MOFS

UNIT-1
Financial Services:-
Financial Institutions
Institutions that provide credit and credit related services are called financial institutions.
 FIs act as saving mobilisers by transferring funds from surplus to deficit units.
 FIs are major participants of financial system.
 FIs deal in financial resources by accepting deposits from individuals and institutions and
lending them to trade and industry.
 FIs also deal in financial assets and investment in securities.
 FIs buy and sell financial instruments and generate these new instruments.
 FIs are regulated by SEBI, RBI etc.
 FIs include: 1. Banking Institutions and 2. Non Banking Institutions as LIC,
UTI etc.
 FIs also include specialized financial institutions as NABARD, EXIM etc.

Financial Services
The functions and services that are provided by the financial institutions in a financial system
are called financial services. Financial services rendered by the financial intermediaries’ reduce
the gap between unaware and amateur investors and mounting sophistication of financial
market and instruments.
 Financial Services aid in obtaining funds and finances as well as distribution
of the same.
 FS are rendered by Stock Exchanges, Financial Institutions, Banks,
Insurance Companies etc.
 FS are goverened by SEBI, RBI, Dept. of Banking and Insurance, GOI.

Financial Markets
Financial markets help in purchase and sale of financial claims, assets, services
and securities.
 FMs transfer funds from surplus to deficit units.
 Banking and NBFIs, dealers, borrowers, lenders, investors, depositors and
agents are the players of FMs.

Financial Instruments
Financial claims such s financial assets and securities dealt in the financial market are called
financial instruments.
 These allow faster conversion into cash
 These can be pledged for taking loans
 Easily tradable and marketable
 These are short term, medium term and long term.
 Buying and selling them involves transaction cost.

FINANCIAL SERVICES: MEANING

Financial Services constitute one of the most significant components of the Financial System.
Services that are financial in nature are known as financial services. These services are given by
banks, FIs, Insurance companies and other intermediaries in the financial market. These cater to
the needs of individuals, companies as well as institutions. The efficiency of financial system is
determined to quite an extent on the quality of financial services.

FINANCIAL SERVICES: OBJECTIVES

1. Mobilization of funds: Financial services help to raise funds from the individuals,
companies and institutions. Various financial instruments help to pool these funds as equities,
bonds, mutual funds.

2. Deployment of funds: Large number of financial services is available in the financial

markets which help in utilization of funds. Funds may be used for the purpose of rendering
services as factoring, credit rating, securitization, bill discounting etc. Financial services also
help to decide the financial mix.

3. Providing specialized need based services: But for traditional services like banking and
insurance, financial services include credit ratings, factoring, securitization, book building,
merchant banking housing finance etc. Specific institutions as banks, insurance companies,
stock exchanges, Non Banking Finance Companies etc. provide these services.

4. Regulation of services: These services are governed by the statutory bodies of the country as
Reserve Bank of India, Securities Exchange Board of India, Department of Banking and
Insurance of the Government of India with rules and legislations.

5. Economic development: Financial Services help in the economic growth of the country.
These mobilize the savings of vast population and channelize the same into proper productive
avenues. This leads to capital formation and increased GDP and growth of a country.

FINANCIAL SERVICES: FEATURES

1. Intangible: Financial services are invisible in nature. Unlike a tangible financial product they
do not bear a form. They are dependent on the innovativeness, attractiveness and quality of the
supplier.

2. Inseparable: Financial services cannot be separated from the supplier. Eg: credit ratings
have to be obtained from the credit rating agencies only.

3. Customer focused: Financial services are rendered as per the need of the customer. These
have to be tailor made to suit the requirements of individual customer.
4. Heterogeneous: Even if the financial product is the same, services have to be provided
keeping into mind the nature, type and geographical location of the receiver. Same set of
services would not serve the purpose of all.

5. Dynamic: The nature, quality and quantum of financial services change with the change in
the environment. For instance, services like factoring and securitization are of recent origin.

FINANCIAL SERVICES: TYPES

Financial Services can be categorized into
two:
1. Asset/ Fund based services: Fund based income come mainly from interest, lease rentals
etc. because these involve provision of funds against assets, bank deposits etc. The following
are the fund based services:

i) Lease financing: Lease financing is one of the important sources of medium- and long-term
financing where the owner of an asset gives another person, the right to use that asset against
periodical payments.
The owner of the asset is known as lessor and the user is called lessee. The periodical payment
made by the lessee to the lessor is known as lease rental. Under lease financing, lessee is given
the right to use the asset but the ownership lies with the lessor and at the end of the lease
contract, the asset is returned to the lessor or an option is given to the lessee either to purchase
the asset or to renew the lease agreement.

ii) Hire purchase: Hire purchase is a method of providing finance for the purchase of fixed
asset to be acquired on future date. Under this method of financing, the cost price is paid
gradually in installments. Ownership of the asset purchased is transferred only after the
payment of the last
installment, though the right to use emerges immediately.

Bill discounting: Discounting of bills is an attractive fund based

iii)
financial
service provided by the finance companies. “Bill of Exchange is a written, unconditional order
by one party (the drawer) to another (the drawee) to pay a certain sum, either immediately (a
sight bill) or on a fixed date (a term bill), for payment of goods and/or services received”. The
drawee accepts the bill by putting his signature on it. This way he rather converts it into a post
dated cheque and enters into a binding contract. Discounting of bill is a very convenient and
prominent form of financing as the bank lends advance money without asking for any collateral
security.

iv) Venture capital: Venture capital (VC) is the finance given to budding
entrepreneurs who are in early-stage or emerging stage of growth. The venture capital funds
lend money against their investment in companies’ equity capital. It is perceived that these
ventures have high potential for future growth and that is the major reason as to why venture
capitalist undertakes the risk of providing money to the untried businessmen. The entrepreneurs
favor it as their startup proects do not have access to capital markets. It engulfs high risk for the
investor, but it has the ability of earning above-average returns.

v) Housing finance: Housing finance is the financial access that provides for the building and
construction of housing facilities. It refers to the finance that is used to make and maintain the
nation’s housing stock. But it also includes the money that is needed to pay for it, in the form of
rents, mortgage loans and repayments.

2. Non fund/ fee based services: these services are primarily advisory in nature and the
financial institution charges a fee for rendering them. These include the following:

i) Merchant Banking: Merchant banking refers to giving financial advice and services on the
issues of portfolio construction and portfolio management to the big corporations and rich
individuals. The main activities included in merchant banking service offered by the bank to its
clients are: Issue Management, Payment of Dividend Warrants and Interest Warrants, Refund
Orders; Debenture Trustee; Underwriting function and acting as a Monitoring Agency etc.
Grindlays Bank was the first one to set up Merchant Banking Division in 1969 in India. Then
many other foreign banks followed suit. State Bank of India also started rendering this service
in 1973.

ii) Credit Rating: Credit rating is an evaluation of the credit worthiness of a customer either in
general terms or with respect to a specific debt or financial obligation. A credit rating can be
assigned to an entity that intends to borrow or raise finance/ money and largely includes an
individual, corporate, state or provincial authority, or sovereign government.

iii) Stock Broking: A stockbroker is a middleman who is a professional individual and is

attached with a brokerage firm or broker-dealer. His main function is to buy and sell stocks and
other securities for both his retail and institutional clients. He performs this activity through a
stock exchange as well as over the counter. His remuneration includes a fee or commission. In
order to give a push to the resource mobilization process in the country stock broking has
emerged as a very important financial service. SEBI is the chief governing body of this
financial service.

FINANCIAL SERVICES: IMPORTANCE

i) It serves as a bridge between saving-surplus and saving-deficits.
ii) Financial services help in pooling the resources of vast spread population.
iii) Financial services help to put the pooled resources into productive use.
iv) Financial services have helped to improve the process of capital formation thereby
leading to economic development.
v) Financial services bring the other three components of the financial system viz.
financial institutions, financial markets and financial instruments into action and use.

Indian and Global Perspective:-

India has a diversified financial sector undergoing rapid expansion, both in terms of strong
growth of existing financial services firms and new entities entering the market. The sector
comprises commercial banks, insurance companies, non-banking financial companies, co-
operatives, pension funds, mutual funds and other smaller financial entities. The banking
regulator has allowed new entities such as payment banks to be created recently, thereby adding
to the type of entities operating in the sector. However, the financial sector in India is
predominantly a banking sector with commercial banks accounting for more than 64% of the
total assets held by the financial system.

The Government of India has introduced several reforms to liberalise, regulate and enhance this
industry. The Government and Reserve Bank of India (RBI) have taken various measures to
facilitate easy access to finance for Micro, Small and Medium Enterprises (MSMEs). These
measures include launching Credit Guarantee Fund Scheme for MSMEs, issuing guidelines to
banks regarding collateral requirements and setting up a Micro Units Development and
Refinance Agency (MUDRA). With a combined push by Government and private sector, India
is undoubtedly one of the world's most vibrant capital markets.

ADVANTAGE:-

GROWING DEMAND
*Rising income is driving the demand for financial services across income brackets.

*Investment corpus in Indian insurance sector might rise to US$ 1 trillion by 2025.

*With >2,100 fintechs operating currently, India is positioned to become one of the largest
digital markets with rapid expansion of mobile and internet.

INNOVATION
*India benefits from a large cross-utilization of channels to expand reach of financial services.

*Emerging digital gold investment options.

*In the Union Budget 2022-23 India announced plans for a central bank digital currency
(CBDC) which will be known as Digital Rupee.

POLICY SUPPORT
*The government has approved 100% FDI for insurance intermediaries and increased FDI limit
in the insurance sector to 74% from 49% under the Union Budget 2021-22.

GROWING PENETRATION
*Credit, insurance and investment penetration is rising in rural areas.

*HNWI participation is growing in the wealth management segment.

*Lower mutual fund penetration of 5-6% reflects latent growth opportunities.

India’s financial services industry has experienced huge growth in the past few years. This
momentum is expected to continue. India’s private wealth management Industry shows huge
potential. India is expected to have 6.11 lakh HNWIs by 2025. This will indeed lead India to be
the fourth largest private wealth market globally by 2028. India’s insurance market is also
expected to reach US$ 250 billion by 2025. This will further offer India an opportunity of US$
78 billion of additional life insurance premiums from 2020-30.

GLOBAL PERSPECTIVE:-
International financial services and the role of GATS:-
The Uruguay Round of trade negotiations has paved the way for the deregulation of financial
services in many developing and developed countries and has led to a significant increase in the
volume of international financial services activities. It is noteworthy that further negotiations on
trade in financial services continued, after the completion of the Uruguay Round, with a new
Agreement reached under the General Agreement on Trade in Services (GATS) in December
1997. The Agreement covers

Trade in financial services:-

While in the past, national statistics used to register fees and commissions of financial
institutions as trade in financial services predominantly, this definition was broadened due to
the increasingly integrated financial markets and changes in the role of the financial institutions.
International financial services now cover three distinct elements of the current account balance
of payments of countries. These three categories, listed below, are well articulated in the work
of the OECD (1989)

Typology of international financial services:-

GATS has accepted four types of trade in financial services. These categories have been
articulated by Moshirian (1994b). While in the past, national statistics did not adequately collect
the appropriate data for trade in financial services (see Arndt, 1984; Moshirian, 1993), data
collection for international financial services improved in the 1990s and hence a large majority
of the following four international financial services activities are captured in the national
statistics of the OECD

Comparative advantage in financial services:-

The modern trade theories have been used to test for the existence of factor intensity and factor
endowment envisaged in the Heckscher–Ohlin–Samuelson (H–O–S) theory as well as other
new factors that have been identified in the 1960s and 1970s as the major sources of
comparative advantage in goods. The same empirical testing has been conducted in the area of
financial services by Moshirian (1994a) who used the modern trade theories including factor
intensity, factor endowment and technology in

The role of FDI in international financial services:-

The earlier studies of trade in goods such as Caves (1981) and Balassa and Bauwens (1987)
demonstrated that FDI is a substitute for trade and hence these two activities should be treated
as substitutes for each other. However, as multinational corporations have become the main
players in the global economy, Helpman (1984) and Helpman and Krugman (1985) developed a
trade theory in the presence of IIT in which FDI was an integral part of generating more
international trade.

Future challenges for Indian banks:-

Improving Risk Management System:- RBI had issued guidelines on asset liability
management and Risk Management Systems in Banks in 1999 and Guidance Notes on Credit
Risk Management and Market Risk Management in October 2002 and the Guidance note on
Operational Risk Management in 2005. Though Basel II focuses significantly on risks it
implementation cannot be seen as an end in itself. The current business environment demands
an integrated approach to risk management. It is no longer sufficient to manage each Risk
Independently. Banks in India are moving from the individual segment system to an enterprise
wide Risk Management System. This is placing greater demands on the Risk Management skills
in Banks and has brought to the forefront, the need for capacity building, while the first priority
would be risk integrating across the entire Bank, the desirability of Risk aggregation across the
Group will also need attention. Banks would be required to allocate significant resources
towards this objective over the next few years.

Rural Coverage:- Indian local banks specially state bank groups having a good coverage and
many branches in rural areas. But that is quite lacking technical enhancement. The services
available at cities are specifically not available to rural branches, which are necessary if banks
want to compete now a day.

Technological Problems:- That is true that Indian banks were already started computerized
workings and so many other technological up gradation done but is this sufficient? In metro
cities Indian local banks are having good comparable technology but that cannot be supported
and comparable by the whole network of other cities and village branches.

Corporate Governance Banks not only accept and deploy large amount of uncollateralized
public funds in fiduciary capacity, but they also leverage such funds through credit creation.
Banks are also important for smooth functioning of the payment system. Profit motive cannot
be the sole criterion for business decisions. It is a significant challenge to banks where the
priorities and incentives might not be well balanced by the operation of sound principles of
Corporate Governance. If the internal imbalances are not re-balanced immediately, the
correction may evolve through external forces and may be painful and costly to all stakeholders.
The focus, therefore, should be on enhancing and fortifying operation of the principles of sound
Corporate Governance.

Customer Services There are concerns in regard to the Banking practices that tend to exclude
vast sections of population, in particular pensioners, self employed and those employed in
unorganized sector. Banks are expected to oblige to provide Banking services to all segments of
the population, on equitable basis. Further, the consumers interests are at times not accorded
full protection and their grievances are not properly attended to by Banks. Banks are expected
to encourage greater degree of financial inclusion in the country setting up of a mechanism for
ensuring fair treatment of consumers; and effective redressed of customer grievances.

Branch Banking Traditionally Banks have been looking to expansion of their Branch Network
to increase their Business. The new private sector banks as well as the foreign banks have been
able to achieve business expansion through other means. Banks are examining the potential
benefits that may accrue by tapping the agency arrangement route and the outsourcing route.
While proceeding in this direction banks ought not to lose sight of the new risks that they might
be assuming in outsourcing. Hence they have to put in place appropriate strategies and systems
for managing these new risks.

Competition With the ever increasing pace and extent of globalization of the Indian economy
and the systematic opening up of the Indian Banking System to global competition, banks need
to equip themselves to operate in the increasingly competitive Environment. This will make it
imperative for Banks to enhance their systems and procedures to international standards and
also simultaneously fortify their financial positions.

Financial sector reforms in India:-

Reforms in the Banking Sector:-
 Reduction in CRR and SLR has given banks more financial resources for lending to the
agriculture, industry and other sectors of the economy.
 The system of administered interest rate structure has been done away with and RBI no
longer decides interest rates on deposits paid by the banks.
 Allowing domestic and international private sector banks to open branches in India, for
example, HDFC Bank, ICICI Bank, Bank of America, Citibank, American Express, etc.
 Issues pertaining to non-performing assets were resolved through Lok adalats, civil
courts, Tribunals, The Securitisation And Reconstruction of Financial Assets and the
Enforcement of Security Interest (SARFAESI) Act.
 The system of selective credit control that had increased the dominance of RBI was
removed so that banks can provide greater freedom in giving credit to their customers.

Reforms in the Debt Market

 The 1997 policy of the government that included automatic monetization of the fiscal
deficit was removed resulting in the government borrowing money from the market
through the auction of government securities.
 Borrowing by the government occurs at market-determined interest rates which have
made the government cautious about its fiscal deficits.
 Introduction of treasury bills by the government for 91 days for ensuring liquidity and
meeting short-term financial needs and for benchmarking.
 To ensure transparency the government introduced a system of delivery versus payment
settlement.
Reforms in the Foreign Exchange Market
 Market-based exchange rates and the current account convertibility was adopted in 1993.
 The government permitted the commercial banks to undertake operations in foreign
exchange.
 Participation of newer players allowed in rupee foreign currency swap market to
undertake currency swap transactions subject to certain limitations.
 Replacement of foreign exchange regulation act (FERA), 1973 was replaced by the
foreign exchange management act (FEMA), 1999 for providing greater freedom to the
exchange markets.
 Trading in exchange-traded derivatives contracts was permitted for foreign institutional
investors and non-resident Indians subject to certain regulations and limitations.
 Impact of Various Reforms

Impact of Various Reforms in the Financial Sector

 It increased the resilience, stability and growth rate of the Indian economy from around
3.5 % to more than 6% per annum.
 A resilient banking system helped the country deal with the Asian economic crisis of
1977-98 and the Global subprime crisis.
 The emergence of private sector banks and foreign banks increased competition in the
banking sector which has improved its efficiency and capability.
 Better performance by stock exchanges of the country and adoption of international best
practices.
 Better budget management, fiscal deficit, and public debt condition have improved after
the financial sector reforms.

What Is Risk Management?

In the financial world, risk management is the process of identification, analysis, and
acceptance or mitigation of uncertainty in investment decisions. Essentially, risk management
occurs when an investor or fund manager analyzes and attempts to quantify the potential for
losses in an investment, such as a moral hazard, and then takes the appropriate action (or
inaction) given the fund's investment objectives and risk tolerance.
Credit Risk
Banks often lend out money. The chance that a loan recipient does not pay back that money can
be measured as credit risk. This can result in an interruption of cash flows, increased costs for
collection, and more.

Market Risk
This refers to the risk of an investment decreasing in value as a result of market factors (such as
a recession). Sometimes this is referred to as “systematic risk.”

Operational Risk
These are potential sources of losses that result from any sort of operational event; e.g. poorly-
trained employees, a technological breakdown, or theft of information.

Reputational Risk
Let’s say a news story breaks about a bank having corruption in leadership. This may damage
their customer relationships, cause a drop in share price, give competitors an advantage, and
more.

Liquidity Risk
With any financial institution, there is always the risk that they are unable to pay back its
liabilities in a timely manner because of unexpected claims or an obligation to sell long-term
assets at an undervalued price.

Risk Management Process:-

Risk Identification In Banks
Banks must create a risk identification process across the organization in order to develop a
meaningful risk management program. Note that it’s not enough to simply identify what
happened; the most effective risk identification techniques focus on root cause. This allows for
identification of systemic issues so that controls can be designed to eliminate the cost and time
of duplicate effort.

Assessment & Analysis Methodology

Assessing risk in a uniform fashion is the hallmark of a healthy risk management system. It’s
important to be able to collect and analyze data to determine the likelihood of any given risk
and subsequently prioritize remediation efforts.

Mitigate

Risk mitigation is defined as the process of reducing risk exposure and minimizing the
likelihood of an incident. Top risks and concerns need to be continually addressed to ensure the
bank is fully protected.

Monitor
Monitoring risk should be an ongoing and proactive process. It involves testing, metric
collection, and incidents remediation to certify that the controls are effective. It also allows for
addressing emerging trends to determine whether or not progress is being made on various
initiatives.

Connect
Creating relationships between risks, business units, mitigation activities, and more paints a
cohesive picture of the bank. This allows for recognition of upstream and downstream
dependencies, identification of systemic risks, and design of centralized controls. Eliminating
silos eliminates the chances of missing critical pieces of information.
 Report
Presenting information about how the risk management program is going – in a clear and
engaging way – demonstrates effectiveness and can rally the support of various stakeholders at
the bank. Develop a risk report that centralizes information and gives a dynamic view of the
bank’s risk profile.

Reserve Bank of India

 The Reserve Bank of India was established on April 1, 1935 in accordance with the
provisions of the Reserve Bank of India Act, 1934.
 The Central Office of the Reserve Bank was initially established in Calcutta but was
permanently moved to Mumbai in 1937. The Central Office is where the Governor sits
and where policies are formulated.
 Though originally privately owned, since nationalization in 1949, the Reserve Bank is
fully owned by the Government of India.
 The Reserve Bank’s affairs are governed by a central board of directors. The board is
appointed by the Government of India in keeping with the Reserve Bank of India Act.
 The directors are appointed/nominated for a period of four years.
 RBI is a statutory body. It is responsible for printing of currency notes and managing the
supply of money in the Indian economy.

Issue of Notes

 The Reserve Bank has the monopoly for printing the currency notes in the country.
 It has the sole right to issue currency notes of various denominations except one rupee note
(which is issued by the Ministry of Finance).
 The Reserve Bank has adopted the Minimum Reserve System for issuing/printing the currency
notes.

Banker to the Government

 The second important function of the Reserve Bank is to act as the Banker, Agent and Adviser
to the Government of India and states.
 It performs all the banking functions of the State and Central Government and it also tenders
useful advice to the government on matters related to economic and monetary policy.
 It also manages the public debt of the government.

Banker’s Bank

 The Reserve Bank performs the same functions for the other commercial banks as the other
banks ordinarily perform for their customers.
 RBI lends money to all the commercial banks of the country.

Controller of the Credit

 The RBI undertakes the responsibility of controlling credit created by the commercial banks.
 RBI uses two methods to control the extra flow of money in the economy. These methods are
quantitative and qualitative techniques to control and regulate the credit flow in the country.
 When RBI observes that the economy has sufficient money supply and it may cause inflationary
situation in the country then it squeezes the money supply through its tight monetary policy and
vice versa.

Custodian of Foreign Reserves

 For the purpose of keeping the foreign exchange rates stable, the Reserve Bank buys and sells
the foreign currencies and also protects the country’s foreign exchange funds.
 RBI sells the foreign currency in the foreign exchange market when its supply decreases in the
economy and vice-versa. Currently India has Foreign Exchange Reserve of around US$ 390bn.