Financial Intermediaries

Dr Anu Kohli
v
Financial Institutions (Intermediaries)
• The role of financial institutions is to provide financial
services to develop the financial sector and foster
entrepreneurship. A financial institution also focuses on
corporate governance and institution building.

• Financial institutions provide services as intermediaries of

financial markets. They are responsible for transferring
funds from investors to companies in need of those
funds. They also facilitate the flow of money through the
economy.
Financial Institutions: Banks
History of Banking in India
• The first bank in India, though conservative, was established
in 1786. From 1786 till today, the journey of Indian Banking
System can be segregated into five distinct phases:
• In over five decades since independence, banking system
in India has passed through five distinct phase, viz.
(1) Evolutionary Phase (prior to 1950)
(2) Foundation phase (1950-1968)
(3) Expansion phase (1968-1984)
(4) Consolidation phase (1984-1990)
(5) Reformatory phase (since 1990)
Financial Institutions: Banks
• Now a days all Banks are Schedule Banks and there is no Non
Schedule Bank. The system of Non Schedule Bank was abolished
long back.
( The Banks which were not in the direct control of RBI were non
schedule Bank )
• Scheduled Banks in India constitute those banks which have been
included in the Second Schedule of Reserve Bank of India (RBI) Act,
1934. RBI in turn includes only those banks in this schedule which
satisfy the criteria laid down vide section 42 (6) (a) of the Act.
Commercial banks in India comprise of: State bank of India and its
associates, Nationalised banks, Foreign banks, Private sector
banks, Co-operative banks and Regional Rural banks.
Financial Institutions: Banks
• The following are the Scheduled Banks in India (Public Sector):

All the associate banks of SBI are

merged with SBI since 2017
Financial Institutions: Banks
Financial Institutions: Banks
Scheduled Urban Co-operative Banks
• Initially set up to supplant indigenous sources of rural credit,
particularly money lenders, today they mostly serve the needs
of agriculture and allied activities, rural-based industries
and to a lesser extent trade and industry in urban centers.
• Co-operative banks have a three tier structure — primary
(agriculture or urban) credit societies, district central co-
operative banks and at the apex level, state co-operative
banks.
• What are urban co-operative banks? Who regulates them?
• Primary (urban) credit societies that meet certain specified
criteria can apply to RBI for a banking license to operate as
urban co-operative banks. Primary (urban) co-operative banks
are registered and governed by state governments under the
respective co-operative societies acts of the concerned states.
Scheduled Urban Co-operative Banks
Essential Characteristics of Banks
According to Section 5(b) of the Banking Regulation Act
are:
1. Acceptance of deposits from the public
2. For the purpose of lending or investment
3. Repayable on demand or otherwise
4. Withdrawal by means of any instrument whether a
cheque or otherwise.

Two important functions: acceptance of deposits and

lending of funds.
Functions of Banks
1. Deposits
Deposits are the main source of funds for commercial
banks. The amount mobilized as deposits is then lent in the form
of advances. Banks mobilizes the savings by accepting the
deposits.

Deposits are categorized into:

(i) Demand deposits: deposits which can be withdrawn without
notice and can be repaid on demand. eg. Current accounts
and Saving accounts.
(ii) Time deposits: deposits which are repayable after a fixed
date or after a period of notice. eg. Fixed deposits,
Recurring/ Cumulative deposits, Miscellaneous deposits,
Cash certificates etc.
Functions of Banks ………contd.
2. Credit Creation
Banks are the creators of credit. This creation of
credit distinguishes the banks from the non-banking
institutions. Banks create deposits in the process of their
lending operations. When the bank mobilizes savings, it
lends the amount that remains after providing for reserves.
The amount lend is either deposited in the same bank or in
some other bank. This leads to the creation of credit, which
in turn increases the liabilities and assets in the banking
system – i.e. the total amount of money in circulation.
Functions of Banks ………contd.
3. Lending of Funds:
Commercial banks mobilizes savings from the surplus
spending sectors and lend these funds to the deficit spending
sectors. Both financial activities of private sector as well as of
government sector facilitated. Eg. Cash credit, overdrafts, loan
system etc.
4. Ancillary Functions
- transfer of funds
- collection
- foreign exchange
- safe deposit locker
- gift cheques
- merchant banking
Regulations of banks in India
1. Nationalized Banks – the Banking Companies
(Acquisition) Act, 1970 popularly known as the Bank
Nationalization Act and the Banking Regulation Act,
1949.
2. SBI – the State Bank of India Act, 1955
3. Associate banks of SBI – the State Bank of India
(Subsidiary) Act, 1959
4. Private banks – the Banking Regulation Act, 1949
Resource Requirements of Banks
• Banks depend on deposits and non-deposits to meet their
resource requirements.
• Deposits constitute the largest source of funds for the
banks. Banks mobilize deposits from house hold sectors,
corporate sector, financial institutions, NRI, foreign
consulates and embassies deposits, government, etc.
• Banks raise non deposit resources through public issues
both debt and equity in the domestic capital market and
borrowings both at home and abroad. Bank raise short
term funds by borrowings in the call/notice money
markets, repo markets etc. Banks also resort to external
commercial borrowings (ECBs) and inter-bank borrowings
in India and abroad to raise funds.
Lending or Extension of Credit
• Both for small borrowers to various sectors of the
economy.
• Ranging from short term credit for seasonal agricultural
operations to long term credit for creation of assets.
• In order to ensure that the bank credit flows to the vital
sectors of the economy and according to national
priorities, the concept of priority sector lending was
developed.
• The broad sectors under the revised norms include
Agriculture (both direct and indirect), Small Enterprises
(both direct and indirect), Retail Trade in essential
commodity and consumer cooperative stores, Micro
credit, Educational Loans and Housing Loans
Infrastructure Projects
• Banks finance both short-term working capital and long
term requirements of industry.
• Banks finance Infrastructure Projects by way of term
loans, bonds and guarantees.
• For funding large infrastructure projects, banks also
syndicate loans – in which different banks come forward
to share the loan amount.
• Banks also lend to Special Purpose Vehicles (SPVs) in
the private sector, registered under Companies Act for
directly undertaking infrastructure projects.
Household Sector
• Banks lend funds to the house hold sector in the form of
housing loans, auto loans, advances to individuals against
fixed deposits, credit cards, educational loans and loans
for purchase of consumer durables.
• These are categorized as retail loans as the average size
of the loan is very small and loans are widely distributed
over a large number of borrowers.
Non Performing Assets (NPAs)
• NPAs are loans given by a bank or financial institutions
wherein the borrower defaults or delays interest or
principal payments.
• According to the RBI norms, any interest or loan
repayment delayed beyond 90 days has to be identified
as a non-performing asset.
NPA Settlement
Now banks and financial institutions saddled with bad loans
have multiple options like
• direct settlement across the table,
• legal recourse in the form of approaching the high court or
debt recovery tribunals,
• enforcement of the new securitization law (where
securities pledged with them could be attached and
subsequently sold) &
• lastly selling it to asset reconstruction companies (ARCs).
• Banks have been advised to devise one-time compromise
settlement scheme for resolution of NPAs.
• As per this scheme, for NPAs upto Rs. 10 crore, the minimum
amount that should be recovered should be 100 per cent of the
outstanding balance in the account.
• Lok Adalats have been set up to help banks to settle disputes
involving accounts in ‘doubtful’ and ‘loss’ category with outstanding
balance of Rs. 5 lakhs to Rs. 20 lakhs.
• Debt recovery tribunals were setup under the Recovery of Debts
due to Banks and Financial Institutions Act, 1993. This Act
provides for the establishment of tribunals for expeditious
adjudication and recovery of debts due to banks and for matters
connected therewith and incidental thereto. DRTs have been
empowered to decide on cases of advances of Rs. 10 lakhs and
above.
• The scheme of CDR was institutionalized in 2001-02 to provide a timely and
transparent system for restructuring of corporate debts of Rs. 20 crore and
above with the banks and financial institutions.
• Corporate Debt Restructuring (“CDR”) mechanism is a voluntary non
statutory mechanism under which financial institutions and banks come
together to restructure the debt of companies facing financial difficulties
due to internal or external factors, in order to provide timely support to such
companies.
• RBI has advised public sector banks to examine all cases of willful default of
Rs. One crore and above and file criminal suits in such cases. A willful
defaulter does not get any new loans from FIs nor can he raise funds from
the capital market.
• The Government enacted the Securitization and Reconstruction of Financial
Assets and Enforcement of Security Interest Act, 2002 for enforcement of
security interest for realization of dues without the intervention of courts or
tribunals. This act is a step towards bringing down the level of risk in the
system and encouraging banks to lend.
Asset Reconstruction Company (ARC)
• An Asset Reconstruction Company (ARC) is setup to help
the banks and financial institutions to clear up their balance
sheets.
• The functions of an ARC are acquisition of financial assets,
change or take over of management/sale or lease of
business of the borrower, rescheduling of debts,
enforcement of security interest, and settlement of dues
payable by the borrower.
• The Asset Reconstruction Company of India Limited
(ARCIL) is the first asset reconstruction company of India. It
is sponsored by the State Bank of India, ICICI Bank Ltd.,
Industrial Development Bank of India, Housing Development
Finance Corporation Limited and HDFC Bank Ltd.
• The Credit Information Bureau of India Limited provides
credit information of borrowers to banks, financial
institutions, non-banking financial companies, and credit
card companies.
Bank facilities to NBFCs
• Banks extend need based working capital facilities as well
as term loans to all NBFCs registered with RBI and
engaged in equipment leasing, hire-purchase loans,
factoring and investment activities.
• Banks also extend financial assistance to support the
factoring business of Factoring Companies.
Financial Institutions: NBFC
Meaning of Non-Banking Financial Company (NBFC)
• A Non-Banking Financial Company (NBFC) is a company registered under the
Companies Act, 1956 engaged in the business of loans and advances, acquisition of
shares/stocks/bonds/debentures/securities issued by Government or local authority or
other marketable securities of a like nature, leasing, hire-purchase, insurance business,
chit business but does not include any institution whose principal business is that
of agriculture activity, industrial activity, purchase or sale of any goods (other
than securities) or providing any services and sale/purchase/construction of
immovable property.
• The difference between banks & NBFCs :
• NBFCs lend and make investments and hence their activities are akin to that of banks;
however there are a few differences as given below:
• i. NBFC cannot accept demand deposits;
• ii. NBFCs do not form part of the payment and settlement system and cannot
issue cheques drawn on itself;
• iii. deposit insurance facility of Deposit Insurance and Credit Guarantee
Corporation is not available to depositors of NBFCs, unlike in case of banks.
Financial Institutions: NBFC
• Non Banking Financial Companies (NBFCs) registered
with RBI under three categories are.

• Number of NBFCs permitted to accept public deposits is

244
• List of NBFCs not accepting Public Deposits
• List of the Non-Banking Financial Companies - Micro
Finance Institutions (NBFC-MFIs)