MASTER OF COMMERCE SEMESTER III MANAGEMENT OF FINANCIAL SERVICES MCM613
CHANDIGARH UNIVERSITY Institute of Distance and Online Learning Course Development Committee Prof. (Dr.) R.S.Bawa Pro Chancellor, Chandigarh University, Gharuan, Punjab Advisors Prof. (Dr.) Bharat Bhushan, Director – IGNOU Prof. (Dr.) Majulika Srivastava, Director – CIQA, IGNOU Programme Coordinators & Editing Team Master of Business Administration (MBA) Bachelor of Business Administration (BBA) Coordinator – Dr. Rupali Arora Coordinator – Dr. Simran Jewandah Master of Computer Applications (MCA) Bachelor of Computer Applications (BCA) Coordinator – Dr. Raju Kumar Coordinator – Dr. Manisha Malhotra Master of Commerce (M.Com.) Bachelor of Commerce (B.Com.) Coordinator – Dr. Aman Jindal Coordinator – Dr. Minakshi Garg Master of Arts (Psychology) Bachelor of Science (Travel &TourismManagement) Coordinator – Dr. Samerjeet Kaur Coordinator – Dr. Shikha Sharma Master of Arts (English) Bachelor of Arts (General) Coordinator – Dr. Ashita Chadha Coordinator – Ms. Neeraj Gohlan Academic and Administrative Management Prof. (Dr.) R. M. Bhagat Prof. (Dr.) S.S. Sehgal Executive Director – Sciences Registrar Prof. (Dr.) Manaswini Acharya Prof. (Dr.) Gurpreet Singh Executive Director – Liberal Arts Director – IDOL © No part of this publication should be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording and/or otherwise without the prior written permission of the authors and the publisher. SLM SPECIALLY PREPARED FOR CU IDOL STUDENTS Printed and Published by: TeamLease EdtechLimited www.teamleaseedtech.com CONTACT NO:01133002345 For: CHANDIGARH UNIVERSITY Institute of Distance and Online Learning 2 CU IDOL SELF LEARNING MATERIAL (SLM)
First Published in 2021 All rights reserved. No Part of this book may be reproduced or transmitted, in any form or by any means, without permission in writing from Chandigarh University. Any person who does any unauthorized act in relation to this book may be liable to criminal prosecution and civil claims for damages. This book is meant for educational and learning purpose. The authors of the book has/have taken all reasonable care to ensure that the contents of the book do not violate any existing copyright or other intellectual property rights of any person in any manner whatsoever. In the event the Authors has/ have been unable to track any source and if any copyright has been inadvertently infringed, please notify the publisher in writing for corrective action. CONTENTS 3 CU IDOL SELF LEARNING MATERIAL (SLM)
Unit-1: Financial Services ................................................................................ 5 Unit-2 Financial Systems And Markets ........................................................... 24 Unit-3 Financial Reforms Of India ................................................................. 46 Unit -4 Leasing .............................................................................................. 56 Unit 5 Legal Aspects Of Leasing ..................................................................... 73 Unit -6 Merchant Banking .............................................................................. 82 Unit-7 Regualtion Of Merchant Banking Activity ...........................................110 Unit-8 Introduction To Banking And Insurance .............................................119 Unit – 9 Credit Rating .................................................................................147 Unit -10 Credit Rating Agencies Of India ......................................................164 Unit-11 Concept, Nature, Scope Of Factoring .................................................176 Unit-12 Evaluation Of Factoring ...................................................................... 1 4 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT-1: FINANCIAL SERVICES STRUCTURE 1.0 Learning Objectives 1.1 Introduction 1.2 MeaningofFinancialServices 1.3 ClassificationofFinancialServicesIndustry 1.4 ScopeofFinancialServices 1.5 CausesforFinancialInnovation 1.6 NewFinancialProductsandServices 1.7 InnovativeFinancialInstruments 1.8 ChallengesFacingtheFinancialServicesSector 1.9 PresentScenario 1.10 Summary 1.11 Keywords 1.12 Learning activity 1.13Unit EndQuestions 1.14References 1.0 LEARNING OBJECTIVES After studying this unit, students will be able to: Definefinancialserviceandexplainitsscope. Discussaboutthevariousinnovativefinancialinstruments. Describethechallengeswhicharebeingfacedbyfinancialservicesector. ExplainthepresentscenariooffinancialservicesectorinIndia 1.1 INTRODUCTION There has been an upsurge in the financial services provided by various banks andfinancial institutions since 1990. Efficiency of emerging financial system depends uponthe quality and variety of financial services provided by the banking and non- bankingfinancialcompanies.Financialservices,throughthenetworkofelementssuchasfinancial institutions, financial markets and financial instruments, serve the needs ofindividuals,institutionsandcorporates.Itisthroughtheseelementsthatthefunctioningofthefinan cialsystemisfacilitated.Infact,anorderlyfunctioningofthefinancialsystem depends, to a great extent, on the range and the quality of financial servicesextendedbyahostofproviders. 1.2 MEANINGOFFINANCIALSERVICES 5 CU IDOL SELF LEARNING MATERIAL (SLM)
The Indian Financial services industry has undergone a metamorphosis since 1990.During the late seventies and eighties, the Indian financial service industry was dominated bycommercial banks and other financial institutions which cater to the requirements of theIndianindustry.Infactthecapitalmarketplayedasecondaryroleonly.Theeconomicliberalizatio nhasbroughtinacompletetransformationintheIndianfinancialservicesindustry. Priortotheeconomicliberalization,theIndianfinancialservicesectorwascharacterized by so many factors which retarded the growth of this sector. Some of thesignificantfactorswere: Excessivecontrolsintheformofregulationsofinterestrates,moneyratesetc. ToomanycontroloverthepricesofsecuritiesundertheerstwhileControllerofCapitalIssues. Non-availabilityoffinancialinstrumentsonalargescaleaswellasondifferentvarieties. Absenceofindependentcreditratingandcreditresearchagencies. Strictregulationoftheforeignexchangemarketwithtoomanyrestrictionsonforeigninvestment andforeignequityholdinginIndiancompanies. Lackofinformationaboutinternationaldevelopmentsinthefinancialsector. AbsenceofadevelopedGovernmentsecuritiesmarketandtheexistenceofstagnantcapitalmark etwithoutanyreformation. Non-availabilityofdebtinstrumentsonalargescale. However,aftertheeconomicliberalisation,theentirefinancialsectorhasundergone a sea-saw change and now we are witnessing the emergence of new financialproducts and services almost everyday. Thus, the present scenario is characterized byfinancial innovation and financial creativity and before going deep into it, it is imperativethatoneshouldunderstandthemeaningandscopeoffinancialservices. In general, all types of activities which are of a financial nature could be broughtunder the term ‘financial services’. The term “Financial Services” in a broad sense means“mobilizingandallocatingsavings”.Thus,itincludesallactivitiesinvolvedinthetransformati onofsavingintoinvestment. The‘financialservice’canalsobecalled‘financialintermediation’Financialintermediation is a process by which funds are moblised from a large number of saversand make them available to all those who are in need of it and particularly to corporatecustomers. Thus, financial services sector is a key are and it is very vital for industrialdevelopments. A well developed financial services industry is absolutely necessary tomobilize the savings and to allocate them to various investable channels and thereby topromoteindustrialdevelopmentinacountry. 1.3 CLASSIFICATIONOFFINANCIALSERVICESINDUSTRY ThefinancialintermediariesinIndiacanbetraditionallyclassifiedintotwo: Capitalmarketintermediariesand Moneymarketintermediaries. 6 CU IDOL SELF LEARNING MATERIAL (SLM)
The capital market intermediaries consist of term lending institutions and investinginstitutions which mainly provide long term funds. On the other hand, money marketconsists of commercial banks, co-operative banks and other agencies which supply onlyshort term funds. Hence, the term ‘financial services industry’ includes all kinds oforganizations which intermediate and facilitate financial transactions of both individuals and corporate customers. 1.4 SCOPEOFFINANCIALSERVICES Financial services cover a wide range of activities. They can be broadly classifiedintotwonamely: 1. Traditionalactivities 2. Modernactivities Traditionalactivities Traditionally, the financial intermediaries have been rendering a wide range ofservices encompassing both capital and money market activities. They can be groupedundertwoheadsviz; I. Fundbasedactivities II. Non-fundbasedactivities Fundbasedactivities:Thetraditionalserviceswhichcomeunderfundbasedactivitiesarethefollow ing: Underwritingoforinvestmentinshares,debentures,bondsetc.ofnewissues(primarymarketact ivities) Dealinginsecondarymarketactivities. Participatinginmoneymarketinstrumentslikecommercialpapers,certificateofdeposits,treas urybills,discountingofbillsetc. Involving in equipment leasing, hire purchase, venture capital, seed capitaletc. Dealinginforeignexchangemarketactivities. Non-fund based activities :Financial intermediaries provide services on the basis ofnon-fund activities also. This can also be called “fee based” activity. Today, customerswhether individual or corporate are not satisfied with mere provision of finance. Theyexpect more from financial service companies. Hence, a wide variety of services, arebeingprovidedunderthishead.Theyincludethefollowing: Managing the capital issues i.e., management of pre-issue and post- issueactivitiesrelatingtothecapitalissueinaccordancewiththeSEBIguidelinesandthusenablingth epromoterstomarkettheirissues. Makingarrangementsfortheplacementofcapitalanddebtinstrumentswithinvestmentinstituti ons. 7 CU IDOL SELF LEARNING MATERIAL (SLM)
Arrangementoffundsfromfinancialinstitutionsfortheclients’projectcostorhisworkingcapita lrequirements. AssistingintheprocessofgettingallGovernmentandotherclearances. Modernactivities Besidestheabovetraditionalservices,thefinancialintermediariesrenderinnumerable services in recent times. Most of them are in the nature of non-fund basedactivity. In view of the importance, these activities have been discussed in brief under thehead ‘New financial products and services’. However, some of the modern servicesprovidedbythemare givenin briefhereunder: Renderingprojectadvisoryservicesrightfromthepreparationoftheproject report till the raising of funds for starting the project with necessaryGovernmentapproval. Planning for mergers and acquisitions and assisting for their smooth carryout. Guidingcorporatecustomersincapitalrestructuring. ActingasTrusteestothedebenture-holders. Recommendingsuitablechangesinthemanagementstructureandmanagementstylewithavie w toachievingbetterresults. Structuringthefinancialcollaboration/jointventuresbyidentifyingsuitablejointventurepartne randpreparingjointventureagreement. Rehabilitatingandreconstructingsickcompaniesthroughappropriateschemeofreconstructio nandfacilitatingtheimplementationofthescheme. Hedgingofriskduetoexchangeraterisk,interestraterisk,economicriskandpoliticalriskbyusin gswapsandotherderivativeproducts. ManagingtheportfoliooflargePublicSectorCorporations. Undertaking risk management services like insurance services, buy-backoptionsetc. Advising the clients on the question of selecting the best source of fundstaking into consideration the quantum of funds required, their cost, lendingperiodetc. Guiding the clients in the minimization of the cost of debt and in thedeterminationoftheoptimumdebt-equitymix. Undertakingservicesrelatingtothecapitalmarketsuchas: Clearingservices, Registrationandtransfers, Safe-custodyofsecurities, Collectionofincomeonsecurities. Promoting credit rating agencies for the purpose of rating companies whichwanttogopublicbytheissueofdebtinstruments. Sourcesofrevenue Accordingly, there are two categories of sources of income for a financial servicecompanynamely: (i)fund-basedand(ii)fee-based. 8 CU IDOL SELF LEARNING MATERIAL (SLM)
Fund-based income comes mainly from interest spread (difference between theinterest paid and earned), lease rentals, income from investments in capital market andreal estate. On the other hand, fee-based income has its sources in merchant banking,advisory services, custodial services, loan syndication etc. In fact, a major part of theincome is earned through fund-based activities. At the same time, it involves a large shareof expenditure also in the form of interest and brokerage. In recent times, a number ofprivatefinancialcompanieshavestartedacceptingdepositsbyofferingaveryhighrateofinterest. Whenthecostofdepositresourcesgoesup,thelendingrateshouldalsogoup.Itmeansthatsuchcompa niesshouldhavetocompromisethequalityofitsinvestments. Fee-based income, on the other hand, does not involve much risk. But, it requires alotofexpertiseonthepartofafinancialcompanytooffersuchfee-basedservices. 1.5 CAUSES FOR FINANCIAL INNOVATION Financial intermediaries have to perform the task of financial innovation to meetthe dynamically changing needs of the economy and to help the investors cope with anincreasingly volatile and uncertain market place. There is a dire necessity for the financialintermediariestogoforinnovationduetothefollowingreasons: Low profitability :The profitability of the major financial intermediary, namelythebankshasbeenverymuchaffectedinrecenttimes.Thereisadeclineintheprofitability of traditional banking products. So, they have been compelled to seek outnewproductswhichmayfetchhighreturns. Keen competition :The entry of many financial intermediaries in the financialsectormarkethasledtoseverecompetitionamountthemselves.Thiskeencompetitionhas paved the way for the entry of varied nature of innovative financial products so as tomeetthevariedrequirementsoftheinvestors. Economic Liberalisation :Reform of the financial sector constitutes the mostimportant component of India’s programme towards economic liberalization. The recenteconomic liberalization measures have opened the door to foreigncompetitors to enterinto our domestic market. Deregulation in the form of elimination of exchange controlsand interest rate ceilings have made the market more competitive. Innovation has becomeamustforsurvival. Improved communication technology :The communication technology hasbecome so advanced that even the world’s issuers can be linked with the investors in theglobal financial market without any difficulty by means of offering so many options andopportunities. Hence, innovative products are brought into the domestic market in notime. Customer Service :Now-a-days, the customer’s expectations are very great.Theywantnewerproductsatlowercostoratlowercreditrisktoreplacetheexistingones. To meet this increased customer sophistication, the financial intermediaries areconstantly undertaking research in order to invent a new product which may suit to therequirementoftheinvestingpublic.Innovationsthushelptheminsolicitingnewbusiness. 9 CU IDOL SELF LEARNING MATERIAL (SLM)
Global impact :Many of the providers and users of capital have changed theirroles all over the world. Financial intermediaries have come out of theirtraditionalapproach and they are ready to assume more credit risks. As a consequence, manyinnovations have taken place in the global financial sector which have its own impact onthedomesticsectoralso. Investor awareness :With a growing awareness amongst the investing public,there has been a distinct shift from investing the savings in physical assets like gold,silver,landetc.tofinancialassetslikeshares,debentures,mutualfundsetc.Again,withinthe financial assets, they go from ‘risk free’ bank deposits to risky investments in shares.Tomeetthegrowingawarenessofthepublic,innovationhasbecometheneedofthehour. FinancialEngineering Thus, the growing need for innovation has assumed immense importance in recenttimes. This process is being referred to as financial engineering. Financial engineering isthelifebloodofanyfinancialability.“Financialengineeringisthedesign,thedevelopment and the implementation of innovative financial instruments and processesandtheformulationofcreativesolutionstoproblemsinfinance”. 1.6 NEWFINANCIALPRODUCTSANDSERVICES Today, the importance of financial services is gaining momentum all over theworld. In these days of complex finance, people expect a Financial Service Company toplayaverydynamicrolenotonlyasaprovideroffinancebutalsoasadepartmentalstore of finance. With the injection of the economic liberation policy into our economyand the opening of the economy to multinationals, the free market concept has assumedmuch significance. As a result, the clients both corporates and individuals are exposed tothe phenomena of volatility and uncertainty and hence they expect the financial servicecompanytoinnovatenewproductsandservicesoastomeettheirvariedrequirements. As a result of innovations, new instruments and new products are emerging in thecapitalmarket.Thecapitalmarketandthemoneymarketaregettingwidenedanddeepened. Moreover, there has been a structural change in the international capitalmarket with the emergence of new products and innovative techniques of operation in thecapitalmarket.Manyfinancialintermediariesincludingbankshavealreadystartedexpanding their activities in the financial services sector by offering a variety of newproducts.Asaresult,sophisticationandinnovationshaveappearedinthearenaoffinancialinter mediations.Someofthemarediscussedbelow: Merchant Banking :A merchant banker is a financial intermediary who helps totransfer capital from those who posses it to those who need it. Merchant bankingincludes a wide range of activities such as management of customers securities,portfoliomanagement,projectcounselingandappraisal,underwritingofsharesand debentures, loan syndication, acting as banker for the refund orders, handlinginterest and dividend warrants etc. Thus, a merchant banker renders a host ofservicestocorporatesandthuspromotesindustrialdevelopmentinthecountry. 10 CU IDOL SELF LEARNING MATERIAL (SLM)
Loan Syndication :This is more or less similar to ‘consortium financing’. But,this work is taken up by the merchant banker as a lead-manager. It refers to a loanarranged by a bank called lead manager for a borrower who is usually a largecorporate customer or a Government Department. The other banks who are willingto lend can participate in the loan by contributing an amount suitable to their ownlending policies. Since a single bank cannot provide such a huge sum as loan, anumberofbanksjointogetherandformasyndicate.Italsoenablesthemembersof the syndicate to share the credit risk associated with a particular loan amongthemselves. Leasing :A lease is an agreement under which a company or a firm, acquires aright to make use of a capital asset like machinery, on payment of a prescribed feecalled “rental charges”. The lessee cannot acquire any ownership to the asset, buthe can use it and have full control over it. he is expected to pay for all maintenancecharges and repairing and operating costs. In countries like the U.S.A., the U.K.andJapanequipmentleasingisverypopularandnearly25%ofplantandequipment is being financed by leasing companies. In India also, many financialcompanies have started equipment leasing business. Commercial banks have alsobeenpermittedtocarryonthisbusinessbyformingsubsidiarycompanies. Mutual Funds :A mutual fund refers to a find raised by a financial servicecompanybypoolingthesavings ofthepublic.Itisinvestedinadiversifiedportfoliowithaviewtospreadingandminimizingrisk.Thefu ndprovidesinvestment avenue for small investors who cannot participate in the equities of bigcompanies. It ensures low risk, steady returns, high liquidity and better capitalappreciationinthelongrun. Factoring :Factoring refers to the process of managing the sales ledger of aclient by a financial service company. In other words, it is an arrangement underwhich a financial intermediary assumes the credit risk in the collection of bookdebtsforitsclients.Theentireresponsibilityofcollectingthebookdebtspassesontothefactor.Hi sservicescanbecomparedtoadelcredreagentwhoundertakes tocollectdebts.But,afactorprovidescreditinformation,collectsdebts, monitors the sales ledger and provides finance against debts. Thus, heprovidesanumberofservicesapartfromfinancing. Forfeiting :Forfeiting is a technique by which a forfeitor (financing agency)discounts an export bill and pay ready cash to the exporter who can concentrate onthe export front without bothering about collection of export bills. The forfeitordoes so without any recourse to the exporter and the exporter is protected againsttheriskofnon-paymentofdebtsbytheimporters. Venture Capital :A venture capital is another method of financing in the form ofequityparticipation.Aventurecapitalistfinancesaprojectbasedonthepotentialities of a new innovative project. It is in contrast to the conventional“security based financing”. Much thrust is given to new ideas or technologicalinnovations. Finance is being provided not only for ‘start-up capital’ but also for‘developmentcapital’bythefinancialintermediary. Custodial Services :It is another line of activity which has gained importance, oflate. 11 CU IDOL SELF LEARNING MATERIAL (SLM)
Underthis, a financial intermediary mainly provides services to clients,particularly to foreign investors, for a prescribed fee. Custodial services provideagency services like safe keeping of shares and debentures, collection of interestand dividend and reporting of matters on corporate developments and corporatesecuritiesto foreign investors. Corporate Advisory Service :Financial intermediaries particularly banks haveset up corporate advisory service branches to render services exclusively to theircorporate customers. For instance, some banks have extended computer terminalsto their corporate customers to that they can transact some of their importantbanking transactions by sitting in their own office. As new avenues of finance likeEuro loans, GDRs etc. are available to corporate customers, this service is ofimmensehelptothecustomers. Securitisation:Securitisationisatechniquewherebyafinancialcompanyconverts its ill- liquid, non-negotiable and high value financial assets into securitiesof small value which are made tradable and transferable. A financial institutionmight have a lot of its assets blocked up in assets like real estate, machinery etc.whicharelongterminnatureandwhicharenon- negotiable.Insuchcases,securitisation would help the financial institution to raise cash against such assetsbymeansofissuingsecuritiesofsmallvaluestothepublic.Likeanyothersecurity, they can be traded in the market. it is best suited to housing financecompanies whose loans are always long term in nature and their money is lockedupforaconsiderablelongperiodinrealestates.Securitisationistheonlyanswertoconvertthes eill-liquidassetsintoliquidassets. Derivative Security :A derivative security is a security whose value dependsupon the values of other basic variables backing the security. In most cases, thesevariables are nothing but the prices of traded securities. A derivative security isbasically used as a risk management tool and it is resorted to cover the risk due topricefluctuationsbytheinvestmentsmanager.Justlikeaforwardcontractwhichis a derivative of a spot contract, a derivative security is derived from other tradingsecurities backing it. Naturally the value of a derivative security depends upon thevalues of the backing securities. Derivative helps to break the risks into variouscomponents such as credit risk, interest rates risk, exchange rates risk and so on. Itenables thevarious riskcomponents tobe identifiedprecisely andpriced themandeventradedthemifnecessary.Financialintermediariescangoforderivativessince they will have greater importance in the near future. In India some forms ofderivativesareinoperation. New Products in ForexMarket :New products have also emerged in the forexmarkets of developed countries. Some of these products are yet to make full entryinIndianmarkets.Amongthem,thefollowingaretheimportantones: Forward Contracts :A forward transaction is one where the delivery of aforeign currency takes place at a specified future date for a specified price. Itmayhaveafixedmaturityfore.g.31stMayoraflexiblematurityfore.g.1stto 31st May. There is an obligation to honour this contract at any cost, failingwhich, there will be some penalty. 12 CU IDOL SELF LEARNING MATERIAL (SLM)
Forward contracts are permitted only forgenuine business transactions. It can be extended to other transactions likeinterestpayments. Options :As the very name implies, it is a contract wherein the buyer of theoption has a right to buy or sell a fixed amount of currency against anothercurrency at a fixed rate on a future date according to his option. There is noobligationtobuyorsell,butitiscompletelylefttohisoption.Optionsmaybe of two types namely call options and put options. Under call options, thecustomer has an option to buy and it is the option to sell under put options.OptionstradingwouldleadtospeculationandhencetherearemuchrestrictionsinIndia. Futures :It is a contract wherein there is an agreement to buy or sell a statedquantity of foreign currency at a future date at a price agreed to between thepartiesonthestatedexchange.Unlikeoptions,thereisanobligationtobuyor sell foreign exchange on a future date at a specified rate. it can be dealtonlyinastockexchange. Swaps :A swap refers to a transaction wherein a financial intermediary buysand sells a specified foreign currency simultaneously for different maturitydates- say,forinstance,purchaseofspotandsaleofforwardorviceversawithdifferentmaturities.Thusswap swouldresultinsimultaneousbuyingand selling of the same foreign currency of the same value for differentmaturities to eliminate exposure risk. It can also be used as a tool to enterarbitrage operations, if any,between two countries. It can also be used in theinterestratemarketalso. Lines of Credit (LOC) :It is an innovative funding mechanism for the import ofgoodsandservicesondeferredpaymentterms.LOCisanarrangementoffinancing institution/bank of one country with another institution/bank/agent tosupport the export of goods and services to as to enable the importers to import nodeferred payment terms. This may be backed by a guarantee furnished by theinstitution/bank in the importing country. The LOC helps the exporters to getpayment immediately as soon as the goods are shipped, since, the funds would bepaid out of the pool account with the financing agency and it would be debited totheaccountoftheborroweragency/importerwhosecontractforavailingthefacility is already approved by the financing agency on the recommendation of theoverseasinstitution.Itactsasconductoffinancingwhichisforacertainperiodand on certain terms for the required goods to be imported. The greatest advantageis that it saves a lot of time and money on mutual verification of bona-fides, sourceoffinanceetc.Itservesasasourceofforex. 1.7 INNOVATIVE FINANCIAL INSTRUMENTS In recent years, innovation has been the key word behind the phenomenal successof many of the financial service companies and it forms an integral part of all planningand policy decisions. This has helped them to keep in tune with the changing times 13 CU IDOL SELF LEARNING MATERIAL (SLM)
andchangingcustomerneeds.Accordingly,manyinnovativefinancialinstrumentshavecome into the financial market in recent times. Some of them have beendiscussedhereunder: CommercialPaper:Apaperisashort-termnegotiablemoneymarketinstrument. It has the character of an unsecured promissory note with a fixedmaturity of 3 to 6 months. Banking and non-banking companies can issue this forraisingtheirshorttermdebt.Italsocarriesanattractiverateofinterest.Commercial papers are sold at a discount from their face value and redeemed attheirfacevalue.Sinceitsdenominationisveryhigh,itissuitableonlytoinstitutionalinvestorsandco mpanies. Treasury Bill : A treasury bill is also a money market instrument issued by theCentral Government. It is also issued at a discount and redeemed at par. Recently,the Government has come out with short term treasury bills of 182-days bills and364-daysbills. Certificate of Deposit : The scheduled commercial banks have been permitted toissue certificate of deposit without any regulation on interest rates. This is also amoney market instrument and unlike a fixed deposit receipt, it is a negotiableinstrument and hence it offers maximum liquidity. As such, it has a secondarymarkettoo.Sincethedenominationisveryhigh,itissuitabletomainlyinstitutionalinvesto rsandcompanies. Inter-bank Participations (IBPs) : The schemeofinter-bankparticipationisconfined to scheduled banks only for a period ranging between 91 days and 180days.Thismaybe‘withrisk’participationor‘withoutrisk’participation.However, only a few banks have so far issued IBPs carrying an interest rateranging between 14 and 17 per cent per annum. This is also a money marketinstrument. Zero Interest Convertible Debenture/Bonds : As the very name suggests, theseinstruments carry no interest till the time of conversion. These instruments areconvertedintoequitysharesafteraperiodoftime. Deep Discount Bonds :There will be no interest payments in the case of deepdiscount bonds also. Hence,they are sold ata large discount to their nominalvalue. For example, the Industrial Development Bank of India issued in February1996 deep discount bonds. Each bond having a face value of Rs.2,00,000 wasissued at a deep discounted price of Rs.5300 with a maturity period of 25 years. Ofcourse, provisions are there for early withdrawal or redemption in which case thedeemed face value of the bond would be reduced proportionately. This bond couldbegiftedtoanyperson. Index-Linked Guilt Bonds : These are instruments having a fixed maturity. Theirmaturity value is linked to the index prevailing as on the date of maturity. Hence,theyareinflation-freeinstruments. Option Bonds : These bonds may be cumulative or non-cumulative as per theoption of the holder of the bonds. In the case of cumulative bonds, interest isaccumulated and is payable only on maturity. But, in the case of non-cumulativebond, the interest is paid periodically. This option has to be exercised by theprospectiveinvestoratthetimeofinvestment. 14 CU IDOL SELF LEARNING MATERIAL (SLM)
Secured Premium Notes : These are instruments which carry no interest of threeyears. In other words, their interest will be paid only after 3 years, and hence,companieswithhighcapitalintensiveinvestmentscanresorttothistypeoffinancing. MediumTermDebentures:Generally,debenturesarerepayableonlyafteralong period. But, these debentures have a medium term maturity. Since they aresecured and negotiable, they are highly liquid. These types of debt instruments areverypopularinGermany. Variable Rate Debentures : Variable rate debentures are debt instruments. Theycarry a compound rate of interest, but this rate of interest is not a fixed one. Itvaries from time to time in accordance with some pre-determined formula as weadoptinthecaseofDearnessAllowancecalculations. Non-Convertible Debentures with Equity Warrants : Generally debentures areredeemed on the date of maturity. but, these debentures are redeemed in full at apremiumininstalmentsasinthecaseofanticipatedinsurancepolicies.Theinstalments may be paid at the end of 5th, 6th, 7th and 8th year from the date ofallotment. Equity with 100% Safety Net :Some companies make “100% safety net” offerto the public. It means that they give a guarantee to the issue price. Suppose, theissue price is Rs.40/- per share (nominal value of Rs.10/- per share), the companyis ready to get it back at Rs.40/- at any time, irrespective of the market price. Thatis, even if the market price comes down to Rs.30/- there is 100% safety net andhencethecompanywillgetitbackatRs.40/-. CumulativeconvertiblePreferenceShares:Theseinstrumentsalongwithcapital and accumulated dividend must be compulsorily converted into equityshares in a period of 3 to 5 years from the date of their issue, according to thediscretion of the issuing company. The main object of introducing it is to offer theinvestoranassuredminimumreturntogetherwiththeprospectofequityappreciation.Thisinstru mentisnotpopularinIndia. ConvertibleBonds:Aconvertiblebondisonewhichcanbeconvertedintoequitysharesataper- determinedtimingneitherfullyorpartially.Therearecompulsory convertible bonds which provide for conversion within 18 months oftheir issue. There are optionally convertible bonds which provide for conversionwithin 36 months. There are also bonds which provide for conversion after 36monthsandtheycarry‘call’and‘put’features. Debentureswith‘Call’and‘Put’Feature:Sometimesdebenturesmaybeissued with ‘Call’ and ‘Put’ feature. In the case of debentures with ‘Call feature’,the issuing company has the option to redeem the debentures at a certain pricebeforethematuritydate.Inthecaseofdebentureswith‘Putfeatures’,thecompanygivesthehold ertherighttoseekredemptionatspecifiedtimesatpredeterminedprices. Easy Exit Bond : As the name indicates, this bond enables the small investorsto encash the bond at any time after 18 months of its issue and thereby paving away for an easy exit. It has a maturity period of 10 years with a call option anytime after 5 years. Recently the IDBI has issued this type of bond with a facevalueofRs.5000perbond. Retirement Bond : This type of bond enables an investor to get an assuredmonthly 15 CU IDOL SELF LEARNING MATERIAL (SLM)
income for a fixed period after the expiry of the ‘wait period’ chosenby him. No payment will be made during the ‘wait period’. The longer the waitperiod, the higher will be the monthly income. Besides these, the investor willalso get a lump sum amount on maturity. For example, the IDBI has issuedRetirement Bond ‘96 assuring a fixed monthly income for 10 years after theexpiryofthewaitperiod.Thisbondcanbegiftedtoanyperson. Regular Income Bond : This bond offers an attractive rate of interest payable halfyearly with the facility of early redemption. The investor is assured of regular andfixedincome.Forexample,theIDBIhasissuedRegularIncomeBond’96carrying 16% interest p.a. It is redeemable at the end of every year from the expiryof3yearsfromthedateofallotment. Infrastructure Bond : It is a kind of debt instrument issued with a view to givingtax shelter to investors. The resources raised through this bond will be used forpromotinginvestmentinthefieldofcertaininfrastructureindustries.Taxconcessions are available under Sec.88, Sec.54 EA and Sec.54EB of the IncomeTaxAct.HUDCOhasissuedforthefirsttimesuchbonds.ItsfacevalueisRs.1000 each carrying an interest rate of 15% per annum payable semi annually.Thisbondwillalsobelistedinimportantstockexchanges. CarrotandStickbonds:Carrotbondshavealowconversionpremiumtoencourage early conversion, and sticks allowtheissuertocallthebondataspecified premium if the common stock is trading at a specified percentage abovethestrikeprice. Convertible Bonds with a Premium put : These are bonds issued at face valuewith a put, which means that the bond holder can redeem the bonds for more thantheirfacevalue. Debt with Equity Warrant : Sometimes bonds are issued with warrants for thepurchaseofshares.Thesewarrantsareseparatelytradable. Dual Currency Bonds : Bonds that are denominated and pay interest in onecurrency and are redeemable in another currency come under this category. Theyfacilitateinterestratearbitragebetweentwomarkets. ECUBonds(EuropeanCurrencyUnitBonds):Thesebondsaredenominatedinabasketofcur renciesofthe10countriesthatconstitutetheEuropeancommunity. They pay principal and interest in ECUs or in any of the 10 currenciesattheoptionoftheholder. YankeeBonds:IfbondsareraisedinU.S.A.,theyarecalledYankeebondsandiftheyareraisedin Japan,theyarecalledSamuraiBonds. Flip-FlopNotes:Itisakindofdebtinstrumentwhichpermitsinvestorstoswitch between two types of securitiese.g. to switch over from a long term bondtoashorttermfixed-ratenote. FloatingRateNotes(FRNs):Thesearedebtinstrumentswhichfacilitateperiodicinterestratea djustments. Loyalty Coupons : These are entitlements to the holder of debt for two to threeyears to exchange into equity shares at discount prices. To get this facility, theoriginalsubscribermustholdthedebtinstrumentsforthesaidperiod. GlobalDepositoryReceipt(GDR):Aglobaldepositoryreceiptisadollardenominated instrument traded on a stock exchange in Europe or the U.S.A./ orboth. It represents a certain 16 CU IDOL SELF LEARNING MATERIAL (SLM)
number of underlying equity shares. Though the GDRis quoted and traded in dollar terms, the underlying equity shares are denominatedinrupees.Thesharesareissuedbythecompanytoanintermediarycalleddepository in whose name the shares are registered. It is the depository whichsubsequentlyissuestheGDRs. 1.8 CHALLENGES FACING THE FINANCIAL SERVICES SECTOR However, the financial service sector has to face many challenges in its attempt tofulfilltheevergrowingfinancialdemandsoftheeconomy.Someoftheimportantchallengesarerep ortedhereunder: Lack of qualified personnel : The financial services sector is fully geared to thetask of ‘financial creativity’. However, this sector has to face many challenges. Infact, the dearth of qualified and trained personnel is an important impediment in itsgrowth. Hence, it is very vital that a proper and comprehensive training must begiventothevariousfinancialintermediaries. Lack of investor awareness : The introduction of new financial products andinstruments will be of no use unless the investor is aware of the advantages anduses of the new and innovative products and instruments. Hence, the financialintermediaries should educate the prospective investors/users of the advantages ofthe innovative instruments through literature, seminars, workshops, advertisementsandeventhroughaudio-visualaids. Lack of transparency : The whole financial system is undergoing a phenomenalchangeinaccordancewiththerequirementsofthenationalandglobalenvironments. It is high time that this sector gave up their orthodox attitude ofkeepingaccountsinahighlysecretmanner.Hence,thissectorshouldoptforbetter levels of transparency. In other words, the disclosure requirements and theaccountingpracticeshavetobeinlinewiththeinternationalstandards. Lack of specialization : In the Indian scene, each financial intermediary seems todeal in different financial service lines without specializing in one or two areas. Inother words, each intermediary is acting as a financial super market delivering somany financial products and dealing in different varieties of instruments. In othercountries, financial intermediaries like Newtons, Solomon Brothers etc. specializein one or two areas only. This helps them to achieve high levels of efficiency andexcellence.Hence,inIndiaalso,financialintermediariescangoforspecialization. Lackofrecentdata:Mostoftheintermediariesdonotspendmoreonresearch.Itisveryvitalthatones houldbuildupaproperdatabaseonthebasisofwhichone could embark upon ‘financial creativity’. Moreover, a proper data base wouldkeep oneself abreast of the recent developments in other parts of the whole worldandaboveall,itwouldenablethefundmanagerstotakesoundfinancialdecisions. Lack of efficient risk management system : With the opening of the economy tomultinationals and the exposure of Indian companies to international competition,much importance is given to foreign portfolio flows. It involves the utilization ofmulti currency 17 CU IDOL SELF LEARNING MATERIAL (SLM)
transactions which exposes the client to exchange rate risk, interestrate risk and economic and political risk. Unless a proper risk management systemis developed by the financial intermediaries as in the West, they would not be in apositiontofulfilthegrowingrequirementsoftheircustomers.Hence,itisabsolutely essential that they should introduce Futures, Options, Swaps and otherderivativeproductswhicharenecessaryforanefficientriskmanagementsystem. Theabovechallengesarelikelytoincreaseinnumberwiththegrowingrequirementsofthecustomers. Thefinancialservicessectorshouldriseuptothe occasiontomeetthesechallengesbyadoptingnewinstrumentsandinnovativemeansoffinancingsot hatitcouldplayaverydynamicroleintheeconomy. 1.9 PRESENT SCENARIO Thepresentscenariooffinancialservicesectoris: Conservatismtodynamism: At present, the financial system in India is in a process of rapid transformation,particularly after the introduction of reforms in the financial sector. The mainobjective of the financial sector reforms is to promote an efficient, competitive anddiversified financial system in the country. This is very essential to raise theallocative efficiency of available savings, increase the return on investment andthus to promote the accelerated growth of the economy as a whole. As a result, wehave recently witnessed phenomenal changes in the money market, securitiesmarket, capital market, debt market and the foreign exchange market. In thischanged context, the role of financial services has assumed greater significance inourcounty.Atpresent,numerousnewfinancialintermediarieshavestartedfunctioning with a view to extending multifarious services to the investing publicin the area of financial services. The emergence of various financial institutionsand regulatory bodies have transformed the financial services sector from being aconservativeindustrytoaverydynamicone. EmergenceofPrimaryEquityMarket: Now,wearealsowitnessingtheemergenceofmanyprivatesectorfinancialservices. The capital markets which were very sluggish, have become a popularsource of raising finance. The number of stock exchanges in the country has goneupfrom9in1980to24in2004.Theaggregatefundsraisedbytheindustriesinthe primary markets have gone from up. The number of companies listed on thestockexchange havealsogoneupfrom2265 in1980toover10000in2004.Thus, the primary equity market has emerged as an important vehicle to channelise thesavings of the individuals and corporates for productive purposes and thus topromotetheindustrialandeconomicgrowthofournation. ConceptofCreditRating: There is every possibility of introducing equity grading. Hitherto, the investmentdecisions of the investors have been based on factors like name recognition of thecompany, operations of the group, market sentiments, reputation of the promotersetc. Now, grading from an 18 CU IDOL SELF LEARNING MATERIAL (SLM)
independent agency would help the investor in hisportfolio management and thus, equity grading is going to play a significant role ininvestment decision-making. From the company point of view, equity gradingwould help to broaden the market for their public offer, to replace the namerecognition by objective opinion and to have a wider investor base. Thus, gradingwould give further fillip to the primary market. Moreover, the concept of creditrating would play a significant role in identifying the risk level of the corporateentityinwhichtheinvestorwantstotakepart. Now it is mandatory for the non-banking financial companies to get credit ratingfor their debt instruments. The three major credit rating agencies functioning inIndiaare: CreditRatingInformationServicesofIndiaLtd.(CRISIL) CreditAnalysisandResearchltd.(CARE)and InvestmentInformationandCreditRatingAgency(ICRA) DuffPhelpsCreditRatingPvt.Ltd.(DCRIndia) Theiractivitieshavebeenmainlyconfinedtodebtinstrumentsonly. ProcessofGlobalisation: Again, the process of globalisation has paved the way for the entry of innovativeandsophisticatedfinancialproductsintoourcountry.SincetheGovernmentisvery keen in removing all obstacles that stand in the way of inflow of foreigncapital, the potentialities for the introduction of innovative international financialproductsinIndiaareverygreat.Moreover,Indiaislikelytoenterthefullconvertibility era soon. Hence, there is every possibility of introduction of moreandmoreinnovativeandsophisticatedfinancialservicesinourcountry. Process of Liberalisation: Realizing all these factors, the Government of India has initiated many steps to reform the financial services industry. The Government has already switched over to free pricing of issues from pricing issues. The interest rates have been deregulated. The private sector has been permitted to participate in banking and mutual funds and the public sector undertakings are being privatized. The Securities Exchange Board of India has liberalized many stringent conditions so as to boost the capital and money markets. In this changed context, the financial service industry in India has to play a very position and dynamic role in the years to come by offering many innovative products to suit to the varied requirements of the millions of prospective investors spread throughout the country. 1.10 SUMMARY Financial services constitute an important component of the financial system.Financial services serve the needs of individuals, institutions and corporate through anetwork of elements. Prior to economic liberalization, the Indian Financial Service Sectorwascharacterizedbysomanyfactorswhichretardeditsgrowth.Financialservicescoversa wide range of activities and they can be broadly classified into traditional activities 19 CU IDOL SELF LEARNING MATERIAL (SLM)
andmodern activities. In the changed economic scenario, many financial intermediaries havestarted expanding their activities in the financial services sector by offering a variety ofnew products. The financial service sectorhas thus emerged as the fastest growingsunrise industry. However, the financial service sector has to face many challenges in itsattempttofulfilltheevergrowingfinancialdemandsoftheeconomy. 1.11 KEYWORDS Financial Service: Financial services comprise of various functions and services that areprovidedbyfinancialinstitutionsinfinancialsystem. Securitisation: It is a technique whereby a financial company converts its ill-liquid, non- negotiable and high value financial assets into securities of small value which are madetradableandtransferable. Treasury Bill: A treasury bill is a money market instrument issued by the CentralGovernment. Convertible Bond: A convertible bond is one which can be converted into equity sharesatapre-determinedtimingeitherfullyorpartially. 1.12 LEARNING ACTIVITY 1. Is there more competition or synergy between the development of online banks and fintechs? ___________________________________________________________________________ ___________________________________________________________________________ 2. How to establish a better formal financial service for fishers in a fishery? ___________________________________________________________________________ ___________________________________________________________________________ 1.13UNIT ENDQUESTIONS 20 A. Descriptive Questions Short Questions 1. What is the importance of financial services? 2. Define fund-based activities of financial services. 3. Illustrate non-fund based activities of financial services 4. Narrate about modern activities of financial services. 5. What is the present scenario of financial services sector? CU IDOL SELF LEARNING MATERIAL (SLM)
Long Questions 1. Defineafinancialserviceindustryanddiscussthevariousservicesrenderedbyit. 2. “Financialintermediarieshavetoperformthetaskoffinancialinnovationtomeetthedynamicall ychangingneedsoftheeconomy”.Discuss. 3. Discusssomeoftheinnovativefinancialinstrumentsintroducedinrecenttimesinthefinancialse rvicesector. 4. CriticallyanalyzethepresentpositionofthefinancialservicesectorinIndiaandstatethechalleng esithastofaceintheyearstocome. B. Multiple Choice Questions 1……. is not a financial instrument. a. Cheque b. Promissory note c. Bill of exchange d. None of these 2. In which year IRDA was set up? a. 1999 b. 2005 c. 2010 d. 2009 3. Underwriting comes under…………. activity. a. Non-fund-based b. Fund-based c. Modem d. Traditional 4. The arrangement of funds from financial institutions for the client's project cost or his working capital requirements. a. Non-fund-based b. Fund-based c. Modem d. Traditional 5. The following is not the cause of financial innovation: a. High profitability b. Keen competition c. Economic liberalisation 21 CU IDOL SELF LEARNING MATERIAL (SLM)
d. Customer service 6. A…………. is an agreement under which a company or a firm acquires a right to make use of a capital asset on payment of a prescribed fee called 'rental charges'. a. Forfeiting b. lease c. Venture Capital d. factoring 7. A…….. refers to a fund raised by a financial service company by pooling the savings of the. public. a. Shares b. Debentures c. Mutual funds d. None of these 8. Short-term financial instruments lasts for………. a. One year or less b. Above 5 years c. Above 10 years d. Above 15 years 9. are easily transferable and possess liquidity. a. Equity b. Debt c. Cash d. Derivatives 10. The following is not a debt based financial instrument: a. CD b. T-Bill c. Derivatives d. Commercial Paper Answers 1(b) , 2(b) , 3(b) ,4(c) ,5(b) ,6(b) ,7(c) ,8(b) ,9(d) ,10(b) 1.14REFERENCES 22 Text Books: Bhalla, V. K.“ Management of Financial Services” Anmol Publications CU IDOL SELF LEARNING MATERIAL (SLM)
Clifford Gomez “ Financial Markets, Institutions and Financial Services”, PHI Learning Rose, Peter and Hudgins, Sylvia,“ Bank Management and Financial Services”, McGraw Hills. Reference Books: Padamlatha ,“ Management of Banking and Financial Services”, Pearson Education. Saunders, Antony and Cornett, Marcia,“ Financial Institutions Management: A Risk Management Approach” McGraw Hills . 23 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT-2 FINANCIAL SYSTEMS AND MARKETS STRUCTURE 2.0 Learning Objectives 2.1 Introduction 2.2 ConceptofFinancialSystem 2.3 FinancialConcepts 2.4 DevelopmentofFinancialSysteminIndia 2.5 WeaknessesofIndianFinancialSystem 2.6 Summary 2.7 Keywords 2.8 Learning activity 2.9Unit EndQuestions 2.10References 2.0 LEARNING OBJECTIVES After studying this unit, students will be able to: Explain thevariousconceptsoffinancialsystem HighlightthedevelopmentsandweaknessoffinancialsysteminIndia 2.1 INTRODUCTION A system that aims at establishing and providing a regular, smooth, efficient andcost effective linkage between depositors and investors is known as financial system. Thefunctions of financial system are to channelise the funds from the surplus units to thedeficitunits.Anefficientfinancialsystemnotonlyencouragessavingsandinvestments,it also efficiently allocates resources in different investment avenues and thus acceleratesthe rate of economic development. The financial system of a country plays a crucial roleof allocating scare resources to productive uses. Its efficient functioning is of criticalimportancetotheeconomy. 2.2 CONCEPTOFFINANCIALSYSTEM Financialsystemisoneoftheindustriesinaneconomy.Itisaparticularlyimportant industry that frequently has a far reaching impact on society and the economy.Butifitsocculttrappingsarestrippeditislikeanyindustry,agroupoffirmsthatcombine factors of production (land, labour and capital) under the general direction of amanagement team and produce a product or cluster of products for sale in financialmarket. The product of the financial industry is not tangible rather it is an intangibleservice. Financial industry as a whole, produces a wide range of services but all theseservices are related directly or 24 CU IDOL SELF LEARNING MATERIAL (SLM)
indirectly to assets and liabilities, that is, claims on people,organization, institutions, companies and government. These are the forms in whichpeople accumulate much of their wealth. In simple terms we are referring to paper assets :shares,debentures,deposits,mortgagesandothersecurities.Thus,financialsystemperforms certain essential functions for the economy, including maintenance of paymentsystem(throughwhichpurchasingpoweristransferredfromoneparticipanttoanotheri.e. from buyer to seller), collection and allocation of the savings of society, and creationof a variety of stores of wealth to suit the preferences of savers. This brief sketch of functions of financial system gives us its gist. Performance of these functions pre- supposes the existence of financial assets, financial institutions (intermediaries) and financial markets. A combination of these three constitute financial system.To interpret the financial system and evaluate its performance, it requires anunderstanding of its functions in an economy. Financial system in fact has the followingfunctions: Capitalformationfunction: This is the process of diversion of the productive capacity of the economy to themaking of capital goods which increase future productive capacity. Process of capitalformation involve three distinct but inter-dependent activities : savings, finance andinvestment. Allocativefunction: Thefinancialsysteminprocessofcapitalformationhastodecideastohowcapital is to be used. Poor choice in deciding which economic projects are to be embarkedupon, leads to wastage of resources. The better the quality of judgment exercised inallocation,themorerapideconomicprogresswillbe. Servicefunction: An effective financial system offers the economic segments services in form ofproviding opportunities to hold wealth in secured and convenient way so that they pay apositiverateofreturn.Theavailabilityoftheseservicesofthefinancialsystemcontributesimportant ly,ifinanintangibleway,tothesatisfactionofconsumers. 2.3 FINANCIAL CONCEPTS Anunderstandingofthefinancialsystemrequiresanunderstandingofthefollowingconcepts: 1. Financialassets 2. Financialintermediaries 3. Financialmarkets 4. Financialratesofreturn 5. Financialinstruments 1.FinancialAssets In any financial transaction, there should be a creation or transfer of financialassets. Hence, the basic product of any financial system is the financial asset. A financialassets is one which 25 CU IDOL SELF LEARNING MATERIAL (SLM)
is used for production or consumption or for further creation of assets.For instance, A buys equity shares and these shares are financial assets since they earnincomeinfuture. Inthiscontext,onemustknowthedistinctionbetweenfinancialassetsandphysicalassets.Unlikefina ncialassets,physicalassetsarenotusefulforfurtherproductionofgoodsorforearningincome.Forexa mpleXpurchaseslandandbuilding,orgoldorsilver.Thesearephysicalassetssincetheycannotbeuse dforfurtherproduction.Manyphysicalassetsareusefulforconsumptiononly. It is interesting to note that the objective of investment decides the nature of theasset. For instance if a building is bought for residence purpose, it becomes a physicalasset.Ifthesameisboughtforhiring,itbecomesafinancialasset. ClassificationofFinancialAssets Financial assets can be classified differently under different circumstances. Onesuchclassificationis: Marketableassets Non-marketableassets Marketable Assets :Marketable assets are those which can be easily transferred fromone person to another without much hindrance. Examples are shares of listed companies,Governmentsecurities,bondsofpublicsectorundertakingsetc. Non-Marketable Assets :On the other hand, if the assets cannot be transferred easily,they come under this category. Examples are bank deposits, provident, funds, pensionfunds,NationalSavingsCertificates, insurancepoliciesetc. Yetanotherclassificationisasfollows: Moneyorcashasset Debtasset Stockasset Cash Asset : In India, all coins and currency notes are issued by the RBI and the Ministry of Finance, Government of India. Besides, commercial banks can also create money by means of creating credit. When loans are sanctioned, liquid cash is not granted.Instead an account is opened in the borrower’s name and a deposit is created. It is also a kind of money asset. Debt Asset : Debt asset is issued by a variety of organizations for the purpose of raising their debt capital. Debt capital entails a fixed repayment schedule with regard to interest and principal. There are different ways of raising debt capital. Example are issue of debentures, raising of term loans, working capital advance, etc. Stock Asset : Stock is issued by business organizations for the purpose of raising their fixed capital. There are two types of stock namely equity and preference. Equity shareholders are the real owners of the business and they enjoy the fruits of ownership and at the same time they bear the risk as well. Preference shareholders, on the other hand get a fixed rate of dividend (as in the case of debt asset) and at the same time they retain some characteristics of equity. 26 CU IDOL SELF LEARNING MATERIAL (SLM)
2.FinancialIntermediaries Thetermfinancialintermediaryincludesallkindsoforganizationswhichintermediateandfacilitatef inancialtransactionsofbothindividualandcorporatecustomers. Thus, it refers to all kinds of financial institutions and investing institutionswhich facilitate financial transactions in financial markets. They may be in the organizedsectororintheunorganizedsector.Theymayalsobeclassifiedintotwo: Capitalmarketintermediaries Moneymarketintermediaries Capital Market Intermediaries :These intermediaries mainly provide long term fundsto individuals and corporate customers. They consist of term lending institutions likefinancialcorporationsandinvestinginstitutionslikeLIC. Money Market Intermediaries :Money market intermediaries supply only short termfundstoindividualsandcorporatecustomers.Theyconsistcommercialbanks,co- operativebanks,etc. 3.FinancialMarkets Generally speaking, there is no specific place or location to indicate a financialmarket. Wherever a financial transaction takes place, it is deemed to have taken place inthe financial market. Hence financial markets are pervasive in nature since financialtransactions are themselves very pervasive throughout the economic system. For instance,issue of equity shares, granting of loan by term lending institutions, deposit of money intoabank,purchaseofdebentures,saleofsharesandsoon. However, financial markets can be referred to as those centers and arrangementswhichfacilitatebuyingandsellingoffinancialassets,claimsandservices.Sometimes, wedofindtheexistenceofaspecificplaceorlocationforafinancialmarketasinthecaseofstockexchan ge. ClassificationofFinancialMarkets TheclassificationoffinancialmarketsinIndiaisexplained below. UnorganisedMarkets In these markets there are a number of money lenders, indigenous bankers, tradersetc., who lend money to the public. Indigenous bankers also collect deposits from thepublic. There are also private finance companies, chit funds etc., whose activities are notcontrolledbytheRBI.RecentlytheRBIhastakenstepstobringprivatefinancecompaniesandchitf undsunderitsstrictcontrolbyissuingnon-bankingfinancialcompanies (Reserve Bank) Directions, 1998. The RBI has already taken some steps tobringtheunorganizedsectorundertheorganizedfold.Theyhavenotbeensuccessful.The regulations concerning their financial dealings are still inadequate and their financialinstrumentshavenotbeenstandardized. OrganisedMarkets 27 CU IDOL SELF LEARNING MATERIAL (SLM)
In the organized markets, there are standardized rules and regulations governingtheirfinancialdealings.Thereisalsoahighdegreeofinstitutionalizationand instrumentalisation.ThesemarketsaresubjecttostrictsupervisionandcontrolbytheRBIorotherreg ulatorybodies.Theseorganizedmarketscanbefurtherclassifiedintotwo.Theyare: Capitalmarket Moneymarket Capital Market :The capital market is a market for financial assets which have a longor indefinite maturity. Generally, it deals with long term securities which have a maturityperiodofaboveoneyear.Capitalmarketmaybefurtherdividedintothreenamely: A. Industrialsecuritiesmarket B. Governmentsecuritiesmarketand C. Longtermloansmarket A.Industrialsecuritiesmarket: As the very name implies, it is a market for industrial securities namely: (i) Equityshares or ordinary shares, (ii) Preference shares, and (iii) Debentures or bonds. Itis amarketwhereindustrialconcernsraisetheircapitalordebtbyissuingappropriateinstruments.Itcan befurthersubdividedintotwo.Theyare: i. PrimarymarketorNewissuemarket ii. SecondarymarketorStockexchange Primary Market :Primary market is a market for new issues or new financial claims.Hence it is also called New Issue market. The primary market deals with those securitieswhichareissuedtothepublicforthefirsttime.Intheprimarymarket,borrowersexchange new financial securities for long term funds. Thus, primary market facilitatescapitalformation. Therearethreewaysbywhichacompanymayraisecapitalinaprimarymarket.Theyare: Publicissue Rightsissue Privateplacement The most common method of raising capital by new companies is through sale ofsecurities to the public. It is called public issue. When an existing company wants to raiseadditional capital, securities are first offered to the existing shareholders on a pre-emptivebasis.Itiscalledrightsissue. Privateplacementisawayofsellingsecuritiesprivatelytoasmallgroupofinvestors. Secondary Market :Secondary market is a market for secondary sale of securities. Inother words, securities which have already passed through the newissuemarketaretraded in this market. Generally, such securities are quoted in the stock exchange and itprovidesacontinuousandregularmarketforbuyingandsellingofsecurities. Thismarket consists of all stock exchanges recognized by the Government of India. The stockexchanges in India are regulated under the Securities Contracts (Regulation) Act, 28 CU IDOL SELF LEARNING MATERIAL (SLM)
1956.The Bombay Stock Exchange is the principal stock exchange in India which sets the toneoftheotherstockmarkets. B. GovernmentSecuritiesMarket ItisotherwisecalledGilt- Edgedsecuritiesmarket.ItisamarketwhereGovernmentsecuritiesaretraded.InIndiatherearemany kindsofGovernmentSecurities-short term and long term. Long term securities are traded in this market whileshort term securities are traded in the money market. Securities issued by the CentralGovernment, State Governments, Semi-Government authorities like City Corporations,PortTrusts.ImprovementTrusts,StateElectricityBoards,AllIndiaandStatelevelfina ncialinstitutionsandpublicsectorenterprisesaredealtinthismarket. Government securities are issued in denominations of Rs.100. Interest is payablehalf-yearly and they carry tax exemptions also. The role of brokers in marketing thesesecuritiesispracticallyverylimitedandthemajorparticipantinthismarketinthe “commercialbanks”becausetheyholdaverysubstantialportionofthesesecuritiestosatisfytheirS.L. R.requirements. Thesecondarymarketforthesesecuritiesisverynarrowsincemostoftheinstitutionalinvestorstendto retainthesesecuritiesuntilmaturity.TheGovernmentsecuritiesareinmanyforms.Thesearegenerall y: Stockcertificatesorinscribedstock PromissoryNotes BearerBondswhichcanbediscounted. Government securities are sold through the Public Debt Office of the RBI whileTreasuryBills(shorttermsecurities)aresoldthroughauctions. Government securities offer a good source of raising inexpensive finance for theGovernmentexchequerandtheinterestonthesesecuritiesinfluencesthepricesandyieldsinthism arket.Hencethismarketalsoplaysavitalroleinmonetarymanagement. C. LongTermLoansMarket Development banks and commercial banks play a significant role in this market bysupplying long term loans to corporate customers. Long term loans market may further beclassifiedinto: Termloansmarket Mortgagesmarket FinancialGuaranteesmarket Term Loans Market :In India, many industrial financing institutions have been createdby thee Government both at the national and regional levels to supply long term andmediumtermloanstocorporatecustomersdirectlyaswellasindirectly.Thesedevelopment banks dominate the industrial finance in India. Institutions like IDBI, IFCI,ICICI, and other state financial corporations come under this category. These institutionsmeetthegrowingandvariedlong-termfinancialrequirementsofindustriesbysupplying 29 CU IDOL SELF LEARNING MATERIAL (SLM)
long term loans. They also help in identifying investment opportunities, encourage newentrepreneursandsupportmodernizationefforts. MortgagesMarket:Themortgagesmarketreferstothosecenterswhichsupplymortgage loan mainly to individual customers. A mortgage loan is a loan against thesecurity of immovable property like real estate. The transfer of interest in a specificimmovable property to secure a loan is called mortgage. This mortgage may be equitablemortgageorlegalone.Againitmaybe afirstchargeorsecondcharge.Equitablemortgage is created by a mere deposit of title deeds to properties as security whereas inthe case of legal mortgage the title in the property is legally transferred to the lender bytheborrower.Legalmortgageislessrisky.Similarly, in the first charge, the mortgager transfers his interest in the specificpropertytothemortgageeassecurity.Whenthepropertyinquestionisalreadymortgaged once to another creditor, it becomes a second charge when it is subsequentlymortgaged to somebody else. The mortgagee can also further transfer his interest in themortgagedpropertytoanother.Insuch acase,itiscalledasub-mortgage. The mortgage market may have primary market as well secondary market. Theprimarymarketconsistsoforiginalextensionofcreditandsecondarymarkethassalesandre- salesofexistingmortgagesatprevailingprices. In India residential mortgages are the most common ones. The Housing and UrbanDevelopment Corporation (HUDCO) and the LIC play a dominant role in financingresidential projects. Besides, the Land Development Banks provide cheap mortgage loansfor the development of lands, purchase of equipment etc. These development banks raisefinancethroughthesaleofdebentureswhicharetreatedastrusteesecurities. Financial Guarantees Market :A Guarantee market is a center where finance isprovided against the guarantee of a reputed person in the financial circle. Guarantee is acontract to discharge the liability of a third party in case of hisdefault. Guarantee acts asasecurityfromthecreditor’spointofview.Incasetheborrowerfailstorepaytheloan, the liability falls on the shoulders of the guarantor. Hence the guarantor must be known toboththeborrowerandthelenderandhemusthavethemeanstodischargehisliability. Thoughtherearemanytypesofguarantees,thecommonformsare: (i) Performance Guarantee, and (ii) Financial Guarantee. Performance guarantees cover thepaymentofearnestmoney,retentionmoney,advancepayments,non- completionofcontractsetc.Ontheotherhandfinancialguaranteescoveronlyfinancialcontracts. InIndia,themarketforfinancialguaranteesiswellorganized. ThefinancialguaranteesinIndiarelateto: Deferredpaymentsforimportsandexports Mediumandlongtermloansraisedabroad 30 CU IDOL SELF LEARNING MATERIAL (SLM)
Loansadvancedbybanksandotherfinancialinstitutions These guarantees are provided mainly by commercial banks, development banks,Governments both central and states and other specialized guarantee institutions likeECGC (Export Credit Guarantee Corporation) and DICGC (Deposit Insurance and CreditGuarantee Corporation). This guarantee financial service is available to both individualandcorporatecustomers.Forasmoothfunctioningofanyfinancialsystem,thisguarantees erviceisabsolutelyessential. ImportanceofCapitalMarket Absenceofcapitalmarketactsasadeferentfactortocapitalformationandeconomicgrowth.Resourc eswouldremainidleiffinancearenotfunneledthroughcapitalmarket.Theimportanceofcapitalmark etcanbebrieflysummarizedasfollows: The capital market serves as an important source for the productive use of theeconomy’ssavings.Itmobilizesthesavingsofthepeopleforfurtherinvestmentandthusavoidsthe irwastageinunproductiveuses. It provides incentives to saving and facilitates capital formation by offeringsuitableratesofinterestasthepriceofcapital. It provides an avenue for investors, particularly the household sector to investinfinancialassetswhicharemoreproductivethanphysicalassets. It facilitates increase in production and productivity in the economy and thusenhancetheeconomicwelfareofthesociety.Thus,itfacilitates“themovement of stream of command over capital to the point of highest yield”towards those who can apply them productively and profitably to enhance thenationalincomeintheaggregate. The operations of different institutions in the capital market induce economicgrowth. They give quantitative and qualitative directions to the flow of fundsandbringaboutrationalallocationofscarceresources. A healthy capital market consisting of expert intermediaries promotes stabilityinvaluesofsecuritiesrepresentingcapitalfunds. Moreover,itservesasanimportantsourcefortechnologicalupgradationintheindustrialsectorb yutilizingthefundsinvestedbythepublic. Thus, a capital market serves as an important link between those who save andthosewhoaspiretoinvestthesesavings. MoneyMarket Money market is a market for dealing with financial assets and securities whichhave a maturity period of upto one year. In other words, it is a market for purely shorttermfunds.Themoneymarketmaybesubdividedintofour.They are: (i) Callmoneymarket (ii) Commercialbillsmarket (iii) Treasurybillsmarket (iv) Shorttermloanmarket 31 CU IDOL SELF LEARNING MATERIAL (SLM)
CallMoneyMarket:Thecallmoneymarketisamarketforextremelyshortperiodloanssayonedayto fourteendays.So,itishighlyliquid.Theloansarerepayableon demandattheoptionofeitherthelenderortheborrower.InIndia,callmoneymarketsare associated with the presence of stock exchanges and hence, they are located in majorindustrial towns like Bombay, Calcutta, Madras, Delhi, Ahmedabad etc. The specialfeatureofthismarketisthattheinterestratevariesfromdaytodayandevenfromhourto hour and centre to centre. It is very sensitive to changes in demand and supply of callloans. Commercial Bills Market :It is a market for bills of exchange arising out of genuinetrade transactions. In the case of credit sale, the seller may draw a bill of exchange on thebuyer. The buyer accepts such a bill promising to pay at a later date specified in the bill.The seller need not wait until the due date of the bill. Instead, he can get immediatepaymentbydiscountingthebill.In India the bill market is under-developed. The RBI has taken many steps todevelop a sound bill market. The RBI has enlarged the list of participants in the billmarket.TheDiscountandFinanceHouseofIndiawassetupin1988topromotesecondary market in bills. In spite of all these, the growth of the bill market is slow inIndia. There are no specialized agencies for discounting bills. The commercial banks playasignificantroleinthismarket. Treasury Bills Market :It is a market for treasury bills which have ‘short-term’maturity. A treasury bill is a promissory note or a finance bill issued by the Government.It is highly liquid because its repayment is guaranteed by the Government. It is animportant instrument for short term borrowing of the Government. There are two types oftreasury bills namely (i) ordinary or regular and (ii) adhoc treasury bills popularly knownas‘adhocs’. Ordinarytreasurybillsareissuedtothepublic,banksandotherfinancialinstitutions with a view to raising resources for the Central Government to meet its shortterm financial needs. Adhoc treasury bills are issued in favour of the RBI only. They arenot sold through tender or auction. They can be purchased by the RBI only. Adhocs arenotmarketableinIndiabutholdersofthesebillscansellthembackto364daysonly.Financial intermediaries can park their temporary surpluses in these instruments and earnincome. Short-Term Loan Market : It is a market where short-term loans are given to corporate customersfor meeting their working capital requirements. Commercial banks play a significant role in this market. Commercial banks provide short term loans in the form of cash credit and overdraft. Overdraft facility is mainly given to business people whereas cash credit is given to industrialists. Overdraft is purely a temporary accommodation and it is given in the current account itself. But cash credit is for a period of one year and it is sanctioned in a separate account. ForeignExchangeMarket Thetermforeignexchangereferstotheprocessofconvertinghomecurrenciesinto foreign currencies and vice versa. According to Dr. Paul Einzing “Foreign 32 CU IDOL SELF LEARNING MATERIAL (SLM)
exchangeisthesystemorprocessofconvertingonenationalcurrencyintoanother,andoftransferring moneyfromonecountrytoanother”. The market where foreign exchange transactions take place is called a foreignexchange market. It does not refer to a market place in the physical sense of the term. Infact, it consists of a number of dealers, banks and brokers engaged in the business ofbuying and selling foreign exchange. It also includes the central bank of each country andthetreasuryauthoritieswhoenterintothismarketascontrollingauthorities. Functions:Themostimportantfunctionsofthismarketare: Tomakenecessaryarrangementstotransferpurchasingpowerfromonecountrytoanother. Toprovideadequatecreditfacilitiesforthepromotionofforeigntrade. Tocoverforeignexchangerisksbyprovidinghedgingfacilities. InIndia,theforeignexchangebusinesshasathree-tieredstructureconsistingof: Tradingbetweenbanksandtheircommercialcustomers. radingbetween banksthrough authorizedbrokers. Tradingwithbanksabroad. Brokers play a significant role in the foreign exchange market in India. Apart fromauthorised dealers, the RBI has permitted licensed hotels and individuals (known asAuthorised Money Changers) to deal in foreign exchange business. The FEMA helps tosmoothen the flow of foreign currency and to prevent any misuse of foreign exchangewhichisascarcecommodity. 4.FinancialRatesofReturn MosthouseholdsinIndiastillprefertoinvestonphysicalassetslikeland,buildings, gold, silver etc. But, studies have shown that investment in financial assets likeequities in capital market fetches more return than investments on gold. It is imperativethat one should have some basic knowledge about the rate of return on financial assetsalso. The return on Government securities and bonds are comparatively less than oncorporate securities due to lower risk involved therein. The Government and the RBIdeterminetheinterestratesonGovernmentsecurities.Thus,theinterestratesareadministered and controlled. The peculiar feature of the interest rate structure is that theinterest rates do not reflect the free market forces. They do not reflect thescarcity valueof capital in the country also. Most of these rates are fixed on an ad hoc basis dependinguponthecreditandmonetarypolicyoftheGovernment. Generally the interest rate policy of the Government is designed to achieve thefollowing: ToenabletheGovernmenttoborrowcomparativelycheaply. Toensurestabilityinthemacro-economicsystem. Tosupportcertainsectorsthroughpreferentiallendingrates. Tomobilizesubstantialsavingsintheeconomy. The interest rate structure for bank deposits and bank credits is also determined bythe RBI. Similarly the interest rate on preference shares is fixed by the Government at14%. Normally, interest is a reward for risk undertaken through investment and at 33 CU IDOL SELF LEARNING MATERIAL (SLM)
thesametimeitisareturnforabstainingfromconsumption.Theinterestratestructureshouldallocates carcecapitalbetweenalternativeuses.Unfortunately,inIndiatheadministered interest rate policy of the Government fails to perform the role of allocatingscarcesourcesbetweenalternativeuses. Recent Trends :With a view to bringing the interest rates nearer to the free marketrates,theGovernmenthastakenthefollowingsteps: Theinterestratesoncompanydepositsarefreed. Theinterestrateson364daysTreasuryBillsaredeterminedbyauctionsandtheyareexpectedtore flectthefreemarketrates. ThecouponratesonGovernmentloanshavebeenrevisedupwardssoastobemarketoriented. Theinterestratesondebenturesareallowedtobefixedbycompaniesdependinguponthemarketr ates. Themaximumratesofinterestpayableonbankdeposits(fixed)arefreedfordepositsofaboveone year. Thus, all attempts are being taken to adopt a realistic interest rate policy so as togive positive return in real terms adjusted for inflation. The proper functioning of anyfinancialsystemrequires agood interestrate structure. 5. FinancialInstruments Financial instruments refer to those documents which represent financial claims onassets. As discussed earlier, financial asset refers to a claim to the repayment of a certainsumofmoneyattheendofaspecifiedperiodtogetherwithinterestordividend.ExamplesareBi llofexchange,PromissoryNote,TreasuryBill,GovernmentBond,Deposit Receipt, Share, Debenture, etc. Financial instruments can also be called financialsecurities.Financialsecuritiescanbeclassifiedinto: Primaryordirectsecurities. Secondaryorindirectsecurities. Primary Securities :These are securities directly issued by the ultimate investors to theultimatesavers,e.g.sharesanddebenturesissueddirectlytothepublic. SecondarySecurities:Thesearesecuritiesissuedbysomeintermediariescalledfinancial intermediaries to the ultimate savers, e.g. Unit Trust of India and mutual fundsissue securities in the form of units to the public and the money pooled is invested incompanies.Againthesesecuritiesmaybeclassifiedonthebasisofdurationasfollows: Short-termsecurities Medium-termsecurities Long-termsecurities Short-term securities are those which mature within a period of one year.Forexample, Bill of Exchange, Treasury Bill, etc. Medium-term securities are those whichhave a maturity period ranging between one and five years like Debentures maturingwithin a period of 5 years. Long-term securities are those which have a maturity period ofmorethanfiveyears.Forexample,GovernmentBondsmaturingafter10years. 34 CU IDOL SELF LEARNING MATERIAL (SLM)
CharacteristicFeaturesofFinancialInstruments Generallyspeaking,financialinstrumentspossessthefollowingcharacteristicfeatures: Mostoftheinstrumentscanbeeasilytransferredfromonehandtoanotherwithoutmanycumbers omeformalities. Theyhaveareadymarketi.e.,theycanbeboughtandsoldfrequentlyandthustradinginthesesecur itiesismadepossible. They possess liquidity, i.e., some instruments can be converted into cashreadily. For instance, a bill of exchange can be converted into cash readily bymeansofdiscountingandrediscounting. Mostofthesecuritiespossesssecurityvalue,i.e.,theycanbegivenassecurityforthepurposeofrai singloans. Somesecuritiesenjoytaxstatus,i.e.,investmentinthesesecuritiesareexemptedfromIncomeTa x,WealthTax,etc.,subjecttocertainlimits. Theycarryriskinthesensethatthereisuncertaintywithregardtopaymentofprincipal orinterest ordividendasthecasemaybe. These instruments facilitate future trading so as to cover risks due to pricefluctuations,interestratefluctuationsetc. These instruments involve less handling costs since expenses involved inbuyingandsellingthesesecuritiesaregenerallymuchless. Thereturnontheseinstrumentsisdirectlyinproportiontotheriskundertaken. Theseinstrumentsmaybeshort-termormediumtermorlong-termdependinguponthematurity periodoftheseinstruments. 2.4 DEVELOPMENT OF FINANCIAL SYSTEM IN INDIA Some serious attention was paid to the development of a sound financial system inIndiaonlyafterthelaunchingoftheplanningerainthecountry.AtthetimeofIndependencein1947,t herewasnostrongfinancialinstitutionalmechanisminthecountry.There was absence of issuing institutions and non-participation of intermediaryfinancial institutions. The industrial sector also had no access to the savings of thecommunity. The capital market was very primitive and shy. The private as well as theunorganized sector played a key role in the provision of ‘liquidity’. On the whole, chaoticconditionsprevailedinthesystem.Withtheadoptionofthetheoryofmixedeconomy,thedeve lopmentofthefinancial system took a different turn so as to fulfill the socio-economic and politicalobjectives. The Government started creating new financial institutions to supply financebothforagriculturalandindustrialdevelopmentanditalsoprogressivelystartednationalizin gsomeimportantfinancialinstitutionssothattheflowofthefinancemightbeintherightdirection. NationalisationofFinancialInstitution AsweknowthattheRBIistheleaderofthefinancialsystem.But,itwasestablishedasaprivateinstituti onin1935.Itwasnationalizedin1948.Itwasfollowedby the nationalization of the Imperial Bank 35 CU IDOL SELF LEARNING MATERIAL (SLM)
of India in 1956 by renaming it as State BankofIndia.Inthesameyear,245LifeInsuranceCompanieswerebroughtunderGovernmentcontr olbymergingallofthemintoasinglecorporationcalledLifeInsurance Corporation of India. Another significant development in our financial systemwas the nationalization of 14 major commercial banks in 1969. Again, 6 banks werenationalized in 1980. This process was then extended to General Insurance Companieswhich were reorganized under the name of General Insurance Corporation of India. thus,theimportantfinancialinstitutionswerebroughtunderpubliccontrol. StartingofUnitTrustofIndia Another landmark in the history of development of our financial system is theestablishmentofnewfinancialinstitutionstostrengthenoursystemandtosupplyinstitutionalcred ittoindustries. The Unit Trust of India was established in 1964 as a public sector institution tocollectthesavingsofthepeopleandmakethemavailableforproductiveventures.Itistheoldestandl argestmutualfundinIndia.Itisgovernedbyitsownstatuesandregulations. However, since 1994, the schemes of UTI have to be approved by the SEBI.It has introduced a number of open- ended and close-ended schemes. It also provides re- purchasefacilityofunitsofthevariousincomeschemesofUTIarelinkedwithstockexchanges.Itsinv estmentisconfinedtobothcorporateandnon- corporatesectors.Ithasestablishedthefollowingsubsidiaries: (i) TheUTIBankLtd.,inApril1994. (ii) TheUTIInvestorServiceLtd.,toactasUTI’sownRegistrarandTransferagency. (iii) TheUTISecurityExchangeLtd. EstablishmentofDevelopmentBanks: Manydevelopmentbankswerestartednotonlytoextendcreditfacilitiestofinancial institutions but also to render advisory services. These banks are multipurposeinstitutionswhichprovidemediumandlongtermcredittoindustrialundertakings,disc overinvestmentprojects,undertakethepreparationofprojectreports,providetechnical advice and managerial services and assist in the management of industrial units.These institutions are intended to develop backward regions as well as small and newentrepreneurs. The Industrial Finance Corporation of India (IFCI) was set up in 1948 with theobject of “making medium and long term credits more readily available to industrialconcernsinIndia,particularlyundercircumstanceswherenormalbankingaccommodatio n is inappropriate or recourse to capital issue method is impracticable”. Atthe regional level, State Financial Corporations were established under the State FinancialCorporationAct,1951withaviewtoprovidingmediumandlongtermfinancetomediuman dsmallindustries.ItwasfollowedbytheestablishmentoftheIndustrialCredit and Investment Corporation of India (ICICI) in 1955 to develop large and mediumindustries in private sector, on the initiative of the World Bank. It adopted a moredynamic and modern approach in industrial financing. Subsequently, the Government ofIndia set up the Refinance Corporation 36 CU IDOL SELF LEARNING MATERIAL (SLM)
of India (RCI) in 1958 with a view to providingrefinance facilities to banks against term loans granted by them to medium and smallunits.LateronitwasmergedwiththeIndustrialDevelopmentBankofIndia. The Industrial Development Bank of India (IDBI) was established on July 1, 1964as a wholly owned subsidiary of the RBI. The ownership of IDBI was then transferred tothe Central Government with effect from February 16, 1976. The IDBI is the apexinstitution in the area of development banking and as such it has to co- ordinate theactivities of all the other financial institutions. At the State level, the State IndustrialDevelopmentCorporations(SIDCO)/StateIndustrialInvestmentCorporationswerecrea tedtomeetthefinancialrequirementsoftheStatesandtopromoteregionaldevelopment. In 1971, the IDBI and LIC jointly set up the Industrial Reconstruction CorporationofIndia(IRCI)withthemain objective of reconstructionandrehabilitationofsickindustrial undertakings. The IRCI was converted into a statutory corporation in March1985 and renamed as the Industrial Reconstruction Bank of India (IRBI). In 1997, theIRBI has to be completely restructured since it itself has become sick due to financing ofsickindustries.Now,itisconvertedintoalimitedcompanywithanewnameofIndustrial Investment Bank of India (IIBI). Its objective is to finance only for expansion,diversification, modernization etc., of industries and thus it has become a developmentbank. The Small Industries Development Bank of India (SIDBI) was set up as a whollyowned subsidiary of IDBI. It commenced operations on April 2, 1990. The SIDBI hastaken over the responsibility of administrating the Small Industries Development FundandtheNationalEquityFund. InstitutionforFinancingAgriculture In 1963, the RBI set up the Agricultural Refinance and Development Corporation(ARDC) to provide refinance support to banks to finance major development projectssuchasminorirrigation,farmmechanization,,landdevelopment,horticulture,dailydevelo pment, etc. However, in July 1982, the National Bank for Agriculture and RuralDevelopment(NABARD)wasestablishedand theARDCwasmergedwithit.Thewholesphere of agricultural finance has been handed over to NABARD. The functions of theAgricultural Credit Department and Rural Planning and Credit Cell of the RBI have beentakenoverbyNABARD. InstitutionforForeignTrade The Export and Import Bank of India (EXIM Bank) was set up on January 1, 1982totakeovertheoperationsofInternationalFinancewingoftheIDBI.Itsmainobjectiveis to provide financial assistance to exporters and importers. It functions as the principalfinancialinstitutionforcoordinatingtheworkingofotherinstitutionsengagedinfinancingo fforeigntrade.Italsoprovidesrefinancefacilitiestootherfinancialinstitutionsagainsttheirexport- importfinancingactivities. 37 CU IDOL SELF LEARNING MATERIAL (SLM)
InstitutionforHousingFinance The National Housing Bank (NHB) has been set up on July 9, 1988 as an apexinstitution to mobilize resources for the housing sector and to promote housing financeinstitutionsbothatregionalandlocallevels.Italsoprovidesrefinancefacilitiestohousingfina nceinstitutionsandscheduledbanks.Italsoprovidesguaranteeandunderwriting facilities to housing finance institutions. Again, it co-ordinates the workingofallagenciesconnectedwithhousing. StockHoldingCorporationofIndiaLtd.(SHCIL) Recently in 1987 another institution viz., Stock Holding Corporation of India Ltd.was set up to tone up the stock and capital markets in India. Its main objective is toprovide quick share transfer facilities, clearing services, Depository services, supportservices, management information services and development services to investors bothindividualsandcorporates.TheSHCILwassetupbysevenAllIndiafinancialinstitutionsviz.,ID BI,IFCI,ICICI,LIC,GIC,UTIandIRBI. MutualFundsIndustry Mutual funds refer to the funds raised by financial service companies by poolingthe savings of the public and investing them in a diversified portfolio. They provideinvestment avenues for small investors who cannot participate in the equities of bigcompanies. Mutual funds have been floated by some public sector banks, LIC, GIC andrecentlybyprivatesectoralso. VentureCapitalInstitutions Venture capital is another method of financing in the form of equity participation.A venture capitalist finances a project based on the potentialities of a new innovativeproject.Muchthrustisgiventonewideasortechnologicalinnovations.Indeeditisalong term risk capital to finance high technology projects. The IDBI venture capital fundwas set up in 1986. The IFCI has started a subsidiary to finance venture capital viz., TheRisk Capital and Technology Finance Corporation (RCTC). Likewise the ICICI and theUTI have jointly set up the Technology Development and Information Company of IndiaLimited (TDICI) in 1988 to provide venture capital. Similarly many State FinancialCorporations and commercial banks have started subsidiaries to provide venture capital.TheIndusVentureCapitalFundandtheCreditCapitalVentureFundLimitedcomeunderthep rivatesector. CreditRatingAgencies Of late, many credit rating agencies have been established to help investors tomake a decision of their investment in various instruments and to protect them from riskyventures. At the same time it has the effect of improving the competitiveness of thecompanies so that one can excel the other. Credit rating is now mandatory for all debtinstruments.Similarly,foracceptingdeposits,non- bankingcompanieshavetocompulsorilygoforcreditrating.Someofthecreditratingagenciesestabli shedare: CreditRatingandInformationServicesofIndiaLtd.(CRISIL) 38 CU IDOL SELF LEARNING MATERIAL (SLM)
InvestmentInformationandCreditRatingAgencyofIndiaLtd.(ICRA) CreditAnalysisandResearchLtd.(CARE) DuffPhelpsCreditRatingPvt.Ltd.(DCRIndia) The rating is confined to fixed deposits, debentures, preference shares and shortterminstrumentslikecommercialpaper.Theestablishmentofvariouscreditratingagencies will go a long way in stabilizing the financial system in India by supplying vitalcreditinformationaboutcorporatecustomers. MultiplicityofFinancialInstruments The expansion in size and number of financial institutions has consequently led toa considerable increase in the financial instruments also. New instruments have beenintroduced in the form of innovative schemes of LIC, UTI, Banks, Post Office SavingsBankAccounts,Sharesanddebenturesofdifferentvarieties,PublicSectorBonds,National Savings Scheme, National Savings Certificates, Provident Funds, Relief Bonds,Indira Vikas Patra, etc. Thus different types of instruments are available in the financialsystem so as to meet the diversified requirements of varied investors and thereby makingthesystemmorehealthyandvibrant. LegislativeSupport TheIndianfinancialsystemhasbeenwellsupportedbysuitablelegislativemeasures taken by the Government then and there for its proper growth and smoothfunctioning. Though there are many enactments, some of them are very important. TheIndian Companies Act was passed in 1956 with a view to regulating the function ofcompanies from birth to death. It mainly aims at giving more protection to investors sincethere is a diversity of ownership and management in companies. It was a follow up to theCapital Issues Control Act passed in 1947. Again, in 1956, the Securities Contracts(Regulations) Act was passed to prevent undesirable transactions in securities. It mainlyregulatesthebusinessoftradinginthestockexchanges.ThisActpermittedonlyrecognizedsto ckexchangestofunction. Toensuretheproperfunctioningoftheeconomicsystemandtopreventconcentration of economic power in the hands of a few, the Monopolies and RestrictiveTrade Practices Act was passed in 1970. In 1973, the Foreign Exchange Regulations Actwas enacted to regulate the foreign exchange dealings and to control Indian investmentsabroadandviceversa. TheCapitalIssueControlActwasreplacedbysettingupoftheSecuritiesExchange Board of India. Its main objective is to protect the interest of investors bysuitably regulating the dealings in the stock market and money market so as to achieveefficient and fair trading in these markets. When the Government adopted the NewEconomic Policy, many of these Acts were amended so as to remove many unwantedcontrols. Bank and financial institutions have been permitted to become members of thestock market in India. They have been permitted to float mutual funds, undertake leasingbusiness,carryoutfactoringservicesetc. Besides the above, the Indian Contract Act, The Negotiable Instruments Act, TheLaw of Limitation Act, The Banking Regulations Act, The Stamp Act etc., deserve aspecial mention. 39 CU IDOL SELF LEARNING MATERIAL (SLM)
When the financial system grows, the necessity of regulating it alsogrows side by side by means of bringing suitable legislations. These legislative measureshave re-organised the Indian financing system to a greater extent and have restoredconfidenceinthemindsoftheinvestingpublicaswell. 2.5 WEAKNESSES OF INDIAN FINANCIAL SYSTEM After the introduction of planning, rapid industrialization has taken place. It has inturn led to the growth of the corporate sector and the Government sector. In order to meetthegrowingrequirementsoftheGovernmentandtheindustries,manyinnovativefinancial instruments have been introduced. Besides, there has been a mushroom growthof financial intermediaries to meet the ever growing financial requirements of differenttypesofcustomers.Hence,theIndianfinancialsystemismoredevelopedandintegratedtoda ythanwhatitwas50yearsago.Yet,itsuffersfromsomeweaknessesaslistedbelow: LackofCo-ordinationbetweendifferentFinancialInstitutions There are a large number of financial intermediaries. Most of the vital financialinstitutions are owned by the Government. At the same time, the Government is also thecontrolling authority of these institutions. In these circumstances, the problem of co-ordination arises. As there is multiplicity of institutions in the Indian financial system,thereislackofco- ordinationintheworkingoftheseinstitutions. MonopolisticMarketStructures InIndiasomefinancialinstitutionsaresolargethattheyhavecreatedamonopolisticmarketstructures inthefinancialsystem.Forinstancetheentirelifeinsurance business is in the hands of LIC. The UTI has more or less monopolized themutualfundindustry.Theweaknessofthislargestructureisthatitcouldleadtoinefficiency in their working or mismanagement or lack of effort in mobilizing savings ofthepublicandsoon.Ultimatelyitwouldretardthedevelopmentofthefinancialsystemofthecountr yitself. DominanceofDevelopmentBanksinIndustrialFinancing The development banks constitute the backbone of the Indian financial systemoccupyinganimportantplaceinthecapitalmarket.TheindustrialfinancingtodayinIndia is largely through the financial institutions created by the Government both at thenational and regional levels. These development banks act as distributive agencies only,since, they derive most of their funds, from their sponsors. As such, they fail to mobilizethe savings of the public. This would be a serious bottleneck which stands in the way ofthegrowthofanefficientfinancialsysteminthecountry.For industriesabroad,institutional finance has been a result of institutionalization of personal savings throughmedialikebanks, LIC,pensionand providentfunds,unittrustsandsoon.Buttheyplayless significant role in Indian financial system, as far as industrial financing is concerned.However, in recent times attempts are being made to raise funds from the public throughthe issue of bonds, units, debentures and so on. It will 40 CU IDOL SELF LEARNING MATERIAL (SLM)
go a long way in forging a linkbetweenthenormalchannelsofsavingsandthedistributingmechanism. InactiveandErraticCapitalMarket The important function of any capital market is to promote economic developmentthrough mobilization of savings and their distribution to productive ventures. As far asindustrialfinanceinIndiaisconcerned,corporatecustomersareabletoraisetheirfinancialresource sthroughdevelopmentbanks.So,theyneednotgotothecapitalmarket. Moreover, they don’t resort to capital market since it is very erratic and inactive.Investors too prefer investments in physical assets to investments in financial assets. Theweaknessofthecapitalmarketisaseriousprobleminourfinancialsystem. ImprudentFinancialPractice The dominance of development banks has developed imprudent financial practiceamong corporate customers. The development banks provide most of the funds in theform of term loans. So there is a preponderance of debt in the financial structure ofcorporate enterprises. This predominance of debt capital has made the capital structure ofthe borrowing concerns uneven and lopsided. To make maters worse, when corporateenterprises face any financial crises, these financial institutions permit a greater use ofdebtthanawarranted.Itisagainstthetraditionalconceptofasoundcapitalstructure. However, in recent times all efforts have been taken to activate the capital market.Integration is also taking place between different financial institutions. For instance, theUnitLinkedInsuranceSchemesoftheUTIarebeingofferedtothepublicincollaboration with the LIC. Similarly the refinance and rediscounting facilities providedby the IDBI aim at integration. Thus, the Indian financial system has become a developedone. 2.6 SUMMARY A system that aim at establishing and providing a regular smooth, efficientand cost effective linkage between depositors and investors in known as financial system. Afinancialsystemcompaniesoffinancialinstitutions,financialservices,financialmarkets and financial instruments. These constituents are closely related and work inconjuction with each others. A financial asset is one which is used for production orconsumption or for further creation of assets. Financial intermediaries includes all kindsof financial institutions and investing institutions which facilitate financial transaction infinancial markets. Financial markets facilitate buying and selling of financial claims,assets,servicesandsecurities.Financialmarketisclassifiedintoorganisedandunorganised markets. Financial claims such as financial assets and securities dealt in afinancial market are referred to as financial instruments. Financial instruments can beclassified into primary and secondary securities. With the adoption of the theory of mixedeconomy, the development of the financial system took a 41 CU IDOL SELF LEARNING MATERIAL (SLM)
different turn as to fulfill thesocio-economicandpoliticalobjectives. TheGovernmenthasstartedcreatingnewfinancialinstitutionsanditalsoprogressivelystartedn ationalisingsomefinancialinstitutions so that the flow of the finance might be in the right direction. Indian financialsystem is more developed and integrated today than it was 50 years ago, but it suffersfromsome weaknesses. 2.7 KEYWORDS FinancialSystem:Asetofcomplexandcloselyconnectedinstructions,agents,practices, markets transactions, claims and liabilities relating to financial aspects of aneconomyisreferredasfinancialsystem. Financial Asset: Financial assets refer to claim of periodical payments of certain sum ofmoneybywayofpaymentofprincipal,interestordividend. PrimaryMarket:Itisamarketfornewissueofshares,debenturesandbonds. SecondaryMarket:Themarketwhereexistingsecuritiesaretradedisreferredtoassecondarym arket. MoneyMarket:Itisamarketforshort- termmoneyandfinancialassetsthatarenearsubstitutesformoney. CapitalMarket:Itisamarketforfinancialassetswhichhavealongorindefinitematurity. FinancialInstruments:Financialinstrumentsrefertothosedocumentswhichrepresentfinanc ialclaimsonassets. 2.8 LEARNING ACTIVITY 1. As an employee of the finance department of a corporation you are asked to explain the matching principle to an executive of the organisation. ___________________________________________________________________________ ___________________________________________________________________________ ______ 2. You know that you will need to give practical examples. What are you going to advise the executive? ___________________________________________________________________________ ___________________________________________________________________________ ______ 3. A large corporation is to seek funding direct from the international capital markets. What is direct finance and why might the corporation wish to raise funds directly from the capital markets? ___________________________________________________________________________ ___________________________________________________________________________ ______ 42 CU IDOL SELF LEARNING MATERIAL (SLM)
2.9 UNIT END QUESTIONS A. Descriptive Questions Short Answer Questions 1. Explain the functions of financial services. 2. How the financial services are classified? 3. What is the nature and scope of financial services? 4. What are the causes of financial innovation? 5. What are the new financial products and services? 6. What are various innovative financial instrument? 7. What are the challenges faced by financial services sector? Long Questions 1. DiscusstheclassificationofIndianfinancialmarketsandexplainthefeaturesofeachmarket. 2. ClassifythevariousfinancialintermediariesfunctioningintheIndianfinancialsystemand bringouttheirfeatures. 3. Definefinancialinstruments?Whataretheircharacteristics? 4. TraceoutthedevelopmentofthefinancialsysteminIndia. 5. “Inspiteofsuitablelegislativemeasures,theIndianfinancialsystemremainsweak.”Comment. B. Multiple Choice Questions 1. The following one is a kind of fee based activity of a financial intermediary. a. hire purchase financing b. leasing c. capital issue management d. underwriting 2. Find the odd man out a. commercial paper b. share certificate c. certificate of deposit d. treasury bill. 3.The process of managing the sales ledger of a client by a financial service companyis called _____ a. forfeiting b. factoring c. leasing d. securitization of debt 43 CU IDOL SELF LEARNING MATERIAL (SLM)
4. The inflation free instrument is ______________. a. option bond b. index linked guilt bond c. variable rate debenture d. deep discount bond 5. Non-banking companies should compulsorily get credit rating for their _________. a. capital market instruments b. money market instruments c. debt market instruments d. None of these 6. The important goal of the financial service industry is to mobilise and allocate _________. a. saving b. sales c. purchase d. All of these 7. Term lending institutions are ________ market intermediaries. a. cash b. credit c. capital d. sales 8. To regulate the securities market and to protect the investor's interest ________ hasbeen created by the Government of India. a. SEBI b. RRB c. RBI d. SBI 9. underwriting of shares by a financial intermediary is a kind of ___________ activity. a. cash based b. time based c. fund based d. All of these. 10. ___________ bonds are sold at a large discount to their nominal value. a. Deep discount 44 CU IDOL SELF LEARNING MATERIAL (SLM)
b. Discount c. Profit d. None of these Answers 1(a) ,2(c) ,3(d) ,4(a) ,5(a) ,6(d) ,7(c) ,8(a) ,9(c) ,10(a) 2.10REFERENCES Text Books: Bhalla, V. K.“ Management of Financial Services” Anmol Publications Clifford Gomez “ Financial Markets, Institutions and Financial Services”, PHI Learning Rose, Peter and Hudgins, Sylvia,“ Bank Management and Financial Services”, McGraw Hills. Reference Books: Padamlatha ,“ Management of Banking and Financial Services”, Pearson Education. Saunders, Antony and Cornett, Marcia,“ Financial Institutions Management: A Risk Management Approach” McGraw Hills 45 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT-3 FINANCIAL REFORMS OF INDIA STRUCTURE 3.0 Learning Objectives 3.1 Introduction 3.2 NatureorCharacteristicsofFinancial Reforms 3.3 Regulators 3.4 Indian Banking Sector and Financial Reforms 3.5 Impact on the Reform Measures 3.6 Capital Market Reform 3.7 The regulatory Framework 3.8 Mutual Funds 3.9 Overall Approach to reforms 3.10 Summary 3.11 Keywords 3.12 Learning activity 3.13 Unit End Questions 3.14 References 3.0 LEARNING OBJECTIVES After studying this unit, students will be able to: Focus on allocating the resources proficiently Discussthereform processes of the government. Describetheoperational efficiency of financial sector. 3.1 INTRODUCTION Financial sector is the mainstay of any economy and it contributes immensely in the mobilisation and distribution of resources. Financial sector reforms have long been viewed as significant part of the program for policy reform in developing nations. Earlier, it was thought that they were expected to increase the efficiency of resource mobilization and allocation in the real economy to generate higher rates of growth. Recently, they are also seen to be critical for macroeconomic stability. It was due to the repercussion of the East Asian crisis, since weaknesses in the financial sector are broadly regarded as one of the major causes of collapse in that region. The elements of the financial sector are Banks, Financial Institutions, Instruments and markets which mobilise the resources from the surplus sector and channelize the same to the different needy sectors in the economy. The process of accumulative capital growth through institutionalisation of savings and investment fosters economic growth. Reform of the 46 CU IDOL SELF LEARNING MATERIAL (SLM)
financial sector was recognized, from the very beginning, as an integral part of the economic reforms initiated in 1991. The economic reform process occurred amidst two serious crisis involving the financial sector the balance of payments crisis that endangered the international credibility of the country and pushed it to the edge of default; and the grave threat of insolvency confronting the banking system which had for years concealed its problems with the help of faulty accounting strategies. Furthermore, some deep rooted problems of the Indian economy in the early nineties were also strongly related to the financial sector such as large scale pre-emption of resources from the banking system by the government to finance its fiscal deficit. Excessive structural and micro regulation that inhibited financial innovation and increased transaction costs.Relatively inadequate level of prudential regulation in the financial sector.Poorly developed debt and money markets.And outdated (often primitive) technological and institutional structures that made the capital markets and the rest of the financial system highly inefficient. 3.2 NATUREAND CHAREACTERISTICS OF FINANCIAL REFORMS Financial and banking sector reforms are in following areas: Financial markets Regulators The banking system Non-banking finance companies The capital market Mutual funds Overall approach to reforms Deregulation of banking system Capital market developments Consolidation imperative 3.3 REGULATORS The Finance Ministry constantly formulated major strategies in the field of financial sector of the country. The Government acknowledged the important role of regulators. The Reserve Bank of India (RBI) has become more independent. Securities and Exchange Board of India (SEBI) and the Insurance Regulatory and Development Authority (IRDA) became important institutions. Some opinions are also there that there should be a super-regulator for the financial services sector instead of multiplicity of regulators. 3.4 INDIAN BANKING SECTOR AND FINANCIAL REFORMS 47 CU IDOL SELF LEARNING MATERIAL (SLM)
The main intent of banking sector reforms was to uphold a diversified, efficient and competitive financial system with the aim of improving the allocative efficiency of resources through operational flexibility, improved financial viability and institutional solidification. As early as August 1991, the government selected a high level Committee on the Financial System (the Narasimham Committee) to look into all facets of the financial system and make comprehensive recommendations for improvements. The Committee submitted its report in November 1991, making several recommendations for reforms in the banking sector and also in the capital market. Soon thereafter, the government announced broad acceptance of the approach of the Narasimham Committee and a process of gradualist reform in the banking sector and in the capital market was set in motion, a process that has now been under way for more than six year. The Narasimham Committee In India, around 80% of businesses are regulated by public sector banks. PSBs are still governing the commercial banking system. The RBI has given licenses to new private sector banks as part of the liberalization process. The RBI has also been granting licenses to industrial houses. Many banks are effectively running in the retail and consumer segments but are yet to deliver services to industrial finance, retail trade, small business and agricultural finance. Major change observed by individuals is many transformation in policies of the banking sector. The reforms have focussed on eliminating financial repression through reductions in statutory pre-emptions, while stepping up prudential regulations at the same time. Additionally, interest rates on both deposits and lending of banks have been gradually deregulated. The major reforms relating to the banking system were: Capital base of the banks were strengthened by recapitalization, public equity issues and subordinated debt. Prudential norms were introduced and progressively tightened for income recognition, classification of assets, provisioning of bad debts, marking to market of investments. Pre-emption of bank resources by the government was reduced sharply. New private sector banks were licensed and branch licensing restrictions were relaxed. Similarly, several operational reforms were introduced in the area of credit policy: Detailed regulations relating to Maximum Permissible Bank Finance were abolished. Consortium regulations were relaxed substantially. Credit delivery was shifted away from cash credit to loan method. Many reports signified that the initial steps have been taken in the form of allowing new banks to set up shop. Private Corporates, public sector entities and Non-Banking Finance Companies with a strong track record can now apply to set up new banks and the Reserve bank of India will consider these applications in the coming months. The addition of new banks will mean more competition for this sector in the country and it will lead to a development in services for the end customer. It is anticipated to increase financial enclosure as more and more people across the country will be able to access banking facilities. In 48 CU IDOL SELF LEARNING MATERIAL (SLM)
reforms for the existing banks the public sector banks have been allowed to increase or decrease the authorised capital without the presence of an overall ceiling. This will provide greater flexibility to the banks to conduct their fund raising activities as per the requirements. The strict restriction of voting rights in banks will also be relaxed and this will aid the banking sector to develop, as large investors will be able to get a bigger voice in the coming days in the banks and the manner in which they operate. When evaluating banking sector reform, it can be identified that banks have experienced strong balance sheet growth in the post-reform period in an environment of operational flexibility. Enhancement in the financial health of banks, reflected in noteworthy improvement in capital adequacy and improved asset quality, is distinctly observable. It is striking that this progress has been realised despite the espousal of international best practices in prudential norms. Competitiveness and productivity gains have also been enabled by proactive technological deepening and flexible human resource management. These significant gains have been achieved even while renewing goals of social banking viz. maintaining the wide reach of the banking system and directing credit towards important but underprivileged sectors of civilisation. Forex market reform: Forex market reform took place in 1993 and the successive adoption of current account convertibility were the acmes of the forex reforms introduced in the Indian market. Under these reforms, authorised dealers of foreign exchange as well as banks have been given greater sovereignty to perform in activities and numerous operations. Additionally, the entry of new companies have been allowed in the market. The capital account has become effectively adaptable for non-residents but still has some reservations for residents. 3.5 IMPACT ON THE REFORM MEASURES The broader objectives of the financial sector reform process are to articulate the policy to enhance the financial condition and to reinforce the institutions. As part of the reforms process, many private banks were granted licence to operate in India. This has resulted into a competitive environment in the banking industry which in turn has assisted in using the resources more competently. Conventionally, the industrial units were sanctioned term loan by the development banks and working capital by the commercial banks. The reform process has transformed the pattern of financing and now both the institutions are willing to extend long term loan as well as working capital loan. But there is some difference in the mode of operation. This has empowered the industrial units to avail credit facilities from a single institution. Despite the fact that the banks provide both the term loan and the working capital loans, the industrial units prefer the development banks for the following reasons. It provides equal support to the new as well as existing industries. The period of repayment of loan is comparatively longer. Besides providing financial backing, it acts as the implementing agency for the different government sponsored schemes. Hence the industrial units can avail of both the financial 49 CU IDOL SELF LEARNING MATERIAL (SLM)
assistance as well as the incentives offered under various development schemes through a Single Window System. As lending is the main activity of these institutions, it acquires specialisation in this field and can share its expertise with the industrial units. 3.6 CAPITAL MARKET REFORM Capital market is defined as a financial market that works as a channel for demand and supply of debt and equity capital. It channels the money provided by savers and depository institutions (banks, credit unions, insurance companies, etc.) to borrowers and investees through a variety of financial instruments (bonds, notes, shares) called securities. A capital market is not a compact unit, but a highly decentralized system made up of three major parts that include stock market, bond market, and money market. It also works as an exchange for trading existing claims on capital in the form of shares. The Capital Market deals in the long-term capital Securities such as Equity or Debt offered by the private business companies and also governmental undertakings of India. Structure of capital market of India Figure 3.1 – Indian capital market In the agenda of financial sector reforms, Improvement of the capital market is important area and action has been taken parallel with reforms in banking. India has experienced functioning in capital markets the Bombay Stock Exchange (BSE) for over a hundred years but until the 1980s, the volume of activity in the capital market was relatively limited. Capital market activity extended rapidly in the 1980s and the market capitalization of companies registered in the BSE rose from 5 per cent of GDP in 1980 to 13 per cent in 1990. It is observed that the Indian capital market has perceived major reforms in the decade of 1990s and thereafter. It is on the edge of the growth. Thus, the Government of India and SEBI took numerous measures in order to improve the working of the Indian stock exchanges and to make it more progressive and energetic. The Securities and Exchange Board of India (SEBI) was well- known in 1988. It got a legal status in 1992. SEBI was principally set up to control the activities of the commercial banks, to control the operations of mutual funds, to work as a 50 CU IDOL SELF LEARNING MATERIAL (SLM)
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