25 Indian Financial System Securities and Exchange Board of India (SEBI) I sector compries the following segments or of Finance: the Reserve Bank of India (RBI), the and other regulatory bodies. This organised financia constituents : * Financial Institutions (Intermediaries) + Financial Markets © Financial Instruments © Financial Services © Regulators The above mentioned five constitutentes of financial system varied and diverse their diversity and varied nature ret shown the chart given below : nature and flect the level of services rendered by the financial system as ‘Organised Scetor z (iar ] x Fa + Financial ‘inancial Financial Financial k& Markets Institutions Instruments, Regulators Services — + L Money Capit ‘© Equity Shares ‘© Merchant Banking Market Market © Debt. Instruments Credit Rating @ Preference Shares © Factoring HS, © Mutual Funds Units ‘© Underwriting Primary ‘Secondary ‘© Post Office Schemes © Venture Capital Market Market © Bank Deposit Schemes © Leasing ¥ ¥ + Treasury Call ‘Commercial ‘© Government Bint” | | Money Bills © Central Bank (RBI) © Securities Exchange Banking Non-banking] |_Board of India (SEBD) Commercial | [Co-operative NBFCs | | Debt. Financial | [ Mutual Insurance Banks Banks Institutions. Funds | | Companies ‘The Indian Financial System FINANCIAL INSTITUTIONS (INTERMEDIARIES) Financial institutions (intermediaries) are business organisations that act as mobitisers and depositories of savings and as purveyors of credit or finance. The financial intermediaries act as middlemen between the savers (by accumulating funds from them) and borrowers (by lending these funds). Thus, they channelise the funds of surplus economic units to those who want to spend on real capital investment. The financial institutions by themselves neither create economic values in products nor trade them against money, rather they render financial services of dealing in financial assets. The main characteristics of financial intermediaries/institutions are as follows : > Savings Mobilisers : Financial institutions act as mobilisers and transferors of savings or funds from surplus to deficit units. ivIndian Financial System 26 : i i liccting resources by accepting ions deals in financial resources, col y f ade industry and others. They deal in financial besides rending various specialised > Dealers : Financial " deposits from individuals and lending them to trade, ind assets, accept deposits, grant loans and invest in securities, financial serviees. icipants : Financial institutions are n > Participants : Financial institu ts i ah y Gancrnvors : Financial institutions buy and sell financial instruments and are resp generating financial investments. > Regulation ; Financial institutions are regu regulatory bodies. Functions of Financial Institution (Intermediaries) Financial institutions (intermediaries) are business organisations serving as a link between severs and investors and thus help in the credit-allocation process. If finance were to be described as circulatory system of the economy, financial institutions are its brain. They make decisions about most efficient use of scare capital. That is why that countries with developed financial institutions grow faster and countries with weak ones are more likely to face financial crises. The major functions or services provided by the financial institutions are : > Liability, asset and size transformation consisting of mobilisation of funds and their allocation by providing large loans on the basis of numerous small deposits. > Maturity transformation by offering the savers tailor-made short-term claims or liquid deposits, and thus offering borrowers long-term loans matching the cash flows generated by their investment. >» Risk transformation by transforming and reducing the risk involved in direct lending by acquiring diversified portfolios. Payment transformation by offering a very convenient mode of payment for goods and services, ‘The cheque system and credit card system are the easiest methods of payments in the economy. .__.., Through these services. financial institutions are able to top savings, They enable the financial institutions to facilitate the availability of finance to consumers to spend in anticipation of income and entrepreneurs to acquire physical capital. tn the postreform era, the functions and nature of activity of the financial institutions have ise. Many financial institutions, besides providing direct loans, have diversified themselves into areas of financial servi i dive services such as merchant bankin; iti 1 issuing guarantees. } hn epee an jor participants in the finaneial system of a country. major participant ane, lated by Ministry of Finance, RBI, SEBI and other ‘Types of Financial Institutions With regard tothe nature of type of their activities the fh as banking and non-banking fi A. Banking (4) Commercial Banks ; * Public Sector Banks : ‘© Private Sector Banks au ab © Foreign Banks : * Regional Rural Banks (®) Co-operative Banks * Rural Co-operative Banks # Urban Co-operative Banks inancial intermediaries can be classified ‘ancial institutions as chart given below on next page «_ Indian Financial System 27 p. Non-Banking Entities Non-Banking Finance Companies (NBECS) «Equipment Leasing Companies Hire Purchase Companies Investment Companies Loan Companies ¢ Residuary Non-Banking Companies (RNBCs) Housing Finance Companies Mutual Benefit Finance Companies (MBFCs) «Miscellaneous Non-Banking Companies (MNBCs) Development Finance Institutions (a) All-India Institutions ¢ Term Lending Institutions (IFCI, 1BI, EXIM Bank, TFCI, IDFC) Refinance Institutions (NABARD, SIDBI, NHB) « Investment Institutions (LIC, GIC) : (b) State-Level Institutions « State Financial Corporations (SFCs) # State Industrial Development Corporations (SIDCs) (c) Specialised Institutions « Export Credit Guarantee Corporation (ECGC) « Bank Deposit Insurance Corporation (BDIC) earlier DICGC A brief description of the above financial institutions is given hereunder : A. Banking Institutions Banking institutions are creators and purveyors of credit i.e. they moblise savings by accepting monetary deposits from the people, participate in payments mechanisum for exchange of goods and services and extend credit while lending money. The banks create credit in the form of promises to pay and lend to their borrowers as facilities to draw funds. The basic categories of banks are : (1) Commercial Banks : In the financial structure of every modern economy, the commereial banks occupy @ unique position, and they primarily deal in money and credit. Their major function is to mobilise the savings of the community in the form of a variety of deposits and to give loans and advances to borrowers for varied purposes. Thus, the two most important functions of commercial banks are : (i) accepting deposits from individuals business firms and institutions, and (ii) advancing loans for productive purposes and usually for short-term. In addition to these functions banks also render some valuable services to their customers. The commercial bank can be classified on the basis of ownership in following categories : () Public Sector Banks : These banks are owned and controlled by the government, In India, the nationalised banks and regional rural banks come under these categories. (ii) Private Sector Banks : These banks are owned by the private individuals or corporations and not jperative societies. After economic reforms, the number of such banks by the government or coo} lowed more private bank to be has increased and the Finance Minister in his budget speech all start provided they meet RBI’s norms. Recently before the election two new banks i.e. IDFC Bank and Bandhan Bank have been given licenses.Indian Financial Systery 28 State Government and the vere set up by the val Banks were set ti ry Tess Bank HY he objective of developing the rural si the rural areas Fo nario smal formers, small enfeprencut nthe rl ae vovide banking services and eredit to sma in mobilising rural savings. Advances tg Repos Rs nk ae layed an nota tn I direct advances of RRBs, i ela sas 0% share in the total dir : ker sections account for more than 40% sha ive intutions which are baseg Cooperate ne: Co ras at eel storm all the main banking o ive Banks : Coop. : ; 7 ines cei SE ee a Peettane facilities. Some of the fu ie deposit mobilisation, supply of credit and provision o| i diuled banks. The cooperative Saree banks are scheduled banks and many of them are non-scl i mobilise funds through the bone -ferm deposits, and some of them also mobilis . eSear Cl ee Mate f the cooperative banks significantly consists of sik resources of fomving foo ie WADARD RBI and the Government. Eton ive crt ties are operating in the Indian economy. These Sei emt eee : (D Rural credit societies which are primarily institutions canbe classified in two broad categories: (i) Rur Sy nowagicl The ‘erculural: and (i) Urban ered sovietis which are primarily non-a cS ae Agricultural Credit Society (PACS) at the village level; Central Cooperative Banks ( 's) at the di 5 ks (SCBs) at the state level provide short/medium term loans Gistrit level and State Cooperative Banks (SCBs) a : Scoenaresce and the long-term lending is done by the ‘Development Banks’. The Urban Cooper ‘ect both the working capital as well as fixed capital requirements, B. Non-Banking Finance Companies (iii) Regional Rural Banks : Regio As per RBI classification, the Non-Bank Companies include Non-bank finance companies and Non-bank non-finance companies. The non-bank non-finance companies are the companies Which are engaged in activities like manufacturing, trade ete, and accept deposits from the public for their own use. On the other hand, Non-Bank Finance. Compinies (NBFCs) ate financial intermediaries The significance of NBFCS ties in that they prov; of return on deposits, and Sectors where credit advantages of NBFCS are + Orientation; and (iv) prompt provision of services, 1) Gis : () faa a NBFCS : The NBECS are clesstied into various types depending upoa the “sed activities petformed by them in busing ino st » then or the main businéss condueted by them. The iiost > Equipment Leusing hich esr & Compan tA lease may be defined as a Contractual airangement in "es thease inne ici, OVieS the asset for the use ot the lessee (who! 8 periodic Gn called premium, Ate the en tie, Payments (rentals) with or without further paymentIndian Financlat System Q) @) @) 29 > Hire Purchase Companies : Mire purchase is « system under whieh term loan is provided for purchase of goods or services and this loan is then amortized in installments as lai down through a contract, under the contrnet the ownership of asset is transferred to the owner once the contract of loan is signed. Commercial Banks, IDBI, ICICI, SFC, NSIC ete, are involved in such financing. > Investment Companies : Investment companies which provide loans for personal as well as commercial purpose and charge a higher rate of interest as compared to banks. Inspite of the interest rate charged being higher they are popular due to the hassle free procedure heen Nfich no security is sought as compared to commercial banks which ecapared ts Soca ae provide higher interest on deposits accepted by them as > Loan Companies : These are the non-banking financial intermediaries which may be run by individuals, firms and private companies who are engaged in the business of financing. They obtain funds in the form of deposits from the public and give loans to wholesale and retail traders, small scale industries and self employed persons. These companies offer high rate of interest on deposits from public alongwith gif/prize money schemes to attract investors. The loans advanced by these companies do not carry and security and hence they chage high rate of interest varying between 36% to 48% p.a. > Residuary Non-Banking Companies (RNBCs) : These are companies which receive deposits and do not belong to any of the above categories. The deposit acceptance activities of these companies are governed by the provisions of Residuary Non-Banking Companies (Reserve Bank) Directions, 1987. under the new regulatory framework of RBI (amendment) Act, 1997, the RBI has extended prudential norms to those companies, introduced compulsory registration requirements, specified minimum rate of interest payable on their deposits under different schemes. Miscellaneous Non Banking Companies (NINBCs) or Chit Fund : These are those non-banking financial companies which are engaged in Chit Fund business. The members of chit fund make regular subscriptions to fund over a definite period. Every member shall in his turn be entitled to a prize amount. The operations of chit fund companies are governed under the Chit Fund Act. 1982 which is administered by state governments. Their deposit taking activities are regulated by the RBI. MNBCs are more popular in Tamil Nadu and Kerala. ‘ Mutual Benefit Finance Companies (MBFCs) or Nidhis : MBFCs are those finance companies which are notified as Nidhi Company under section 620-A of Companies Act, 1956. Nidhis are popular among middle-class fameties in urban areas. They act as mutual benefit funds and work for members only. The sources of funds for Nidhis are share capital, deposit from their members and the public Nidhis advance loans to their members for several purpose like house constraction redemption of old debts, meeting medical expenses etc. MBFCs or Nidhis 334, They do not require registration maintain and repair, marriages, are exempted from the main provisions of RBI Act, 19: liquid assets or credit a reserve fund. Housing Finance Companies : Hou: construct u of a charge or interest and involves hypothecation of the land oF bui Housing and Urban Development Corporation (HUDCO), Housing Development and Finance Corporation (HDFC), sing companies provide loan for the purpose of house + for different time periods. This loan is # secured loan ing against it. Housing companies in India include State Housing Finance Societies (SHFS). other then these LIC, GIC, UTI alsoIndian Financial System Q @) @) 29 > Hire Purchase Companies : \ire purchase is a system under which term loan is provided for purchase of goods or services and this Joan is then amortized in installments as laid down through a contract, under the contract the ownership of asset is transferred to the owner once the contract of loan is signed. Commercial Banks, IDBI, ICICI, SFCs, NSIC etc. are involved in such finaneing, p Investment Companies ; Investment companies which provide loans for personal as well as commercial purpose and charge a higher rate of interest as compared to banks. Inspite of the ee rate charged being higher they are popular due to the hassle free procedure ce eee cn ich no security is sought as compared to commercial banks which eee ee Provide higher interest on deposits accepted by them as > Loan Companies : These are the non-banking financial intermediaries which may be run by inaividuals, firms and private companies who are engaged in the business of financing. They obtain funds in the form of deposits from the public and give loans to wholesale and retail traders, small scale industries and self employed persons. These companies offer high rate of interest on deposits from public alongwith gifv/prize money schemes to attract investors. The loans advanced by these companies do not carry and security and hence they chage high rate of interest varying between 36% to 48% p.a. » Residuary Non-Banking Companies (RNBCs) : These are companies which receive deposits and do not belong to any of the above categories. The deposit acceptance activities of these companies are governed by the provisions of Residuary Non-Banking Companies (Reserve Bank) Directions, 1987. under the new regulatory framework of RBI (amendment) Act, 1997, the RBI has extended prudential norms to those companies, introduced compulsory registration requirements, specified minimum rate of interest payable on their deposits under different schemes. Miscellaneous Non Banking Companies (MNBCs) or Chit Fund : These are those non-banking financial companies which are engaged in Chit Fund business. The members of chit fund make regular subscriptions to fund over a definite period. Every member shall in his turn be entitled to 2 prize amount. The operations of chit fund companies are governed under the Chit Fund Act, 1982 which is administered by state governments. Theit deposit taking activities are regulated by the RBI. MNBCs are more popular in Tamil Nadu and Kerala. Mutual Benefit Finance Companies (MBFCs) or Nidhis : MBFCs are those finance companies which are notified as Nidhi Company under section 620-A of Companies Act, 1956. Nidhis are popular among middle-class fameties in urban areas. They act as mutual benefit funds and work for members only. The sources of funds for Nidhis are share capital, deposit from their members and the public Nidhis advance loans to their members for several purpose like house constraction redemption of old debts, meeting medical expenses etc. MBFCs or Nidhis 134, They do not require registration maintain and repair, marriages, are exempted from the main provisions of RBI Act, 19: liquid assets or credit a reserve fund. Housing Finance Companies : Housing companies provide loan for the purpose of house construction in lieu of a charge or interest for different time periods. This loan is a secured loan and involves hypothecation of the Iand or building against it. Housing companies in India include Housing and Urban Development Corporation (HUDCO), State Housing Finance Societies (SHS). Housing Development and Finance Corporation (HDFC), other then these LIC, GIC, UTT alsonn Indian Financial System 2.10 i controlled institutions are monitored an have entered into the area of housing finance, All hese institutions by a committee set-up by RBI. C, Development Financial Institutions which its financial system The economic development of any country depends on the ie oftbanks and financial mobilises and allocates resources efficiently and effectively. There Fae tations. These institutions that perform this function, one of them development, Financial Institutions’, institutions are also called ‘Development Banks” or Tnyes a inma|awdslomg-tcra Development financial institutions (Banks) are agencies t 7 ia 1d development of the country, Financial assistance and act as catalytic agents in promoting ae ture and other key sectors. They They are engaged in promoting and development of industry, aie ndertaking feasibility studies also provide promotional services such as discovering Projet ieee nlomeatati of projects, The and providing technical, financial ane managerial assistance for the jectives of developments are as follows : E : 1 7 hes et as an agent of development in various sectors, namely, industry, agriculture, and international trade. * To accelerate the growth of the economy. * To allocate resources to high priority areas. E To foster rapid Industialstion particularly in the private sector, so as to provide employment opportunities as well as higher production. * To develop entrepreneurial skills. + To promote the development of fural areas, * To finance housing, small scale ihdustries, infrastructure, and social utilities, Classification of Development Banks : Since independence, the Government of India established many financial institutions which are as follows : (@) All India Level Institutions > Development Banks : «Industrial Finance Corporation of India Ltd. (1948) * Industrial Investment Bank of India Ltd, (1997)* + Export-Import (EXIM) Bank (1982) ‘ * Tourism Finance Corporation of India Ltd, > Refinance Institutions : + NABARD (1982) * Sinall Industries Development Bank of India (1990) * National Housing Bank (1980) > Investment Institutions + * Life Insurance Corporation (1986) * General Insurance Corpo (1972) > Specialised Financia, Institutions : * Infrastructure Development Finance Corporation Ltd, IDFC (1997) ‘The earstiwhile Industrial ReconstIndian Financial System : « TFCL Venture Capital Funds Lid : 1VCE (1988) « ICICI Venture Funds Management Corporation Ltd. (1988) () State Level Institutions «Site Financial Corporations ($FCs) i «Sate Industial Development Comdratons(SIDCS) (¢) Other Institutions «Export Credit Guarantee Corporation of INDIa : ECGC (1957) + Deposit Insurance & Credit Guarante Corporation (1962) Note: (i) Figures in brackets under res, incorporation, Pective institutions indicate the year of establishment or (ii) ICICI and UTI were part of All India Financial Institutions till.2002-03. (ii) IDBI become a commercial bank from 1 October, 2004. At present the country is being served by 58 financial institutions, comprising 12 institutions at national level and 46 institutions at state level, These financial institutions have a network of branches and are supported by technical Consultancy organisations with IDBI acting as the apex institution for coordinating their diverse financing and promotional activities. After the introduction of financial reforms (1991), the role and nature of activity of these financial institutions have undergone atrendous change. Banks have now undertaken the non-banking activities and financial institutions have taken up banking activities. Most to financial markets for raising funds.. FINANCIAL MARKETS, Financial markets are called tobe the backbone of the economy because these provide monetary support and act as a mobilising agent for the growth of the economy. Financial markets refer'to the insitutional arrangements for dealing in financial assets debts or loans and credit instruments of different types such as currency, cheques and deposits, bills, equity, bonds ete.'A financial market comprises of players such as banking and non-banking institutions, dealers, borrowers and lenders, investors and depositors and agents. These participants take an active part in driving demand sopply in the financial market, Characteristics of Financial Markets ia The following are the main features of financial markets : insya0 () A large volume of transactions and the speed with which financial resources move from one market to another, 10 afode Various segments of financial markets such as stock markets, bond market, derivative market, Primary and secondary markets where savers themselves decide when and where they should invest money. aa Highly votatile and susceptible to panic and distress selling as the behaviour of a limited group of operators can get generalised. Dominated by financial intermediaries who take investment decisions as well as risk on behalf of depositors, Instant arbitrage among various markets and type of instruments, vy v v v vIndian Financlal Systeny 212 Functions of Financial Markets A icc a aesumed greater importance in the 5 kets perform : si financial mae short of funds, thereby contributing to The role of financial markets has account of the following functions which funds from savers to those whe fhe economy. he countries taking Pp! le av wake of increased globalisation. * Channelising surplus I higher production and efficiency in tI ® Cross horder movement of funds from tl to countries providing higher returns, in the Se ayers and BOrOWES. + Transformation of financial claims to suit the preferences of Po tie engaged tehdes + Proving information about companics which enables inst tS 1 tock effcentl and keep record of companies activities with a view to trading eae and table financial Crucial rate in the transmission of monetary policy, Decale dev valle markets enable central bank to use market based instruments of mon a cece + Management of economic and financial risks by proper distri rofitable avenues for investments Types of Financial Markets 2 “ ring to the various credit needs of the 7 it markets catei The financial markets are the credit mar! re into: (unorganised markets, and individuals firms and institutions. These markets can be clas (ii) organised markets. (a) Unorganisd Market : In these markets, there are a number of indigenous bankers, money lenders, tenders etc, who lend money to the public Indigenous bankers are the local bankers who provide finance for productive purposes directly to trade and industries and indirectly through money lenders and traders to agriculturists. Indigenous bankers are found in all parts of the country, although their names, styles of functioning and the functions performed by them may differs. In West India, they are called as Marwari or Gujarati Shraffs, Chettiars in South India, and Sahukars in North India. Indigenous bank 0 collect deposits from the public, Money lenders are not bankers, their business is to lend money from his own funds they include large former merchants, tenders, village shopkeepers etc. The methods and areas of operation differ from money lender to money lender, but their funds are own funds, clients are mainly weaker sections of society, credit is prompt and flexible but loans are highly exploitative as they charge high _— rates of interest. (2) Organised Markets : In organised markets, there are standarised rules and regulations and strict Supervision and control is exercised by RBI and other regulatory bodies like SEBI. These organised ‘markets can be further classified into two. These are : © Money Market «Capital market MONEY MARKET A money market is a market for short where funds ean be borrowed for a short period Seainst different types of instruments, called near money. Thus, @ money ma Institutions that deal in the various rm debt instruments, It is a highly liquid market ving a day, a week, a month or 3 to 6 months suc a bil or exchange, banker's acceptances, bonds ete, he collective name given to th : i srades of near money, 8 Minnie Aigisiand— indian Financial Systert / money market does not refer to a particular place where short-term funds are dealt with. The short-term funds. The nr includes all individuals, institutions and intermediaries dealing 1 ifetions between borrowers, lenders and middlemen take plnce through telephone telegraph, mail srarsagents. NO personal contact or presence of the two parties is essential for negotiations in. a anvpey market, However, a geographical name may be given to a money market according «a its motion. For example, the London money market operates from Lambard street and the New York totes market operates from Wall street. But, they attract funds from all over the world to be lent to from all over the globe. Similarly, the Mumbai money market is the centre for short-term borrowers oe bortable funds of not only Mumbai, but also the whole of India. features of a Money Market From the above description, the following general features of a money market are identified— Market for short-term funds : It is a market purely for short-term funds or financial assets called near money. > Deals in financial assets : It deals with financial assets having a maturity period upto one year only, and which can be converted into cash readily without loss and with minimum transaction cost. No formal place : Generally transactions take place through phone i.e., oral communication. Relevant documents and written communications can be exchanged subsequently. There is no formal place like stock exchange as in the case of a capital market. No brokers : Transactions have to be conducted without the help of brokers. Comprises several sub-markets : It is not a single homogeneous market. It comprises of several sub-markets, each specialising in a particular type of financing, e.g., Call money market, ‘Acceptance market. Bill market and so on. Components : The components of a money market are the Central Bank, Commercial Banks, Non-banking Financial Companies, Discount Houses and Acceptance Houses. Commercial banks generally play a dominant role in this market. Functions of Money Market ‘The money market performs the following functions = ‘The basic function of money market is to facilitate adjustment of liquidity position of commercii banks, business corporations and other non-bunk financial institutions. It provides outlets to commercial banks, business corporations, non-bank finaneial concerns and other investors for their short-term surplus funds. It provides short-term funds to the various borrowers such as businessmen, industrialists, traders ‘etc, and enables them to invest their temporary surplus for a short period. » Money market provides short-term funds even to the government institutions. titutes a highly efficient mechanism for credit control. It serves as a ises control on the creation of > The money market const medium through which the Central Bank of the country exerci credit. Money Market Instruments Money market is the place where lenders and bor buying and selling short-term credit instruments. The rowers meet together with the intention of \struments of money market are the liquidIndian Financiat g, Si tem i or are callable on demang, ie ear. The various instrungy® a 24 hin a short period of tim ry from one day f0 one Y assets: interest bearing debts that matins w instruments may ver ' gnown as Tills, are short-term finance bills iggy, ws n trade transaction, like the commercial bills they ve backed by a guarantee from the governmen i. : 364 days treasury ji)” Th Jier issued for 91 days but now there ed RBI 7 ae ens sh hey were earlier iss ' a h auctions con : 0 ‘These treasury bills are few! seman buys and sells these treasury bills. The buying ‘nd ‘as the leader and controller of money ses lt OFT) an rn mnhance period of these y trae money market are as follows that are traded in " ils : Treasury bills, popularly (1) Trensury Bis: Treasury Blt pereeety by the government. They ; These bills are highly liquid and risk-free selling operations are conducted by Discount an RBI for stabilising the money market. itis an instrument in writing containing ay Bills of Exchange : A bills of exchange ot trade bill is hae py cosa ee unconditional order, signed by the maker, directing a cel Gatrumment. Hest bills are always money to the order of a certain person or to the bearer of the in 1 i Sr i i ed by goods. These bills are instruments of Supported by genuine trade transactions and are backed by goods. uments, Areneial tenner i in times of seasonal stringencies financial transactions and supplement the available resources it ot al i for the purpose of re-finance from RBI. The RBI Act provides for re-finance commercial} banks through buying or re-discounting of bills of exchange. . : ) Commercial Papers : Commercial papers (CPs) are short-term usance promissory notes witha Fixed maturity. They are mostly issued by leading, reputed, well established and big corporations, having high credit rating. In India, commercial papers have been introduced as a result of the ‘suggestions of the Working Group on Money Market in 1987, In 1989, RBI decided to introduce & scheme by which certain categories of borrowers could issue commercial papers in the Indian issue of commercial papers, which was money market. In 1990, RBI issued guidelines on the further revised in 1991. These guidelines apply to all non-bank finance and non-finanos companies, The following are the main features of commercial papers : * Commercial papers can be issued by body corporates, whether financial or non-financial, companies. * They are unsecured and backed only by the credit standing of the issuing company. CPs xt generally issued by companies with good credit rating, therefore, they are considered as safe and liquid instruments, Q * These papers may be issued through banks, merchant banks, dealer’s brokers, open market or through direct placement, or through lenders or investors, © The maturity Period should be 12 months and the issue should be for a minimum of & | crore, in multiples of & 25 lakh in the beginnis sn alles beginning but later reduced to € 25 lakh and © 5 © Prior permission of RBI is required for the issue of CPs, Underwriting of CPs is not compulsory. * Commercial papers are mostly used to finan ap ice current transactions of ac be less than 75% of the cash eredit limit of bank’s finance to the ofipay. 2 ed ° All expenses in connection with the issues of CPs should be bore by the company,‘ndan Financial System . and not more than one ya The Reserve Bank of indi has permite banks to isue thse certiaes in order to widen the range of money maket instruments ad fo tive investors greater aesibity i the employment of ther shor-enn sur funds, The man features are: «Thy ae ised a sco, the rte bing ely determined byte suing bank andthe sate. The issuance, in motes of € 5 tek, subject toa minimum of 825 lakh, eal scheduled banks except regional rural banks (RRBs) and scheduled co-operative banks, can issued CD tothe extent of 7% of depsits + CDs-an be issued to indvdul, corporations, compan, uss, finds and associations, as wells non-esident Indians (NRIS, on anonsepatiable basis «Banks ar not permite to buy back thir CDs before thir maturity and to grat loans against their own CDs, . «Cortfcates of deposits are frely transferable by endorsement and delivery but it can be done only afer 45 days from th ie date of issue, Financial Institutions in Money Market The commercial banks; non-bank financial institutions, bill brokers, aoceptance houses and ‘the central bank of the country are the ‘major institutions of the money market. (1) Commercial Banks : The commercial bank are the back bore of the money market The fom one of the major constituents ofthe money market. They us ther short-term surplus funds to gant short-term loans to the money market, ‘They also discount and rediscount the commercial papers such as bill of exchange and treasury bill, Commercial banks always try to maintain a balance between liquidity and profitability, (Q) Non-Bank Financial Institutions : Non-bank financial institutions suchas insurance ‘companies and ober business corporations having shor-period surplus funds lso operate inthe money matt (3) Acceptance Houses : Acceptance houses and bill brokers are the important constituents ofthe money market n developed counties, These house specialise in the aoceptance of rade bill on behalf of their customers, Discount houses and bill brokers discount, buy and sell bills drawn on. the aceptance houses, (4) Central Bank : The Central Bank is the top-most financial institution in the money market. It is regarded as the lender of the last resort, banker to the government, banker’s bank and controller cf the money market, Asa lender of the last resort, the central bank gives temporary financial assistance to commercial banks by rediscounting their eligible bills. The central bank controls the money market with two main instruments, namely, the bank rate and the open market Operations, = CAPITAL MARKET ‘Capital market’ refers to the institional arrangements for falling the. borrowing and the lending of long-term funds, It is concerned with those private, individual and conporate sings tat ae tuned int investment through nev capital ists, Ths, capil mare provides oppouiies to companies to raise funds directly from investors; also, oustanding seturtes ae tought and sold in this market. This market funtfong unde the supervision of Seauntes and Exchange= Indian Financial System, 216 this market are derived from various laws sions regulatin Board of India (SEBI), the regulatory provisions regulating ct, SEBI Act. FEMA, etc. i mpanies A‘ like Securities and Contracts Regulation Act, Comp: Functions and Importance of Capital Market i ilisit s, and diverting them into i Je in mobilising resources, ; 1 te ehamels fw “ttle and promotes the process of economic growth in the roductive channels, In this way, , discussed below— Sin: eis ts nies eae asks Peels ain Eaitae wn and (1) Link between Savers and eum ceri iene and diverting them in productive investors, ys an important role in m i 7 ‘ i ee R ‘tis way, anita market plays a vital role in transferring - ie from surplus and wasteful areas to deficit and productive areas, thus increasing the pi ‘ity and prosperity of the country. *! @ Encouragement to saving With the development of capital market, the banking and non. banking institutions provide instruments which encourage people to save more. In the less. developed countries, in the absence of a capital market, there are very little savings and those ‘who save often invest their savings in unproductive and wasteful directions, i.e, in real estate ike land, gold, and jewellery) and conspicuous consumption. ) Encouragement to Investment : The capital market facilitates the government and thus encourage investment, It provides facilities through banks and non- bank financial institutions, Various financial assets, 28. shares, securities, bonds, etc., induce Savers to lend to the government or invest in industry. With the development of financial institutions, capital becomes more mobile, interest rate falls and investment increases, @) Promotes Economie Growth : The capital market not only reflects the general condition of the orn, but also smoothens and accelerates the process of economic growth. Various institutions intermediaries, allocate the resources rationally in of the capital market, like non-bank financial i accordance with the development needs of the country. Th i a y y. The in the expansion of trade and industry in both ul i ee meszites ene Li rt . économie roth in the country. Publicand private sectors, thus Promoting balanced lyers and ee. ) Byars ‘les of securities and thus ensue the matketability of By advertisin, i ity of i 8 Security prices, th their investments acs the Stock Exchange enabl. and utilise them j rables the investors to k fj (© Mtsafeguards the interests ofthe igen most Profitable Lines Pep track ofIndian Financial Syston 2AT in arte Money Market Capital Market Tris a market for short-term loanable funds | (1) It is a market [3 ng arket fOr long-term fi junds exceedin 1 i () fara period of not exceeding one year. a period one year. arket supplies funds for financi i i (2) This marl cing | (2) This market supplies funds fc ket supplies 4 i for financiny current busines gperations, working capital fixed capital requirements of trade an feqrements af inustes and short petiod boihinigrey as wall ad the tonbeteos Fequirements of the Government, requirements of the Government. ag i) TA ie Shenae a money (3) This market deals in instruments like shares, hange, treasury bills, debentui papers, certificate of deposit etc. cingeare =? wont ccommerci (4) Each single money market instrument is of | (4) Each single capital market instrument is of lige am ee cof minimum for one small amount. Each share value is Rs.10. lth Bash a minimum of Each debenture value is Rs.100. © The Central are te Commercial banks are | (5) Development banks and Insurance the major ions in the money market. companies play a dominant role in the _ capital market. (© Money market instruments generally do not | (6) Capital market instruments generally have have secondary markets, secondary markets, (7) Transactions mostly take place over-the- | (7) Transactions take place at a formal place viz., phone and there is no formal place. stock exchange. (8) Transactions have to be conducted without | (8) Transactions have to be conducted only the help of brokers. through authorised dealers. MARKET FOR COPORATE SECURITIES ‘The corporate securities, viz; bonds or debentures, preferred stock commonly called preference shares and common stock or equity shares, are traded in carefully regulated capital markets. The markets for the three type of corporate securities include— © The Primary or New Issue Markets © The Secondary Markets Primary Market or New Issue Markets ‘The new issue market deals with the new secu! investing public, Ze, the securities that are offered to the investing public for the First time. The trarket therefore, makes available a new block of securities for public subscription. In other words, how iste market deals with raising of fresh capital by companies either for cash or for consideration other than cash. ‘The new issue market be in the form of equity shares, institutions which contribute, um market. ies which were not previously available to the claim, These claims may deposits etc. All financial sare part of new issue + encompasses all institutions dealing in fresh preference shares, debentures, rights issues, ‘derwrite and directly subscribe to the securiIndian Financtat Sse, 28 et Functions of New Issue Mark ve to facilitate transfer of resources from savers 1, ; ion aa ew ise mato fect aster of resourens Fo Sve i ofa new is L 7 The main fanetion individuals, commercial banks, insu He eoajs on ape ti sers. The savers | Se wis eb tated companies and the government. TI asian purser a mobilising the funds frot and transfer them to borrowers 1g fer them r 4 ilisi ie savers and tran ; nr r ‘ i f ce ic growth. It is not only # platform for raising finance to estab important requisite of e« i isations of existing units. The ion/diversification/modernisations teeing units, 7 expansion/diversification/modernis of exiting Si. Tg eae pees oe ‘can be divided into a triple service functions viz. (i) Origination, main function of a new: ee ii) Underwriting; and (ii) Distribution. ia ia eae o Origination: Orgration refers othe work of investigation sai eo on project proposals. Origination starts before an issue is actually ‘two aspects in this function— " f i Prelininary Investigation is a careful study of the technical, economic and finan ty to ensure soundness ofthe project. This is a undertaken by the sponsors of the ist 3 a Advisory services, which improve the quality of capital issues and ensure its success. sory eo yeur aa! which refers to the kind of securities to be issued whether equity share, preference share, debenture or convertible debenture. © Magnitude of issue # Time of floating an issue * Pricing of an issue—whether shares are to be issued at par or at premium. © Methods of issue * Technique of selling the securities ‘The function of origination is done by merchant bankers who may be commercial banks, all India financial institutions or private firms. Initially this service was provided by specialised division of commercial banks. At present, financial institutions and Private firms also perform-this service, Though this service i highly important, the success of the fesue depends, to a large extent, on the efficiency of the market, The origination itself does not guarantee the success of the issue, Underwriting, 4 Specialised service is required in this regard, Companies an issue di se : mechanism ; ¢ different securities in the primary market by any or all of the following 2 ny © Public Issue © Rights Issuendian Financial System : ‘¢ Private Placement © Public issue through Book Building ® Buy-out Deals ‘A public limited company can issue securities through all the mechanisms, but a private limited can issue securities through private placement or rights issue pul c : It is @ system of issuing securities by a public limited company. In this, the qneral public ~ individual investors, institutional investors, mutual fund, NRIs, ete. i invited to subscribe towards the capital of the company, The securities issued through a public issue must get listed on a stock exchange within 10 weeks from the closing of the issue, The stock cxchange’s name should be specified by the company in its prospectus forthe public issue Under this, shares can be issued by the company at par, at premium or ata discount. The issue price is decided by the company itself, private Placement rit is the system of issuing securities, the issuing company approaches the jnvest0rs individually. This mode of raising capital is mainly used by the private limited companies, because @ private limited company cannot invite general public through an advertisement for subscribing towards the capital of the company. However, publi limited companies also use this mechanism of raising capital, Listing of securities issued through this mechanism cannot be done ona stock exchange. On 29 June 2005, SEBI amended listing rules, and now, privately placed debentures can get listed on the stock exchange. For example, Bikaji Foods Pvt Ltd is a private limited and it, too, has issued debentures through this mode. @) Rights Issue + Whenever an existing company issues shares to its existing shareholders on a proportionate basis, itis called Rights Issue, According to law, “a company should offer the securities only to its existing equity shareholders. Whenever such securities are issued subsequently after the initial issue of equity issue, these can be issued to the general public, only when existing shareholders decline to accept such offer.” The subsequent issue of shares can be made to general public after a resolution to this effect has been passed under Section 81 of the ‘Companies Act. (4) Public Issue through Book-Building : Book-building is a mechanism of issuing shares fo the general public, in which the company does not decide the final issue price of the securities. Instead, pricing is done by inviting ‘Bids’ from the public. Decision of final issue price, acceptance of bids and book running is done as per SEBI rules. (6) Buy-out Deals : A company can issue the shares on OTCEI throu deals, which is as follows : ‘The company negotiates with a least one dealer ofthe exchange to buy the complete issue at the specified price. Buy-out deal is done with the intention market. Dealer will have no managerial control over the company. 9°! Dealer has the freedom to sell through the exchange or directly to the public. Secondary Market or Stock Exchange The market where existing securities are traded is referred to as the secondary market or stock market, Ina stock market, outstanding securities of corporate houses as well as government are ded in, According to the rules of SCRA, al transations in securities other than ‘Spot transactions mas he ceeeated on x reognised stock exchange. Stock exchange is synonymous with secondary market, @ ich the mechanism of buy-out iN that the dealer will sell these shares in the generalIndian Financial Systey, 2.20 snich listed securities are bought ang in W "Stock exchange Hs regulated mantel ver) ov stock exchange, ¥) fol an open ee mh the intervention of ments rates F tone according to the DMY-laWs Of stocy 7 . it Of J “itlement sustem of two-way quotation. The set stem of | v the Central Government unde, ton in na At present hee ai ostyand Newt se, in India, majority of the transaction are executed oS are vange become legal and vali onal een a ates ws the role of counter Pe ete should ye differentiated from the produce exchange which is an Saas flows 7 Thus, the main features ofa secondary market or stock exchange are An organisation in the fonm of an association or a companys # A governing board to supervise and regulate activities; * A framework of rules and regulations; ‘+ A-common meeting place for buyers and sellers; and © Brokers to serve as a link between the buyers and sellers. Functions of Stock Exchange A stock exchange performs the following functions: (1) Ready Market : Stock exchange provides a ready and continuous market where investors can convert their money into securities and securities into money easily and quickly. Regular dealings in securities provide liquidity and price continuity to investment in securities. As an organised market, stock exchange facilitates the transfer of ownership of securities and thereby reduces the risk of investors. It provides a convenient meeting place for buyers and sellers of securities, Evaluation of Securities : Stock exchange helps in determining the prices of various securi ies that reflect their real worth. It enables correct appraisal of securities through the interplay of demand and supply. Regular dealings by investors and speculators iron out unjustified fluctuations in prices. The prices at which transactions take place are recorded and published in the form of market quotations, ) Protection of Investors: Stock exchange ensures fair dealings and safety of funds due to exchange, For a stock exchange to fun : Section 4 of SCRA 1956; otherwise it can not fut ‘on, it must be recognised by Q 4) F 5 ¢ = * 8 € iz a 5 Z 2 5 é 2 3 g 2 F & 2 g z = = & - institutions for investment in Securities, In the absence of facilities for quick and Profitable disposal » Such funds may remain idle. Wid icit savings and investment. vane (5) Capital Form finds Deca investors prefer the seow Ths, Stock exchange facilitates capital d of capital into a competitive investment, ne area amasnitan Financlal System 2a conomic Barometer : Stock ¢ : ua Booms, depres somenamaes 4 very sensitive barometer of business conditions in sions and other important i Ss Bri nds on the stock excioe’ Portent events affect prices of securities. Price tre of bani acct the economic elimate in the country. Stock exchanges are not merely chief theatres of busines : ness transa tivities a which indi the general business conditions im yt aoe Aivities they are also barometers indicate (7) Regulation of Company Management company which wants to get i noe ini, steckinnchengee ne tics listed has to submit to these rules and regulations Clearing House of Infe a fluence on the working and management of companies, 0 ie ck exthataaes, fangs: 1 1m of useful business information. iofcrmation a veg east Busine cries which provide data on the corporate sector. Such ess forecastis ; FINANCIAL INSTRUMENTS, recasting and general business trends. nancial in: F Hi ae aces ore ee in the process of intermediation. A choice of financial instruments oo ye financlalimmarket An nant !¥Pes of investors will provide dynamism in trade of the securities in the fina es 's. An array of securities ‘creates development in the financial system. As discussed in chapter 5 an economy devoid Of financial instruments is financially backward. The following instruments are traded i; i y ins led in the Indian capi + Fi i : of i) ownership securities, (ii) debt secur ay ¢ Indian capital market. Financial instrument con: securities. (1) Equity Shares “he shares fre ownership securities. Investors find equity shares the best type of investment as the shares an be traded. The investor participates in the earnings of the company and receives ividends. The equity share value increases and during inflation it acts as a hedge, thus increasing the importance of such shares. The equity shares also have capital appreciation. They are however very risky shares as the prices can also fall and there can be losses. (2) Preference Shares Ss i) mutual funds units, ard (iv) financial engineering Preference shares are fixed dividend bearing instruments, They are called hybrid instruments because they have the features of both the equity shares and bonds. They have certain important features like cumulative dividends and are redeemable after some years. (3) Debentures/Bonds Debentures/Bonds represent borrowed or loan capital. There are many kinds of debentures! bonds in the Indian capital market. These are redeemable, perpetual, convertible, registered and bearer issues. They have a fixed interest called ‘coupon’ rate, These are debt securities and the holders do not have any right to attend the annual general meeting of the company. They are also not allowed to vote in any issues. (4) Financial Engineering Securities or New Innovative Instruments These are new type of securities which combine different features in one security. They are called ‘innovative instruments’. Many companies have tried to innovate to give a choice to the investors. The financial institutions and development banks in India have also issued such securities. The following are some financial engineering securities issued in India. For detailed explanation of the above mentioned securities refer chapter 5 ‘Sources of. Financing’ this book.Indian 1006846 3YStep, 222 les. Lala al ed units. Investors prefer mutual funds because they offer Joy, are called units. Inves a beneficial because they offe ual fund schemes c Me ri aningerienl Mutual fund offer growth, income ang .d ended schemes. Mutual fund secutitie ‘Smal risk and stable income. S advantage of diversification and profes ee index funds, They can be open ended or c (6) Post Office Securities Post offices offer certificates like Inc Certificates. They also provide monthly incor the scheme of public provident funds. The investor has ce i rates of interest for special schemes and liquidity in investment. the various securities of the post offices. : fee ; Ths, ‘there are many instruments from which an investor can select the security of his choice, From the above the following important aspects should be remembered. These are given below, : Equity shares have quick conversion into cash but are highly risky. However, an investor has both dividends and capital appreciation to look forward to in his investments. > Debt securities which offer fixed rate of interest for a fixed term and with a definite maturity period. The investor will benefit with continuous retum in the form of coupon rate. > Financial engineering securities which have many options like liquidity, marketability, convertibility, flexibility, and maturity period and tax benefits. These are innovative securities and combine the advantages of different types of securities. > Mutual funds securities that offer units. They offer freedom ftom management and : oe coupled with a good and stable retum. 0st office securite i i sleet eee oe bid different types of schemes like fixed period with interest and The investor should iti . value, marketability, tartan meet Fd ae ing the features of liquidity, collateral system, the : * maturity period, and risk and tax factor. In the Indi: jal © {stem the numberof instruments kas increased since 1991 and thi facets fre ns eel and this facilitates the linkage between epositors and investors, It tors. It is also to er ings istril ane neourage savings and distribute i n Vikas Patra and National Saving me schemes and schemes for retired investors. they have : vain advantages like tax benefits, higher «Indian investor can choose from .dra Vikas Patra, Kisa (iii) Lease financing. i ings : (iv) Factoring; ic 3 : (¥) Merchant banking, (i) Underwriting ete” Out OF MBA course of Ry