ANSWER KEY-00135

C0921 - F.Y.B. Com. (FINANCIAL MANAGEMENT) (CHOICE BASE) SEMESTER - I / C0584 - Indian Financial System

Q1) a) Answer whether the below statements are True or False: (Attempt any 8) (8 marks)
i) Economic growth and development are possible without finance-False
ii) Money market deals in short term credit-True
iii) SEBI has liberalized many stringent conditions so as to boost the capital and money markets.-
True
iv) In 1936, Reserve Bank of India came into being which made the Central Bank-False
v) Development bank accepts deposits from public-False
vi) NABARD is India’s specialized bank for agriculture and rural development in India-True
vii) SEBI always protect the interest of investors- True
viii) Finance companies are not regulated in India-True
ix) Micro Finance has wider concept as compared to micro credit- True
x) Bank Rate is the qualitative instrument of RBI- False

b) Fill in the blanks: (Attempt any 7) (7 marks)

i) RBI helps in providing finance to industries in India
ii) Development banks provide medium and long term finance to business units
iii) SEBI aims to provide investor protection
iv) The Imperial Bank of India was nationalized in 1955 and was renamed as SBI
v) NABARD provides Refinance assistance for agriculture, promoting rural development activities.
vi) RBI regulates and supervises NBFCs.
vii) Factoring is a type of fund based financial services.
viii) Treasury bill are used to raise short-term funds by the government.
ix) Liquidity risk refers to problems that arise when a firm run short of cash.
x) Reverse Repo rate is the short term borrowing rate at which RBI borrows money from banks.

Q2) Explain in detail the structure of Financial System (15 marks)

Ans: Financial system consists of a variety of institutions, markets and instruments related in a
systematic manner and provide the principal means by which savings are transformed into investments

Structure of Financial system

Need to discuss each part in detail

OR

Q2) a. Explain in detail the flow of funds in financial system. (7 marks)

Financial markets perform the essential economic function of channeling funds from those that have
saved to those that have a shortage of funds. Those who have saved and are lending funds, the lender-
savers, are to the left in Figure 1, and those who must borrow funds to finance their spending, the
borrower-spenders, are to the right.

Figure 1.Flow of funds in the financial system

Borrowers can borrow funds directly from lenders in financial markets by selling financial instruments,
such as certificates of deposit, commercial paper, corporate bonds, government securities, and stocks.
This route is often called direct finance. In general, investment banks and brokerage firms play an
important role in helping borrowers to raise capital or borrow money following this route.

b. Explain the importance of financial system for economic growth (8 marks)

Ans: 1. It links the savers and investors. It helps in mobilizing and allocating the savings efficiently and
effectively. It plays a crucial role in economic development through saving-investment process. This
savings – investment process is called capital formation.
2. It helps to monitor corporate performance.
3. It provides a mechanism for managing uncertainty and controlling risk.
4. It provides a mechanism for the transfer of resources across geographical boundaries.
5. It offers portfolio adjustment facilities (provided by financial markets and financial intermediaries).
6. It helps in lowering the transaction costs and increase returns. This will motivate people to save more.
7. It promotes the process of capital formation.
8. It helps in promoting the process of financial deepening and broadening. Financial deepening means
increasing financial assets as a percentage of GDP and financial broadening means building an increasing
number and variety of participants and instruments.
In short, a financial system contributes to the acceleration of economic development. It contributes to
growth through technical progress.

Q3) Explain in detail the functions and role of RBI (15 marks)

Ans: Functions: Issue of currency notes, banker to government, banker to banks, foreign exchange
management, controller of credit

Role: Protecting the interest of investors; to ensure Development activities in Stock Exchange; regulate
the business of stock exchange and activities of stock exchange; to Regulate Insider Trading

OR

Q3) a. What is the promotional role of development banks? Explain. (8 marks)

Ans: The pace of development cannot be accelerated by providing financial assistance alone. It is
essential to make a correct diagnosis of those factors and plan things accordingly. The growth potential
of different areas, the availability of natural resources, demand conditions, infrastructure facilities, etc.
should be taken into account before deciding the pattern .of industrialization of various places. The task
of identification of growth potentialities and preparation of feasibility studies is not an easy task. It
requires huge finances and technical expertise which is beyond the competence of entrepreneurs of
underdeveloped countries. It is in this area where development banks can play crucial role. In addition
to providing the traditional role of providing financial assistance, development banks in India are
undertaking promotional role also. Some of the areas where these banks are participating are:

1. Surveys of Backward Areas

2. Inter-Institutional Groups (IIG's)
3. Establishing Technical Consultancy Organizations (TCO's)
4. Entrepreneurial Development Programmers (EPP's)
5. Technological Improvements
 b. Explain in brief origin and development of commercial banks (7 marks)
Ans: Enhancement of the RBI Act 1935 gave birth to scheduled banks in India, and some of these banks
had already been established around 1881. The prominent among the scheduled banks is the Allahabad
Bank, which was set up in 1865 with European management. The first bank which was established with
Indian ownership and management was the Oudh Commercial Bank, formed in 1881, followed by the
Ayodhya Bank in 1884, the Punjab National Bank in 1894 and Nedungadi Bank in 1899. Thus, there were
five Banks in existence in the 19th century. During the period 1901-1914, twelve more banks were
established, prominent among which were the Bank of Baroda (1906), the Canara Bank (1906), the
Indian Bank (1907), the Bank of India (1908) and the Central Bank of India (1911). Thus, the five big
banks of today had come into being prior to the commencement of the First World War. In 1913, and
also in 1929, the Indian Banks faced serious crises. Several banks succumbed to these crises. Public
confidence in banks received a jolt. There was a heavy rush on banks. An important point to be noted
here is that no commercial bank was established during the First World War, while as many as twenty
scheduled banks came into existence after independence - two in the public sector and one in the
private sector. The United Bank of India was formed in 1950 by the merger of four existing commercial
banks. Certain non-scheduled banks were included in the second schedule of the Reserve Bank. In view
of these facts, the number of scheduled banks rose to 81. Out of 81 Indian scheduled banks, as many as
23 were either liquidated or merged into or amalgamated with other scheduled banks in 1968, leaving
58 Indian schedule banks. It may be emphasized at this stage that banking system in India came to be
recognized in the beginning of 20th century as powerful instrument to influence the pace and pattern of
economic development of the country. In 1921 need was felt to have a State Bank endowed with all
support and resources of the Government with a view to helping industries and banking facilities to
grow in all parts of the country. It is towards the accomplishment of this objective that the three
Presidency Banks were amalgamated to form the Imperial Bank of India. The role of the Imperial Bank
was envisaged as "to extend banking facilities, and to render the money resources of India more
accessible to the trade and industry of this country, thereby promoting financial system which is an
indisputable condition of the social and economic advancement of India." Until 1935 when RBI came
into existence to play the role of Central Bank of the county and regulatory authority for the banks,
Imperial Bank of India played the role of a quasi-central bank. It functioned as a commercial bank but at
times the Government used it for regulating the money supply by influencing its policies. Thus, the role
of commercial banks in India remained confined to providing vehicle for the community's savings and
attending to the credit needs of only certain selected and limited segments of the economy.

Q4) Describe the functions, objective and role of NABARD. Explain in detail. (15 marks)

Ans: Role:

1) Looks after development of the cottage industry, small scale industry and village industry, and
other rural industries
2) Reaches out to allied economies and supports and promotes integrated development
3) An apex financing agency for the institutions providing investment & production credit for
promoting various developmental activities in rural areas
4) Takes measures towards institution building for improving absorptive capacity of the credit delivery
system
5) Co-ordinates the rural financing activities of all institutions engaged in developmental work at the
field level
6) Maintains liaison with Government of India, state governments, RBI and other national level
institutions concerned with policy formulation
7) Undertakes monitoring and evaluation of projects refinanced by it
8) Refinances the financial institutions which finances the rural sector
9) Participates in development of institutions which help the rural economy
10) Keeps a check on its client institutes
11) Regulates the institutions which provide financial help to the rural economy
12) Provides training facilities to the institutions working in the field of rural upliftment.
Objectives: In discharging its role as a facilitator for rural prosperity, NABARD is entrusted with

 Providing refinance to lending institutions in rural areas

 Bringing about or promoting institutional development and
 Evaluating, monitoring and inspecting the client banks
Functions: Finance function, supervisory function and development functions (in detail)

OR

Q4) a. Explain in brief origin and development of SEBI (7 marks)

Ans: Securities Exchange Board of India (SEBI) was set up in 1988 to regulate the functions of securities
market. SEBI promotes orderly and healthy development in the stock market but initially SEBI was not
able to exercise complete control over the stock market transactions.
It was left as a watchdog to observe the activities but was found ineffective in regulating and controlling
them. As a result in May 1992, SEBI was granted legal status. SEBI is a body corporate having a separate
legal existence and perpetual succession.
With the growth in the dealings of stock markets, lot of malpractices also started in stock markets such
as price rigging, ‘unofficial premium on new issue, and delay in delivery of shares, violation of rules and
regulations of stock exchange and listing requirements. Due to these malpractices the customers started
losing confidence and faith in the stock exchange. So government of India decided to set up an agency
or regulatory body known as Securities Exchange Board of India (SEBI).

b. Explain sources of finance from the point of NBFCs. (8 marks)

Ans: Borrowings from Banks; Shares, Debentures, Commercial Paper, etc.

Q5) a. Describe the functions of Finance Companies (8 marks)

Ans:

 Fill credit gaps by providing lease finance, hire purchase and instalment buying
 Provide loans to buy scooters, cars, TVs, consumer durables
 No cheque system
  Able to attract deposits of huge amounts by offering high rate of interest
 Provide loans to wholesale and retail merchants
 Provide loans without security also
 High rate of interest
 Run chit funds, discount hundies, provide hire purchase, leasing finance, merchant banking
activities
 Provide loans to org with high risk

b. Explain in detail the role of microfinance institutions in rural development. (7 marks)

Ans:

 Categorize & coordinate networking of grass root level organization

 Empower and mainstream women entrepreneurs
 Encourage programs for the disabled
 Endorse socio-economic development thru community based approach
 Extend and make SHG stronger
 Increase the number of wage days and income at household level
 Provide livelihood training to deprived population
 Support activities which have community participating
 Improved standard of living
 Access to capital
 Entrepreneurship
 Social uplifting

OR

Q5) Write short notes on (Attempt any 3) (15 marks)

a. Performance report of SFCs.

There are 18 SFCs (including the Tamil Nadu Industrial Investment Corporation Ltd.) operating in
seventeen different states and Delhi (Union Territory). The SFCs are under the diarchical control of
the State Government and the IDBI.
The SFCs have functions similar to those of the IFCI. They are empowered to provide financial
assistance in the form of loans and advances, subscription to shares and debentures, underwriting
of new issues, and guarantee of loans. But, in practice, they have concentrated mostly on loans and
advances only. There is, therefore, a need for reorientation of their loans policy.

b. Origin of finance companies.

Origin of the first company for doing financial business was formed in late 1930s in South India. In
the beginning, finance business was quite popular in Southern state unlike in other parts of the
country where it penetrated slowly. Till 1965, the business of financing under corporate sector was
regulated by the Companies Act. At that time a need was felt that due to the unique and complex
nature of operations and also financial companies acting as financial intermediaries, there should be
a separate regulatory mechanism. With a view to review the existing framework and address these
shortcomings, various committees were formed and reports were submitted by them.
c. Role of NBFC
 Mobilisation of Resources
 Capital Formation
 Aid in employment generation
 Helps in development of financial markets
 Helps in attracting foreign grants
 Development of sectors like Transport & Infrastructure
 Substantial employment generation
 Help & increase wealth creation
 Broad base economic development

d. Objectives of SEBI
SEBI was set up with the main purpose of keeping a check on malpractices and protect the interest
of investors. It was set up to meet the needs of three groups.

1. Issuers: For issuers it provides a marketplace in which they can raise finance fairly and easily.
2. Investors: For investors it provides protection and supply of accurate and correct information.
3. Intermediaries: For intermediaries it provides a competitive professional market.

e. Role of commercial banks

The general role of commercial banks is to provide financial services to general public and business
and companies, ensuring economic and social stability and sustainable growth of the economy. In
this respect, "credit creation" is the most significant function of commercial banks.
(in detail)