Industrial Finance – Financial System

Evolution (Money)
• Barter was the first stage

• Metal coins and paper notes as money.

Commodity money
 Metallic money
 Paper money
 Credit money
The Functions of Money
Qualities of Good Money

The following are the qualities of good money:

• General acceptability
• Stability in value
• Durability
• Divisibility
• Homogeneity
• Portability
• Cognizability
 Various measures of Money SS in
an Economy
M1 = Currency with the public + Demand deposits
with the banking system + Other deposits with the RBI

M2 = M1 + savings deposits of post office savings

banks

M3= M1 + Time deposits of Banks

M4 = M3 + All deposits with post office savings banks

(excluding National Savings Certificates)
Money in Circulation
Gresham’s Law

Gresham’s Law explains that when good money and bad money
circulate simultaneously and when they are full legal tender, bad
money drives good money out of circulation.

The law expresses a simple human tendency. A man always tries to

dispose off things which are bad and less valuable and keep good and
more valuable things.
 The Demand for Money
According to Keynes, the various liquidity motives are transactions,
precautionary and speculative, on account of which it is demanded :

• Transactions motive
• Precautionary motive
• Speculative motive
• Deflationary motive
The Quantity Theory
According to the quantity theory, price level varies directly with the quantity of
money and inversely with the volume of trade. That is, if the quantity of money
is doubled, price level also will be doubled and therefore, the value of money
will be halved. The following equation has been provided by Fisher:
Inflation
• Inflation is the most experienced economic phenomenon in India
and in the rest of the world. Though everyone, including economists,
understands the gravity of the problem, nobody has a readymade
solution to combat it.
• Inflation is said to exist when there is a rise in prices and a
corresponding fall in the value of money.
• Situations leading to inflation may arise generally under the following
circumstances:
Periods when inflation is found fairly common
 Demand-pull inflation
 Cost-push inflation
Cost-push inflation Vs. Demand-pull
Inflation
• Cost-push inflation theorizes that as costs to
producers increase from things like rising wages,
these higher costs are passed on to consumers.

• Demand-pull inflation takes the position that

prices rise when aggregate demand exceeds the
supply of available goods for sustained periods of
time.
Effects of Inflation

• Effects on production
• Effects on distribution
• Business community
• Fixed income groups
• Debtors and creditors
• Farmers
• Social and political effects
Deflation
• Deflation means a contraction of currency and credit leading to a fall in
prices.

• It is the opposite of inflation, another extreme currency situation, where

prices fall and the value of money rises.

• Deflation, according to Paul Einzig, “is a state of disequilibrium in which

a contraction of purchasing power tends to cause, or is the effect of,
the price level”.
Money Market
• A money market is a market that deals in short-term loans
or financial assets.
• It refers to the market for short-term requirement and
deployment of funds where participants lend and borrow.

• It is a market wherein financial institutions work together

for the purpose of dealing in financial or monetary assets,
generally referred to as near substitutes of money, which
may be of short-term or long-term maturity.

• “Short-term” implies, generally a period up to one year

and the term “near substitutes of money” refers to
financial assets which can be quickly converted into
money with minimum transaction cost.
Objectives of Money Market
The following are the objectives of a money market:

• It provides space for parking and using gainfully surplus

funds.
• It offers a forum for overcoming deficiencies of short-term
instruments.
• It enables the Reserve Bank, through its market
intervention, to impact and regulate liquidity to the
economy.
• It offers a chance to the users of short-term funds to access
their needs from suppliers easily, adequately and cost-
effectively.
Money Market Instruments
• The call/notice money market
• Interbank call markets
• Treasury bills
• Certificates of deposit
• Commercial papers
• Repo markets
• Term money markets
• Commercial bill markets
• Money market mutual funds
Indian Money Market Structure
Functions of a Money Market
• Money market helps in mobilizing savings, capital
formation and supply of funds to trade and industry by
offering different types of suitable and attractive schemes to
match the needs of various sections of society.
• A proper, balanced and efficient working of money market
helps in balancing excessive or limited supply of funds to
match seasonal variations in demand.
• A well-functioning money market helps to minimize
seasonal fluctuations in interest rates.
• A money market enables borrowers to get funds at
cheaper interest rates by facilitating increased supply of
funds and making them available to legitimate borrowers.
(Continued)

• An orderly and efficient functioning money market helps

different regions through quick transfer of funds from
one place to another.

• A money market augments the liquidity available to the

entire economy.

• A money market, by offering a platform for profitable

investment opportunities for short-term surplus funds,
helps to increase the profit of individuals and financial
institutions.
The Indian Capital Market
 The Capital Market
• The capital market is the market for long-term funds.
• It refers to the facilities and institutional arrangements available for
borrowing and lending term funds for investment purposes.
• Industry raises finance from the capital market with the help of a
number of instruments.

• Broadly speaking, corporations have a choice of

(i) equity finance and (ii) debt finance.
• Experience in different countries varies. Generally, equity-based
capital is cheap and less cumbersome to manage and service.

• Substituting equity finance for debt finance makes domestic firms

less vulnerable to fluctuations in earnings or increases in interest
rates.
Constituents
• The primary market: The primary capital market (a market for new
issues of shares, debentures and bonds).

• The secondary market: In the secondary market (where already issued

and outstanding shares are bought and sold),

• There was a perceptible expansion of activity during 2020–21 with BSE

and NSE indices scaling new peaks at 49,000 and 14,000, respectively, in
January 2021.
 (Continued)

• The debt market: Debt market is an important constituent of

capital market.
• The Indian debt market has two segments:
(i) Government securities market and
(ii) Corporate debt market.
• The government securities market, otherwise known as Gilt-
edged securities market, is where government securities are
traded. There are both short- and long-term markets for these
securities.
• In the corporate debt market, as had been the practice in the
past, private placements have been dominating the mobilization of
resources.
 Development
• Legislative measures
• Establishment of development banks and expansion of the public
sector
• Growth of underwriting business
• Public confidence
• Increasing awareness of investment opportunities
• Capital market reforms
Capital Market Structure
 Role of Securities Market in
Economic Growth
• The securities market helps in the allocation to best companies
• The securities market is conducive to sustained economic growth
• The securities market provides a bridge between savings and investment
• The securities market provides connectivity to the rest of the world
• The securities market will deter capital flight to developed countries
Regulatory Framework of the
Indian Capital Markets

 Securities and Exchange Board of India (SEBI)

 Reserve Bank of India (RBI)
 Department of Corporate Affairs (DCA)
 Stock Exchanges
 Public Disclosure
 What Is a Commercial Bank?
 A bank is an institution which deals with money.
 A bank can be defined as an institution, whose business is
handling other people’s money.

 Today,banks are those institutions which receive funds

from the public and give loans to those people in the
community who are in need of them.

 Banks can profit in such transactions. The main objective

of any bank is to secure profit. Other considerations are
secondary. The most important bank is a commercial bank.
Functions
A commercial bank performs the following transactions:
• It receives deposits
• It advances loans
• It discounts the bills of exchange
• It maintains safe-deposit vaults
• It transfers funds
• It performs miscellaneous functions
 Importance
• Banks are necessary for the growth of trade and industry. Almost all
transactions in the sphere of trade and commerce are credit transactions in
which banks provide the necessary backing. By offering discount facilities
for bills of exchange, banks facilitate internal as well as international trade.

• The total volume of money in any economy consists of coins, currency notes
and bank money. The credit-creating and credit-curtailing capacity of the
commercial banks helps to have elasticity and flexibility in the credit
structure and the monetary system of the country.

• Banks encourage entrepreneurship, by helping the established

manufacturers to increase their production capacity by adopting new
methods and introducing better machinery.

• Commercial banks encourage savings and accumulation of wealth by the

public. By mobilizing the idle and dormant capital of the community, banks
direct it to productive channels.
Current Indian Banking Situation

•Rapid branch expansion

•Banks in the public sector
•Banks in the private sector
•Deposit mobilization
•Expansion of bank credit
Indian Banking: Challenges
• Financial intermediaries
• Market discipline
• Adopting international standards
• Technology banking
• Rural banking
• Deregulation
• Increasing efficiency
Financial Institutions
 Development Banks

A development bank may be defined as a multipurpose financial

institution which shares entrepreneurial risk, shapes its approach in
tune with the industrial climate and encourages new industrial projects
with a view of bringing about speedier economic growth.

As development banks in a developing country, these financial

institutions have responsibilities and commitments far beyond their
raison d’être, as profit-making commercial institutions. They have to
contribute to national development.
Salient Features
The salient features of a development bank are as follows:
• It offers medium- and long-term finance to entrepreneurs
• Its assistance is “project oriented” rather than “security oriented”
• It acts as a “partner in progress”, and guides, supervises and advises the
entrepreneurs
• It offers both equity capital and debt capital
 The Industrial Finance
Corporation of India
• The Industrial Finance Corporation of India (IFCI), the first of the term-
financing institutions to be set up jointly by the Government of India, RBI
and other financial institutions, was established on 1 July, 1948 by a
special Act of the Parliament.
• Some of the noteworthy contributions of IFCI include improvement of
Indian industry, export promotion, import substitution, development in
business, pollution control measures, energy preservation and rendering
direct and indirect employment.
 Functions and Type of Assistance
to Industry
• It grants loans and advances to or subscribes to debentures of
industrial organizations.
• It guarantees loans raised by industrial organizations from the capital
market, scheduled banks or state cooperative banks.
• It gives guarantees with regard to deferred payments for imports of
capital goods manufactured in India.
• It guarantees loans raised from or credit arrangements made by
industrial organizations with any bank or financial institution outside
India with the approval of the Central Government.
• It underwrites the issue of shares and debentures by industrial
organizations.
(Continued)
• It subscribes directly to the shares and debentures of industrial
organizations.
• It acts as an agent of the Central Government and World Bank relating
to loans sanctioned by them to industrial organizations in India.
• It participates in the administration of the soft loan scheme for
modernization and rehabilitation of sick industries along with other all
Indian term lending institutions.
• It provides financial assistance for setting up industrial projects in
backward areas notified by the Central Government on concessional
terms.
• It provides guidance in project planning and implementation through
specialized agencies
 The Industrial Credit and Investment
Corporation of India
• The Industrial Credit and Investment Corporation of India (ICICI), a private
sector development bank, was established as a public limited company on
5 January, 1955.
• The main objective of the ICICI was to promote industrial development in
the private sector by providing financial, technical, administrative and
related services. The ICICI was established with a view to
(a) help in the promotion, expansion and modernization of industrial
enterprises in the private sector;
(b) encourage and promote the participation of private capital, both Indian
and foreign, in such enterprises and
(c) stimulate the growth of private ownership of industrial investments and
expansion of investment markets
Functions of ICICI
ICICI provides assistance to industrial enterprises by:
 Providing medium- and long-term rupee loans to industrial concerns
 Giving loans in foreign currencies towards the cost of imported capital
equipment
 Offering guarantees to the loans raised by companies in the open
market
 Promoting and underwriting new issues of industrial securities
 Contributing directly to shares and debentures of companies
(Continued)

 Offering funds available for reinvestment by revolving

investments as rapidly as prudent
 Providing technical and managerial know-how to industries
 Helping industrial concerns in obtaining technical and
administrative services from internal and external sources
• Sponsoring the participation of both internal and external private
capital in industrial concerns.
The Industrial Development Bank
of India
• The Industrial Development Bank of India (IDBI) was set up as an apex
development finance institution. It was set up as a statutory corporation
under Industrial Development Bank of India Act, 1964.
• IDBI was initially established as a wholly owned subsidiary of the RBI,
but in 1976 the ownership of IDBI was transferred to the Central
Government.
• The imperatives of rapid industrialization, long-term financial
requirements of heavy industry beyond the resources of the then
existing institutions, absence of a nodal agency to coordinate the
activities of other financial institutions and gaps in the financial and
promotional services were the main factors that prompted the
establishment of the IDBI.
Functions of IDBI
• Contributing to the shares and bonds of financial institutions and
guaranteeing their underwriting obligations
• Refinancing term loans and export credits extended by other financial
institutions
• Giving loans and advances directly to industrial concerns
• Offering guarantees for deferred payments due from and loans raised by
industrial units
• Subscribing to and underwriting shares and debentures of industrial
concerns
• Providing financial intermediation services such as accepting,
discounting and rediscounting bonafide commercial bills or promissory
notes of industrial concerns including bills arising out of sale of
indigenous machinery on deferred payment basis
(Continued)
• Funding turnkey projects by Indians abroad and extending credit to
foreigners for buying capital goods from India
• Filling the gaps in the industrial structure of the country by planning,
promoting and developing industries. The Bank may undertake
promotional activities like marketing and investment research, techno-
economic surveys, etc
• Giving technical and managerial assistance for promotion and expansion
of industrial undertakings
• Coordinating and regulating the activities of other financial institutions
The Industrial Investment Bank of
India
• In April 1971, Industrial Reconstruction Corporation of India (IRCI) was
set up at the instance of IDBI as a joint stock company to revive and
rehabilitate sick and weak industrial units. The IFCI, ICICI, LIC and public
sector banks had contributed to its share capital.

• The IRCI was reconstituted and rechristened as Industrial

Reconstruction Bank of India (IRBI) on 26 March, 1985 as a statutory
corporation, the principal credit and reconstruction agency for industrial
revival modernization, expansion rehabilitation, expansion,
reorganization, diversification and rationalization in the country. It was
primarily entrusted with the task of reviving the sick industrial concerns.
Functions of IIBI
• As a full-fledged development bank, the IIBI now undertakes the
functions such as:
• Granting medium- and long-term loans
• Providing hire-purchase of equipment, leasing finance and finance
for the purpose of buying assets
• Underwriting shares and debentures
• Subscribing directly to shares and debentures
• Guaranteeing deferred payments
• Granting short-term working capital loans
The Small Industries Development
Bank of India
The Small Industries Development Bank of India (SIDBI) was set up
under the Indian Companies Act, 1956 on 2 April, 1990 under a special
Act of Parliament, as a wholly owned subsidiary of the IDBI. SIDBI took
over the outstanding portfolio of IDBI relating to the small-scale sector
worth over INR 40 billion.

The authorized capital of SIDBI is INR 2.50 billion which could be

increased to INR 100 billion. It has taken over the responsibility of
administering Small Industries Development Fund and National Equity
Fund which were earlier administered by IDBI.
 Functions of SIDBI
SIDBIs main functions are:
• SIDBI refinances loans and advances extended by primary lending
institutions to small-scale industrial units
• It discounts and rediscounts bills arising from sale of machinery to or
manufactured by industrial units in the small-scale sector
• It extends need capital/soft loan assistance under National Equity Fund,
Mahila Udyam Nidhi, Mahila Vikas Nidhi and through specified agencies
• It grants direct assistance and refinance for financing exports of
products manufactured in the small-scale sector
(Continued)
• It extends support to State Small Industries Development Corporations
(SSIDCs) for providing scarce raw materials to and marketing the end
products of industrial units in the small-scale sector
• It gives financial support to National Small Industries Corporation (NSIC)
for offering leasing, hire-purchase and marketing support to industrial
units in the small-scale sector
• It provides services such as leasing, factoring, etc. to industrial concerns
in the small-scale sector.
 State Financial Corporations

The need for state level financial institutions was felt to meet the
financial needs of local, medium- and small-sized industries as the IFCI
provides finance to large public companies and cooperative societies.
On 28 September, 1951 the Parliament passed the State Financial
Corporations Act, which empowered the State Governments to
establish financial institutions for their local limits. Accordingly, 17 SFCs
were set up under the Act by the respective state governments as
regional institutions.
Functions
The SFCs function as regional development banks in respective states.
They are authorized to provide financial assistance in the following
forms:

• Providing loans or advances and subscribing to the debentures of

industrial units
• Giving guarantee to loans raised by industrial units on such terms and
conditions as may be agreed upon mutually
• Underwriting shares, debentures and other industrial securities
• Providing guarantee to deferred payments for the purchase of capital
goods within India
(Continued)

• Diffused customer loyalty

• Employee-related problems
• Need for customer-retention strategies
• Innovative services
• Consolidation
• Globalization/Overseas expansion
• Risk management and Basel-II
• Challenging role of regulators