regulates credit and gives service for the promotion and development of rural sectors
mainly agriculture, small scale industries, cottage and village industries, handicrafts. It
also finances rural crafts and other allied rural economic activities to promote integrated
rural development. It helps in securing rural prosperity and its connected matters.
NABARD's credit functions cover planning, dispensation and monitoring of credit.
This activity involves:
 Framing policy and guidelines for rural financial institutions
 Providing credit facilities to issuing organizations
 Preparation of potential-linked credit plans annually for all districts for
identification of credit potential
 Monitoring the flow of ground level rural credit
Major Activities
 Preparing of Potential Linked Credit Plans for identification of exploitable
potentials under agriculture and other activities available for development through
bank credit.
 Refinancing banks for extending loans for investment and production purpose in
rural areas.
 Providing loans to State Government/Non Government Organizations
(NGOs)/Panchayati Raj Institutions (PRIs) for developing rural infrastructure.
 Supporting credit innovations of Non Government Organizations (NGOs) and
other non-formal agencies.

47
  Extending formal banking services to the unreached rural poor by evolving a
supplementary credit delivery strategy in a cost effective manner by promoting
Self Help Groups (SHGs)
 Promoting participatory watershed development for enhancing productivity and
profitability of rain fed agriculture in a sustainable manner.
 On-site inspection of cooperative banks and Regional Rural Banks (RRBs) and
iff-site surveillance over health of cooperatives and RRBs.

Export Import Bank of India

Export Import Bank of India is also known as Exim Bank of India and was
established by an Act passed by the Indian Parliament in September, 1981. Export Import
Bank of India is fully owned by the Indian government and it started its operations in
March, 1982.

The major objectives of Export Import Bank of India are to provide economic
assistance to importers and exporters and to function as the apex financial institution. Its
services include export credit, overseas investment finance, agri & SME finance, film
finance and finance for units that are export oriented.

The total amount of loans disbursed by Export Import Bank of India amounted to
Rs. 150,389 million in 2005- 2006 and in the following year, this figure increased to Rs.
220760 million.

The net profit of the Bank came to around Rs. 2707 million in 2005- 2006. In the
following year this figure increased to Rs. 2994 million. The head office of Export
Import Bank of India is located in Mumbai and its regional offices are located at Pune,
Kolkata, Hyderabad, New Delhi, Bangalore, Chennai and Ahmadabad. The Bank's
overseas offices are located at London, Washington D.C., Dakar, Dubai, Singapore and
Johannesburg.

National Housing Bank India

48
 The National Housing Bank (NHB) was established on 9th July 1988 the National
Housing Bank Act, 1987 to function as a principal agency to promote Housing Finance
Institutions and to provide financial and other support to such institutions.

The National Housing Bank Act empowers National Housing Bank or NHB to:
o Direct and regulate the functioning of housing finance institutions for fair
practices
o Provide loans, advances or any other financial assistance to Banks and housing
finance institutions for slum improvement
o Supervise mobilization of resources and extension of credit for housing

NHB has the main objective of promoting a network of highly efficient and
dedicated housing finance institutions to cater to the finance needs from various regions
and income groups. In order to upgrade the housing stock in the country, National
Housing Bank undertakes augmentation of supply of buildable land and building
materials.

Besides raising resources for the housing sector, NHB also provides refinance to
major housing finance institutions. All the Housing Finance Companies registered with
the National Housing Bank are eligible for refinance support from NHB if they have net
owned funds of minimum Rs. 10.0 crores. National Housing Bank has contributions in
equity capital of five Housing Finance Companies (HFC).

Along with the HFC's, National Housing Bank also engages in direct lending to
state housing boards and development authorities. It also provides financial assistance to
people affected by natural calamities like earthquake, flood, cyclones etc.

49
INDUSTRIAL Credit and Investment Corporation of India (ICICI)

ICICI Bank was originally promoted in 1994 by ICICI Limited, an Indian

financial institution, and was its wholly-owned subsidiary. ICICI's shareholding in ICICI
Bank was reduced to 46% through a public offering of shares in India in fiscal 1998, an
equity offering in the form of ADRs listed on the NYSE in fiscal 2000, ICICI Bank's
acquisition of Bank of Madura Limited in an all-stock amalgamation in fiscal 2001, and
secondary market sales by ICICI to institutional investors in fiscal 2001 and fiscal 2002.
ICICI was formed in 1955 at the initiative of the World Bank, the Government of
India and representatives of Indian industry. The principal objective was to create a
development financial institution for providing medium-term and long-term project
financing to Indian businesses. In the 1990s, ICICI transformed its business from a
development financial institution offering only project finance to a diversified financial
services group offering a wide variety of products and services, both directly and through
a number of subsidiaries and affiliates like ICICI Bank. In 1999, ICICI become the first
Indian company and the first bank or financial institution from non-Japan Asia to be
listed on the NYSE.

ICICI Bank is India's second-largest bank with total assets of Rs. 3,744.10 billion
(US$ 77 billion) at December 31, 2008 and profit after tax Rs. 30.14 billion for the nine
months ended December 31, 2008. The Bank has a network of 1,416 branches and about
4,644 ATMs in India and presence in 18 countries. ICICI Bank offers a wide range of
banking products and financial services to corporate and retail customers through a
variety of delivery channels and through its specialized subsidiaries and affiliates in the
areas of investment banking, life and non-life insurance, venture capital and asset
management. The Bank currently has subsidiaries in the United Kingdom, Russia and
Canada, branches in United States, Singapore, Bahrain, Hong Kong, Sri Lanka, Qatar
and Dubai International Finance Centre and representative offices in United Arab
Emirates, China, South Africa, Bangladesh, Thailand, Malaysia and Indonesia. Our UK
subsidiary has established branches in Belgium and Germany.

50
LIFE INSURANCE CORPORATION (LIC)

The story of insurance is probably as old as the story of mankind. The same
instinct that prompts modern businessmen today to secure themselves against loss and
disaster existed in primitive men also. They too sought to avert the evil consequences of
fire and flood and loss of life and were willing to make some sort of sacrifice in order to
achieve security. Though the concept of insurance is largely a development of the recent
past, particularly after the industrial era – past few centuries – yet its beginnings date
back almost 6000 years.

Life Insurance in its modern form came to India from England in the year 1818.
Oriental Life Insurance Company started by Europeans in Calcutta was the first life
insurance company on Indian Soil. All the insurance companies established during that
period were brought up with the purpose of looking after the needs of European
community and Indian natives were not being insured by these companies. However,
later with the efforts of eminent people like Babu Muttylal Seal, the foreign life insurance
companies started insuring Indian lives. But Indian lives were being treated as sub-
standard lives and heavy extra premiums were being charged on them. Bombay Mutual
Life Assurance Society heralded the birth of first Indian life insurance company in the
year 1870, and covered Indian lives at normal rates. Starting as Indian enterprise with
highly patriotic motives, insurance companies came into existence to carry the message
of insurance and social security through insurance to various sectors of society. Bharat
Insurance Company (1896) was also one of such companies inspired by nationalism. The
Swadeshi movement of 1905-1907 gave rise to more insurance companies. The United
India in Madras, National Indian and National Insurance in Calcutta and the Co-operative
Assurance at Lahore were established in 1906. In 1907, Hindustan Co-operative
Insurance Company took its birth in one of the rooms of the Jorasanko, house of the great
poet Rabindranath Tagore, in Calcutta. The Indian Mercantile, General Assurance and
Swadeshi Life (later Bombay Life) were some of the companies established during the
same period. Prior to 1912 India had no legislation to regulate insurance business. In the
year 1912, the Life Insurance Companies Act, and the Provident Fund Act were passed.
The Life Insurance Companies Act, 1912 made it necessary that the premium rate tables

51
and periodical valuations of companies should be certified by an actuary. But the Act
discriminated between foreign and Indian companies on many accounts, putting the
Indian companies at a disadvantage.

LIC has been one of the pioneering organizations in India who introduced the
leverage of Information Technology in servicing and in their business. Data pertaining to
almost 10 crore policies is being held on computers in LIC. We have gone in for relevant
and appropriate technology over the years.

1964 saw the introduction of computers in LIC. Unit Record Machines introduced
in late 1950’s were phased out in 1980’s and replaced by Microprocessors based
computers in Branch and Divisional Offices for Back Office Computerization.
Standardization of Hardware and Software commenced in 1990’s. Standard Computer
Packages were developed and implemented for Ordinary and Salary Savings Scheme
(SSS) Policies.
OBJECTIVE OF LIC

 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.

 Maximize mobilization of people's savings by making insurance-linked savings

adequately attractive.
 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.
 Conduct business with utmost economy and with the full realization that the
moneys belong to the policyholders.
 Act as trustees of the insured public in their individual and collective capacities.

52
  Meet the various life insurance needs of the community that would arise in the
changing social and economic environment.
 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.

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.

53
 CHAPTER 8
GLOBAL CRISIS IMPACT ON INDIAN FINANCIAL SYSTEM

As might be expected, the main impact of the global financial turmoil in India has
emanated from the significant change experienced in the capital account in 2008-09 so
far, relative to the previous yeari. Total net capital flows fell from US$17.3 billion in
April-June 2007 to US$13.2 billion in April-June 2008. While Foreign Direct Investment
Likewise if we seen that in our INDIA we don’t face any recession period we just face
i

only slow down period. Because through out the year like wise upto 1996 to 2006 we
seen the growth of our Indian financial system but after 2006 to onwards India face only
slow down period. so its proves that stronger capability that our Indian Financial System
is much more stronger than any other.

If we talk about our CRR RATIO that is 4.75%.

And SLR is 12%
Our GDP is 7.9%
So it proves that day by day our financial system is increasing.
Earlier our GDP growth rate is 7.6% and before that, it was 6….something.
So the data also proves that our Financial systemi is stronger than any other.

The main example is like wise earlier INDIA doesnot charge any import tax so that
would mainly effect in our domestic sectors.eg.likewise earlier china mainly import their
product in low cost so that will effect in our domestic market mainly.and after charging
Import taxes rate of their product has increased so no one purchase the product easiy.

Our Indian Financial System in another term also stronger than any other because we
have lots of Foreign Investment in our INDIA.And through this our India currency would
increasing day by day.
Right now our India currency is 46.43%.

54
(FDI) inflows have continued to exhibit accelerated growth (US$ 16.7 billion during
April-August 2008 as compared with US$ 8.5 billion in the corresponding period of
2007), portfolio investments by foreign institutional investors (FIIs) witnessed a net
outflow of about US$ 6.4 billion in April-September 2008 as compared with a net
inflow of US$ 15.5 billion in the corresponding period last year.

GOVERNMENT also take some actions which proves that our Indian financial system is
much stronger than any other.likewise RBI has asked that smaller banks should merge
with each other and make a larger one in order to increase Credit lending capacity.
EG: CANARA BANK and DENA bank will merge in coming days.

Conclusion

Economic growth and development of any country depend on a well-knit Financial

system.
Basically financial system is a set of comprises of financial intermediaries like wise
financial institution, financial market, financial services, financial instruments which help
in making formation of a capital.

By having good Financial Market position it’s a edge over the other competitiors.
EG: Top 5 companies if we talk about these are as follows:

1:Infosys technology ltd.

2:Tata consultancy services
3:Wipro technologies
4:Satayam computers ltd.
5:Hindustan computer technologies ltd.
And also I-Flex company

55
 Similarly, external commercial borrowings of the corporate sector declined from
US$ 7.0 billion in April-June 2007 to US$ 1.6 billion in April-June 2008, partially in
response to policy measures in the face of excess flows in 2007-08, but also due to the
current turmoil in advanced economies. Whereas the real exchange rate appreciated from
an index of 104.9 (base 1993-94=100) (US$1 = Rs. 46.12) in September 2006 to 115.0
(US$ 1 = Rs. 40.34) in September 2007, it has now depreciated to a level of 101.5 (US $
1 = Rs. 48.74) as on October 8, 2008.

 Primary Market

Primary Market may be defined as a market for new issues. The primary market
is the pacesetter for mobilizing resources by corporates. The bull-run in the secondary
market enabled and emboldened companies to enter the market with big issues and attract
investors and traders to invest in public issues to reap high profits following their listing.

Their mainy services is that they possess sufficient domain expertise to build core
systems and provide BPO service in the financial service domain.

Other than that mainly our Indian IT vendors are vanguard of IT outsourcing.However
their main competitive advantage of cost is fast eroding due to the expansion of Global
service Vendors likewise IBM, Accenture, HP etc. into INDIA and other low cost
countries and from the newer low cost offshore location.

So our Indian financial system contributes at each sector whether in banking, IT sectors,
pharmaceuticals
Or in FMCGS etc…
Recently our INDIAN FINCIAL SYSTEM increasing day by day. By providing at less
rate of home loans or many other facilities that are provided by governments. So our
Indian Financial System is much more stronger than any other system of any country.

56
 The companies profitability performance was also good. The market, however,
underwent turmoil as soon as an FII-driven crisis developed in the secondary market and
the mega crash occurred in January second week

Presently, the primary market is in a bearish mood and this can be seen from the way
the issues of Wockhardt Hospital and Emaar MGF have gone.

There are two factors for this depressing outlook

 Continuing uncertainties; and

 Further crash of the stock prices and hesitation on the part of investors due to fall
in shares of Reliance Power as soon as they were listed. Investors lost nearly Rs
70 per share on listing of Reliance Power.

Only 19 companies have entered the capital market in the current financial year
so far, mobilizing Rs 1,968 crore, the lowest since 2003-04. Interestingly, of these 19
public offers, only four are trading above the issue prices while 13 are trading at
discounts. Two are not yet listed. IPO investors have become cautious as 70 per cent
public offers made last financial year are currently trading at a discount.

Following this poor show of public offers and a slippery secondary market,
several Indian promoters have withdrawn their plans to raise funds through public offers.
The Securities and Exchange Board of India (Sebi) data show that 24 promoters, who
were planning to raise Rs 21,300 crore, have either put their plans on hold or have
withdrawn their offer documents after submitting the red-herring prospectus. 

According to Prime Database, four companies, collectively planning to raise Rs

4,517 crore, have withdrawn their offer documents since April 2008. This includes JSW
Energy (Rs 4,000 crore), RNS Infrastructure (Rs 300 crore), Cellebrum Technologies (Rs
200 crore) and Elysium Pharmaceuticals (Rs 17 crore).

Many real estate and financial services sector companies have postponed or
cancelled their IPO plans after stocks from these sectors reported more than 50 per cent

57
erosion in their market value. Promoters of Emaar MGF Land, Wockhardt Hospitals and
SVEC Constructions pulled out their IPOs, amounting to Rs 1,317 crore, due to low
response from retail investors. There are over 100 companies such as Essar Power, GMR
Energy, ICICI Securities, Lodha Builders, Sterlite Energy and SRL Ranbaxy, which had
announced their IPO intentions but have now stalled their plans.

 Secondary Market

The sensex climbed at a rapid rate, touching record heights in 2007 -2008. The
average Indian investor who traditionally has been a very conservative investor became
more confident and started investing heavily in the stock market. The stock market grew
in leaps and bounds and its growth in the last five years itself has been a phenomenal
twenty five per cent.

The BSE Sensex increased significantly from a level of 13,072 as at end-March

2007 to its peak of 20,873 on January 8, 2008 in the presence of heavy portfolio flows
responding to the high growth performance of the Indian corporate sector. With portfolio
flows reversing in 2008, partly because of the international market turmoil, the Sensex
has now dropped to a level of 11,328 on October 8, 2008, in line with similar large
declines in other major stock markets.

Against this backdrop the unthinkable happened, the stock market Of the United
states of America or Wall street stock exchange crashed due to a crisis in the housing
finance sector of its leading banks, caused due to delinquency and non-repayment of
housing loans. This resulted in a panic in the world market including India. The Foreign
Investment also came down heavily due to a liquidity crunch in the major companies.
The banks stopped lending to the bankers and in effect the market came to a sudden stop.
The Indian investor panicked again and started selling like crazy. Major companies
started making announcements like job layoffs to minimize their losses.

 Money Markets

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 Money markets are the markets for short-term, highly liquid debt securities.
Examples of these include banker’s acceptances, repos, negotiable certificates of deposit,
and Treasury Bills with maturity of one year or less and often 30 days or less. Money
market securities are generally very safe investments, which return relatively, low
interest rate that is most appropriate for temporary cash storage or short term time needs.
Whereas capital markets are the markets for intermediate, long-term debt and corporate
stocks. The National Stock Exchange, where the stocks of the largest Indian.
Corporations are traded, is a prime example of a capital primary market. Regarding
timing, there is no hard and fast rule on this, but when describing debt markets, short
term generally means less than one year, intermediate term means one to five years, and
long term means more than five years.

o Impact on money market

Money Market is actually an inter-bank market where banks borrow and lend
money among them to meet short-term need for funds. Banks usually never hold the
exact amount of cash that they need to disburse as credit. The ‘inter-bank’ market
performs this critical role of bringing cash-surplus and cash-deficit banks together and
lubricates the process of credit delivery to companies (for working capital and capacity
creation) and consumers (for buying cars, white goods etc). As the housing loan crisis
intensified, banks grew increasingly suspicious about each other’s solvency and ability to
honor commitments. The inter-bank market shrank as a result and this began to hurt the
flow of funds to the ‘real’ economy. Panic begets panic and as the loan market went into
a tailspin, it sucked other markets into its centrifuge.

The liquidity crunch in the banks has resulted in a tight situation where it has
become extremely difficult even for top companies to take loans for their needs. A sense
of disbelief and extreme precaution is prevailing in the banking sectors. The global
investment community has become extremely risk-averse. They are pulling out of assets
that are even remotely considered risky and buying things traditionally considered safe-
gold, government bonds and bank deposits (in banks that are still considered solvent).

59
 As such this financial crisis is the culmination of the above-mentioned problems
in the global banking system. Inter-bank markets across the world have frozen over. The
meltdown in stock markets across the world is a victim of this contagion.

Governments and central banks (like Fed in US) are trying every trick in the book
to stabilize the markets. They have pumped hundreds of billions of dollars into their
money markets to try and unfreeze their inter-bank and credit markets. Large financial
entities have been nationalized. The US government has set aside $700 billion to buy the
‘toxic’ assets like CDOs that sparked off the crisis. Central banks have got together to co-
ordinate cuts in interest rates. None of this has stabilized the global markets so far.
However, it is hoped that proper monitoring and controlling of the money market will
eventually control the situation.

Reasons for this turmoil

The turmoil in the international financial markets of advanced economies that

started around mid-2007 has exacerbated substantially since August 2008. The financial
market crisis has led to the collapse of major financial institutions and is now beginning
to impact the real economy in the advanced economies. As this crisis is unfolding, credit
markets appear to be drying up in the developed world.

Why did this huge fall happen?

Many factors. The global crisis can be said to be a fault of the Federal Bank of
USA. One, there is a change in the global investment climate. One of the primary triggers
is the huge fear of the United States' economy going into a recession with foreign
institutional investors trying to reallocate their funds from risky emerging markets to
stable developed markets. Analysts are now expecting a cut in US interest rates.

 Bad lending policies

In 2005-07 the property markets were on a high growth path. The property prices
kept increasing. A sense of complacency had set in the real estate markets. It was

60
assumed that the residential property prices would keep increasing forever. Mortgage
lenders relaxed lending standards. Billions of dollars of sub-prime loans were to given
borrowers with the sketchiest credit histories on recommendations of mortgage brokers
who were more interested in their commission.

Loans were structured very innovatively. Some gave borrowers the ability to skip
repayments and some had interest rates that rose over the life of the loan. Lenders were
not worried about repayments as defaults if any, on loans, could be recouped from the
property itself.

Contrary to this assumption, the property bubble burst leading to sharp

depreciation in property prices. As loans were given to people who could not repay it in
the best of time, mortgage repayments defaults kept increasing, triggering off a chain of
events that led to the bankruptcies of the hallowed institutions of Wall Street.

The rise in default rates in the sub-prime market is essentially due to two things.
Most borrowers got into adjustable rate mortgages where the interest rates were
reset periodically. Second, as the US Fed relentlessly hiked policy rates (17 times
between 2004 and 2006), mortgage rates rose as much as 40 per cent. Sub-prime
borrowers, characterized by low and often volatile incomes, found that they could
not service their loans any longer. The result is the large default across the board,
which plagues the markets. Therefore, the Fed has to shoulder at least part of the blame
for the current mess.

Perhaps the US central bank could have been a little more prescient and figured
out that the series of rate hikes had the potential to trigger a crisis of this kind. The
existence of the large quantum of sub-prime assets and the impact of mortgage rate resets
should have figured more actively in their monetary policy discussions much earlier.
Finally, if the Fed had felt that the excess liquidity was whipping up too much froth in
the housing market, it should have excised the problem much earlier than allowing
festering.

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 As growth slows in the U.S. and Europe, emerging economies' exports to them
will slow. In the past, a 1 percent decline in U.S. growth has led to a decline in growth in
emerging economies by 0.5 to 1 percent, depending on trade and financial links with the
United States.

The present crisis is the result of a perfect storm: a macroeconomic environment with
a prolonged period of low interest rates, high liquidity and low volatility, which led
financial institutions to underestimate risks, a breakdown of credit and risk management
practices in many financial institutions, and shortcomings in financial regulation and
supervision.

 This environment both fueled a U.S. housing boom and encouraged banks and other
institutions to take on excessive leverage to generate high returns.
 Financial institutions weakened their lending standards and took on excessive risk.
The most obvious example is the US sub-prime mortgage market, but the holders of
these risks were not only in the United States, and problems may also surface in other
kinds of lending—for example leveraged loans and consumer credit—or other
countries. Nor is the problem confined to industrial countries. For example loose
credit in some emerging economies may lead to problems down the road.
 A bleaker economic outlook would in turn make it more difficult to get out of the
financial crisis, because it worsens the prospects of businesses and individuals. This
is one reason that equity markets have fallen as the risks of a U.S. recession and a
global downturn have grown

Are Foreign Investors Responsible for this crisis

FII (Foreign Institutional Investors) is used to denote an investor, it is mostly

of the form of a institution or entity which invests money in the financial markets of a
country. The term FII is most commonly used in India to refer to companies that are
established or incorporated outside India, and is investing in the financial markets of

62
India. These investors must register with the Securities & Exchange Board of India
(SEBI) to take part in the market.

 Influence of FIIs on Indian Stock Market

The current investments of FIIs is Rs. 2,55,464.40 Crores. This is almost 9% of

the total market capitalization.

 They increased depth and breadth of the market.

 They played major role in expanding securities business.
 Their policy on focusing on fundamentals of the shares had caused efficient
pricing of shares.

These impacts made the Indian stock market more attractive to FIIs and also
domestic investors, which involve the other major player MF (Mutual Funds). The
impact of FIIs is so high that whenever FIIs tend to withdraw the money from market, the
domestic investors become fearful and they also withdraw from market.

Policy followed by government for investors

In early 2008, the government liberalised its policy towards foreign investment in
the following key economic sectors by increasing the maximum permitted foreign
investment to:
 49 per cent for commodity exchanges
 49 per cent for credit information companies
 74 per cent for non-scheduled airlines (however, foreign airlines are not
allowed to invest in a scheduled airline company in India), and
 100 per cent in titanium mining with prior Indian Government approval.

 Participatory Notes

In October last year, the markets regulator had put a 40 per cent cap on FIIs’ total
asset holding via participatory notes or overseas derivatives instruments and stopped

63
them from issuing fresh P-notes or renewal of old ones with an 18-month deadline
ending in March 2009 to do the needful. The moved was aimed to keep track of foreign
flows into the country. SEBI has now decided to do away with the conditions limiting
FIIs’ allocation of funds between debt and equity to provide greater flexibility and
investment options to overseas investors.

SEBI had done away with the existing limit on distribution of FII investment a
day after the government doubled the cap on their investment in corporate debt to $6
billion. The decision came in the wake of FIIs pulling out of the Indian equity market and
pumping money in the debt market. FIIs have taken out US$11.56 billion from equity
market and bought net debt worth US$1.8 billion since January. However, another
regulation that FIIs investing up to 100 per cent in the debt market will have to form a
100 per cent fund for this purpose and get it registered with Sebi remains, the central
bank said.

 Security Receipts

So far as security receipts issued by the Asset Reconstruction Companies (ARCs)

are concerned, the total holding of a single FII in each tranche of scheme must not exceed
10 per cent of the issue. Besides, the total holding of all FIIs put together must not exceed
49 per cent of the paid up value of each tranche of scheme of security receipts issued by
ARCs. The relaxation, according to Sebi, is aimed at according “greater flexibility to the
FIIs to allocate investments across equity and debt.”

“It will have a two-way positive impact. This will enable FIIs to invest without
any obligation and will also enable Indian companies to get more funds for their
expansion plans,” observed Nexgen Capital Equity Head Jagannadham     Thunuguntla.

 Corporate Debts

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 The move comes a day after government doubled the limit of FII investment in
corporate debts to US$6 billion. Finance Minister P Chidambaram, on Friday, said

“Sebi had informed me that it would address any request for relaxation in the proportion
of investment in equity and debt required to be maintained by an FII under current
regulations.”

Sebi said the enhanced limit for investment in corporate debts will be allocated
among the FIIs on a “first come first served” basis up to a ceiling of US$300 million per
entity.

 Two views

The Finance Minister P Chidambaram has urged banks to lower interest rates, in
the light of the steps taken by RBI both on liquidity and interest rate, and several public
sector banks have already announced plans on reducing their prime lending rates. Banks
have been asked to increase credit for productive purposes and ensure credit quality. RBI
has also suggested to banks to restructure the dues of small and medium enterprises on
merits.

The Reserve Bank of India had vigorously moved in October to bring down the
cash reserve ratio from a peak of 9 per cent to 5.5 per cent, reduce the key policy interest
rate from 9 to 7.5 per cent and also the statutory liquidity ratio by one percentage point to
24 per cent of their net demand and time liabilities.

As part of measures to minimize the adverse impact of global crisis on domestic

economy, the Finance Minister has reduced certain duties to give relief to some of the
affected sectors like steel and aviation. On the budgetary side, higher allocations for
social sectors and rural employment and other flagship programmes should generate
consumption, which contributes to economy’s growth.

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 CHAPTER 9
FUTURE VISION OF INDIAN FINANCIAL SYSTEM

A financial system, which is inherently strong, functionally diverse and displays

efficiency and flexibility, is critical to our national objectives of creating a market-driven,
productive and competitive economy. A mature system supports higher levels of
investment and promotes growth in the economy with its depth and coverage. The
financial system in India comprises of financial institutions, financial markets, financial
instruments and services. The Indian financial system is characterised by its two major
segments - an organised sector and a traditional sector that is also known as informal
credit market. Financial intermediation in the organised sector is conducted by a large
number of financial institutions which are business organisations providing financial
services to the community. Financial institutions whose activities may be either
specialised or may overlap are further classified as banking and non-banking entities. The
Reserve Bank of India (RBI) as the main regulator of credit is the apex institution in the
financial system. Other important financial institutions are the commercial banks (in the
public and private sector), cooperative banks, regional rural banks and development
banks. Non-bank financial institutions include finance and leasing companies and other
institutions like LIC, GIC, UTI, Mutual funds, Provident Funds, Post Office Banks etc.
The banking system is, by far, the most dominant segment of the financial sector,
accounting as it does, for over 80 per cent of the funds flowing through the financial
sector. The aggregate deposits of the scheduled commercial banks (SCBs) rose from
Rs.5,05,599 crore in March 1997 to Rs.11,03,360 crore in March 2002 representing a rise
of 17 per cent. During the same period, the credit portfolio (food and non-food) of SCBs
grew from Rs.2,78,401 crore to Rs. 5,89,723 crore, i.e. by 16 per cent. The net profits of
SCBs witnessed a noticeable upturn from Rs.6,403 crore in 2000-01 to Rs.11, 572 crore
in 2001-02. The extent and coverage of the banking system can be gauged from the fact
that the number of branches of SCBs grew from 8045 in 1969 to 66,186 in June 2002.
While rural branches constituted 49 per cent of the total in 2002, semi-urban branches
accounted for 22 per cent, urban branches accounted for 16 per cent and metropolitan
branches accounted for 13 per cent.

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 As regards the capital market, the resource mobilization from the primary market
by non-government public limited companies has declined in the recent past from the
high levels witnessed between 1992-93 and 1996-97. Resource mobilization of these
companies in the public issues market stood at Rs. 5,692 crore in 2001-02 registering an
increase of 16.4 per cent over the amount mobilized during the previous year. The public
issues market has been dominated by debt issues both in the private and public sectors in
the recent past. In recent years, private placement has emerged as an important vehicle
for raising resources by banks, financial institutions and public and private sector
companies. Such placements continued to dominate the primary market although the pace
of growth of the private placement market has slackened during the last two years.
Resource mobilization by mutual funds is an important activity in the capital markets.
Although there has been a decline in the net resource mobilization by mutual
funds to the extent of 28 per cent during 2001-02, according to SEBI, outstanding net
assets of all mutual funds stood at Rs.1,00,594 crore as at end-March 2002. The strong
potential of the capital market as an area of resource mobilization needs no emphasis and
this segment of the financial sector would continue to play a significant role in the future.

Future direction of reforms

If the financial sector reforms are viewed in a broad perspective, it would be
evident that the first phase of reforms focussed on modification of the policy framework,
improvement in financial health of the entities and creation of a competitive
environment. The second phase of reforms target the three interrelated issues viz. (I)
strengthening the foundations of the banking system; (ii) streamlining procedures,
upgrading technology and human resource development; and (iii) structural changes in
the system. These would cover aspects of banking policy, and focus on institutional,
supervisory and legislative dimensions.

Although significant steps have been taken in reforming the financial sector, some
areas require greater focus. One area of concern relates to the ability of the financial
sector in its present structure to make available investible resources to the potential

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investors in the forms and tenors that will be required by them in the coming years, that
is, as equity, long term debt and medium and short-term debt. If this does not happen,
there could simultaneously exist excess demand and excess supply in different segments
of the financial markets. In such a situation the segment facing the highest level of
excess demand would prove to the binding constraint to investment activity and
effectively determine the actual level of investment in the economy. Such problems could
be resolved through movement of funds between various types of financial institutions
and instruments and also by portfolio reallocation by the savers in response to differential
movements in the returns in the alternative financial instruments. In this context, it is
very important to identify the emerging structure of investment demand, particularly
from the private sector, in order to reorient the functioning of the financial sector
accordingly, so that investment in areas of national importance flows smoothly.

A major area that needs to be focused in the context of the country’s development
policy is investment in infrastructure. Financing of infrastructure projects is a specialized
activity and would continue to be of critical importance in the future. A sound and
efficient infrastructure is a sine qua non for sustainable economic development. A
deficient infrastructure can be a major impediment in a country’s economic growth
particularly when the economy is on the upswing. A growing economy needs supporting
infrastructure at all levels, be it adequate and reasonably priced power, efficient
communication and transportation facilities or a thriving energy sector. Such
infrastructure development has a multiplier effect on economic growth, which cannot be
overlooked. Infrastructure services have generally been provided by the public sector all
over the world for a large part of the twentieth century as most of these services have an
element of public good in them. It was only in the closing years of the century that
private financing of infrastructure made substantial progress.

It may be relevant to point out that infrastructure was largely privately financed in
the nineteenth century. The twenty-first century would, therefore, be more like the
nineteenth than the twentieth century.

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 This trend has been visible in India as well where financing of infrastructure was
till recently a Government activity. This has been so because infrastructure services are
difficult to price so as to fully cover all costs thereby making it unattractive for private
sector participation. Also the provisions of infrastructure usually involve high upfront
costs and long payback periods and the private investor is often unable to provide the
large initial capital required and is not capable of obtaining matching long-term finance.
Finally crosssubsidization, which forms an important part of infrastructure provision, is
easier done by public sector than the private.

However, there has been a paradigm shift in funding of infrastructure from the
Government to the private sector mainly due to budgetary constraints in making available
funds to meet the huge requirements of the infrastructure sector. The other contributing
factors for the diminishing role of the Government have been the dissatisfaction with the
performance of state provided infrastructure, more efficient utilization of resources by the
private sector and greater Government emphasis on allocation of budgetary resources to
social service sectors such as health and education. The Government’s role is perceived
as the ability to provide a stable and conducive macro economic environment and carry
out necessary regulatory reforms, which in turn would facilitate private sector
investments in the infrastructure sector.

The Government continues to play the role of a facilitator and the development of
infrastructure really becomes an exercise in public-private partnership. The fact that
funding for infrastructure has increasingly to come from the private sector has now been
widely recognized and the focus of the debate has been on best practices in reform
strategies, regulatory frameworks and risk mitigation techniques. The Government has
the challenging task of providing fair, predictable and sustainable framework for private
sector participation in infrastructure that will deliver better services with greater
efficiency. It has been observed globally that project finance to developing countries
flows in where here is a relatively stable macro-economic environment.

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 However, there are certain other conditions, which must be present. These include
regulatory reforms and opening markets to competition and private investment.
Liberalized financial markets, promoting the deepening and widening of local markets,
wider use of risk management and other financial products, improved legal frameworks
and accounting standards and privatization programmes are some of the other aspects
which favourably impact on infrastructure project finance. Infrastructure projects are
characterised by large capital costs and long gestation periods. The assets of these
projects are not easily transferable and the services provided are non-tradable in nature.
These projects are typically vulnerable to regulatory and political changes and are also
dependent on supportive infrastructure. There are also politically sensitive issues like
tariffs and relocation and rehabilitation of people. For these reasons, the infrastructure
projects carry a relatively higher risk profile and, therefore, this funding is different from
the traditional balance sheet financing. The characteristics and complex nature of
infrastructure projects call for proper risks assessment and mitigation mechanisms. The
financing of infrastructure projects is largely cash flow based and not asset based. In fact,
in some sectors like telecom, roads, bridges etc. the tangible assets may not even provide
adequate cover for the loans. These projects are financed through Special Purpose
Vehicles by way of non-recourse/limited recourse financing structures. The approach to
such projects is to properly identify and allocate various elements of project risks to the
entities participating in the project. The role of sponsors is normally limited to bringing
in the contracted equity/contingent equity contribution.

As far as long-term debt is concerned, at present the Government monopolises

practically all forms of long term funds, such as insurance, pension and provident funds.
With the desired shift in investment responsibilities, it has become necessary for the
Government to vacate some of this space for the private sector. Conditions should also be
created whereby savers are attracted towards investing in long-term debt instruments.
One way is to make much more concerted efforts for the creation of a debt market, for, in
the absence of such a market, practically all debt investments are held to maturity and
this illiquidity reduces the attractiveness of debt instruments particularly those of longer
maturity. Until the secondary debt market becomes sufficiently active so as to absorb

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debt instruments of various maturities, there is a case for the Central Government to
move its debt portfolio towards the shorter end of the maturity spectrum, which would
increase liquidity in the debt market. This would be consistent with the recommendation
for the Centre to vacate more space in SLR placements in favour of states and PSEs.

The insurance sector has been an important source of low cost funds of long-term
maturities all over the world. In the Indian context, however, the insurance companies,
particularly in life insurance, apart from covering risk are also committed to repayment of
the principal with interest although with long maturities and thereby tend to act as
investment funds. One of the reasons that this has happened is that the average premium
charged by the insurance companies in India tends to be relatively high due to obsolete
and rigid actuarial practices and inefficient operations. There is pressing need to reorient
the insurance sector in a manner that if fulfills its principal mandate of providing risk
cover. The opening up of the insurance sector to private participation, including banks in
August 2000 has been able to instill an element of competition which would in turn
promote efficiency and professionalism and enhance consumer choice through product
innovation.

Banking System
An area of concern which impacts on investment is the relatively high interest
rate structure that prevails in the country. Interest rates are no doubt related to inflation in
a trend sense but this relationship is primarily with respect to the rates received by the
savers. With a decrease in inflationary expectations in the economy the nominal deposit
rates should be amenable to reduction without materially affecting the expected real
returns to the savers. The Government would have to clearly signal an anti-inflationary
stance in a credible manner and also the actual rate of inflation would need to be brought
down to its target level and maintained there for a sufficient period of time for
inflationary expectations to be adjusted downwards. A beginning has been made by
reducing the interest rates on small savings schemes run by the Government as well as on
bank deposits. However interest rates paid by borrowers are also dependent on the level
of efficiency of the financial system. The spread between the deposit and lending rates in

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India is high by international standards and reflects both the constraints faced by and the
relatively low level of efficiency in the financial intermediation system. Although in
recent years there has been considerable liberalisation in the banking sector with
tightening of prudential norms and accounting practices which have led to an
improvement in the health of the banking sector, there are some areas of concern which
need to be examined. The banking industry has a high level of non-performing assets
(NPAs) to contend with. High NPAs raise the cost of bank operations and thereby the
spread and efforts need to be made to bring these down. However, a balance has to be
drawn between the reduction in NPAs on one hand and ensuring adequate supply of
credit to the economy on the other. Excessive pressure on banks to reduce NPAs is likely
to lend to a high degree of selectivity in the credit disbursal process and consequently, a
reduction of the total level of credit as dictated by the growth of deposits. The rate of
reduction of NPAs will therefore have to be fairly gradual keeping in mind the notional
lending risks associated with the Indian economy and the speed at which debt recovery
and settlement processes operate. In addition, the factors other than NPAs which affect
the level of spread required for the viability of banks would need to be considered in the
context of national priorities and policy objectives. To achieve this, action has to be taken
on strengthening and professionalising the internal control and review procedures of
banks and financial institutions with a view to ensuring autonomy with accountability.
Also the process of judicial review and implementation of debt recovery processes and
decisions need to be given further impetus and the role of the States is critical in this
regard. In this context, the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act 2002 will go a long way in allowing the banks to
take control of the assets of willful defaulters without going through cumbersome and
time consuming litigation.

The ability of the banks to increase their loan portfolio is not only determined by
a growth in their deposits, but also by the need to conform with prudential norms relating
to capital adequacy. Once a bank has reached a level of advances commensurate with the
capital adequacy norms, any increase in loan assets has to be preceded by a
proportionate increase in capital.

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 A very important challenge before Indian banking will be to manage the different
segments of the economy. Banking services have to be delivered in keeping with the
different levels of economic prosperity enjoyed by the population in rural, semi-urban,
urban and metropolitan areas, and their relative needs. Providing high technology driven
banking in the metros on the one hand to ensuring availability of basic banking services
in the rural areas on the other, form the two ends of the spectrum and banks need to
manage both equally competently.

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 CHAPTER 10
GROWTH OF INDIAN FINANCIAL SYSTEM

After independence the mixed economy theory was adopted for the growth of the
financial system and also for fulfilling socio-economic & political objectives. Following
were the significant changes that took place after independence:
1. The govt. started creating new financial institutions to supply finance both for
agriculture & industrial development.
2. A number of other institutions also participated in industrial financing by mobilizing
public savings through introduction of insurance schemes and mutual funds.
3. In order to promote industries in the state, various SIDC were established to promote
medium scale industrial units.
4. The financial system was focusing more towards the development of capital market
after the entry of private sector was allowed into banking and insurance sector.
5. The secondary market was strengthen with the establishment of various regional
stock exchanges in different parts of the country.
6. With the development of the various credit rating agencies it has provided a lot of
help to the investors to make decisions of their investments in different instruments
and also protect them from risky ventures.
7. With the increase in the size and number of financial institutions it has led to
considerable increase in the financial instruments, which thereby helps to meet the
diversified needs of the investors.
8. The international capital market needs are catered with the introduction of more
transparency in the trading and settlement practices in the various stock exchanges.
9. One of the most significant developments in the Indian financial system is the
introduction of derivative trading which includes stock, interest, futures and options.

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 FINDINGS

INDIAN FINANCIAL SYSTEM

Basically we found that our Indian Financial system is much more stronger than
any other financial system of any other country.

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