Transcription

What Are Financial Services?

In this module, we are going to understand four specific things about financial services. First, what are financial services
in India; second, pillars of financial services; third, evolution of the entire banking sector in India; and fourth, what
exactly is money supply and how is the management of money supply is done in India. If you are going to understand
about each of these specifics, then in the financial services, we are going to understand about need for financial
services, how the entire structure of the institution is being set up in India and the scale and size of financial services
in India.

When we talk about pillars of financial services, we'll talk about the regulatory bodies and the functions done by three
regulators, namely Reserve Bank of India, Securities and Exchange Board of India and Insurance Regulatory and
Development Authority of India. Fourth is not widely used or widely known, but which is Pension Funds Regulatory
and Development Authority of India. In the evolution of banking sector, we will understand about two specific
committees and the implementation of their suggestions in the overall banking sector, that is, reports by
Narasimham’s Committee and reports by Raghuram Rajan's Committee.

In the last section of this particular model, we will understand about the monetary policy of India, what RBI done to
control the ore of inflation and what are the kind of tools they operate with to control the overall money supply and
the inflation.

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In this session, we are going to understand about what are financial services. But before that, let's understand the
scale of some of the most famous financial services or the products which India has given to the world. So, we all know
about Visa, right? So, if you just talk about Visa, Visa processed 10 trillion worth of payments in 2021, but that's for
the entire world, so visa is a worldwide company, so they have processed 10 trillion worth of payments in 2021
globally.

Now, if you compare that with our India's own homegrown payment service, which is UPI (Unified Payments Interface)
that processed 1 trillion worth of payments in 2021, but that's just in India. So, if UPI were to go global, imagine the
amount of volume it will generate and no wonder companies like Visa and Mastercard are already seeing UPI as a
threat to their overall existence. So, India's financial services ecosystem is on the verge of exploding. No wonder a lot
of funding is coming to this segment. A lot of FinTechs are coming to this segment.

But before we proceed, we need to understand what are financial services. So, financial services are any transaction
that involves the transfer of money or the consideration of money is a part of a financial service. So, if we are making
a payment, that is a part of a financial service. If you are depositing a cheque, that is a part of a financial service. And
the various types of financial services are banking, payments, broking, asset management, insurance, anything which
falls under this will be a part of a gamut of overall financial service.

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We need to understand and need to answer this very specific question, which is: why is a financial service needed?
Now, financial services are needed for four reasons which are it enables something, it establishes trust into something.
Third, it provides a measure of risk management and fourth, we can expand this knowledge to enhance the overall
product. So, let's understand each of these reasons.

First, it enables something. So, without financial services, how would we transfer funds at the lowest possible cost?
Think about this. If you need money, I have funds with me, but we live in different cities. If I were to come there or
you were to come into my city, then that entire exercise would have been very costly. Rather, if I can transfer via funds
via bank, then that's the cheapest and the fastest possible way.

Second, it establishes a trust. Think about this. Will you lend to someone just like that? Answer is no, but if a bank is
in between, then answer is yes, we can give it via check, we can transfer it via UPI. Third, it provides the overall risk
management. So, without financial services, will you be able to manage risk effectively? Now, what type of risk we are
talking about. Think about this. If there is no intermediary, no bank and I am giving you some money, then what is the
trail of that money? What is the proof of the money which I have given it to you? There is no proof, right? But with a
bank or with financial services or the service providers, we can actually track that.

Fourth is use of knowledge. Experts are needed at an individual and a corporate level with the kind of knowledge,
which we have we can expand, we can provide the better the faster services and the answer to this is the recent
example of UPI. It's a revolutionised product. It has revolutionised the entire banking financial services industry. So,
now we have understood about two specific things what are the financial services and why it is needed.

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We need to understand about the structure of financial institutions in India. Now that means that India has two
different types of financial institutions. First is, banks and second non-banks. Now, within banks, we have three
different types of institutions: Commercial banks, cooperative banks and third type niche banks, which includes likes
of payment banks and small finance banks. Within non-banks, we have five different type of institutions, development
banks, insurance companies, NBFCs, which are commonly known as non-banking financial corporations or companies
and mutual funds and other pension funds.

Now, if we just have to describe each of these in one line, then how does it look like? So, if we talk about commercial
banks, commercial banks are something which we see they out likes of SBI, ICICI banks or HDFC banks are the types of
commercial banks. Now, commercial banks have full authority to have pan India presence and can do lending as well
as savings function. When we talk about cooperative banks, these are the kinds of region-specific banks, which are for
specific reasons like Saraswat bank, is one of the largest cooperative banks in India.

When we talk about niche banks, these are the newest category of banks, which RBI is approved like so PayTM
payments bank or Airtel payments bank. The function of payments bank is to have a faster payment mechanism,
primarily through UPI or wallet. These are the banks set up to have an overall financial inclusion in India. Then, we
have small finance banks. This are the kind of banks to provide small ticket size loans likes of AU small finance banks
or the Dhanalakshmi bank are the kind of example in this particular category.

When we talk about non-banks, so the difference between banks and non-banks is banks can actually have a lending
function as well as savings function. In the case of non-banks, they are primarily the lenders, you cannot actually
deposit or you cannot actually open a savings account with this kind of an entities. So, here we have five different
types of entities. First, development banks. So, these are the kind of banks, which are for a specific function like to
support, export and import. So, we have a bank called as an Exim bank.

Then, we have a SIDBI bank, which provides small ticket size loans and only to let's say the lower middle class, for
example autowalas. So, if autowalas need a loan, they can get a loan from SIDBI bank as well. Then, we have insurance
companies. Within that, we have two sections; general insurance and life insurance. So, likes of HDFC life insurance or
HDFC general insurance or LIC, these are the kind of companies which falls into this category.

Then, we have non-banking financial co-operations. These are the kind of companies which can be into landing like so
Bajaj Finance or Bajaj Finserv. Let's say they provide loans for the white goods, TVs or mobile phones or laptops, etc.
Then, we have mutual funds. Mutual funds are the saving instrument likes of ICICI mutual fund or HDFC mutual fund,
so they can provide mutual funds into both equity category as well as in the debt category, and then finally, we have
pension funds or primary dealers, which provides assistance with brokerage with the brokers to provide stock market
dealing or provide national pension scheme, so these are the kind of funds, which provide retirement solutions as well
plus this support other financial institutions. So, in a way this is the entire structure.

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Now, when we talk about core functions, which they do. So, there are five core functions, savings, lending, payments,
investments and risk management. These are the five core functions, which these entities work on. So, savings are
primarily for banks, like so HDFC bank and ICICI bank. They do provide saving solutions, then we have lending function.
So, all the banks and NBFCs provide lending solutions.

Then, we have payments as a solution likes of banks and FinTech, which provides payment services, also PayTM,
Zomato, these are the kind of companies which provides various kinds of payment services. Then, we have investment
services, that's where the mutual fund comes into picture, and finally, we have risk management where we have
insurance in the segment. It can be either general insurance or a life insurance. So, that's in a nutshell, covers the
entire scope of financial services and the kind of services they provide.

If you talk about how big is the Indian financial market, and within that, how big are our banks or how big are our
payment services or how big are our mutual funds, then we need to look at some of the specifics. So, we have some
examples over here that will tell us about how big are this, and that will also give us the opportunity to understand
how big this can become. So, for example, when we talk about banks, if we talk about SBI's balance sheet size, it is 35
lakh crore and SBI is the largest bank in India. It is one of the most systematically important banks in India.

Another systematically important bank in India is HDFC bank who has balance sheet size of 18 lakh crore. It is one of
the largest banks in the private sector in India and is one of the top five largest banks in India. But if we compare that
with some of the global peers, so, for example, J.P. Morgan and Chase is one of the largest banks in the world. It has
a balance sheet size of 3 crore crore.

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So, SBI's balance sheet size is still 10 times lesser than JPMC, and JPMC is the world's fifth largest bank by assets. Top
four are from China. This is how and this is the scale which is it India right now, though, India is big, but India has an
immense opportunity to become bigger because of the population and because people are moving from lower middle
class to middle and then eventually per capita income will increase. So, that's with respect to banks.

When we talk about payments, so UPI is the fastest growing payment services in the world. UPID transaction worth
one trillion dollars, so basically 75 lakh crore rupees in 2021, and in 2022, this is likely to surpass anywhere between
one crore crore to 1.25 crore crore. So, that's how ups ecosystem in India is. When we compare to some of the other
established players like Visa, Visa did $10 trillion, basically worth of transactions in 2021. So, UPI is still 10 times smaller
than Visa. However, Visa did all these payments globally versus UPI, which does largely or most of it in India.

So, if UPI has to go global, imagine the amount it will be able to do it because one of the fastest and the best payment
ecosystem in the world. When you talk about mutual funds, it's basically only 5% of the Indians have demat account.
That does not mean that out of 130 crore population, basically 7 and 7.5 crore population have a demand account.
Basically, India just has five to six crore active demand account, and in one family, we can have multiple demat account.
So, if we just talk about households, so India has 30 to 35 crore households, out of which only like 2 or 3 crore
households have active demand account, so that's basically, just 10% of the households have demat account.

Entire mutual funds industry size is equivalent to India's one-year savings. So, think about it. India's entire GDP, India's
one year GDP is close to $3 trillion and entire mutual fund size is 20% of that because India saves 20% of the GDP. So,
India's savings is close to like $600 billion every year. That's the entire size of the mutual fund industry. Now, if one
fine year, people decide that, rather than saving everything and putting everything or large amount of it into fixed
deposits or in gold or in real estate, let's spark 50% in mutual funds, so that's basically $300 billion, mutual fund
industry will grow by 50%.

So, currently it is a $600 billion will in one fine year, if people decide and if the market perform, it can actually grow by
50%-60% in a year. So, this is the kind of scale which we are talking about and that's why people are bullish on India
and that's why the FinTech boom is really happening in India.

So, when we talk about various types of financial institutions, we also need to understand their motivation, why each
of these companies or each of these institutions provide financial services. First, banks. So, why do banks provide
financial services, so they have three reasons, three motivations to provide financial services; first lending, second
payments and third other services. So, through lending, when they lend, they get interest income, so that's the first
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motivation. When it comes to payment, they can collect data of the clients and they get service income on each
transaction.

So, for example, NEFT is about 1 lakh rupees, they get 10 or 15 rupees for that. So, the more the support they provide
to their clients, the better it is for them, plus they get data of their clients so that they can cross sell. So, if they know
certain client has a salary of so and so amount, based on that they can cross sell and ask or pitch a client a retail product
like a home loan. So, that's how the data itself is very important and that's why they are into payment services. What
kind of other services, which is a third option? So, that's basically providing locker services or providing a brokerage
account, providing Forex services or providing debit card or a credit card.

Through that, they engage with clients, they provide diversification to their income that also generates an additional
fee income, and these are the three services and that's why the banks are in the financial services. They provide
financial services.

Now, we have a second institution which is non-banking financial corporations and why they provide financial services.
So, they provide two different types of services first is the lending service and second is they have an aspiration to
become a bank and that's why they provide financial services? So, why lending? So, lending because they earn an
interest income like bank does and second, they have an option or they get a chance to lend to certain sectors, which
banks do not lend to like real estate sector. So, real estate sector lot of banks, because the chances of default is very
high, they do not land and that's why NBFCs get a chance to lend to this particular segment.

Second reason is they want to become a bank at some stage. Obviously, when a small institution or any kind of an
NBFC becomes a bank, they get access to lot of other services like they get cheaper access to funds, they can open
savings account, they can host, they can provide other solutions like locker services or like Forex services, and hence
they want to enhance their entire portfolio, and with that motivation, they provide financial services so that at some
stage they can become a bank.

We have third sort of institution, which is brokers. So, why brokers provide financial services, so they have three
reasons first lending, second distribution and third manufacturing of financial products. Now, lending because they
generate interest income. But the question is what do they lend against? So, think about this scenario, you have an
account with HDFC securities, which is a broker or a Motilal Oswal Broker. Now, in your demat account, you have
certain shares, but you need certain amount of money. So now, you go to your broker, ask them that you need a loan,
because you have a demat account and within your demat account, there are certain amount of shares which are
already there or a mutual fund which is already there.
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You don't want to sell those shares or mutual funds, but you want loan against those shares and mutual funds, and
that's why the broker comes into picture, broker works with the bank tells them yes, this particular person has a demat
account, this is the holding. So, give loan against the shares or securities and mutual funds, so you pledge your shares
and mutual funds and get a loan, and both banks and brokers get interest income.

Second, if a broker has a network, it can generate actually income from distribution of products. What do you mean
by that? So, for example, Motilal Oswal Financial Services is a pure play broker, but you are Motilal Oswal’s client and
you need to invest in let's say HDFC mutual funds mutual fund. So, Motilal Oswal will give you an advice, please invest
in HDFC mutual fund through us because you are our client. You agree and Motilal Oswal gets a commission from
HDFC mutual fund because they got a business through that channel. So, that's where the income from products
comes and these products can be anything; it can mutual fund, it can be insurance, it can be gold, it can be real estate,
it can be portfolio management services, it can be anything.

And third manufacturing of these products. Now, what do you mean by manufacturing? This is not a manufacturing in
a factory, but this is a creation of new products. So, Motilal Oswal can actually get into a set management which they
are in, so they can actually launch their mutual fund service. They have done that. It can be let's say any other company,
for example, NJ India Private Nivesh. NJ India Private Nivesh is the largest distributor of mutual fund in India. Now,
they want to start their own mutual fund company, so they are actually now getting into manufacturing of products,
so that they can actually do lending as well as well as they generate more income from the product. So, these are the
three motivations, which the brokers have to provide financial services.

Now, finally, we have insurance. So, why insurers provide financial services. So, they have two motivations; first spread
the risk and second, they can invest to generate income. So, what do you mean by spreading the risk? Now, think
about this scenario if I am going for a life insurance with LIC of India. Now like me, there are 1 lakh more people who
wants to open a life insurance policy. Why? Because if something happens to me or something happens to an
individual's life, his or her family needs to be protected, so that risk should be reduced, so insurance allows people to
reduce risk or transfer risk to LIC. So, if something happens to me and if I have a policy upon if something happens to
me, LIC will take care of my family because whatever was the sum assured, LIC will give it to my family.

But till the time such event happens, LIC will get that premium on the yearly basis from me, so that's an insurance
premium. Now, why will LIC do that? Because LIC is aware that at any given point in time not everybody will suffer
from the same disease or not everybody will suffer from the same catastrophe unless there is a natural disaster, so
they try to spread risk, they try to sell policy to as many people as they can.
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So, the premium income surpasses any of this event specific risk, which they are supposed to honor the commitment,
so they get the money, plus somebody who has an insurance is insured, so risk is transferred. So, that's basically
spreading the risk, they help with that, and second, whatever money they get, they get through premium, they can
invest and generate the additional income, so they are into asset management services as well. So, these are the two
biggest motivations for insurance company provide financial services.

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