CU- SEM III -BCM112- Management of Financial Institutions and Services

lowered, the reserves of commercial banks are raised. They lend more and the economic activity is favourably affected.  Selective Credit Controls: Selective credit controls are used to influence specific types of credit for particular purposes. They usually take the form of changing margin requirements to control speculative activities within the economy. When there is brisk speculative activity in the economy or in particular sectors in certain commodities and prices start rising, the central bank raises the margin requirement on them. The result is that the borrowers are given less money in loans against specified securities. For instance, raising the margin requirement to 60% means that the pledger of securities of the value of Rs 10,000 will be given 40% of their value,i.e. Rs 4,000 as loan. In case of recession in a particular sector, the central bank encourages borrowing by lowering margin requirements.  To Regulate And Expand Banking: RBI regulates the banking system of the economy. RBI has expanded banking to all parts of the country. Through monetary policy, RBI issues directives to different banks for setting up rural branches for promoting agricultural credit. Besides it, government has also set up cooperative banks and regional rural banks. All this has expanded banking in all parts of the country. 3.5 FISCAL POLICY The Fiscal Policy implies the decisions taken by the government with respect to its revenue collection (through taxation), expenditure and other financial operations to accomplish certain national goals. The government uses its expenditure and taxation programmes to generate the desirable effects or eliminate the undesirable effects on the production, employment and national income of the economy. The Fiscal Policy aims at ensuring a long-run stability of the economy, could be achieved only by controlling the short-run economic fluctuations. Definition According to Culbarston, “By fiscal policy we refer to government actions affecting its receipts and expenditures which we ordinarily taken as measured by the government’s receipts, its surplus or deficit.”

Arthur Smithies defines fiscal policy as “a policy under which the government uses its expenditure and revenue programs to produce desirable effects and avoid undesirable effects on the national income, production and employment.” Otto Eckstein defines fiscal policy as “changes in taxes and expenditures which aim at short-run goals of full employment and price-level stability.” Objectives of Fiscal Policy The objectives of the fiscal policy of the government are as follows:  RESOURCE MOBILIZATION Fiscal policy allows the government to mobilize resources for public expenditure and development. There are three ways of resource mobilization viz. taxation, public savings and private savings through issue of bonds and securities.  RESOURCE ALLOCATION The funds mobilized under fiscal policy are further allocated for development of social and physical infrastructure. For example, the government collected tax revenues are allocated to various ministries to carry out their schemes for development.  REDISTRIBUTION OF INCOME The taxes collected from rich people are spent on social upliftment of the poor and this fiscal policy in a welfare state tried to reduce inequalities of income using resource allocation.  PRICE STABILITY, CONTROL OF INFLATION, EMPLOYMENT GENERATION Government uses fiscal measures such as taxation and public expenditure to stabilize the prices and control inflation. Government also generates employment by speeding infrastructure development.  BALANCED REGIONAL DEVELOPMENT A large part of the government tax revenues are given out to less developed states as statutory and discretionary grant. This helps in the balanced regional development of the country.  BALANCE OF PAYMENTS Using fiscal policy measures government tries to promote exports to earn foreign exchange. This helps in maintaining favourable balance of trade and balance of payments.

Capital Formation and National Income Fiscal policy measures help in increasing the capital formation and economic growth. Increased capital formation leads to increase in national income. 3.6 VARIOUS TYPES OF FISCAL POLICIES  Contractionary Fiscal Policy This involves cutting government spending or raising taxes. Thus, the tax revenue generated is more than government spending. Also, it cuts on the aggregate demand in the economy. So, the economic growth leading to the reduction in inflationary pressures of the economy.  Expansionary Fiscal Policy This is generally used to give a boost to the economy. Thus, it speeds up the growth rate of the economy. Also, during the recession period when the growth in national income is not enough to maintain the current living of the population. So, a tax cut and an increase in government spending would boost economic growth and decrease the unemployment rates. Although this is not a sustainable solution. Because this can lead to a budget deficit. Thus, the government should use this with caution.  Neutral Fiscal Policy His policy implies a balance between government spending and Furthermore, it means that tax revenue is fully used for government spending. Also, the overall budget outcome will have a neutral effect on the level of economic activities. Types of Fiscal Policy There are major components to the fiscal policies and they are  Expenditure Policy Government expenditure includes capital expenditure and revenue expenditure. Also, the government budget is the most important instrument that embodies government expenditure policy. Furthermore, the budget is also for financing the deficit. Thus, it fills the gal between income and government spending.  Taxation Policy The government generates its revenue by imposing both indirect taxes and direct taxes. Thus, it is

important for the government to follow a judicial system for taxation and impose correct tax rates. This is because of two reasons. The higher the tax, the reduction in the purchasing power of the people. This will lead to a decrease in investment and production. Furthermore, the lower tax will leave more money with people that lead to high spending and thus higher inflation.  Surplus and Debt Management When the government receives more amount than it spends than it is known as surplus. Also, when the spending is more than the income than it is known as a deficit. In order to fund the deficits, the government needs to borrow from domestic or foreign sources. Components of Fiscal Policy There are four key components of Fiscal Policy are as follows: Taxation Policy Expenditure Policy Investment & Disinvestment policy Debt / surplus management.  Taxation Policy We have already discussed in detail about the taxation policy in previous module. The government gets revenue from direct and indirect taxes. Via its fiscal policy, government aims to keep the taxes as much progressive as possible. Further, judicious taxation decisions are very important for economy because of two reasons:  Higher than usual tax rate will reduce the purchasing power of people and will lead to an decrease in investment and production.  Lower than usual tax rates would leave more money with people to spend and this would lead to inflation. Thus, the government has to make a balance and impose correct tax rate for the economy.  Expenditure Policy Expenditure policy of the government deals with revenue and capital expenditures. These expenditures are done on areas of development like education, health, infrastructure etc. and to pay internal and external debt and interest on those

debts. Government budget is the most important instrument embodying expenditure policy of the government. The budget is also used for deficit financing i.e. filling the gap between Government spending and income.  Investment and Disinvestment Policy Optimum levels of domestic as well as foreign investment are needed to maintain the economic growth. In recent years, the importance of FDI has increased dramatically and has become an instrument of integrating the domestic economies with global economy.  Debt / Surplus Management If the government received more than it spends, it is called surplus. If government spends more than income, then it is called deficit. To fund the deficit, the government has to borrow from domestic or foreign sources. It can also print money for deficit financing. Merits of Fiscal Policy Taxation Resources need to be mobilized so that there can be funds for financing the development programs in the public sectors. The tax policy should be such that it can be focused on the effective deployment of all available resources and can be used in the implementation of other development efforts. It is the most effective in the total quantum savings in an economy. Development of the private sector Policies can direct investment in necessary stations, both in public and private sectors, with incentives attached, may accelerate economic growth. Policies should be such that all available resources should make their way into the necessary and needed development opportunities. Ensure Economic Stability & Curb Inflation Fiscal policy should be designed with the thought that it is the tool, a powerful instrument, to deal with a situation of inflation. One effort in this is to design a robust tax system that counters economic disruptions. To remove Economic Inequalities So that the benefits of development can be equally shared by all inhabitants of an economy, the income should be appropriately distributed, it is a fundamental part of economic development. This endeavor can be achieved by the proper application of taxes. Welfare schemes, where we

increase public expenditure for the less privileged class, can be promoted. Full Employment To achieve higher rate of growth, fully employed resources is desirable, this will increase the productive capacity of the economy. Now to increase employment, the government should direct the state expenditure towards providing social overheads, and encourage investments so that production increases. States should indulge in local public community development, which will eventually involve more labour and less capital per head. Capital Formation There are many economic theories that suggest that the best amount of capital formation becomes a key factor to economic growth, especially in developing countries. Taxes, transfer payments, rebate, subsidies etc…, are known to benefit economic growth by increasing the capital formation. Once the objective of fiscal policy is implemented, based on the nature of requirement in any economy, the success purely depends upon, how effectively, timely measures are put in place, and ensuring effective administration during the implementation phase. Demerits of Fiscal Policy Correct Size And Nature Of Fiscal Policy: The most important necessity on which the success of fiscal policy will depend is the ability of public authority to frame the correct size and nature of fiscal policy on the one hand and to foresee the correct timing of its application on the other. It is, however, too much to expect that the government would be able to correctly determine the size, nature of composition and appropriate execution- time of fiscal policy. Fiscal Selectivity: When monetary policy is general in nature and impersonal in impact, the fiscal policy, in contrast, is selective. The former permits the market mechanism to operate smoothly. The latter, on the contrary, encroaches directly upon the market mechanism and gives rise to an allocation of resources which may be construed as good or bad depending upon one’s value judgements. A particular set of fiscal measures may have an excessively harsh impact upon certain sectors, while leaving others almost unaffected. Inadequacy Of Fiscal Measures: In anti-depression fiscal policy, the expnsion of public spending and reduction on taxes are always

important elements. The question arises naturally, whether a specific variation in public spending or taxes will bear the desired results or not. In case the injections or withdrawals from the circular flow are more or less than what are required, the system will fail to move in the desired direction. This results in exaggeration of instability in the economy. Reduction IN National INCOME: Balanced budget multiplier as a fiscal weapon can be gainfully applied during depression is conditioned by the fact of marginal propensity to spend of the recipients of public expenditure being larger than or, at least, equal to that of the taxpayers. In case it becomes smaller than the taxpayers, the fiscal programmes under balanced budget will bring about reduction in the national income. Solution for Unemployment: The purpose of fiscal policy will be defeated if the policy can not maintain a rising supply level of work effort. The money national income will rise with increase in productive efficiency and increased supply of work effort. But if the tax measures are stringent and too high, they will certainly affect the incentive to work. This is an important limitation of fiscal policy. Adverse Effect on debt Management: The use of fiscal instruments during unemployment and depression is often associated with the subsequent problem of debt management. Because deficit budgeting is the normal fiscal cure, public debt is made for financing it. And if the process of recovery from depression is long, the creation of budget deficit year after year will create a huge problem of debt repayment and debt management. 3.7 DIFFERENCE BETWEEN FISCAL AND MONETARY POLICY BASIS FOR FISCAL POLICY MONETARY POLICY COMPARISON The tool used by the central Meaning The tool used by the government bank to regulate the money in which it uses its tax revenue supply in the economy is and expenditure policies to affect known as Monetary Policy. the economy is known as Fiscal Policy.

Administered by Ministry of Finance Central Bank Nature The fiscal policy changes every The change in monetary policy Related to year. depends on the economic status of the nation. Government Revenue & Expenditure Banks & Credit Control Focuses on Economic Growth Economic Stability Policy Tax rates and government spending Interest rates and credit ratios instruments Political Yes No influence Fig 3.1 comparison of fiscal policy and monetary policy Key Differences Between Fiscal Policy and Monetary Policy The following are the major differences between fiscal policy and monetary policy.  The policy of the government in which it utilises its tax revenue and expenditure policy to influence the aggregate demand and supply for products and services the economy is known as Fiscal Policy. The policy through which the central bank controls and regulates the supply of money in the economy is known as Monetary Policy.  Fiscal Policy is carried out by the Ministry of Finance whereas the Monetary Policy is administered by the Central Bank of the country.  Fiscal Policy is made for a short duration, normally one year, while the Monetary Policy lasts longer.  Fiscal Policy gives direction to the economy. On the other hand, Monetary Policy brings price stability.

 Fiscal Policy is concerned with government revenue and expenditure, but Monetary Policy is concerned with borrowing and financial arrangement.  The major instrument of fiscal policy is tax rates and government spending. Conversely, interest rates and credit ratios are the tools of Monetary Policy.  Political influence is there in fiscal policy. However, this is not in the case of monetary policy. 3.8 SUMMARY  The Monetary Policy is the plan of action undertaken by the monetary authority, especially the central banks, to regulate and control the demand for and supply of money to the public and the flow of credit so as to achieve the macroeconomic goals.  “Monetary policy involves the influence on the level and composition of aggregate demand by the manipulation of interest rates and the availability of credit”-D.C. Aston.  Advantages of Monetary Policies : o It promotes political freedom o It promotes transparency and predictability o It can promote low inflation rates o It can lead to lower rates of mortgage payments o It allows for the imposition of quantitative easing by the Central Bank o It Can Bring Out The Possibility Of More Investments Coming In And Consumers Spending More.  Disadvantages of Monetary policies : o It does not guarantee economy recovery. o It is not that useful during global recessions. o Its ability to cut interest rates is not a guarantee o It can take time to be implemented

o It could discourage businesses to expand.  The instruments of monetary policy are of two types: first, quantitative, general or indirect; and second, qualitative, selective or direct.  The Fiscal Policy implies the decisions taken by the government with respect to its revenue collection (through taxation), expenditure and other financial operations to accomplish certain national goals.  According to Culbarston, “By fiscal policy we refer to government actions affecting its receipts and expenditures which we ordinarily taken as measured by the government’s receipts, its surplus or deficit.”  Types of Fiscal Policies : A. CONTRACTIONARY FISCAL POLIC B. EXPANSIONARY FISCAL POLICY. C. NEUTRAL FISCAL POLICY 3.9 KEY WORDS/ABBREVIATIONS Monetary quantitative, qualitative, Bank Rate Open Market policy general or selective or Policy Operations indirect direct Reserve Ratios Credit Expenditure Fiscal Policy Taxation Controls Policy Policy Investment & Debt / surplus Disinvestment management policy 3.10 LEARNING ACTIVITY

Activity 1 : Fiscal Policy and Monetary Policy: What’s the Difference? _________________________________________________________________________________ ________________________________________________________________________________ 3.11 UNIT END QUESTIONS (MCQ AND DESCRIPTIVE) A. Descriptive Types Questions Short Answer 1. Define Monetary Policy and explain its Objectives ? 2. Explain the Advantages and Disadantages of Monetary Policies? 3. Describe the Instruments of Monetary Policies? 4. Define Fiscal Policy and explain its Objectives? Long Amswer 1. Describe various types of Fiscal Policies? 2. Discuss the Merits of Fiscal Policies? 3. Discuss the Demerits of Fiscal Policies? 4. Explain the Difference between Fiscal and Monetary Policies? B. Multiple Choice Questions 1. Fiscal Policy is made for a short duration, normally a. 2 Year b. 1 Year c. 6 Months d. 5 Years 2. The major instrument of fiscal policy________ and _____________ a. Tax Rates and Government Spending b. Money Interest and Bank Interest c. Cash flow and Debt flow.

d. None of the Above. 3.______________ is concerned with government revenue and expenditure. a.Fiscal Policy b. Monetary Policy c. Interest REPO Rate d. All of the Above. 4._______________ concerned with borrowing and financial arrangement. a.Fiscal Policy b. Monetary Policy c. Interest REPO Rate d. All of the Above. 5. Fiscal Policy is carried out by the _________ a. State Bank of India b. State Governments c. Central Government d. Ministry of Finance 6. The Monetary Policy is administered by the ____________ a. Central Bank of the country b. State Governments c. Central Government d. Ministry of Finance. 3.11 REFERENCES Text Books:  T1 Fabozzi - Foundations of Financial Markets and Institutions (Pearson Education,3rdEd.).  T2 Khan M Y - Financial Services (Tata Mc Graw Hill).  R1 Machiraju H R - Indian Financial System (Vikas Publication).

 R2 Bhole L M - Financial Institutions and Markets (Tata McGraw-Hill).

UNIT - 4: OVERVIEW OF FOREGIN EXCHANGE MARKET Structure 4.0. Learning Objectives 4.1. Introduction 4.2. Functions of Foreign Exchange Market 4.3. Structure of Foreign Exchange Market 4.4. Types of Foreign Exchange Market 4.5. Advantages of Forex Market 4.6. Disadvantages of Forex Market 4.7. Foreign Exchange Regulation ACT (FERA) 4.8. Summary 4.9. Key Words/Abbreviations 4.10. Learning Activity 4.11. Unit End Questions (MCQ and Descriptive) 4.12. References 4.0 LEARNING OBJECTIVES After studying this unit, students will be able to:  Understand the concept of Foreign Exchange Market.  Describe the functions of Foreign Exchange Market  Understand the types of Foreign Exchange Market  Describe the advantages and disadvantages of Foreign Exchange Market.  Understand the concept of FERA

4.1 INTRODUCTION An Exchange Rate is Just a Price. The foreign exchange (FX or FOREX) market is the market where exchange rates are determined. Exchange rates are the mechanisms by which world currencies are tied together in the global marketplace, providing the price of one currency in terms of another. An exchange rate is a price, specifically the relative price of two currencies. For example, the U.S. dollar/Mexican peso exchange rate is the price of a peso expressed in U.S. dollars. On March 23, 2015, this exchange rate was USD 1.0945 per EUR, or, in market notation, 1.0945 USD/EUR. The exchange rate is just a price, but it is an important one: St plays a very important role in the economy since it directly influences imports, exports, & cross-border investments. It has an indirect effect on other economic variables, such as the domestic price level, Pd, and real wages. For example: when St increases, foreign imports become more expensive in USD. Then, the domestic price level Pd increases and, thus, real wages decrease (through a reduction in purchasing power). Also, when St increases, USD-denominated goods and assets are more affordable to foreigners. Foreigners buy more goods and assets in the U.S. (exports, real estate, bonds, companies, etc.). These factors drive aggregate demand up and, thus, GDP increases. Foreign exchange market is described as an OTC (Over the counter) market as there is no physical place where the participants meet to execute their deals. It is more an informal arrangement among the banks and brokers operating in a financing centre purchasing and selling currencies, connected to each other by tele communications like telex, telephone and a satellite communication network, SWIFT. The term foreign exchange market is used to refer to the wholesale a segment of the market, where the dealings take place among the banks. The retail segment refers to the dealings take place between banks and their customers. The retail segment refers to the dealings take place between banks and their customers. The retail segment is situated at a large number of places. They can be considered not as foreign exchange markets, but as the counters of such markets. The leading foreign exchange market in India is Mumbai, Calcutta, Chennai and Delhi is other centers accounting for bulk of the exchange dealings in India. The policy of Reserve Bank has been to decentralize exchages operations and develop broader based

exchange markets. As a result of the efforts of Reserve Bank Cochin, Bangalore, Ahmadabad and Goa have emerged as new centre of foreign exchange market. The participants in the foreign exchange market comprise; (i) Corporates (ii) Commercial banks (iii) Exchange brokers (iv) Central banks 4.2 FUNCTIONS OF FOREIGN EXCHANGE MARKET Foreign exchange market performs the following three functions: 1. Transfer Function: It transfers purchasing power between the countries involved in the transaction. This function is performed through credit instruments like bills of foreign exchange, bank drafts and telephonic transfers. 2. Credit Function: It provides credit for foreign trade. Bills of exchange, with maturity period of three months, are generally used for international payments. Credit is required for this period in order to enable the importer to take possession of goods, sell them and obtain money to pay off the bill. 3. Hedging Function: When exporters and importers enter into an agreement to sell and buy goods on some future date at the current prices and exchange rate, it is called hedging. The purpose of hedging is to avoid losses that might be caused due to exchange rate variations in the future. The third function of a foreign exchange market is to hedge foreign exchange risks. The parties to the foreign exchange are often afraid of the fluctuations in the exchange rates, i.e., the price of one currency in terms of another. The change in the exchange rate may result in a gain or loss to the party concerned. Thus, due to this reason the FOREX provides the services for hedging the anticipated or actual claims/liabilities in exchange for the forward contracts. A forward contract is usually a three month contract to buy or sell the foreign exchange for another currency at a fixed date in the future at a price agreed upon today. Thus, no money is exchanged at the time of the contract. There are several dealers in the foreign exchange markets, the most important amongst them

are the banks. The banks have their branches in different countries through which the foreign exchange is facilitated, such service of a bank are called as Exchange Banks. Structure of Foreign Exchange Market The structure of the foreign exchange market constitutes central banks, commercial banks, brokers, exporters and importers, immigrants, investors, tourists. These are the main players of the foreign market, their position and place are shown in the figure below. At the bottom of a pyramid are the actual buyers and sellers of the foreign currencies- exporters, importers, tourist, investors, and immigrants. They are actual users of the currencies and approach commercial banks to buy it. The commercial banks are the second most important organ of the foreign exchange market. The banks dealing in foreign exchange play a role of “market makers”, in the sense that they quote on a daily basis the foreign exchange rates for buying and selling of the foreign currencies. Also, they function as clearing houses, thereby helping in wiping out the difference between the demand for and the supply of currencies. These banks buy the currencies from the brokers and sell it to the buyers. The third layer of a pyramid constitutes the foreign exchange brokers. These brokers function as a link between the central bank and the commercial banks and also between the actual buyers and commercial banks. They are the major source of market information. These are the persons who do not themselves buy the foreign currency, but rather strike a deal between the buyer and the seller on a commission basis. The central bank of any country is the apex body in the organization of the exchange market. They work as the lender of the last resort and the custodian of foreign exchange of the country.

The central bank has the power to regulate and control the foreign exchange market so as to assure that it works in the orderly fashion. One of the major functions of the central bank is to prevent the aggressive fluctuations in the foreign exchange market, if necessary, by direct intervention. Intervention in the form of selling the currency when it is overvalued and buying it when it tends to be undervalued. 4.3 TYPES OF FOREIGN EXCHANGE MARKET Broadly, the foreign exchange market is classified into two categories on the basis of the nature of transactions. These are: Fig 4.1 Types of foreign exchange market Spot Market: A spot market is the immediate delivery market, representing that segment of the foreign exchange market wherein the transactions (sale and purchase) of currency are settled within two days of the deal. That is, when the seller and buyer close their deal for currency within two days of the deal, is called as Spot Transaction. Thus, a spot market constitutes the spot sale and purchase of foreign exchange. The rate at which the transaction is settled is called a Spot Exchange Rate. It is the prevailing exchange rate in the market. Forward Market: The forward exchange market refers to the transactions – sale and purchase of foreign exchange at some specified date in the future, usually after 90 days of the deal. That is, when the buyer and seller enter into a contract for the sale and purchase of foreign currency after 90 days of the deal

at a fixed exchange rate agreed upon now, is called a Forward Transaction. Thus, the forward market constitutes the forward transactions in foreign exchange. The exchange rate at which the buyers or sellers settle the transactions in the forward market is called a Forward Exchange Rate. Thus, the spot and forward markets are the important kinds of foreign exchange market that often helps in stabilizing the foreign exchange rate. SPECULATION IN FOREIGN EXCHANGE MARKET “Speculation” in Foreign Exchange is an act of buying and selling the foreign currency under the conditions of uncertainty with a view to earning huge gains. Often, the speculators buy the currency when it is weak and sells when it is strong. Also, if the spot rate of the currency is expected to increase in the future, then the speculator buys forward and sell “on the spot” the currency bought by him. On the contrary, if the speculator anticipates a fall in the exchange rate, then he “sells forward” at the current rate and buy the spot when the currency is needed for the delivery. The speculation is said to have both the stabilizing and destabilizing impact on the exchange rate. Such as, if the speculator buys the currency when it is cheap and sells when it is dear, is said to have a stabilizing effect on the exchange rate. However, there is a controversy with respect to the stabilizing and destabilizing of exchange rate due to the speculative transactions. One of the controversial conditions for destabilizing speculation is that “selling a currency when it is weak, expecting it to get weaker or buying it when the price rise in the expectation that it will rise more.” However, Milton Friedman has pointed out that the speculation is said to be stabilizing, if the exchange rate were highly overvalued or undervalued and speculation drove it towards equilibrium thereby reinforcing the market movements. According to Robert Aliber, “ The speculation is said to be destabilizing if the spot and forward markets move in the same direction rather than in OPPOSITE DIRECTIONS” In a general view, if the speculation pushes the exchange rate beyond or below the critical level form where the return is impossible or disadvantageous, it is said to be destabilizing. However, the advocates of flexible exchange rate believe that the speculation cannot be destabilizing. Thus, it can be concluded from the above discussion, that when the speculator

buys the currency when it is weak and sells when it is strong, then it will be stabilizing. Types of Foreign Exchange Transactions Spot Transaction: The spot transaction is when the buyer and seller of different currencies settle their payments within the two days of the deal. It is the fastest way to exchange the currencies. Here, the currencies are exchanged over a two-day period, which means no contract is signed between the countries. The exchange rate at which the currencies are exchanged is called the Spot Exchange Rate. This rate is often the prevailing exchange rate. The market in which the spot sale and purchase of currencies is facilitated is called as a Spot Market. Forward Transaction: A forward transaction is a future transaction where the buyer and seller enter into an agreement of sale and purchase of currency after 90 days of the deal at a fixed exchange rate on a definite date in the future. The rate at which the currency is exchanged is called a Forward Exchange Rate. The market in which the deals for the sale and purchase of currency at some future date is made is called a Forward Market. Future Transaction: The future transactions are also the forward transactions and deals with the contracts in the same manner as that of normal forward transactions. But however, the transactions made in a future contract differs from the transaction made in the forward contract on the following grounds: The forward contracts can be customized on the client’s request, while the future contracts are standardized such as the features, date, and the size of the contracts is standardized. The future contracts can only be traded on the organized exchanges, while the forward contracts can be traded anywhere depending on the client’s convenience.

No margin is required in case of the forward contracts, while the margins are required of all the participants and an initial margin is kept as collateral so as to establish the future position. Swap Transactions: The Swap Transactions involve a simultaneous borrowing and lending of two different currencies between two investors. Here one investor borrows the currency and lends another currency to the second investor. The obligation to repay the currencies is used as collateral, and the amount is repaid at a forward rate. The swap contracts allow the investors to utilize the funds in the currency held by him/her to pay off the obligations denominated in a different currency without suffering a foreign exchange risk. Option Transactions: The foreign exchange option gives an investor the right, but not the obligation to exchange the currency in one denomination to another at an agreed exchange rate on a pre- defined date. An option to buy the currency is called as a Call Option, while the option to sell the currency is called as a Put Option. Thus, the Foreign exchange transaction involves the conversion of a currency of one country into the currency of another country for the settlement of payments. 4.4 ADVANTAGES OF FOREIGN EXCHANGE MARKET The biggest financial market in the world is the biggest market because it provides some advantages to its participants. Some of the major advantages offered are as follows:  FLEXIBILITY Forex exchange markets provide traders with a lot of flexibility. This is because there is no restriction on the amount of money that can be used for trading. Also, there is almost no regulation of the markets. This combined with the fact that the market operates on a 24 by 7 basis creates a very flexible scenario for traders. People with regular jobs can also indulge in Forex trading on the weekends or in the nights. However, they cannot do the same if they are trading in the stock or bond markets or their own countries! It is for this reason that Forex trading is the trading of choice for part time traders since it provides a flexible schedule with least interference in their full time jobs.

Transparency: The Forex market is huge in size and operates across several time zones! Despite this, information regarding Forex markets is easily available. Also, no country or Central Bank has the ability to single handedly corner the market or rig prices for an extended period of time. Short term advantages may occur to some entities because of the time lag in passing information. However, this advantage cannot be sustained over time. The size of the Forex market also makes it fair and efficient! 4.5 DISADVANTAGES OF FOREIGN EXCHANGE MARKET It would be a biased evaluation of the Forex markets if attention was paid only to the advantages while ignoring the disadvantages. Therefore, in the interest of full disclosure, some of the disadvantages have been listed below:  COUNTERPARTY RISKS Forex market is an international market. Therefore, regulation of the Forex market is a difficult issue because it pertains to the sovereignty of the currencies of many countries. This creates a scenario wherein the Forex market is largely unregulated. Therefore, there is no centralized exchange which guarantees the risk free execution of trades. Therefore, when investors or traders enter into trades, they also have to be cognizant of the default risk that they are facing i.e. the risk that the counterparty may not have the intention or the ability to honor the contracts. Forex trading therefore involves careful assessment of counterparty risks as well as creation of plans to mitigate them.  LEVERAGE RISKS Forex markets provide the maximum leverage. The word leverage automatically implies risk and a gearing ratio of 20 to 30 times implies a lot of risk! Given the fact that there are no limits to the amount of movement that could happen in the Forex market in a given day, it is possible that a person may lose all of their investment in a matter of minutes if they placed highly leveraged bets. Novice investors are more prone to making such mistakes because they do not understand the amount of risk that leverage brings along!  OPERATIONAL RISKS Forex trading operations are difficult to manage operationally. This is because the Forex

market works all the time whereas humans do not! Therefore, traders have to resort to algorithms to protect the value of their investments when they are away. Alternatively, multinational firms have trading desks spread all across the world. However, that can only be done if trading is conducted on a very large scale. Therefore, if a person does not have the capital or the know how to manage their positions when they are away, Forex markets could cause a significant loss of value in the nights or on weekends. 4.6 FOREIGN EXCHANGE REGULATION ACT ( FERA) The FERA (Foreign Exchange Regulation Act) deals with laws which relate to foreign exchange in India. The laws were made to manage foreign investments in India. The FERA has its origin at the time of Indian Independence. In the beginning, it was a temporary arrangement to control the flow of foreign exchange. In 1957 the act was made permanent. As the industrialization grew in India, there was an increase in the foreign exchange investments. As a result, there arose a need to protect it. Accordingly, in 1973 the Foreign Exchange Regulation Act was amended. FERA consists of 81 complex sections. Under FERA, any offence was a criminal one which included imprisonment as per code of criminal procedure, 1973. Objectives of FERA : o To prevent the outflow of Indian currency o To regulate dealings in foreign exchange and securities o To regulate the transaction indirectly affecting foreign exchange o To regulate import and export of currency and bullion o To regulate employment of foreign nationals o To regulate foreign companies  To regulate acquisition, holding etc of immovable property in India by nonresidents o To regulate certain payments . o To regulate dealings in foreign exchange and securities. o To regulate the transactions indirectly affecting foreign exchange.

Provisions of FERA : • Regulation of dealing in foreign exchange. • Restrictions on payments. • Restrictions regarding assets held by non-residents and import & export of certain currency & bullion. • Duty on persons entitled to receive foreign exchange and payment for exported goods. • Restriction on appointment of certain persons and companies as agents or technical or management advisers in India • Restriction on establishment of place of business in India • Prior permission of Reserve Bank required for taking up employment in India by nationals of foreign state • Restrictions on immovable property. Basic definitions of FERA o Authorized dealer- means a person for the time being authorized to deal in foreign exchange. o Bearer certificate- means a certificate to securities of which the title to the securities is transferable. o Coupon- means a coupon representing dividends or interest on a security. o Currency- includes all coins, currency notes, banks notes, postal notes, postal orders, money orders, cheques, drafts, traveller's cheques, letters of credit, bill of exchange and promissory notes. o Foreign currency- means any currency other than Indian currency. o Foreign exchange- means foreign currency all deposits, credits and balance payable in any foreign currency and any drafts traveller's cheque, letters of credit and bill of exchange drawn in the form of Indian currency but payable in any foreign currency. o Foreign security- means any security created or issued elsewhere than in India and any security the principal of interest on which is payable in any foreign currency or elsewhere than in India.

o Money changer- means a person for the time being authorized to deal in foreign currency. o Overseas market- means the market in the country outside India and in which such goods are intended to be sold. o Transfer- in relation to any security includes transfer by way of loan or security. Officers of Enforcement The officers of Enforcement take different roles in foreign exchange enforcement. They are as follows o Director of Enforcement o Additional Director of Enforcement o Deputy Director of Enforcement o Assistant Director of Enforcement o Officers of Enforcement can be appointed for the purposes of this Act. The appointment of enforcement officer and their powers are appointed by central government. The Central Government may appoint persons such as it thinks fit to be officers of Enforcement. Subject to conditions and limitations as the Central Government may impose an officer of Enforcement may exercise powers and discharge the duties conferred on him under this Act. Features of FERA : FERA applied to all citizens of India. The idea was to regulate the foreign payments that deal the Foreign Exchange & securities and conservation of Foreign exchange for the nation. RBI can authorize a person / company to deal in foreign exchange and also can authorize the dealers to do transact the Foreign Currencies subject to review. RBI was given power to revoke the authorization in case of non-compliancy. RBI authorizes Money Changers who will convert the currency of one nation to currency of other nation at rates determined by RBI. For whatever purpose Foreign exchange is required it has to be used only for that purpose. If he feels that he cannot use the currency for that particular purpose he would sell it to an authorized dealer within 30 days. Some of the rules and restrictions that are followed by RBI are as follows  Restrictions on import and export of certain currency

 Restrictions on payments that is illegal  Restrictions on dealing in foreign exchange  Payment for exported goods are done according to RBI  Restrictions on issue of bearer securities  Restriction on settlement in other country  Restriction on holding of immovable property outside India.  Restrictions on the appointment of certain persons and companies as agents for doing FOREX  Restrictions on establishment of place of business in India  Permission of Reserve Bank required for practicing profession, etc. in India by nationals of foreign States  Restriction on acquisition, holding, etc., of immovable property in India  RBI has the Power to call for information of any person documents like Indian currency, foreign exchange and books of account.  Power to search suspected persons and to seize documents. 4.7 SUMMARY  Foreign exchange market is the market in which foreign currencies are bought and sold. The buyers and sellers include individuals, firms, foreign exchange brokers, commercial banks and the central bank.  Functions of Foreign Exchange Market : a. Transfer Function b. Credit Function c. Hedging Function  The structure of the foreign exchange market constitutes central banks, commercial banks, brokers, exporters and importers, immigrants, investors, tourists.  The commercial banks are the second most important organ of the foreign exchange market.

 The third layer of a pyramid constitutes the foreign exchange brokers.  The central bank of any country is the apex body in the organization of the exchange market.  One of the major functions of the central bank is to prevent the aggressive fluctuations in the foreign exchange market, if necessary, by direct intervention.  Types of Foreign Exchange Market : 1. Spot Market 2. Forward Market.  Types of Foreign Exchange Transactions : 1. Spot Transaction 2. Forward Transaction 3. Future Transaction. 4. Swap Transactions. 5. Option Transactions  Foreign Exchange Regulation Act (FERA) : Foreign Exchange Regulation Act (FERA) was introduced at a time when foreign exchange (Forex) reserves of the country were low.  Authorized dealer- means a person for the time being authorized to deal in foreign exchange.  Bearer certificate- means a certificate to securities of which the title to the securities is transferable.  Coupon- means a coupon representing dividends or interest on a security.  Currency- includes all coins, currency notes, banks notes, postal notes, postal orders, money orders, cheques, drafts, traveller's cheques, letters of credit, bill of exchange and promissory notes.  Foreign currency- means any currency other than Indian currency.  Foreign exchange- means foreign currency all deposits, credits and balance payable in any foreign currency and any drafts traveller's cheque, letters of credit and bill of exchange drawn in the form of Indian currency but payable in any foreign currency.  Foreign security- means any security created or issued elsewhere than in India and any security the principal of interest on which is payable in any foreign currency or elsewhere than in India

4.8 KEY WORDS/ABBREVIATIONS Foreign Exchange Rate FX or FOREX Hedging forward Exchange Function contract Regulation ACT (FERA) Brokers Spot Market Forward Spot Forward Market Transaction Transaction Future Swap Option Authorized Currency Transaction Transactions Transactions dealer 4.9 LEARNING ACTIVITY Activity 1 : Discuss the role of FERA in India? 4.10 UNIT END QUESTIONS (MCQ AND DESCRIPTIVE) A. Descriptive Types Questions Short Answer 1. Define Foreign Exchange Market and its functions? 2. Describe the structure of Foreign Exchange Market? 3. Explain the Types of Foreign Exchange Market? 4. Describe the Types of Foreign Exchange Transactions? Long Answer 1. Describe the advantages and disadvantages of Foreign Exchange Market? 2. Discuss in detail about FERA? And its basic Definitions? 3. Explain the features of FERA?

B. Multiple Choice Questions 1. Functions of Foreign Exchange Market a. Transfer Function b. Credit Function c. Hedging Function d. All of the above. 2. The third layer of a pyramid constitutes ____ a. Foreign Exchange Brokers b. Commercial Banks c. Central Bank d. Expoters and Importers 3. The foreign exchange market is classified into a. Spot Market b. Spot Market and Forward Market c. Cash Market and Money Market d. Spot Transaction and Swap Transaction. 4._______________ means a person for the time being authorized to deal in foreign exchange. a. Authorized Dealer b. Money Changer c. Transfer d. Foreign Security. 5. ______________is the apex body in the organization of the exchange market. a. The central bank of any country. b. State Bank of any country c. Government

d. None of the above. 4.11 REFERENCES Text Books:  T1 Fabozzi - Foundations of Financial Markets and Institutions (Pearson Education,3rdEd.).  T2 Khan M Y - Financial Services (Tata Mc Graw Hill).  R1 Machiraju H R - Indian Financial System (Vikas Publication).  R2 Bhole L M - Financial Institutions and Markets (Tata McGraw-Hill).

UNIT - 5: FINANCIAL SECTOR REFORMS IN INDIA Structure 5.0. Learning Objectives 5.1. Introduction 5.2. Major Contours of the Financial Sector reforms in india 5.3. Principals of Financial sector reforms in india 5.4. Financial sector reforms in india. 5.5. Summary 5.6. Key Words/Abbreviations 5.7. Learning Activity 5.8. Unit End Questions (MCQ and Descriptive) 5.9. References 5.0 LEARNING OBJECTIVES After studying this unit, students will be able to: • Understand the financial sector reforms in India • Explain the Principals of financial sector reforms in India • Outline the important financial sector reforms in India

5.1 INTRODUCTION Financial sector refers to the part of the economy which consists of firms and institutions that have the responsibility to provide financial services to the customers of the commercial and retail segment. The financial sector can include commercial banks, non banking financial companies, investment funds, money market, insurance and pension companies, and real estate etc. The financial sector is considered as the base of the economy which is essential for the mobilization and distribution of financial resources. The financial sector reforms refer to steps taken to reform the banking system, capital market, government debt market, foreign exchange market etc. An efficient financial sector is necessary for the mobilization of households savings and to ensure their proper utilisation in productive sectors. Before 1991, the Indian financial sector was suffering from several lacunae and deficiencies which had reduced their quality and efficiency of operations. Therefore, financial sector reforms had become essential at that time. The 'Financial Sector Reforms' in India is, an integral part of the overall programme of economic reforms, aimed at improving productivity and efficiency. In India, reform of the domestic financial sector did not fomn part of the initial set of reforms, but events quickly moved it to forefront. Today, financial sector restructuring, liberalisation and deregulation have become more prominent on the refom agenda. In any financial sector reform, the institutions immediately affected are the 'Banks', since they typically dominate the financial systems, in the eariy stages of financial development. Banks are central to providing short-term financing to the various economic entifies. Banks are also distinguishable from other financial institutions by a unique characteristic, which gives them power to provide means of payment in non-cash transactions. As the reform of the financial system takes its root, it is the banking system which comes to face increasing competition from non-banks and the capital markets. A major lesson to be learnt from the experiences of the other countries which have gone through a programme of financial sector reform, is that, reforms are successful, only if they are accompanied by fiscal consolidation, moderate inflation and no sharp appreciation's in the real effective interest rate. The problem which the financial sector reforms, ran into in the Southern cone countries were, because of uncontrolled inflation and sharp appreciation in real exchange rate. In those circumstances, interest rate deregulation faced even more difficulties. Also, in those countries no effective prudential guidelines had been put in place either prior to or simultaneously with the

introduction of the reforms. On the contrary, the Indian Financial Sector Reforms has gone, hand in hand with fiscal reforms, trade reforms and exchange rate reforms. The 3 major building blocks of the financial sector reform in India have been ;- 1. Removing or relaxing the external constraints; 2. Introduction of prudential norms; and 3. Institutional strengthening. The chief merit of reform process, has been the cautions sequencing of reforms and the consistent and the mutually reinforcing character of the various measures taken. Even as the new prudential norms are being introduced, the capital base of the banks has been strengthened and orgnisational improvements are being put in place. Through these reform measures, foundation for an efficient and a wellfunctioning banking system is laid dovm. A renewed and a reinvigorated banking system can play an important role in accelerating economic growth. Banking system is on the threshold of a second revolution. It has, however miles to go. But the steps that are being taken, are in right direction. 5.2 MAJOR CONTOURS OF THE FINANCIAL SECTOR REFORMS IN INDIA On a general understanding, there are three groups of reform measures that are used to handle the problems faced by the financial sector. These are that of removal of financial repression, rehabilitation of the banking system and lastly, deepening and development of capital markets. The focal issues addressed by financial sector reforms in India have primarily aimed to include the following: Removal of the problem of financial repression. Creation of an efficient, profitable and healthy financial sector. Enabling the process of price discovery by market determination of interest rates which leads to an improvement in the efficiency in the allocation of resources.

Providing institutions with greater operational and functional autonomy. Prepping up the financial system for international exposure and competition. Introduction of private equity in public sector banks and their listing. Opening up of the external sector in a regulated manner. Promoting financial stability in the back-drop of domestic and external shocks. Objectives of Financial Sector Reforms in India The primary objective of financial sector reforms in the 1990s was to create an efficient, competitive and stable that could contribute in greater measure to stimulate growth. Economic reform process took place amidst two serious crises involving the financial sector: a) The crisis involving the balance of payments that had threatened the international credibility of the country and dragged it towards the brink of default. b) The crisis involving the grave threat of insolvency threatening the banking system which had concealed its problems for years with the aid of defective accounting policies. Apart from the above two dilemmas, there were many deeply rooted problems of the Indian economy in the early 1990s which were strongly related to the finance sector. Prevalent among these were: Till the early 1990s, the Indian financial sector could be described as an example of financial repression. The sector was characterized by administered interest rates fixed at unrealistically low levels, large pre-emption of resources by authorities and micro regulations which direct the major flow of funds back and forth from the financial intermediaries. The act of the government involving large scale pre-emption of resources from the banking system to finance its fiscal deficit. More than necessary structural and micro-regulation that inhibited financial innovation and increased transaction costs. Relatively inadequate level of prudential regulation in the financial sector. Inadequately developed debt and money markets. Obsolete and out-dated technological and institutional structures that lead to the consequent inefficiency of the capital markets and the rest of the financial system.

Till the early 1990s, the Indian financial system was characterized by extensive regulations viz. administered interest rates, weak banking structure, directed credit programmes, lack of proper accounting, risk management systems and lack of transparency in operations of major financial market participants. Furthermore, this period was characterized by the restrictive entry of foreign banks since after the nationalization of banks in 1969 and 1980, almost 90 per cent of the banking assets were under the control of government owned banks and financial institutions. The financial reforms initiated in this era attempted to overcome these weaknesses with the view of enhancing efficient allocation of resources in the Indian economy. The Reserve Bank of India had been making efforts since 1986 to develop efficient and healthy financial markets which were accelerated after 1991. RBI focused on the development of financial markets especially the money market, government securities market and the forex markets. Financial markets also benefited from close coordination between the Central Government and the RBI as also between the other regulators. 5.3 PRINCIPLES OF FINANCIAL SECTOR REFORMS IN INDIA Former RBI Governor, Dr. Y.V. Reddy has stated that the financial sector reforms in India are based on Punch-sutra or five principles which are explained as follows: Introduction of various measures by cautious and gradual phasing thus giving time to various agents to carry out the necessary norms. For instance, the gradual introduction of prudential norms. Mutually reinforcing measures, that would serve as enabling reforms which would not in anyway disrupt the confidence in the system. E.g. Improvement in the profitability of banks by the combined reduction in refinance and Cash Reserve Ratio. Complementary nature of the reforms in the banking sector with other commensurate changes in fiscal, external and monetary policies. Development of the financial infrastructure in terms of technology, changing legal framework, setting up of a supervisory body, and laying down of audit standards. Introducing initiatives to nurture, integrate and develop money, Forex and debt market so as to give an equal opportunity to all major banks to develop skills and to participate.

Reasons for financial sector reforms in India After independence, India inherited various deprivations and problems due to colonial legacy. The country was lagging behind in social as well as economic affairs. To attain the goal of rapid economic development, India adopted the system of planned economy based on the Mahala Nobis model. This model had started showing its limitations in the mid-80s and early nineties. The government adopted the strategy of fiscal activism for economic growth and large doses of public expenditure were financed by heavy borrowings at concessional rates. This was responsible for comparatively weak and underdeveloped financial markets in India. Due to the policy of Fiscal activism, the fiscal deficit increased year after year. The policy of automatic monetization of Fiscal deficit had inflationary tendencies and other negative impacts on the economy. The nationalisation of Banks had given complete control over these banks to the government, which resulted in the limited role of market forces in the financial sector. The growth rate was hovering around 3.5 % per annum before 1980, and it reached around 5% in the mid-1980s. This growth rate was proving insufficient to solve the economic and financial problems of the country. Lack of transparency and professionalism in the banking sector and issues of red- tapism had been responsible for the increase of non performing assets. There were issues of inadequate level of proper Regulation in the financial sector. The technologies used in the financial system and their institutional structures were outdated. By 1991, India was facing several economic problems. The war in the Middle East and the fall of USSR had put pressure on the Foreign Exchange Reserves of India. India was facing the balance of payment crisis and reforms were now inevitable. The Strategy Adopted By India For Financial Sector Reforms To initiate financial reforms, India adopted the path of gradual reforms instead of Shock Therapy. This was necessary to ensure continuity and stability of the financial sector in India. India incorporated International best practices at the same time adjusted it as per the

local requirements. The first generation reforms aimed to create an efficient and profitable financial sector by ensuring flexibility to operate with functional autonomy. The second generation reforms were incorporated to strengthen the financial system through structural improvements. India adopted the policy of consensus driven approach for liberalisation as this was necessary for a democracy. 5.4 FINANCIAL SECTOR REFORMS IN INDIA Narasimham Committee report, 1991 : The Narasimham committee was established in August 1991 to give comprehensive recommendations on the financial sector of India including the capital market and banking sector. The major recommendations made by the committee are To reduce the cash reserve ratio CRR and the statutory liquidity ratio SLR- The committee recommended reducing CRR to 10% and SLR to 25% over the period of time. Recommendations on priority sector lending- the committee recommended to include marginal farmers, small businesses cottage industries etc in the definition of priority sector. The committee recommended for fixing at least 10% of the credit for priority sector lending. Deregulation of interest rates- the committee recommended deregulating the interest rates charged by the banks. This was necessary to provide independence to the banks for setting the interest rates themselves for the customers. The committee recommended to set up tribunals for recovering loans of non- performing assets etc. It gave recommendations on asset quality classifications. The committee recommended for entry of new private banks in the banking system.

Banking sector reforms Changes in CRR and SLR: One of the most important reforms includes the reduction in cash reserve ratio (CRR) and statutory liquidity ratio (SLR). The SLR has been reduced from 39% to the current value of 19.5%. The cash reserve ratio has been reduced from 15 % to 4%. This reduction in the SLR and CRR has given banks more financial resources for lending to the agriculture, industry and other sectors of the economy. Changes in administered interest rates: Earlier, the system of administered interest rate structure was prevalent in which RBI decided the interest rate charged by the banks. The main purpose was to provide credit to the government and certain priority sectors at concessional rates of interest. The system has been done away and RBI no longer decides interest rates on deposits paid by the banks. However, RBI regulates interest on smaller loans up to Rs 2 lakhs on which the interest rate should not be more than the prime lending rates. Capital Adequacy Ratio: The capital adequacy ratio is the ratio of paid- up capital and the reserves to the deposits of banks. The capital adequacy ratio of Indian banks had not been as per the international standards. The capital adequacy of 8% on the risk-weighted asset ratio system was introduced in India. The Indian banks had to achieve this target by March 31, 1994, while the foreign Bank had to achieve this norm by 31st March 1993. Now, Basel 3 norms are introduced in India. Allowing private sector banks: after the financial reforms, private banks we are given life and HDFC Bank, ICICI Bank, IDBI Bank, Corporation Bank etc. were established in India. This has brought much needed competition in the Indian money market which was essential for the improvement of its efficiency. Foreign banks have also been allowed to open branches in India and banks like Bank of America, Citibank, American Express opened many new branches in India. Foreign banks were allowed to operate in India using the following three channels:  As foreign bank branches,  As a subsidiary of a foreign bank which is wholly owned by the foreign Bank,  A subsidiary of a foreign bank within maximum foreign investment of 74%

Reforms related to non performing assets (NPA): non performing assets are those loans on which the loan installments have not been paid up for 90 days. RBI introduced the recognition income recognition norm. According to this norm, if the income on the assets of the bank is not received in two quarters after the last date, the income is not recognised. Recovery of bad debt was ensured through Lok adalats, civil courts, Tribunals etc. The Securitisation And Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act was brought to handle the problem of bad debts.  Elimination of direct or selective credit controls: earlier, under the system of selective or direct credit control, RBI controlled the credit supply using the system of changes in the margin for providing a loan to traders against the stocks of sensitive commodities and to the stockbrokers against the shares. This system of direct credit control was abolished and now the banks have greater freedom in providing credit to their customers.  Promotion of microfinance for financial inclusion: for the promotion of financial inclusion, microfinance scheme was introduced by the government, and RBI the gave guidelines for it. The most important model for microfinance has been the Self Help Group Bank linkage programme. It is being implemented by the regional rural banks, cooperative banks, and Scheduled commercial banks. Reforms in the government debt market  The policy of automatic monetization of the fiscal deficit of government was phased out in 1997 through an agreement between the government and RBI. Now the government borrows money from the market through the auction of government securities.  The government borrows the money at market determined interest rates which have made the government cautious about its fiscal deficits.  The government introduced treasury bills for 91 days for ensuring liquidity and meeting short-term financial needs and for benchmarking.  Foreign institutional investors were now allowed to invest their funds in the government securities.  The government introduced the system of delivery versus payment settlement for

ensuring transparency in the system.  The system of repo was introduced for dealing with short term liquidity adjustments. Role of regulators  Importance of the role of the regulator was recognised and RBI became more independent to take decisions. More operational autonomy was granted to RBI to fulfill its duties.  The Securities and Exchange Board of India (SEBI) became an important institution in managing the securities market of India.  The insurance regulatory and Development Authority was an important institution for initiating reforms in the Insurance sector. Its responsibilities include the Regulation and supervision of the Insurance sector in India. Reforms in the foreign exchange market Since 1950s, India had a highly controlled foreign exchange market and foreign exchange was made available to the Reserve Bank of India in a very complex manner. The steps taken for the reform of the foreign exchange market were:  In 1993, India moved towards market based exchange rates, and the current account convertibility was now allowed. The commercial banks were allowed to undertake operations in foreign exchange.  The Rupee foreign currency swap market has been developed. New players are now allowed to enter this market and undertake currency swap transactions subject to certain limitations.  The authorised dealers of foreign exchange were now given the permission for activities such as initiating trading positions, borrowing and investing in foreign markets etc. subject to certain limitations and regulations.  The foreign exchange Regulation Act, 1973 was replaced by the foreign exchange management Act, 1999 for providing greater freedom to the exchange markets.  The foreign institutional investors and non-resident Indians were allowed to trade in the exchange-traded derivatives contracts subject to certain regulations and limitations. Other important financial sector reforms  Some important steps were taken for the non-banking financial companies for the

improvement of their productivity, efficiency, and competitiveness. Many of the non- banking financial companies have been brought under the regulation of Reserve Bank of India. Many of the other intermediaries were brought under the supervision of the Board of Financial Supervision.  In 1992, the Monopoly of UTI was ended and mutual funds were opened for the private sector. The mutual fund industry is now controlled by the SEBI Mutual Funds regulations, 1996 and its amendments.  In 1992, the Indian capital market was opened for the foreign institutional investors in all the securities.  Electronic trading was introduced in the National Stock Exchange (NSE) established in 1994, and later on in the Bombay Stock Exchange (BSE) in 1995. Assessment of financial sector reforms  After the financial sector reforms, the resilience and stability of Indian economy have increased. The growth rate up the economy has increased from around 3.5 % to more than 6% per annum.  The country has been able to deal with the Asian economic crisis of 1977- 98 and the recent Global subprime crisis which affected the banking system of the world but did not have much impact on the economy of India.  The banking sector and Insurance sector have grown considerably. The entry of private sector banks and foreign banks brought much-needed competition in the banking sector which has improved its efficiency and capability.  The Insurance sector has also transformed over the period of time. All these have benefited the customer with diversified options.  The stock exchanges of the country have seen growth and stability, and it has adopted the international best practices.  RBI has effectively regulated and managed the growth and operations of the non- banking financial companies of India.  The budget management, fiscal deficit, and public debt condition have improved after the financial sector reforms. The country is moving with more such future reforms in different sectors of the economy.  However, all the issues of Indian economy have not been resolved. The social sector

indicators such as the provision of health facilities, quality of education, empowerment of women etc have not been at par with the economic growth.  Further, the new issues like the recent rise in non-performing assets of banks, slow growth of investments in the economy, the issues of jobless growth, high poverty rate, a much lower growth rate in the agriculture sector etc need to be resolved with more concrete efforts 5.5 SUMMARY  The financial sector reforms refer to steps taken to reform the banking system, capital market, government debt market, foreign exchange market etc.  The primary objective of financial sector reforms in the 1990s was to create an efficient, competitive and stable that could contribute in greater measure to stimulate growth.  Till the early 1990s, the Indian financial sector could be described as an example of financial repression.  Till the early 1990s, the Indian financial system was characterized by extensive regulations viz. administered interest rates, weak banking structure, directed credit programmes, lack of proper accounting, risk management systems and lack of transparency in operations of major financial market participants.  The Reserve Bank of India had been making efforts since 1986 to develop efficient and healthy financial markets which were accelerated after 1991.  Former RBI Governor, Dr. Y.V. Reddy has stated that the financial sector reforms in India.  After independence, India inherited various deprivations and problems due to colonial legacy. The country was lagging behind in social as well as economic affairs.  The nationalisation of Banks had given complete control over these banks to the government, which resulted in the limited role of market forces in the financial sector.  The growth rate was hovering around 3.5 % per annum before 1980, and it reached around 5% in the mid-1980s. This growth rate was proving insufficient to solve the economic and financial problems of the country.  To initiate financial reforms, India adopted the path of gradual reforms instead of Shock Therapy. This was necessary to ensure continuity and stability of the financial sector in India.  The first generation reforms aimed to create an efficient and profitable financial sector by

ensuring flexibility to operate with functional autonomy.  The second generation reforms were incorporated to strengthen the financial system through structural improvements.  India adopted the policy of consensus driven approach for liberalisation as this was necessary for a democracy.  The Narasimham committee was established in August 1991 to give comprehensive recommendations on the financial sector of India including the capital market and banking sector. 5.6 KEY WORDS/ABBREVIATIONS Globalisation Liberalization Financial Banking Electronic Sector reforms Reforms trading Foreign Capital cash reserve statutory Exchange Adequacy ratio (CRR) liquidity ratio Market reforms Ratio (SLR) 5.7 LEARNING ACTIVITY Activity 1 : What do you analyse as the impact of 1991 policy reforms on India's private banks? Activity 2 : “Is globalization good?” Discuss and evaluate. 5.8 UNIT END QUESTIONS (MCQ AND DESCRIPTIVE) A. Descriptive Types Questions Short Amswer 1.Describe the 'Financial Sector Reforms' in india?

2. Describe the Major contours of the financial sector reforms in india? 3. Explain the Objectives and Principles of financial sector reforms in india? Long Answer 1. Explain why financial sector reforms happened in India? And its need? 2. Explain the strategy adopted by india for its reforms in financial sector? 3. Explain in Detail about the Banking Sector reforms in india? B. Multiple Choice Questions 1. How many components are there in Indian financial system? a. 3 b. 6 c. 1 d. 4 2. Which term describes the co-existence of formal and informal financial sectors in developing countries? a. Financial Dualism b. Financial Derivatives c. Financial Regulators d. Financial Instruments 3. Which of the following is a part of formal financial system? a. Financial services b. Informal financial system c. Moneylenders d. Landlords 4. help financial markets and financial intermediaries to channelise funds from lenders to borrowers. a. Financial Derivatives

b. State owned banks c. Financial Instruments d. Financial Regulators 5. Which the following statements is false? a. Financial markets are a mechanism enabling participants to deal in financial claims. b. Financial instruments differ in terms of marketability, liquidity, type of option return, risk and transaction costs. c. Financial regulation is a kind of supervision, which subjects financial institutions to certain requirements, restrictions and guidelines, aiming to maintain the integrity of the financial system. d. Financial markets help the financial instruments in performing the crucial function of channelising funds from lenders to borrowers. 6. Investors arereassured by who regulate the conduct of the financial market and intermediaries to protect investors’ interests. a. Finance Minister b. State Government c. Financial regulators d. Insurance agents 7. Which of the following statements is true? a. A financial system acts as a link between borrowers and investors thereby helping and mobilising savings efficiently and effectively. b. A financial system acts as a link between savers and borrowers thereby helping and mobilising savings efficiently and effectively. c. A financial system acts as a link between savers and investors thereby helping and mobilising savings efficiently and effectively. d. A financial system acts as a link between insurers and investors thereby helping and mobilising savings efficiently and effectively.

8. There are types of financial markets. a. 2 b. 3 c. 4 d. 5 9. Financial systems help overcome an information between borrowers and lenders. a. symmetry b. asymmetry c. scarcity d. sustainability 10. laid the theoretical grounds for the relationship between financial development and economic growth. a. Narsimhan b. McKinnon and Shaw c. Montgomery d. Dave 5.9 REFERENCES Text Books: T1 Fabozzi - Foundations of Financial Markets and Institutions (Pearson Education,3rdEd.). T2 Khan M Y - Financial Services (Tata Mc Graw Hill). Reference Books: R1 Machiraju H R - Indian Financial System (Vikas Publication). R2 Bhole L M - Financial Institutions and Markets (Tata McGraw-Hill)

UNIT - 6: OVERVIEW OF FINANCIAL SERVICES Structure 6.0. Learning Objectives 6.1. Introduction 6.2. Nature of Financial Services 6.3. Scope of Financial Services 6.4. Importance and Features of Financial System 6.5. Types of Financial Services 6.6. Summary 6.7. Key Words/Abbreviations 6.8. Learning Activity 6.9. Unit End Questions (MCQ and Descriptive) 6.10. References 6.0 LEARNING OBJECTIVES After studying this unit, students will be able to: • Describe the Nature of Financial Services • Explain the Scope of Financial Services • Describe the Importance of Financial Services • Explain the features of Financial services • Outline the types of Financial services

6.1 INTRODUCTION The term “financial services” in a broad sense mean “mobilizing and allocating saving”. Thus, it includes all activities involved in the transformation of saving into investment. The term ‘financial service’ is not defined in any statute. Financial services generally means (i) services rendered by banking and non-banking finance companies regulated by the Reserve Bank of India (“RBI”), established under the Reserve Bank of India Act, 1934 (“RBI Act”), (ii) insurance companies regulated by the Insurance Regulatory and Development Authority (“IRDA”) which is a body established under the Insurance Regulatory and Development Authority Act, 1999 (“IRDA Act”) and (iii) other entities regulated by the Securities and Exchange Board of India (“SEBI”), which is a body established under the Securities and Exchange Board of India Act, 1992 (“SEBI Act”). The present situation of the financial services sector in India can be broadly represented as follows: a. RBI, at the apex; b. Commercial banks, which includes, public sector banks and private sector banks; c. Developmental financial institutions, which can be divided into, all India institutions and state level institutions; Insurance companies, which can be classified as, Life Insurance Corporation of India, general insurance corporation of India and private sector insurance companies; e. Other public sector financial institutions, like, post office savings bank, National Bank for Agriculture and Rural Development, National Housing Bank Export Import Bank of India and Small Industries Development Bank of India; f. Mutual funds, like, Unit Trust of India and other mutual funds; g. Non-banking finance corporations, which may be public sector firms or private sector firms; h. Asset reconstruction companies; i. Capital market intermediaries; and j. Credit information companies. Financial services are the economic services provided by the finance industry, which encompasses a broad range of businesses that manage money, including credit unions, banks, creditcard companies, insurance companies, accountancy companies, consumer-finance companies, stock brokerages, investment funds, individual managers and some government-sponsored enterprises.

6.2 NATURE OF FINANCIAL SERVICES  Customer Oriented: Financial services are customer-focused services that are offered as per the requirements of customers. Financial institutions properly study customer needs before designing and offering such services. They are meant to fulfill the specific needs of a customer which differs from person to person.  Intangibility: These services are intangible which makes their marketing a challenging task for financial institutions. Such institutions need to focus on building their brand image by providing innovative and quality products to customers. Firms enjoying better credibility in market are easily able to sell off their products.  Inseparable: Financial services are produced and delivered at the same time simultaneously. These services are inseparable and can’t be stored in advance. Here production and supply function both occurs at the same time.  Manages Fund: Financial services are specialized at managing funds of people. These services enable peoples in allocating their idle lying funds into useful means for earning revenues. Financial services provide various means to people for converting their savings into investment.  Financial Intermediation: These services does the work of financial intermediation as it brings together the lender and borrower. Financial services mobilize the funds of people who are having enough of it and made it available to the one who are in need of it.  Market Based: Financial services are market based which changes as per the changing conditions. It is a dynamic activity which varies as per the variations in socio-economic environment and varying needs of customers.  Distributes Risk: Risk distribution is the key feature offered by financial services. These services transfer the risk of an individual not willing to take among different

persons who all are willing to bear it. Financial institutions diversify the risk and secure people against damages by providing them various insurance policies. 6.3 SCOPE OF FINANCIAL SERVICES Financial services cover a wide range of activities. They can be broadly classified into two, namely : i. Traditional. Activities ii. Modern activities Traditional Activities : Traditionally, the financial intermediaries have been rendering a wide range of services encompassing both capital and money market activities. They can be grouped under two heads, viz. a. Fund based activities and b. Non-fund based activities. Fund based activities : The traditional services which come under fund based activities are the following : i. Underwriting or investment in shares, debentures, bonds, etc. of new issues (primary market activities). ii. Dealing in secondary market activities. iii. Participating in money market instruments like commercial papers, certificate of deposits, treasury bills, discounting of bills etc . iv. Involving in equipment leasing, hire purchase, venture capital, seed capital, dealing in foreign exchange market activities. Non fund based activities :  Financial intermediaries provide services on the basis of non-fund activities also.  This can be called 'fee based' activity. Today customers, whether individual or corporate, are not satisfied with mere provisions of finance.