Indian Financial markets

and system
Introduction
Sub Topics to be covered
 Financial Markets
 Role of Intermediaries in BFSI sector
 History, growth, current position and

challenges for Financial services and

insurance sectors
Financial system
Markets

Services Institutions

Regulators Instruments
Financial Markets
 A financial system is the set of global, regional, or
firm-specific institutions and practices used to
facilitate the exchange of funds.
 Financial markets refer to a centre that provides
the facilities of sale or purchase of financial claims
and services.
 Individuals, financial institutions ,corporations and
government trade in this market either directly or
indirectly through brokers and dealers.
 Activities in financial markets lead to direct effects
on behaviour of individual, business and
consumers.
Components of Financial markets

Financial market
Financial market

Level of
Nature of
Nature Maturity Period organisation
securities

Primary Money Market Organised

Unorganised
Secondary
Capital Market
Key Financial Markets
 Money market (where short term interest
rates are determined)
 Capital Markets ( major effect on people’s

and firm’s decisions)

 Foreign exchange market ( changes in the

foreign exchange rates affect economic

activity)
 Derivatives Market (used for hedging and

speculation objective cannot be ruled out)

Financial Markets in India
 Organised & unorganised
 Low per capita leading to inadequate

participation
 Regulatory bodies like

RBI,SEBI,IRDA,MOF,NCLT
 Paucity of financial instruments
 Issues of corporate governance and scams
Money Market
Key
transmitter for
Banks, Financial Institutions short term
,Primary dealers(PDs) rates

Regulated Low
By risk
Notice Money(till 14 RBI & SEBI +low
days),Term Money, Triparty return
Repo, Market Repo, Repo in
corporate Bond, Treasury
Bills, Commercial papers,
Certificate of deposits,
Money Market Mutual High
Funds, Commercial Bills liquidity
& safety
Money Markets
 Key transmitter of monetary policy rates for short term
 Based on supply and demand for money for short term
 Products are highly liquid and large value deals occur
 High liquidity and less tenure (lower than 1 year) of the
products
 Usually, over the counter deals or previously
negotiated deals are made
 Participants are Banks, Financial Institutions ,Primary
dealers(PDs)
 Unstructured ,Informal as well as Formal Market
 High safety and low returns
 Enables financing and investing for short term
Money Market instruments
Products dealt in are:
Overnight:
 Call money, Triparty Repo, Market Repo, Repo in corporate

Bond
Term Segment:
 Notice Money(till 14 days),Term Money, Triparty Repo,

Market Repo, Repo in corporate Bond, Treasury Bills,

Commercial papers, Certificate of deposits, Money Market
Mutual Funds, Commercial Bills,
https://www.rbi.org.in/scripts/AnnualReportPublications.as
px?Id=10
https://www.moneycontrol.com/news/business/markets/
explained-what-is-repo-and-tri-party-repo-3859991.html
Capital Market
Banks, Financial Institutions
,Primary Regulated Long term
dealers(PDs),Insurance, By Financial
Mutual Funds, SEBI Products
Pension Funds, Hedge
Funds, FDI,FII participants,
Retail & corporate investors Govt Sec.
Bonds ,
Equities, High
Mutual Funds Risk &
Return
Enables capital formation &
economic development
Primary or Low
secondary safety
Capital Markets
 Long tenure assets with higher risk involved
 Enables capital formation & economic

development
 Can be categorised into stock Markets and

Bond Markets OR primary market and

secondary market
Capital Markets
 Products are Equities, Mutual Funds, ETFs,
Securities borrowing and lending schemes,
Debts-Corporate debts and securitised assets
 In bond market, long term trading of

government securities, Bonds issued by PSU

Undertakings/Corporates/Banks like floating
rate bonds, Zero coupon Bonds, Corporate
debentures, state government loans,
securitised assets of banks, FIs , corporates
and others
 Risky financial investors
Hedge Funds:
A hedge fund is an
investment fund charging
a performance fee and
typically open to only a
limited range of investors.
In the United States,
hedge funds are open to
accredited investors only.
Because of this restriction
they are usually exempt
from any direct regulation
by the SEC, NASD and
other regulatory bodies.
Private Equity: Private Equity:
Private equity returns Investment in equity linked
derive from an to an asset which is not
appreciation in value of listed and therefore not
the acquired asset or publicly traded in stock
company. Such markets. In short private
investments are often equity is acquired either
followed by efforts at through the private
restructuring to placement of new shares or
resuscitate loss making the sale of pre-existing
companies or shares by the controlling
substantially improving interest or minority interes
performance of profit
making companies
Participatory Notes (PN)s
 PNs are instruments used by foreign funds /
investors who are not registered with SEBI but
are interested in taking exposure in Indian
securities. FIIs that do not wish to register
with the SEBI but would like to exposure in
Indian securities also use the participatory
notes.
Foreign Exchange Markets
 Largest Financial market with players all over
the world
 Global network working 24 hours a day
 Facilitates determination of foreign exchange

rates between currency pairs

 Participants include Banks, forex dealers,

Central bankers, hedge funds, investors

Derivatives Market
 Derivatives are financial securities and are
financial contracts that obtain value from
something else, known as underlying
securities. Underlying securities may be stocks,
currency, commodities or bonds, etc.
 Formal derivative trading started in year 2001

after electronic trading mechanisms were

introduced in India
 Examples: Forwards, Futures, Options, Swaps
 https://rmoneyindia.com/research-blog-

traders/indian-derivatives-market-investing/
Financial Institutions
Non
Intermediary Others
Intermediary

Direct
Banking
Investments

Support to FI

Non Banking
consultancy
like insurance
Financial Intermediaries-Role
 Mobilise savings
 Capital formation
 Optimal utilisation of resources-Economic

progress
 Liquidity
 Advisory
 Risk reduction
Types of Financial services
 Fund based financial services
◦ Provide finance
◦ Reduce risk
◦ Examples: Insurance, Lease financing, Factoring , Hire
purchase, venture capital, House financing, discounting
◦ Entities: Insurance companies, Banks, Housing finance
institutions
 Fee based financial services
◦ Specialised services
◦ Professional fees charged to clients
◦ Examples: Portfolio consultancy, Merchant banking, Capital
restructuring
◦ Entities: Merchant bankers, Portfolio consultants, Issue
managers
Types of Finance
 Direct Finance: Savers invest their funds
directly without any intervention of the
financial intermediary For example: issue of
equity shares and /or corporate bonds by
companies to public
 Indirect Finance: Involves role of financial

intermediaries to facilitate movement of

funds from surplus units to deficit units For
eg: Banks, Mutual Funds etc
 Forwards
Will buy Will sell
in Future in Future

Will buy a cell phone from seller at Rs 10,000

after 3 months

Will sell a cell phone to buyer at Rs 10,000

after 3 months

Transaction entered into today Believes

Believes
Binding on both parties price of
price of
After 3 months, buyer will pay cellphone
cellphone
Rs 10,000 and seller will will
will rise in
deliver the cellphone to buyer reduce in
future
future
Forwards
 Customised contract
 Between 2 entities
 To buy/sell an asset
 Not available in the public domain
 No margin requirement
 Settlement takes place on a specific date in

future at a pre-agreed price by physical

delivery of the asset and payment
 Involves counterparty risk
Futures
 Standardised contract
 Between 2 entities
 To buy/sell an asset
 Contract traded on an exchange
 Daily settlement, margin requirements
 Final settlement takes place on a specific date
in future at a pre-agreed price by payment of
the difference and not by physical delivery
 No/limited counterparty risk
Futures terminology

 Spot price: The price at which an asset trades

in the spot market.

 Futures price: The price at which the futures

contract trades in the futures market.
Futures Markets

Futures are available for

 Foreign Exchange
 Stocks/shares/ Stock Indices
 Interest rates
 Commodities
Differences between Forwards and
Futures
Forwards Futures
 OTC in nature  Exchange traded
 Customised terms  Standardised
 Low liquidity terms
 No margin payment  High liquidity

 Settlement at end of  Margin payments

period  Daily settlement

 Counterparty risk  No/limited risk
What is an option?
 A contract that gives its holder the right,
but not the obligation, to buy (or sell) an
asset at some predetermined price within
a specified period of time.
 Most important characteristic of an

option:
◦ It does not obligate its owner to take action.
◦ It merely gives the owner the right to buy or
sell an asset.
Options
Seller/Writer of
Buyer of option option
(Right to exercise) (Obligation to act
Option Contract
Pays option as per Buyer’s
premium decision)
Receives premium

Call option Put option

Writer Writer
Buyer has right Buyer has right
obligated to obligated to
to buy at strike to sell at strike
sell at strike buy at strike
price price
price price
Exercise when Exercise when
market price strike price
>strike price >market price
Swaps

BEFORE

AFTER
Four key sectors in BFSI
 Insurance
 Mutual Funds
 NBFCs
 Banks (will be studied separately)
Insurance
What is Insurance?
 Purpose: pooling of risks
 sharing of losses
 transferring risk

 Basic Principle: insurable interest, indemnity,

subrogation, contribution, disclosure, utmost
faith, relevance of proximate cause
 Two main streams: Life & Non Life/General
Key aspects
of insurance
1st year
life
premiums

Low
insurance
penentrati
on 4.21%
Premium/
GDP
Covid -19 India 2nd largest
increased health insurance
insurance technology
coverage market
Number of Insurers in India

Life Insurers General Reinsurer

• 24 Players • 32 Players • GIC of
• Largest :LI India
C
 Market share non life private players

Market share of leading private non-life insurers in India in financial year 2018
Market share of leading private non-life insurers in India FY 2018

ICICI Lombard
Market share of non-life insurers

0% 1% 2% 3% 4% 5% 6% 7% 8% 9%
ICICI Lombard
6.27%
8.2%
merging as
largest non life
HDFC Ergo* 4.84%
3.74%

player amongst
Tata AIG 3.61%
3.36%
Cholamandalam
private
2.72%
2.35%
Royal Sundaram 1.74%

Shriram
1.53%
1.39%
companies
1.27%
Bharti AXA 1.16%
0.54%
Magma HDI 0.35%

Source(s): IRDA (India); ID 656363 , Sta

Types of Life Insurance Products
 Term Insurance
 Endowment Policy
 Whole Life Insurance
 Children's Policies
 Annuity Plans
 Many others
Insurance penetration in select countries
(2018) (premium as a % of GDP)
Insurance density in select countries (2018)
premium paid by insured /total population
Share of private sector life insurers
increasing…
Source: IBEF
New business share in life insurance
Source: IBEF
Insurance market – attractive?
 Growing middle class
 Young insurable population
 Growing awareness of the need for

insurance
 Retirement planning a big opportunity
 Growth in premia expected at 12-15%

over next 3-5 years

 Recent Trends
 New distribution channels – bancassurance,
online distribution have increased reach and
reduced costs
 NGOs helping tap rural markets
 Differentiated Banks – non-exclusive tie-ups
for distribution
 Traditional products are being customised to
meet specific needs
 Private sector share of premium increasing:
◦ Life premium up from 2.0% in FY03 to 25% in new
business in FY19 and non-life premium up from 13%
in FY03 to 55.7% in FY20
Opportunities
 New distribution channels
 B15 cities and other non-metros are a

large potential market

 Scope for increasing client base
 Foreign players bringing expertise and

capital
 IPOs
 Use of Technology for customization and

distribution
Mutual Funds
What are Mutual Funds?
 Mutual fund is a mechanism for pooling the
resources by issuing units to the investors and
investing funds in securities in accordance with
objectives as disclosed in offer document.
 Investments in securities are spread across a

wide cross-section of industries and sectors and

thus the risk is reduced.
 Regulated by SEBI
Key features and significance
 Provides expert advice for management of
financial assets
 Risk diversification
 Economies of scale
 Transparency and accountability led by

regulatory oversight
 Flexibility based on investor preference and

risk appetite
Mutual Fund organisation

SEBI (Regulator)

appoint Trust (Mutual Accountable to

Promoters Unit Holders
Fund)

appoints appoints interact

appoints

Asset Mgmt interacts interacts Transfer

custodian Agent
Co
Types of Mutual Funds -1
Investment
Maturity
objective

Open ended Growth/Equity

Close ended Income/Debt

Balanced/Hybrid

Tax saving

Capital
protection
Types of Mutual Funds -2
Specialized Others

Sector Gilt

Exchange
Index traded
funds

Fund of Load or No
funds Load fund

Real Estate
Funds
Key facts – Mutual Funds.
 As of August 2021, AUM managed by the mutual funds industry
stood at Rs. 36.59 trillion (US$ 492.77 billion) and the total number
of accounts stood at 108.5 million.
 In May 2021, the mutual fund industry crossed over 10 crore folios.
 Inflow in India's mutual fund schemes via systematic investment plan
(SIP) were Rs. 96,080 crore (US$ 13.12 billion) in FY21.
 Equity mutual funds registered a net inflow of Rs. 8.04 trillion (US$
114.06 billion) by end of December 2019.
 The Association of Mutual Funds in India (AMFI) is targeting nearly
five-fold growth in AUM to Rs. 95 lakh crore (US$ 1.47 trillion) and
more than three times growth in investor accounts to 130 million by
2025.
 The total number of accounts (or folios as per mutual fund parlance)
as on November 30, 2021 stood at 11.70 crore (117 million), while
the number of folios under Equity, Hybrid and Solution Oriented
Schemes, wherein the maximum investment is from retail segment
stood at about 9.52 crore (95.2 million).

Source: AMFI & IBEF October 2021

Investors in Mutual funds
Opportunities and Challenges –
Mutual Funds
 Low penetration
 Rising middle class incomes
 Reduction in interest rates may induce
investors to invest in Mutual funds rather than
in Fixed deposits
 Trend is clearly seen in people investing in
financial assets rather than physical assets
 Millennials and Retirees : two ends of the
spectrum – needing customized solutions
 Leverage technology & greater dependence on
financial advisors
NBFCs
What is a NBFC?
 a company registered under the Companies Act, 1956
 engaged in the business of loans and advances,
acquisition of shares/ stocks/ bonds/ debentures/
securities issued by Government or local authority
 or other marketable securities of a like nature, leasing,
hire-purchase, insurance business, chit business
 financial assets constitute more than 50 per cent of
the total assets
 & income from financial assets constitute more than
50 per cent of the gross income
Difference between bank and NBFC
 NBFC cannot accept demand deposits
 NBFC not part of payment and settlement

system
 Cannot issue cheques drawn on self
 Depositors not covered by DICGC insurance
Importance of NBFCs
 Credit intermediation;
 niche financing;
 alternative to banking credit, last mile

servicing

 Can be classified into:

 A)asset liability structures
 B) systemic importance
 C) activities undertaken
Types of NBFCs
Asset Liability structure Non Deposit taking-size Kind of activities
• Deposit taking • Systematically imp • Asset Finance
• Non Deposit taking • Other • Investment Company
• Loan company
• Infrastructure Finance
• NBFC-MI
• Infrastructure Debt
Fund-NBFC
• NBFC –Factors
• Mortgage Guarantee
Companies
• NBFC-Non operative
Financial Holding Co
Challenges -NBFCs
 High dependence on banks for finance
 Withdrawal of investments by Mutual funds due to
confidence issue post IL&FS causing Liquidity issues
 Rating downgrades post IL & FS issue
 High proportion of low rated or unrated advances
 Low demand due to pandemic
 Recent developments to reduce the regulatory
arbitrage between Banks and NBFCs by RBI
 Tough competition by Fintechs

 https://economictimes.indiatimes.com/industry/banking/
finance/rbi-comes-out-with-pca-framework-for-nbfcs/
articleshow/88277487.cms
THANK YOU