INDIAN FINANCIAL SYSTEM AN

OVERVIEW
 Machinery

Employees Raw materials

Company
fundraising
Sales/Promotion Building assets

Product
development

Companies turn to intermediaries to raise funds needed to finance their essential

corporate activities.

For this purpose they raise finance from banks by borrowing.

 An institutional framework existing in a country to enable financial transactions

Four main parts:

Financial Securities/Instruments/assets (loans, deposits, bonds, equities,

etc.)
Financial institutions/intermediaries (banks, mutual funds, insurance
companies, etc.)
Financial markets (money market, capital market, forex market, etc.)
Financial Services (hire purchasing, Leasing, Factoring, Insurance, Venture
capital financing etc.,)

Regulation is another aspect of the financial system (RBI, SEBI, IRDA, FMC)
 Savers/Lenders Securities Borrowers
(HOUSEHOLDS) (HOUSE HOLDS)
(FIRMS) (FIRMS)
(GOVERNMENTS)
Money
(GOVERNMENTS)
(FOREIGNERS) (FOREIGNERS)
Financial System

Financial Financial Financial Financial

Services Markets Instruments Institutions

Capital Market
Debt Market
1) Long-term
Equity Market
1) Lease Financing Instruments
Money Makret 2) Medium-term 1) Regulatory Institutions
2) Hire Purchase
Forex market Instruments 2) Banking Institutions
3) Merchant Banking
Commodities Market 3) Short-term 3) NBFCs
4) Factoring Instruments 4) Development Fin. Inst.
5) Wealth 5) Mutual Funds
Management 6) Insurance Companies
6) Credit Rating Primary Secondary 7) Others
Market Market Equity Debt
 Financial markets are essential to promote economic efficiency.

Financial markets are essential to increase production

Financial markets enhance entrepreneurial development and national welfare

 Financial system consists of financial markets and
financial intermediaries
Financial markets comprise of money market, capital
market, forex market, government securities market and
credit market.
While the capital market is regulated by SEBI, all other
markets are regulated by RBI, the central bank
 Insurance and pension funds are also market participants
The regulators for these two categories are the IRDA and
PFRDA respectively
 Commercial banks [about 60% share]
Urban co-operative banks
Rural financial institutions
Non banking finance companies
Housing finance companies
Development finance institutions
Mutual funds
Insurance companies
 Public sector banks [27]
Private sector banks [20]
Foreign banks [43]
Regional rural banks [56]
 All India financial institutions EXIM bank, NABARD,
SIDBI, NHB
Investment institutions LIC, GIC
State level financial institutions SFC, SIDC
Other public financial institutions
 Deposit taking NBFC-D
Non deposit taking NBFC- ND
Residuary NBFC RNBFC
Housing finance companies HFC
Mortgage guarantee companies
 URBAN CO-OPERATIVE BANKS
Scheduled UCB
Non scheduled UCB
RURAL CO-OPERATIVE CREDIT INSTITUTIONS [96061]
Short term
State co-operative banks
District central co-operative banks
Primary agriculture credit societies
Long term
State Co-operative Agriculture and Rural Development Bank
Primary Cooperative Agriculture and Rural Development Bank.
 Banking is defined as "accepting deposits of money, for the purpose of
lending and investments from public, which is repayable on demand or
otherwise and can be with-drawn by cheque, draft, order or otherwise.
However, the primary activity of the Bank is accepting for the purpose of
lending and investments, deposits of money from public.
This does not mean that any acceptance of deposit say; by a trust, company or
individual can be termed as a banking.
The key differentiators are
Deposit of money
Repayable on demand and
With-drawn by cheque
Acceptance of Deposits alone will not be called Banking.
 Money Supply Cash in Circulation Bank Account
Deposits

= +

Banks can influence the quantity of demand deposits in the economy and the
money supply
Fractional-Reserve Banking System

Banks hold a fraction of the money deposited as reserves with Central Bank
and lend out the rest
This would enable banks repay depositors who withdraw their deposits
Central banks restrict the proportion of a bank's balance sheet that can be lent
out, and use this as a tool for controlling the money supply

When one bank loans money, that money is generally deposited into another
bank
This creates more deposits and more reserves to be lent out.
When a bank makes a loan from its reserves, the money supply increases
Fractional-Reserve Banking System

Deposit

$$$$$$
Central Bank
Bank A

Lends Reserve
$$$
$$
Reserve

Borrower 01 Deposit
$$$
Bank B Lends Borrower 02
Financial intermediaries that facilitate the movement of money

Banks Credit unions

Stock Exchange Insurance companies
NBFC Collective investment
Pension funds schemes
 Primary Services Deposit- Products & Services

Facilitating Accepting Certificate of Current

Payments Deposits Deposit Account

Money
Market Savings
Making Loans Deposit Account
& Investments Account

Loan Products & Services

Real Estate Commercial

Loans loans

Consumer Loans
Payment Products & Services Specialized Products & Services

International Individual
Banking Retirement
Services Accounts
Electronic
Fund Transfer Check services
Systems
Trust Services Savings Bonds

Cash
Safe Deposit
Special Checks Management
Boxes
Services
 INTEREST INCOME

Pays Interest
@ (X-Y)% Retains Spread
(Y%)
Pays Interest
@ X%

Deposits Money

The INCOME for the bank is used to pay banks

EXPENSES- employees, pay for the bank
building, lights, heat, etc. and also provide
some PROFIT for the owners of the bank
Lends Money
 NON-INTEREST INCOME

ATM ACCOUNTS / CHECKS TRANSFERS

Banks also charge fees for services like checking, overdraft protection, Safe
Custody, Safe Deposit Lockers, Depository Services . Service Charges, Loans
Processing charges.
Bank regulations are a form of government regulation
which subjects banks to certain requirements, restrictions
and guidelines, aiming to uphold the soundness and
integrity of the financial system.
Combination of the instability of
banks as well as their important
facilitating role in the economy
led to banking being thoroughly
regulated.

Regular in- bank examinations

are conducted by central and
state regulatory agencies to
verify if banks are complying
with all relevant laws and
regulations.

Banks are susceptible to many

forms of risk which have
triggered occasional
systemic crises.
 Major Risks a bank is exposed to include
Liquidity Risk
The risk that many depositors will request
withdrawals beyond available funds.

Credit Risk
The risk that those that owe money to the bank will
not repay.

Interest Rate Risk

The risk that the bank will become unprofitable if
rising interest rates force it to pay relatively more on
its deposits than it receives on its loans.
Major Risks a bank is exposed to include
Market Risk

Market risk is the possibility of loss to the bank

caused by changes in the market variables. The risk
banks face due to fluctuations in market conditions
and banks exposure to it.

Operational Risk

Risk of loss resulting from inadequate or failed

internal processes, people or from external events.
This includes Legal risk.
 Central banks are non-commercial bodies or government agencies tasked
with responsibility for regulating the banking industry
They act as Lender of last resort in the event of a crisis

USA Federal Reserve

India Reserve Bank of India

UK Bank of England

Japan Bank of Japan

The RBI Act, 1934 envisages major functions
for RBI as a central banker, a promoter and
a regulator

The Banking Regulations Act, 1949 deals

mainly with the administrative and
functional aspects of governance of banks.
The Banking Regulation Act also confers RBI
with powers of supervision over commercial
banks
Reserve requirements in India:
Cash Reserve Ratio (CRR)
Every commercial bank is required to maintain with RBI
every fortnight a minimum average daily cash reserve as % of
its Net Demand and Time Liabilities (NDTL) outstanding as on
the Friday of the previous week. Currently it is 4%
Statutory Liquidity Ratio (SLR)
Every bank is required to maintain a minimum proportion of
the net demand and time liabilities as liquid assets in the
form of cash, gold and approved securities. Presently it is
21.25%.
 The Reserve Bank of India (Amendment) Bill, 2006 has been
enacted and has come into force with its gazette notification.
Consequent upon amendment to sub-Section 42(1), the Reserve
Bank, having regard to the needs of securing the monetary
stability in the country, can prescribe Cash Reserve Ratio (CRR)
for scheduled banks without any floor rate or ceiling rate.

[Before the enactment of this amendment, in terms of Section

42(1) of the RBI Act, the Reserve Bank could prescribe CRR for
scheduled banks between 3 per cent and 20 per cent of total of
their demand and time liabilities].

RBI is empowered to increase this ratio up to 40%. An increase

in SLR also restrict the banks leverage position to pump more
money into the economy
 Bank Rate is the rate at which central bank of the country (in
India it is RBI) allows finance to commercial banks. Bank Rate is a
tool, which central bank uses for short-term purposes. Any
upward revision in Bank Rate by central bank is an indication that
banks should also increase deposit rates as well as
Prime Lending Rate.
Thus any revision in the Bank rate indicates could mean more or
less interest on your deposits and also an increase or decrease in
your EMI

Section 49 of the Reserve Bank of India Act, 1934 requires the

Reserve Bank to make public (from time to time) the standard
rate at which it is prepared to buy or re-discount bills of
exchange or other commercial paper eligible for purchase under
that Act. This is called Bank Rate ( Currently 7%)

 Repo Rate is the interest rate for
secured overnight or short term
financing involving the sale and
repurchase of securities. It is basically
the rate at which RBI lends to
commercials banks for meeting the
short term deficits. RBI varies Repo rate
from time to time to achieve its
monetary policy objectives. ( Currently
6.5%)
The reverse repo rate is the rate at which
the banks park surplus funds with reserve
bank, while the repo rate is the rate at
which the banks borrow from the central
bank. It is mostly done when there is
surplus liquidity in the market. ( Currently
6%)
 http://www.youtube.com/watch?v=7I_k0tAn
Q7U

https://www.youtube.com/watch?v=rWcYj_hk
LP0

http://www.youtube.com/watch?v=GsxmwjQ
WiZs&feature=related