Indian Financial System

Indian Financial System

INDIAN FINANCIAL SYSTEM

Indian Financial System

CONTENTS

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Introduction

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Features of Financial System

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Role of Financial System

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Back Drop of Financial System

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Indian Financial System from 1950 – 1980

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Indian Financial System Post 1990’s

Indian Financial System

INTRODUCTION The financial system or the financial sector of any country consists of:(a) specialized & non specialized specialized financial institution institution (b) organized &unorganized &unorganized financial markets and (c) Financial instruments & services services which facilitate transfer of funds. funds. Proc Proced edur uree & prac practi tice cess adop adopte ted d in the the mark market ets, s, and and fina financ ncia iall inte inter  r  relationships are also the parts of the system. These parts are not always mutu mutual ally ly excl exclus usiv ive. e. For For exam exampl ple, e, the the fina financ ncia iall inst instit itut utio ion n op oper erat atee in financial market and are, therefore a part of such market. The word system in the term financial system implies a set of complex and closely connected or inters mixed institution, agents practices, markets, transactions, claims, & liabilities in the economy. The financial system is concerned about money, credit, & finance – the terms intimately related yet some what different from each other. Money refers to the current medium of exchange or means of   payment.  payment. Credit Credit or Loan is a sum of money money to be returned returned normally normally with with Interest it refers to a debt of economic unit. Finance is a monetary resources comprising debt & ownership fund of the state, company or person.

Indian Financial System

FEATURES OF FINANCIAL SYSTEM -: 1. It provide providess an Ideal Ideal linkag linkagee betwee between n deposi depositor torss savers savers and Investors Therefore it encourages savings and investment. 2. Financ Financial ial system system facili facilitat tates es expans expansion ion of finan financia ciall market marketss over a period of time. 3. Fina Financ ncia iall syst system em shou should ld prom promot otee defi defici cien entt allo alloca cati tion on of  financial resources of socially desirable and economically  productive purpose. 4. Fina Financ ncia iall syst system em infl influe uenc ncee bo both th qu qual alit ity y and and the the pace pace of  economic development.

ROLE OF FINANCIAL SYSTEM: The role of the financial system is to promote savings & investments in the economy. It has a vital role to play in the productive process and in the mobilization of savings and their distribution among the various  productive activities. Savings are the excess of current expenditure over  income. The domestic savings has been categorized into three sectors, household, government & private sectors.

The savings from household sector dominates the domestic savings component. The savings will be in the form of currency, bank deposits, non bank deposits, life insurance funds, provident funds, pension funds, shares, debentures, bonds, units & trade debts. All of these currency & deposi deposits ts are volunt voluntary ary transa transacti ctions ons & precau precautio tionar nary y measur measures. es. The

Indian Financial System

savings in the household sector are mobilized directly in the form of  unit un its, s, prem premiu ium, m, prov provid iden entt fund fund,, and and pens pensio ion n fund fund.. Th Thes esee are are the the cont contra ract ctua uall form formss of savi saving ngs. s. Fina Financ ncia iall acti active vely ly deal dealss with with the the  production, distribution & consumption of goods and services. The financial system will provide inputs to productive activity. Financial sector provides inputs in the form of cash credit & assets in financial for production activities.

The function of a financial system is to establish a bridge between the savers and investors. It helps in mobilization of savings to materialize investment ideas into realities. It helps to increase the output towards the existing production frontier. The growth of the banking habit helps to activate saving and undertake fresh saving. The financial system encourages investment activity by reducing the cost of finance risk. It helps to make investment decisions regarding projects by sponsoring, encouraging, export project appraisal, feasibility studies, monitoring & execution of the projects.

Indian Financial System

An overview of Financial System and Financial Markets in India MINISTRY OF FINANCE

Financial Institutions

RBI

SEBI

IRDA

Insurance company

Mutual Fund

Venture Capital Fund

Capital Market

LIC & Other  Commercial Banks

NBFC

Money Market

Primary Market

Development Banks

Investment Banks

GIC & Other 

Sectoral Banks

State Level Financial Institution

Stock  Exchange

Secondary Market

Government Security Market

Indian Financial System

BACK DROP OF INDIAN FINANCIAL SYSTEM

At the time of independence, India had a reasonably diversified financial system in terms of intermediaries but a somewhat narrow focus on terms of 

Industry’s share in credit doubled, agriculture, rural areas, SSI, exports still neglected

1947

 Neglected: long term, agricultural, and rural area credit  Need for specialized FIs felt. DFIs, SFCs, UTI, Co-op Banks setup.

RRBs setup

1960s

1980s

1970s

 Nationalisation of Banks to ensure credit allocation as per   plan priorities

 NABARD, EXIM, SIDBI,  NHB setup

1990s

Credit to Industry / Govt doubled Highly segmented financial market, highly restricted

intermediation, i.e., a lack of a long term capital market and the relative neglect of agriculture in particular and rural areas in general.

As India embarked on a process of industrialization and growth, RBI set up Development Financial Institutions (DFI’s) and State Finance Corporations (SFC’s) as providers providers of long term capital. Agriculture’s need need for credit was was met by cooperative cooperative banks. UTI was set up to canalize canalize resources from from retail investors to the capital market.

In esse essenc nce, e, the the un unde ders rsta tand ndin ing g that that requ requir irem emen entt of fina financ ncia iall need needss for  for  accelerate accelerated d growth growth and developme development nt was best met by specialize specialized d financial financial

Indian Financial System

intermed intermediarie iariess who performe performed d specialize specialized d functions functions influence influenced d financia financiall market architecture.

To ensure that these specializations were adhered to, financial intermediaries develo developed ped and promot promoted ed by the Reserv Reservee Bank Bank of India India had signif significa icant nt restrictions on both the asset and liabilities side of their balance sheets.

In the 1950s and 1960s, despite an expansion of the commercial banking system in terms of both reach and mobilization of resources, agriculture still remained remained under under funded and rural areas areas under banked. banked. Whereas Whereas industry’s industry’s share in credit disbursed almost doubled between 1951 and 1968, from 34 to 67.5%, agriculture agriculture got barely barely 2% of available. available. Credit to exports exports and small small scale industries were relatively neglected as well.

In view of the above, it was decided to nationalize the banking sector so that cred credit it allo alloca cati tion on coul could d take take plac placee in acco accord rdan ance ce in plan plan prio priori riti ties es..  Nationalization took place in two phases, with a first round in 1969 followed  by another in 1980.

By the mid-seventies it was felt that commercialized banks did not have sufficient expertise in rural banking and hence in 1975 Regional Rural Banks (RRBs) were set up to help bring rural India into the ambit of the financial financial network. network. This effort effort was capped in 1980 with the formati formation on of   National Bank for Agriculture and Rural Development (NABARD), which was to function as an apex bank for all cooperative banks in the country, helping helping control control and guide their their activities activities.. NABARD NABARD was also given the the remit of regulating rural credit cooperatives.

Indian Financial System

Following with the logic of specialization, the 1980s saw other DFIs with specific remits being set set up – e.g. The EXIM Bank for export export financing, the Smal Smalll Indu Indust stri ries es Deve Develo lopm pmen entt Bank Bank of Indi Indiaa (SID (SIDBI BI)) for for smal smalll scal scalee industries and the National Housing Bank (NHB) for housing finance.

Long term finance for the private sector came from DFIs and institutional investors or through through the capital market. However both price and and quantity of  capital issues was regulated by the Controller of Capital Issues. Therefore the deepening of financial intermediation had occurred with an increase increase in the draft by both the commerci commercial al sector sector and the governmen governmentt on financial resources mobilized. At the end of the 1980s then the Indian financial system was characterized   by segmented financial markets with significant restrictions on both the asset and liability side of the balance sheet of financial intermediaries as well as the price at which financial products could be offered.

In the Indian context segmentation segmentation meant that competition competition was muted. muted. In a scenario where price was determined from outside the system and targets were were set set in term termss of qu quan anti titi ties es,, ther theree was was no pres pressu sure re for for no nonn-pr pric icee competiti competition on as well. As a result the financial financial system system had relatively relatively high transaction costs and political economy factors meant that asset quality was not a prime concern. concern. Therefore even though though the Indian financial system at the end of 1980s had achieved substantial expansion in terms of access, this had come at the cost of asset asset quality. In addition, was the fact fact that the draft of the gov govern ernmen mentt on resour resources ces of the financ financial ial system system had increa increased sed significantly. This in itself need necessarily necessarily was not a problem problem but over this

Indian Financial System

  perio period, d, i.e., i.e., the 198 1980s, 0s, the compos compositi ition on of gov govern ernmen mentt expend expenditu iture re was changing as well, with shift towards current rather than capital expenditure. In addition, in the absence of a reasonably liquid market for government securities, an increase in net bank lending to the government meant that the asset side of banks’ balance sheets tended to become increasingly illiquid.

Thee impe Th impetu tuss for for chan change ge came came from from on onee expe expect cted ed and and on onee un unex expe pect cted ed quarter - first, the importance of prudential capital adequacy ratios was underlined by the announcement of BaselI norms (see Error: Reference source source not found found Error Error:: Refere Reference nce source source not found found)) Th That at bank bankss were were expected to adhere to; second the macroeconomic crisis of 1990-91.

The reform process that followed accelerated the process of liberalization already begun in the 1980s and began a series of measured and deliberate steps steps to integr integrate ate India India into into the global global econom economy, y, includ including ing the global global financial network.

Brie Briefl fly y ho howe weve ver, r, give given n the the prob proble lems ms faci facing ng the the fina financ ncia iall syst system em and and keeping in mind the institutional changes necessary to help India financially inte integr grat atee into into the the glob global al econ econom omy, y, fina financ ncia iall refo reform rm focu focuse sed d on the the following: improving the asset quality on bank balance sheets in particular  and operational efficiency in general; increasing competition by removing regulatory barriers to entry; increasing product competition by removing restrictions on asset and liability sides of financial intermediaries; allowing financial intermediaries freedom to set their prices; putting in place a market for government securities; and improving the functioning of the call money market.

Indian Financial System

Thee go Th gove vern rnme ment nt secu securi rity ty mark market et was was part partic icul ular arly ly impo import rtan antt no nott on only ly  because it was decided the RBI would no longer monetize the fiscal deficit, which would now be financed by directly borrowing from the market, but also monetary policy would be conducted through open market operations and a large liquid bond market would help the RBI sterilise, if necessary, foreign exchange movements.

INDIA INDIAN N FINAN FINANCIA CIAL L SYSTE SYSTEM M FROM FROM 1950 1950 TO 1980 – 

Indian Financial System During this period evolved in response to the objective of planned economic development. With the adoption of mixed economy as a pattern of industrial development, a complimentary role was conceived for public and private sector. There was a need to align financial syst system em with with go gove vern rnme ment nt econ econom omic ic po poli lici cies es.. At that that time time ther theree was was govern gov ernmen mentt contr control ol over over distri distribut bution ion of credit credit and financ finance. e. The main main

Indian Financial System

elements of financial organization in planned economic development are as follows:-

1. Public ownership of financial financial institutions institutions –  – 

The nationalization of RBI was in 1948, SBI was set up in 1956, LIC came in to existence in 1956 by merging 245 life insurance companies in 1969, 14 major private banks were brought under the direct control of Government of  India. In 1972, GIC was set up and in 1980; six more commercial banks were brought under public ownership. Some institutions were also set up during this period like development banks, term lending institutions, UTI was set up in public sector in 1964, provident fund, pension fund was set up. In this way public sector occupied commanding position in Indian Financial System.

2. Fortification Fortification Of Institutional Institutional Institution al structure structure – 

Financial institutions should stimulate / encourage capital formation in the econom economy. y. The import important ant featur featuree of well well develo developed ped financ financial ial system system is strengthening of institutional structures. Development Development banks was set up with this objective like industrial finance corporation of India (IFCI) was set up in 1948, state financial corporation (SFCs) were set up in 1951, Industrial credit and Investment corporation of India Ltd (ICICI)was set up in 1955. It was was pion pionee eerr in many many resp respec ects ts like like un unde derw rwri riti ting ng of issu issuee of capi capita tal, l, chan channe neli lisa sati tion on of fore foreig ign n curr curren ency cy loan loanss from from Worl World d Bank Bank to priv privat atee industry. In 1964, Industrial Development of India (IDBI).

3. Protection of Investors – 

Indian Financial System

Lot many acts were passed during this period for protection of investors in financial markets. The various acts Companies Act, 1956 ; Capital Issues Control Act, 1947 ; Securities Contract Regulation Act, 1956 ; Monopolies and Restrictive Trade Practices Act, 1970 ; Foreign Exchange Regulation Act, 1973 ; Securities & Exchange Board of India, 1988.

4. Participation in Corporate Management – 

As participation were made by large companies and financial instruments it leads to accumulation of voting power in hands of institutional investors in several big companies financial instruments particularly LIC and UTI were able to put considerable pressure on management by virtual of their voting  power. The Indian Financial System between 1951 and mid80’s was broad  based number of institutions came up. The system was characterized by diversifying organizations which used to perform number of functions. The Financial structure with considerable strength and capability of supplying industrial capital to various enterprises was gradually built up the whole financial system came under the ownership and control of public authorities in this manner public sector occupy a commanding position in the industrial enterprises. Such control was viewed as integral part of the strategy of   planned economy development.

INDIAN FINANCIAL SYSTEM POST 1990’S The organizations of Indian Financial system witnessed transformation after  launching of new economic policy 1991. The development process shifted

Indian Financial System

from controlled economy to free market for these changes were made in the econom economic ic policy policy.. The role role of gov govern ernmen mentt in busine business ss was reduce reduced d the measure trust of the government should be on development of infrastructure,  public welfare and equity. The capital market an important role in allocation of resources. The major development during this phase are:-

1. Privatisation Institutions  –  –  Privatisation of Financial Institutions

At this time many institutions were converted in to public company and number of private players were allowed to enter in to various sectors:

a) Ind ndus usttrial rial Fina Finan nce Corp Corpo orati ation on Ind ndia ia (IFCI) FCI):: Th Thee pion oneeer  deve develo lopm pmen entt fina financ ncee inst instit itut utio ion n was was conv conver erte ted d in to a pu publ blic ic company.  b) Indu Indust stri rial al

Deve Develo lopm pmen entt Bank Bank of Indi Indiaa & Indu Indust stri rial al Fina Financ ncee

Corporation of India (IDBI & IFCI): IDBI & IFCI ltd offers their  equity capital to private investors. c) Priva rivatte Mu Mutu tuaal Fund Fundss hav have bee been set set up un unde derr the gu guid idel elin ines es  prescribed by SEBI. d) Number Number of private private banks banks and foreign foreign banks banks came came up under under the RBI guidelines. Private institution companies emerged and work under the guidelines of IRDA, 1999. e) In this manner manner government government monopoly monopoly over over financial financial institutio institutions ns has  been dismantled in phased manner. IT was done by converting public financial institutions in joint stock companies and permitting to sell equity capital to the government.

Indian Financial System

2. Reorganization of Institutional Structure – 

The importance of development financial institutions decline with shift to capital market for raising finance commercial banks were give more funds to investment in capital market for this. SLR and CRR were produced; SLR  earlier @ 38.5% was reduced to 25% and CRR which used to be 25% is at   prese present nt 5%. Permis Permissio sion n was also also given given to banks banks to direc directly tly und undert ertake ake leas leasin ing, g, hire hire-p -pur urch chas asee and and fact factor orin ing g bu busi sine ness ss.. Th Ther eree was was trus trustt on development of primary market, secondary market and money market.

3. Investors Protection Protection – 

SEBI SEBI is give given n po powe werr to regu regula late te fina financ ncia iall mark market etss and and the the vari variou ouss intermediaries in the financial markets.

FINANCIAL MARKET

Indian Financial System 

Money Market

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Call Money Market

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Commercial Paper 

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Certificate of Deposit

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Treasury Bill Market

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Money Market Mutual Fund

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Capital Market

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International Capital Market

Indian Financial System

MONEY MARKET AND GOVT. SECURITIES MARKET Money market deal with short term monetary assets and claims, which are generally from one day to one year duration.

Govt. securities on the other hand are also called dated securities to denote that they are generally long term in nature and are issued by state and central govt. under their borrowing programmes and duration of more than one year, generally of 5 years and above.

These securities being long term in nature are also traded in govt. securities market between institution and banks also on the stock exchanges- debt segments.

MONEY MARKET One of the important function of a well developed money market is to channe channeliz lizee saving saving into into short short term term produc productiv tivee invest investmen ments ts like like workin working g capi capita tal. l. Call Call mone money y mark market et,, trea treasu sury ry bill billss mark market et and and mark market etss for  for  commercial paper and certificate of deposit are some of the example of  money market.

CALL MONEY MARKET The call money markets form a part of the national money market, where day –to- day surplus funds, mostly of banks are traded . The call money loans are very short term in nature and the maturity period of this vary from 1 to 15 days. The money which is lent for one day in this market is known as

Indian Financial System

“call money”, and if it exceeds one day (but less than 15 days), is referred as “notice “notice money” in this market market any amount amount could be lent or borrowed borrowed at a convenient interest rate . Which is acceptable to both borrower and lender  .these loans are consider as highly highly liquid as they they are repayable on demand at the option of ether the lender or borrower.

PURPOSE Call money is borrowed from the market to meet various requirements of  commer commercia ciall bill bill market market and commer commercia ciall banks. banks. Commer Commercia ciall bill bill market market  borrower call money for short period to discount commercial bills. Banks borrower in call market to: 1:- Fill the temporary gaps, or mismatches that banks normally face. 2:- Meet the cash Reserve Ratio requirement. 3: - Meet sudden demand for fund, which may arise due to large payment and remittance.

Banks usually borrow form the market to avoid the penal interest rate for not meeting CRR requirement and high cost of refinance from RBI. Call money helps the banks to maintain short term liquidity position at comfortable level.

LOCATION In India call money markets are mainly located in commercial centers and   big big indust industria riall center centerss and indust industria riall center center such such as Mumbai Mumbai,, Calcut Calcutta, ta, Chennai, Delhi and Ahmedabad. As BSE and NSE and head office of RBI

Indian Financial System

and many other banks are situated in Mumbai; the volume of funds involved in call money market in Mumbai is far bigger than other cities.

PARTICIPANTS Initially, only few large banks were operating in the bank market. however  the market market had expanded expanded and now scheduled scheduled , non scheduled scheduled commercial commercial  banks foreign banks ,state , district, and urban cooperative banks , financial institution such as LIC,UTI,GIC, and its subsidiaries , IDBI, NABARD, IRBI, ECGC, EXIM Bank, IFCI, NHB , TFCI, and SIDBI, Mutual fund such as SBI Mutual fund . LIC Mutual funds. And RBI Intermediaries like DFHI and STCI are participants in local call money markets. However RBI has recently introduced restriction on some of the participants to phase them out of call money market in a time bound manner.

Participant in call money market are split into two categories

1:- BORROWER AND LENDER:This Th is comp compri rise sess enti entiti ties es thos thosee who who can can bo both th bo borr rrow ower er and and lend lend in this this market, such as RBI, intermediaries like DFHI, and STCI and commercial  banks.

2:- ONLY LENDER: This category comprises of entities those who can act only as lender, like financial institution and mutual funds.

Indian Financial System

CALL RATES The interest paid on call loan is known as the call rates. Unlike in the case of  other short and long rates. The call rate is expected to freely reflect the day to day availabili availability ty and long rates. rates. These rates vary highly from day to day. Often from hour to hour. While high rates indicate a tightness of liquidity  position in market. The rate is largely subject to be influenced by sources of  supply and demand for funds. The call money rate had fluctuated from time to time reflecting the seasonal variation in fund requirements. Call rates climbs high during busy seasons in relation to those in slack season. These seasonal variations were high due to a limited number of lender and many borrowers. The entry of financial institution and money market mutual funds into the call market has reduced the demand supply gap and these fluctuations gradually came down in recent years.

Though the seasonal fluctuations were reduced to considerable extent, there are still variations in the call rates due to the following reason: 1:- large borrower by banks to meet the CRR requirements on certain dates cause a gate demand for call money. These rates usually go up during the first week to meet CRR requirements and decline afterwards. 2:- the sanction of loans by banks, in excess of their own resources compel the bank to rely on the call market. Banks use the call market as a source of  funds for meeting dis-equilibrium of inflow and out flow of fund s.

Indian Financial System

3:- the withdrawal of funds to pay advance tax by the corporate sector leads to steep increase in call money rates in the market.

COMMERCIAL COMMERCIAL PAPER 

Commercial paper are short term, unsecured promissory notes issued at a discount to face value by well- known companies that are financial strong and carry carry a high credit credit rating rating . They are sold sold directly directly by the issuers issuers to investor, or else placed by borrowers through agents like merchant banks and security houses the flexible maturity at which they can be issued are one of the main attraction for borrower and investor since issues can be adapted to the needs of both. The CP market has the advantage of giving highly rated corporate borrowers cheaper fund than they could obtain from the banks while still providing institutional investors with higher interest earning than they could obtain form the banking system the issue of CP imparts a degree of financial stability to the systems as the issuing company has an incentive to remain financially strong.

THE FEATURES OF CP 1. They are negotiable by endorsement and delivery.

2. They are issued issued in multipl multiplee of Rs 5 lakhs. lakhs. 3. The maturity varies between 15 days to a year. 4.  No prior approval of RBI is needed for CP issued.

5. Th Thee tang tangib ible le net net wort worth h issu issuin ing g comp compan any y shou should ld not be less than than 4 lakhs 6. The company company fund based based working working capital capital limit limit should not not less than Rs 10 crore.

Indian Financial System

7. The issuin issuing g company company shall shall have P2 and A2 rating rating from from CRISIL CRISIL and ICRA.

CERTIFICATE OF DEPOSIT

Certificate of Deposits,. Instruments such as the Certificates of Deposit (CDs introduced in 1989), Commercial Paper (CP introduced in 1989), inte interr-ba bank nk part partic icip ipat atio ion n cert certif ific icat ates es (wit (with h and and with withou outt risk risk)) were were introduced to to increase the range of instruments. instruments. Certificates of Deposit are basically negotiable money market instruments issued by banks and financia financiall institutions institutions during during tight liquidity liquidity conditions. conditions. Smaller Smaller banks with relatively smaller branch networks networks generally mobilise mobilise CDs. As CDs are large size deposits, transaction costs on CDs are lower than retail deposits

FEATURES OF CD 1. All schedule scheduled d bank other other than RRB and schedu scheduled led cooperati cooperative ve  bank are eligible to issue CDs. 2. CDs can be issued issued to individuals, individuals, corporat corporation, ion, companie companies, s, trust, trust, funds and associations. NRI can subscribe to CDs but only on a non- repatriation basis. 3. Th They ey are issu issued ed at a disc discou ount nt rate rate freely freely determ determin ined ed by the issuing bank and market. 4. They They issued issued in the multipl multiplee of Rs 5 lakh subjec subjectt to minimum minimum size of each issue of Rs is 10 lakh.

Indian Financial System

5. Th Thee bank bank can can issue issue CDs CDs rangi ranging ng from from 3 mont month h t 1 year year , whereas financial institution can issue CDs ranging from 1 year  to 3 years.

TREASURY TREASURY BILLS MARKET:-

Treasury bills are the main financial instruments of money market. These  bills are issued by the government. The borrowings of the government are monitored & controlled by the central bank. The bills are issued by the RBI on beha behalf lf of the the cent centra rall go gove vern rnme ment nt.. Th Thee RBI RBI is the the agen agentt of Unio Union n Government. They are issued by tender or tap. The bills were sold to the   pub publi licc by tend tender er meth method od up to 19 1965 65.. Th Thes esee bill billss were were pu putt at week weekly ly auctions. A treasury bill is a particular kind of finance bill. It is a promissory note issued by the government. Until 1950 these bills were also issued by the state government. After 1950 onwards the central government has the authority to issue such bills. These bills are greater liquidity than any other  kind of bills. They are of two kinds: a) ad hoc, b) regular.

Ad hoc treasury bills are issued to the state governments, semi government

departments & foreign ventral banks. They are not marketable. The ad hoc  bills are not sold to the banks & public. The regular treasury bills are sold to the general public & banks. They are freely marketable. These bills are sold  by the RBI on behalf of the central government. The treasury bills can be categorized as follows:-

Indian Financial System

1) 14 days days treas treasury ury bill bills:s:The 14 day treasury bills has been introduced from 1996-97. These  bills are non-transferable. They are issued only in book entry system they would be redeemed at par. Generally the participants in this market are state government, specific bodies & foreign central banks. The discount rate on this bill will be decided at the beginning of the year quarter.

2) 28 days treasury bills:-

These bills were introduced in 1998. The treasury bills in India issued on auction basis. The date of issue of these bills will be announced in advance to the market. The information regarding the notified amount is announced before each auction. The notified amount in respect of  treasury bills auction is announced in advance for the whole year  separa separatel tely. y. A unifor uniform m calend calendar ar of treas treasury ury bills bills issuan issuance ce is also also announced.

3) 91 days treasury bills:-

The 91 days treasury bills were issued from July 1965. These were issued tap basis at a discount rate. The discount rates vary between 2.5 to 4.6% P.a. from July 1974 the discount rate of 4.6% remained uncharged uncharged the return on these bills were very low. However However the RBI  provides rediscounting facility freely for this bill.

4) 182 days treasury bills:-

The 182 days treasury bills was introduced in November 1986. The chakravarthy committee made recommendations regarding 182 day

Indian Financial System

treasury bills instruments. There was a significant development in this market. These bills were sold through monthly auctions. These bills were issued without any specified amount. These bills are tailored to meet the requirements of the holders of short term liquid funds. These   bills were issued at a discount. These instruments were eligible as securities for SLR purposes. These bills have rediscounting facilities.

5) 364 days treasury bills:-

The 364 treasury bills were introduced by the government in April 1992. These instruments are issued to stabilise the money market. These bills were sold on the basis of auction. The auctions for these instruments will be conducted for every fortnight. There will be no indication when they are putting auction. Therefore the RBI does not  provide rediscounting facility to these bills. These instruments have  been instrumental in reducing, the net RBI credit to the government. These bills have become very popular in India.

Money Market Mutual Funds (MMMFs) The benefits of developments in the various in the money market like cell money loans. Treasury bills, commercial papers and certificate of  deposits were available only to the few institutional participants in the mark market et.. Th Thee main main reas reason on for for this this was was that that hu huge ge amou amount ntss were were required to be invested in these instruments, the minimum being Rs. 10 lack, which was beyond the means of individual money markets to small investors.

Indian Financial System

MMMFs are mutual funds that invest primarily in money market inst instru rume ment ntss of very very high high qu qual alit ity y and and of very very shor shortt matu maturi riti ties es.. MMMF MM MFss can can be set set up by very very high high qu qual alit ity y and and of very very shor shortt maturities. MMMFs can be set up by commercial bank, RBI and   public financial institution either directly or through their existing mutual fund subsidiaries. The guidelines with respect to mobilization of funds by MMMFs provide that only individuals are allowed to invest in such funds.

Earlier these funds were regulated by the RBI. But RBI withdrew its guid gu idel elin ines es,, with with effe effect ct form form Marc March h 7, 20 2001 01 and and no now w they they are are governed by SEBI.

The schemes offered by MMMfs can either by open – ended or closeended. In case of open- ended schemer, the units are available for   purchase on a continuous basis and the MMMFs would be willing to repu repurc rcha hase se the the un unit its. s. A clos closee –end –ended ed sche scheme me is avai availa labl blee for  for  subscription for a limited period and is redeemed at maturity.

The guidelines on the on MMMfs specify a minimum lock – in period of 15 days during which the investor cannot redeem his investment. The guideline guideliness also stipulate stipulate the minimum minimum size size of the MMMF to be Rs. 50 crore and this should not exceed 2% of the aggregate deposits of the latest accounting year in the case of banks and 2% of the longterm domestic borrowings in the case of public financial institutions.

Indian Financial System

Structure of capital market CAPITAL MARKET

Secondary Market

Primary Market

Listing

Method of  Issue

Public Issue

Players

Quantum of Issue

Right Issue

Trading

Practices of Settlements & Clearing

Costs of  Issue

Bonus Issue

Private Placement

Operation

Indian Financial System

Companies (Issuer)

Intermediaries (Merchant Banks FIIs & Broker) Investor (Public)

Instruments Interest Rates

Procedures

CAPITAL MARKET Capital market is market for long term securities. It contains financial instruments of maturity period exceeding one year. It involves in long term nature of transactions. It is a growing element of the financial system in the India economy. It differs from the money market in terms of maturity period & liquidity. It is the financial pillar of industrialized economy. The development of a nation depends upon the functions & capabilities of the capital market. Capital market is the market for long term sources of finance. It refers to meet the long term requirements of the industry. Generally the business concerns need two kinds of finance:1. Short Short term funds funds for worki working ng capital capital require requirements ments.. 2. Long term funds funds for purchasing purchasing fixed fixed assets. assets. Therefore the requirements of working capital of the industry are met by the money market. The long term requirements of the funds to the corporate sect sector or are are supp suppli lied ed by the the capi capita tall mark market et.. It refe refers rs to the the inst instit itut utio iona nall arrangements which facilitate the lending & borrowing of long term funds.

IMPORTANCE OF CAPITAL MARKET

Indian Financial System

Capital market deals with long term funds. These funds are subject to uncertainty & risk. Its supplies long term funds & medium term funds to the corporate sector. It provides the mechanism for facilitating capital fund tran transa sact ctio ions ns.. It deal dealss I ordi ordina nary ry shar shares es,, bo bond nd debe debent ntur ures es & stoc stocks ks & securities of the governments. In this market the funds flow will come from save savers rs.. It conv conver erts ts fina financ ncia iall asse assets ts in to prod produc ucti tive ve ph phys ysic ical al asse assets ts.. It   provides incentives to savers in the form of interest or dividend to the investors. It leads to the capital formation. The following factors play an important role in the growth of the capital market:•

A strong & powerful central government.

•

Financial dynamics

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Speedy industrialization

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Attracting foreign investment

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Investments from NRI’s

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Speedy implementation of policies

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Regulatory changes

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Globalization

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The level of savings & investments pattern of the household sectors

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Development of financial theories

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Sophisticated technological advances.

PLAYERS IN THE CAPITAL MARKET MARKET Capital market is a market for long term funds. It requires a well structured market to enhance the financial capability of the country. The market consist a number of players. They are categorized as:1. Comp Compan aniies

Indian Financial System

2. Financ Financial ial inte interme rmedia diarie riess 3. Inv nves esto tors rs..

I.

COMPANIES: Generally every company which is a public limited company can access the capital market. The companies which are in need of finance for  their project can approach the market. The capital market provides funds from the savers of the community. The companies can mobilize the resources for their long term needs such as project cost, expansion & diversification of projects & other expenditure of India to raise the capital from the market. The SEBI is the most powerful organization to moni monito tor, r, cont contro roll & gu guid idan ance ce the the capi capita tall mark market et.. It clas classi sifi fies es the the companies for the issue of share capital as new companies, existing unli un list sted ed comp compan anie ies& s& exis existi ting ng list listed ed comp compan anie ies. s. Acco Accord rdin ing g to its its guidelines a company is a new company if it satisfies all the following:a)

The co company sh shall no not co complete 12 12 mo months of of co commercial

operations. b)

Its audited operative results are not available.

c)

The co company ma may se set up up by by en entrepreneurs wi with or or wi without

track record. A company which can be treated as existing listed company, if its shares are listed in any recognized stock exchange in India. A company is said to be an existing unlisted company if it is a closely held or   private company.

II.

FINANCIAL INTERMEDIARIES:

Indian Financial System

Fina Financ ncia iall inte interm rmed edia iari ries es are are thos thosee who who assi assist st in the the proc proces esss of  conver convertin ting g saving savingss into into capita capitall format formation ion in the countr country. y. A strong strong capi capita tall form format atio ion n proc proces esss is the the ox oxyg ygen en to the the corp corpor orat atee sect sector or.. Therefore the intermediaries occupy a dominant role in the capital formation which ultimately leads to the growth of prosperous to the community. Their role in this situation cannot be. The government should should encour encourage age these these interm intermedi ediari aries es to bu build ild a strong strong financ financial ial empi empire re for for the the coun countr try. y. Th They ey are are also also bein being g call called ed as fina financ ncia iall architectures of the India digital economy. Their financial capability cannot be measured. They take active role in the capital market. The major intermediaries in the capital market are:a) Brokers.  b) Stock Stock broke brokers rs & sub broke brokers rs c) Merc Mercha hant nt bank banker erss d) Unde Underw rwri rite ters rs e) Regi Regist stra rars rs f) Mu Mutu tual al fun und ds g) Collec Collectin ting g agents agents h) Depo Deposi sito tori ries es i) Agents  j)  j) Adve Advert rtis isin ing g age agenc ncie iess

III.

INVESTORS: The capital market consists many numbers of investors. All types of inve invest stor or’s ’s basi basicc ob obje ject ctiv ivee is to get get go good od retu return rnss on thei their  r  investment. Investment means, just parking one’s idle fund in a

Indian Financial System

right parking place for a stipulated period of time. Every parked vehicle shall be taken away by its owners from parking place after  a specific period. The same process may be applicable to the investment. Every fund owner may desire to take away the fund after after a specif specific ic period period.. Theref Therefore ore safety safety is the most most import important ant factor while considering the investment proposal. The investors comprise the financial investment companies & the general public comp compan anie ies. s. Usua Usuall lly y the the indi indivi vidu dual al save savers rs are are also also trea treate ted d as inve invest stor ors. s. Retu Return rn is the the rewa reward rd to the the inve invest stor ors. s. Risk Risk is the the   punishment to the investors for being wrong selection of their  invest investmen mentt decisi decision. on. Return Return is always always chased chased by the risk. An intelligent investor must always try to escape the risk & attract the return. All rational investors prefer return, but most investors are risk risk averag average. e. They They attemp attemptt to get maximu maximum m capita capitall gain. gain. The return can be available to the investors in two types they are in the form of revenue or capital appreciation. Some investors will prefer  for revenue receipt & others prefer capital appreciation. It depends upon their economic status & the effect of tax implications.

STRUCTURE OF THE CAPITAL MARKET IN INDIA The structure of the capital market has undergone vast changes in recent years. The Indian capital market has transformed into a new appearance over  the last four & a half decades. Now it comprises an impressive network of  financial institutions & financial instruments. The market for already issued securities has become more sophisticated in response to the different needs of the invest investors ors.. The specia specializ lized ed finan financia ciall instit instituti utions ons were were involv involved ed in

Indian Financial System

 providing long term credit to the corporate sector. Therefore the premier  financial institutions such as ICICI, IDBI, UTI, and LIC & GIC constitute the largest segment. A number of new financial instruments & financial interm intermedi ediari aries es have have emerge emerged d in the capita capitall market market.. Usuall Usually y the capita capitall markets are classified in two ways:A. On the the basis basis of issuer  issuer  B. On the the basis basis of instrumen instruments ts

On the basis of issuer the capital market can be classified again two types:a)

Corporate se securities ma market

b)

Governments se securities ma market

On the basis of financial instruments the capital markets are classifieds into two kinds:a) Eq Equi uity ty mar marke kett  b)  b) Debt Debt mar marke kett Recent Recently ly there there has been been a substa substanti ntial al develo developme pment nt of the India India capita capitall market. It comprises various submarkets. Equity market is more popular in India. It refers to the market for equity shares of existing & new companies. Every company shall approach the market for raising of funds. The equity market can be divided into two categories (a) primary market (b) secondary market. Debt market represents the market for long term financial instruments such as debentures, bonds, etc.

PRIMARY MARKET

Indian Financial System

To meet the financial requirement of their project company raise their  capital through issue of securities in the company market. Capital issue of the companies were controlled by the capital issue control act 1947. Pricing of issue was determined by the controller of capital issue the main purpose of control on capital issue was to prevent the diversion of  investible resources to non- essential projects. Through the necessity of  retaining some sort of of control on issue of capital capital to meet the above purpose purpose still exist . The CCI was abolished in 1992 as the practice of government control over over the capital issue as well as the overlapping overlapping of issuing has lost its relevance in the changed circumstances.

SECURITIES & EXCHANGE BOARD OF INDIA

INTRODUCTION: INTRODUCTION: It was set up in 1988 through administrative order it became statutory body in 1992. SEBI is under the control of Ministry of Finance. Head office is at Mumb Mu mbai ai and and regi region onal al offi office cess are are at Delh Delhi, i, Calc Calcut utta ta and and Chen Chenna nai. i. Th Thee crea creati tion on of SEBI SEBI is with with the the ob obje ject ctiv ivee to repl replac acee mult multip iple le regu regula lato tory ry structures. It is governed by six member board of governors appointed by government of India and RBI.

OBJECTIVES OF SEBI: 1. To protect protect the the interest interest of invest investors ors in securi securities. ties. 2. To regulate regulate securit securities ies market market and the various various intermed intermediar iaries ies in the market. 3. To develop develop securit securities ies market market over over a period period of of time. time.

Indian Financial System

POWERS AND FUNCTIONS OF SEBI: (1) ISSUE ISSUE GUIDE GUIDELIN LINES ES TO COMPA COMPANIE NIES:S:SEBI issues guidelines to the companies for disclosing information and to protect the interest of investor. The guidelines relates to issue of new new shar shares es,, issu issuee of conv conver erti tibl blee debe debent ntur ures es,, issu issuee by new new companies, etc. After abolition of capital issues control act, SEBI was given powers to control and regulate new issue market as well as stock exchanges.

(2) REGULA REGULATIO TION N OF PORTFOLI PORTFOLIO O MANAGE MANAGEMEN MENT T SERVICES:Portfolio Management services were brought under SEBI regulations in January 1993. SEBI framed regulations for portfolio management keeping securities scams in mind. SEBI has been entrusted with a job to regu regula late te the the work workin ing g of po port rtfo foli lio o mana manage gers rs in orde orderr to give give  protections to investors.

(3) REGULA REGULATIO TION N OF MUTU MUTUAL AL FUN FUNDS: DS:-The mutual funds were placed under the control control of SEBI on January January 1993. Mutual funds have been restricted from short selling or carrying forward transactions in securities. Permission has been granted to invest only in transferable securities in money market and capital market.

(4) CONTR CONTROL OL ON MER MERCHA CHANT NT BANKI BANKING: NG:--

Indian Financial System

Merchant bankers are to be authorized by SEBI, they have to follow code of conduct which makes them responsible towards the investors in respect of pricing, disclosure of/ in the prospectus and issue of  securities, merchant bankers have high degree of accountability in relation to offer documents and issue of shares.

(5) ACTIO ACTION N FOR DELA DELAY Y IN TRAN TRANSFE SFER R AND AND REFUNDS:SEBI has prosecut prosecuted ed many companies companies for delay in transfer transfer of shares shares and refund of money to the applicants to whom the shares are not allotted. These also gives protection to investors and ensures timely  payment in case of refunds.

(6) ISSUE ISSUE GUIDELINE GUIDELINES S TO INTERMEDI INTERMEDIARIE ARIES:S:SEBI controls unfair practices of intermediaries operating in capital market, such control helps in winning investors confidence and also gives protection to investors.

(7) GUIDELINE GUIDELINES S FOR FOR TAKEOV TAKEOVERS ERS AND MERGERS:MERGERS:SEBI EBI makes akes gu guid ideelin lines for for tak takeov eover and and mer merger ger to ensu ensure re transparency in acquisitions of shares, fair disclosure through public announ announcem cement ent and also also to avoid avoid unfai unfairr practi practices ces in takeov takeover er and mergers.

(8) REGULA REGULATIO TION N OF STOCK STOCK EXC EXCHAN HANGES GES FUNCTIONING:-

Indian Financial System

SEBI is working for expanding the membership of stock exchanges to improve transparency, to shorten settlement period and to promote   professionalism among brokers. All these steps are for the healthy growth of stock exchanges and to improve their functioning.

(9) REGULATION OF FOREIGN F OREIGN INSTITUTIONAL INVESTMENT (FIIS):SEBI has started registration of foreign institutional investment. It is for effective control on such investors who invest on a large scale in securities.

TYPES OF ISSUE A company can raise its capital through issue of share and debenture by means of :-

PUBLIC ISSUE :Public issue is the most popular method of raising capital and involves raising capital and involve involve raising of fund direct direct from the public .

RIGHT ISSUE :Right Right issue is the method of raising raising additional additional finance finance from from existing existing members by offering securities to them on pro rata basis.

A company proposing to issue securities on right basis should send a letter letter of offer offer to the shareho shareholders lders giving giving adequate adequate disclos discloser er as to how how the additional amount received by the issue is used by the company.

Indian Financial System

BONUS ISSUE:Some companies distribute profits to existing shareholders by way of  fully paid up bonus share in lieu of dividend. Bonus share are issued in the ratio of existing share held. The shareholder do not have to nay additional payment for these share .

PRIVATE PLACEMENT : private placement market financing is the direct sale by a public limited company or private limited company of private as well as public sector  of its securities to a limited number of sophisticated investors like UTI , LIC , GIC state finance finance corporation corporation and pension and insurance funds the the inter intermed mediar iaries ies are credit credit

rating rating agencie agenciess and trustee trusteess and financi financial al

advisors such as merchant bankers. And the maximum time – frame required for private placement market is only 2 to 3 months. Private   placement placement can can be made out of promote promoterr quota but but it cannot cannot be made with unrelated investors.

SECONDRY MARKET The secondary market is that segment of the capital market where the outstanding securities are traded from the investors point of view the secondary market market imparts liquidity liquidity to the long – term securities held by them by providing providing an auction auction market market for these securities. securities.

The secondary market operates through the medium of stock exchange which regulates the trading activity in this market and ensures a measure of safety and and fair dealing to the the investors.

Indian Financial System

India has a long tradition

of trading in securities going back to nearly

200 years. years. The first first India India stock exchange exchange establishe established d at Mumbai Mumbai in 1875 is the oldest exchange in Asia. The main objective was to protect the character status and interest of the native share and stock broker.

BOMBAY STOCK EXCHANGE Bombay Stock Exchange is the oldest stock exchange in Asia with a rich heritage, now spanning three centuries in its 133 years of existence. What is now popularly known as BSE was established as "The Native Share & Stock  Brokers' Association" in 1875.

BSE is the first stock exchange in the country which obtained permanent recognition (in 1956) from the Government of India under the Securities Contracts (Regulation) Act 1956. BSE's pivotal and pre-eminent role in the development of the Indian capital market is widely recognized. It migrated from the open outcry system to an online screen-based order driven trading system in 1995. Earlier an Association of Persons (AOP), BSE is now a corporatised and demutualised entity incorporated under the provisions of  the the Comp Compan anie iess Act, Act, 19 1956 56,, pu purs rsua uant nt to the the BSE BSE (Cor (Corpo pora rati tisa sati tion on and and Demutualisation) Scheme, 2005 notified by the Securities and Exchange Board of India (SEBI). With demutualisation, BSE has two of world's best exch exchan ange ges, s, Deut Deutsc sche he Börs Börsee and and Sing Singap apor oree Ex Exch chan ange ge,, as its its stra strate tegi gicc  partners.

Over the past 133 years, BSE has facilitated the growth of the Indian

Indian Financial System

corporate sector by providing it with an efficient access to resources. There is perhaps no major corporate in India which has not sourced BSE's services in raising resources from the capital market.

Today, BSE is the world's number 1 exchange in terms of the number of  listed companies and the world's 5th in transaction numbers. The market capitalization as on December 31, 2007 stood at USD 1.79 trillion . An investor can choose from more than 4,700 listed companies, which for easy reference, are classified into A, B, S, T and Z groups.

The BSE Index, SENSEX, is India's first stock market index that enjoys an icon iconic ic stat statur uree , and and is trac tracke ked d worl worldw dwid ide. e. It is an inde index x of 30 stoc stocks ks representing 12 major sectors. The SENSEX is constructed on a 'free-float' methodology, and is sensitive to market sentiments and market realities. Apart from the SENSEX, BSE offers 21 indices, including 12 sectoral indi indice ces. s. BSE BSE has has ente entere red d into into an inde index x coop cooper erat atio ion n agre agreem emen entt with with Deutsche Börse. This agreement has made SENSEX and other BSE indices available to investors in Europe and America. Moreover, Barclays Global Investors (BGI), the global leader in ETFs through its iShares® brand, has crea create ted d the the 'iSh 'iShar ares es® ® BSE BSE SENS SENSEX EX Indi Indiaa Trac Tracke ker' r' whic which h trac tracks ks the the SENSEX. The ETF enables investors in Hong Kong to take an exposure to the Indian equity market. BSE BSE has has tied tied up with with U.S. U.S. Futu Future ress Ex Exch chan ange ge (USF (USFE) E) for for U.S. U.S. do doll llar ar-denominated futures trading of SENSEX in the U.S. The tie-up enables

Indian Financial System

eligible U.S. investors to directly participate in India's equity markets for the firs firstt time time,, with withou outt requ requir irin ing g Amer Americ ican an Depo Deposi sito tory ry Rece Receip iptt (ADR (ADR)) authorization. The first Exchange Traded Fund (ETF) on SENSEX, called "SPIcE" is listed on BSE. It brings to the investors a trading tool that can be easily used for the purposes of investment, trading, hedging and arbitrage. SPIcE allows small investors to take a long-term view of the market.

BSE provides an efficient and transparent market for trading in equity, debt instruments and derivatives. It has a nation-wide reach with a presence in more than 450 cities and towns of India. BSE has always been at par with the intern internati ationa onall standa standards rds.. The system systemss and proces processes ses are design designed ed to safeguard market integrity and enhance transparency in operations. BSE is the first exchange in India and the second in the world to obtain an ISO 9001:2000 certification. It is also the first exchange in the country and second in the world to receive Information Security Management System Standard BS 7799-2-2002 certification for its BSE On-line Trading System (BOLT).

BSE continues to innovate. In recent times, it has become the first national level stock exchange to launch its website in Gujarati and Hindi to reach out to a larger number of investors. It has successfully launched a reporting  p pla latf tfor orm m for for corp corpor orat atee bo bond ndss in Indi Indiaa chri christ sten ened ed the the ICDM ICDM or Indi Indian an Corporate Debt Market and a unique ticker-cum-screen aptly named 'BSE Broadcast' which enables information dissemination to the common man on the street.

Indian Financial System

In 20 2006 06,, BSE BSE laun launch ched ed the the Dire Direct ctor orss Data Databa base se and and ICER ICERS S (Ind (India ian n Corporate Electronic Reporting System) to facilitate information flow and increa increase se transp transpare arency ncy in the Indian Indian capita capitall marke market. t. While While the Direc Director torss Database provides a single-point access to information on the boards of  directors of listed companies, the ICERS facilitates the corporates in sharing with BSE their corporate announcements.

BSE also has a wide range of services to empower investors and facilitate smooth transactions: Investor Services: The Department of Investor Services redresses grievances of investors. BSE was the first exchange in the country to provide an amount of Rs.1 million towards the investor protection fund; it is an amount higher  than than that that of any any exch exchan ange ge in the the coun countr try. y. BSE BSE laun launch ched ed a nati nation onwi wide de investor awareness programme- 'Safe Investing in the Stock Market' under  which 264 programmes were held in more than 200 cities.

The BSE On-line Trading (BOLT): BSE On-line Trading (BOLT) facilitates on-line screen based trading in securities. BOLT is currently operating in 25,000 Trader Workstations located across over 450 cities in India.

BSEWEB BSEWEBX.c X.com om:: In Februa February ry 200 2001, 1, BSE BSE introd introduce uced d the world' world'ss first first centralized exchange-based Internet trading system, BSEWEBX.com. This

Indian Financial System

initiative enables investors anywhere in the world to trade on the BSE  platform. Surveillance: BSE's On-Line Surveillance System (BOSS) monitors on a real real-t -tim imee basi basiss the the pric pricee move moveme ment nts, s, vo volu lume me po posi siti tion onss and and memb member ers' s'  positions and real-time measurement of default risk, market reconstruction and generation of cross market alerts.

BSE Training Institute: BTI imparts capital market training and certification, in collab collabor orati ation on with with repute reputed d manage managemen mentt instit institute utess and univer universit sities ies.. It offers over 40 courses on various aspects of the capital market and financial sector. More than 20,000 people have attended the BTI programmes Awards •

The World Council of Corporate Governance has awarded the Golden Peacock Global CSR Award for BSE's initiatives in Corporate Social Responsibility (CSR).

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The Annual Reports and Accounts of BSE for the year ended March 31, 2006 and March 31 2007 have been awarded the ICAI awards for  excellence in financial reporting.

•

The Human Resource Management at BSE has won the Asia - Pacific HRM awards awards for for its effort effortss in employ employer er brandi branding ng throug through h talent talent management at work, health management at work and excellence in HR through technology

Drawing from its rich past and its equally robust performance in the recent times, BSE will continue to remain an icon in the Indian capital market.

Indian Financial System

NATIONAL STOCK EXCHANGE The National National Stock Stock Exchange Exchange of India India Limited Limited has genesis genesis in the report report of  the High Powered Study Group on Establishment of New Stock Exchanges, which recommended promotion of a National Stock Exchange by financial institutions (FIs) to provide access to investors from all across the country on an equal footing. Based on the recommendations, NSE was promoted by leading Financial Institutions at the behest of the Government of India and was incorporated in November 1992 as a tax-paying company unlike other  stock exchanges in the country. On its recogn recogniti ition on as a stock stock exchan exchange ge und under er the Securi Securitie tiess Contra Contracts cts (Regulation) Act, 1956 in April 1993, NSE commenced operations in the Wholesale Debt Market (WDM) segment in June 1994. The Capital Market (Equ (Equit itie ies) s) segm segmen entt comm commen ence ced d op oper erat atio ions ns in Nove Novemb mber er 19 1994 94 and and operations in Derivatives segment commenced in June 2000.  NSE's mission is setting the agenda for change in the securities markets in India. The NSE was set-up with the main objectives of: •

esta establ blis ishi hing ng a nati nation on-w -wid idee trad tradin ing g faci facili lity ty for for equi equiti ties es,, debt debt instruments and hybrids,

Indian Financial System

•

ensuring equal access to investors all over the country through an appropriate communication network,

•

  pro provi vidi ding ng a fair fair,, effi effici cien entt and and tran transp spar aren entt secu securi riti ties es mark market et to investors using electronic trading systems,

•

enab enabli ling ng shor shorte terr sett settle leme ment nt cycl cycles es and and bo book ok entr entry y sett settle leme ment ntss systems, and

•

Meeting the current international standards of securities markets.

The standards set by NSE in terms of market practices and technology have   becom becomee indust industry ry benchm benchmark arkss and are being being emulat emulated ed by other other market market   participants. NSE is more than a mere market facilitator. It's that force whic hich is gu guid idin ing g the the ind industr ustry y towa owards rds new new ho horrizo izons and and great reateer  opportunities.

The logo logo of the NSE NSE symbol symbolise isess a single single nation nationwid widee securi securitie tiess tradi trading ng facility ensuring equal and fair access to investors, trading members and issuers all over the country. The initials of the Exchange viz., N, S and E have been etched on the logo and are distinctly visible. The logo symbolises use of state of the art information technology and satellite connectivity to  bring  bring about the change change within within the securities securities industry. industry. The logo symbolises symbolises

Indian Financial System

vibrancy and unleashing of creative energy to constantly bring about change through innovation.

CORPORATE STRUCTURE  NSE is one of the first de-mutualised stock exchanges in the country, where the ownership and management of the Exchange is completely divorced from the right to trade on it. Though the impetus for its establishment came from policy makers in the country, it has been set up as a public limited company, owned by the leading institutional investors in the country.

From day one, NSE has adopted the form of a demutualised exchange - the ownership, management and trading is in the hands of three different sets of    people. NSE is owned by a set of  leading leading financia financiall institutio institutions, ns, banks, banks, insurance companies and other financial intermediaries and is managed by  professionals, who do not directly or indirectly trade on the Exchange. This has has comp comple lete tely ly elim elimin inat ated ed any any conf confli lict ct of inte intere rest st and and help helped ed NSE NSE in aggr aggres essi sive vely ly pu purs rsui uing ng po poli lici cies es and and prac practi tice cess with within in a pu publ blic ic inte intere rest st framework.

The NSE model however, does not preclude, but in fact accommodates involvement, support and contribution of trading members in a variety of  ways. Its Board comprises of senior executives from promoter institutions, eminent professionals in the fields of law, economics, accountancy, finance, taxation, and etc, public representatives, nominees of SEBI and one full time executive of the Exchange.

Indian Financial System

While the Board deals with broad policy issues, decisions relating to market operations are delegated by the Board to various committees constituted by it. it. Such Such comm commit itte tees es incl includ udes es repr repres esen enta tati tive vess from from trad tradin ing g memb member ers, s,  professionals, the public and the management. The day-to-day management of the Exchange is delegated to the Managing Director who is supported by a team of professional staff.

STRUCTURE OF INTERNATIONAL CAPITAL MARKET

Indian Financial System

INTERNATIONAL CAPITAL MARKETS

INTERNATIONAL BOND MARKET

FOREIGN BONDS

INTERNATIONAL EQUITY MARKET

EURO BOND

FOREIGN EQUITY

EURO EQUITY

YANKEE BONDS

EURO/ DOLLAR 

AMERICAN DEPOSITORY RECIEPTS

SAMURAI BONDS

EURO/ YEN

IDR/ EDR 

BULLDOG BONDS

EURO/ POUNDS

INTERNATIONAL CAPITAL MARKETS

ORIGIN

GLOBAL DEPOSITORY RECIEPTS

Indian Financial System

The genesis of the present international markets can be teased to 1960s, when there was a real demand for high quality dollar-denominated bonds form wealthy Europeans (and others) who wished to hold their assets their  home countries or in currencies other then their own. These investors were driven by the twin concerns of avoiding taxes in their home country and  protecting themselves against the falling value of domestic currencies. The   bon bonds ds whic which h were were then then avai availa labl blee for for inve invest stme ment nt were were subj subjec ecte ted d to withholding tax. Further it is was also necessary to register to address these concer concerns. ns. Thes Thesee were issu issued ed in beare bearerr forms forms and and so, there there

was no no of 

ownership and tax was withheld.

Also, until 1970, the International Capital Market focused on debt financing and the equity finances were raised by the corporate entities primarily in the domestic markets. This was due to the restrictions on cross-border equity investments prevailing unit then in many countries. Investors too preferred to invest in domestic equity issued due to perceived risks implied in foreign equi equity ty issu issues es eith either er rela relate ted d to fore foreig ign n curr curren ency cy expo exposu sure re or rela relate ted d to apprehensions of restrictions on such investments by the regulator.

Majo Majorr chan change gess have have occu occurr rred ed sinc sincee the the ‘70s ‘70s whic which h have have witn witnes esse sed d expanding and fluctuating trade volumes and patterns with various blocks experiencing extremes in fortunes in their exports/imports. This was the was the period which saw the removal of exchange controls by countries like the UK, franc franc and Japan which which gave a furthe furtherr technolo technology gy of market marketss have have   played an important role in channelizing the funds from surplus unit to deficit units across the globe. The international capital markets also become a major source of external finance for nations with low internal saving. The

Indian Financial System

markets were classified into euro markets, American Markets and Other  Foreign Markets.

THE PLAYERS

Borrow Borrowers ers/Is /Issue suers, rs, Lender Lenders/ s/ Invest Investors ors and Interm Intermedi ediari aries es are the major  major   players of the international market. The role of these players is discussed  below.

BORROWERS/ISSUERS

These primarily are corporates, banks, financial institutions, government and quasi government bodies and supranational organizations, which need forex funds for various reasons. The important reasons for corporate borrowings are, are, need need for for fore foreig ign n curr curren enci cies es for for op oper erat atio ion n in mark market etss abro abroad ad,, dull/s dull/satu aturat rated ed domest domestic ic market market and expans expansion ion of operat operation ionss into into other  other  countries.

Governments borrow in the global financial market to adjust the balance of   payments mismatches, to gain net capital investments abroad and to keep a suffic sufficien ientt invent inventory ory of forei foreign gn curren currency cy reserv reserves es for contin contingen gencie ciess like like supporting the domestic currency against speculative pressures.

LENDERS/INVESTORS

In case of Euro-loans, the lenders are mainly banks who possess inherent confidence in the credibility of the borrowing corporate or any other entity mention above in case of GDR it is the institutional investor and high net

Indian Financial System

worth individuals (referred as Belgian Dentists) who subscribe to the equity of the corporates. For an ADR it is the institutional investor or the individual investor through the Qualified Intuitional Buyer who put in the money in the instrument depending on the statutory status attributed to the ADR as per  statutory requirements of the land.

INTERMEDIARIES LEAD MANGERS

They undertake due diligence and preparation of offer circular, marketing the issues and arranger for road shows.

UNDERWRITERS

Underwriters of the issue bear interest rate/market risks moving against them before they place bonds or Depository Receipts. Usually, the lend managers and co-managers act as underwriters for the issue.

CUSTODIAN

On behalf of DRs, the custodian holds the underlying shares, and collects rupee dividends on the underlying shares and repatriates the same to the depository in US dollars/foreign equity.

Apart from the above, Agents and Trustees, Listing Agents and Depository Banks also play a role in issuing the securities.

THE INSTRUMENTS

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The early eighties witnessed liberalization of many domestic economies and globalization of the same. Issuers form developing countries, where issue of  dollar/foreign dollar/foreign currency denominated equity shares were not permitted, could access international equity markets through the issue of an intermediate instrument called ‘Depository Receipt’.

A Depository Receipt (DR) is a negotiable certificate issued by a depository  bank which represents the beneficial interest in shares issued by a company. These These shares shares are deposi deposited ted with with the the local local ‘custo ‘custodia dian’ n’ appoin appointed ted by the depository, which issues receipts against the deposit of shares.

The various instruments used to raise funds abroad include: equity, straight debt or hybrid instruments. The following figure shows the classification of  intern internati ationa onall capita capitall marke markets ts based based on instru instrumen ments ts used used and market market(s) (s) accessed.

EURO EQUITY

GLOBAL DEPOSITORY RECEIPTS (GDR):

A GDR is a negotiable instrument which represents publicly traded localcurrency equity share. GDR is any instrument in the from of a depository receipt or certificate created by the Overseas Depository Bank outside India and issued to non-resident investors against the issue of ordinary shares or  forei foreign gn curren currency cy conver convertib tible le bon bonds ds of the issuin issuing g compan company. y. Usuall Usually, y, a typical GDR is denominated in US dollars whereas the underlying shares would be denominated in the local currency of the Issuer. GDRs may be – at

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the request of the investor – converted into equity shares by cancellation of  GDRs GDRs thro throug ugh h the the inte interm rmed edia iati tion on of the the depo deposi sito tory ry and and the the sale sale of  underlying shares in the domestic market through the local custodian.

GDRs, per se, are considered as common equity of the issuing company and are entitled to dividends and voting rights since the date of its issuance. The company transactions. The voting rights of the shares are exercised by the Depository as per the understanding between the issuing Company and the GDR holders.

FOREIGN EQUTIY

AMERICAN DEPOSITORY RECEIPTS (ADR):

ADR is a dollar denominated negotiable certificate, it represents a non-US company’s publicly traded equity. It was devised in the last 1920s to help Americ Americans ans invest invest in overse overseas as securi securitie tiess and assist assist non non-US -US compan companies ies wishing to have their stock traded in the American Markets. ADRs are divi divide ded d into into 3 leve levels ls base based d on the the regu regula lati tion on and and priv privil ileg egee of each each company’s issue.

I. ADR ADR LE LEVE VEL L – I:

It is often step of an issuer into the US public equity market. The issu issuer er can can enla enlarg rgee the the mark market et for for exis existi ting ng shar shares es and and thus thus diversify to the investor base. In this instrument only minimum disclosure is required to the sec and issuer need not comply with

Indian Financial System

the US GAAP (Generally Accepted Accounting Principles). This type of instrument is traded in the US OTC Market.

The issuer is not allowed to raise fresh capital or list on any one of the national stock exchanges.

II. ADR LEVEL LEVEL – II: II:

Through this level of ADR, the company can enlarge the investor   base for existing shares to a greater extent. However, significant disclosures have to be made to the SEC. The company is allowed to List on the American Stock Exchange (AMEX) or New York  Stock Exchange (NYSE) which implies that company must meet the listing requirements of the particular exchange.

III. III. ADR ADR LEV LEVEL EL – III: III:

This level of ADR is used for raising fresh capital through Public offering in the US Capital with the EC and comply with the listing requirements of AMEX/NYSE while following the USGAAP.

DEBT INSTRUMENTS INSTRUMENTS

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EUROBONDS

The process of lending money by investing in bonds originated during the 19th century when the merchant bankers began their operations in the intern internati ationa onall market markets. s. Issuan Issuance ce of Eurobo Eurobonds nds became became easier easier with with no exchange controls and no government restrictions on the transfer of funds in international markets.

THE INSTRUMENTS

EUROBONDS

All Eurobonds, through their features can appeal to any class of issuer or  investor. The characteristics which make them unique and flexible are: a)

No with withhol holdin ding g of of taxes taxes of any any kind kind on inte interes rests ts paym payment entss

 b)  b)

They They are are in bearer bearer form form with with intere interest st coup coupon on atta attache ched d

c)

They Th ey are are list listed ed on one one or or more more stoc stock k excha exchang nges es but but issue issuess are

generally traded in the over the counter market.

Typically, a Eurobond is issued outside the country of the currency in which it is denominated. It is like any other Euro instrument and through international syndication and underwriting, the paper is sold without any limit of geographical boundaries. Eurobonds are generally listed on the world's stock exchanges, usually on the Luxembourg Stock Exchange.

a) FIXED-RA FIXED-RATE TE BONDS/STR BONDS/STRAIGH AIGHT T DEBT BONDS: BONDS:

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Straight debt bonds are fixed interest bearing securities which are redeemable at face value. The bonds issued in the Euro-market referred to as Euro-bonds, have interest rates fixed with reference to the creditworthiness of the issuer. The interest rates on dollar  denominated bonds are set at a margin over the US treasury yields. The redemption of straights is done by bullet payment, where the repayment of debt will be in one lump sum at the end of the maturity period, and annual servicing.

b)

FLOATING RATE NOTES (FRNs):

FRNs can be described as a bond issue with a maturity period vary varyin ing g from from 5-7 5-7 year yearss havi having ng vary varyin ing g coup coupon on rate ratess - eith either  er    peg pegge ged d to anot anothe herr secu securi rity ty or re-f re-fix ixed ed at peri period odic ic inte interv rval als. s. Conventionally, the paper is referred to as notes and not as bonds. The spreads or margin on these notes will be above 6 months USOR for Eurodollar deposits.

FOREIGN BONDS

Indian Financial System

These are relatively lesser known bonds issued by foreign entities for  raising medium to long-term financing from domestic money centers in their domestic currencies. A brief note on the various instruments in this category is given below:

a) YANK YANKEE EE BO BOND NDS: S:

These These are are US dollar dollar denomi denominat nated ed issues issues by foreig foreign n bo borro rrower werss (usually foreign governments or entities, supranational and highly rated corporate borrowers) in the US bond markets.

A bond denominated in U.S. dollars and is publicly issued in the U.S. U.S. by fore foreig ign n bank bankss and and corp corpo orati ration ons. s. Acco Accord rdin ing g to the the Securities Act of 1933, these bonds must first be registered with the Securities and Exchange Commission (SEC) before they can  b bee sold sold.. Yank Yankee ee bo bond ndss are are ofte often n issu issued ed in tren trench ches es and and each each offering can be as large as $1 billion.

Due to the high level of stringent regulations and standards that must be adhered to, it may take up to 14 weeks (or 3.5 months) for  a Yankee bond to be offered to the public. Part of the process involves having debt-rating agencies evaluate the creditworthiness of the Yankee bond's underlying issuer.

Foreign issuers tend to prefer issuing Yankee bonds during times when the U.S. interest rates are low, because this enables the foreign issuer to pay out less money in interest payments.

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b) SAMUR SAMURAI AI BONDS: BONDS:

A yen-de yen-denom nomina inated ted bon bond d issued issued in Tokyo Tokyo by a non non-Ja -Japan panese ese company and subject to Japanese regulations. Other types of yendenominated bonds are Euro/yens issued in countries other than Japan.

Samurai bonds give issuers the ability to access investment capital available in Japan. The proceeds from the issuance of samurai  bonds can be used by non-Japanese companies to break into the Japanese market, or it can be converted into the issuing company's local currency to be used on existing operations. Samurai bonds can also be used to hedge foreign exchange rate risks.

These are bonds issued by non-Japanese borrowers in the domestic Japanese markets.

c) BULL BULLDO DOG G BO BOND NDS: S:

These are sterling denominated foreign bond which are raised in the UK domestic securities market.

A sterling denominated bond that is issued in London by a company that is not British.

Thes Th esee ster sterli ling ng bo bond ndss are are refe referr rred ed to as bu bull lldo dog g bo bond ndss as the the  bulldog is a national symbol of England.

d) SHIBOS SHIBOSAI AI BONDS: BONDS:

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Thes Th esee are are the the priv privat atel ely y plac placed ed bo bond ndss issu issued ed in the the Japa Japane nese se markets.

EURONOTES

Euronotes as a concept is different from syndicated bank credit and is different from Eurobonds in terms of its structure and maturity period. Euronotes command the price of a short-term instrument usually a few  basic points over LIBOR and in many instances at sub – LIBOR levels. Thee do Th docu cume ment ntat atio ion n form formal alit itie iess are are mini minima mall (unl (unlik ikee in the the case case of  syndicated credits or bond issues) and cost savings can be achieved on that score score too. too. The fundin funding g instru instrumen ments ts in the form form of Eurono Euronotes tes posses possesss flexibility and can be tailored to suit the specific requirements of different types of borrowers. There are numerous applications of basic concepts of  Euronotes. These may be categorized under the following heads:

a)

COMMERCIAL PA PAPER:

These are short-term unsecured promissory notes which repay a fixed amount on a certain future date. These are normally issued at a discount to face value.

b)

NOTE NOTE ISS ISSUA UANC NCE E FAC FACIL ILIT ITIE IES S (NIF (NIFs) s)::

The currency involved is mostly US dollars. A NIF is a mediumterm legally binding commitment under which a borrower can issue short-term paper, of up to one year. The underlying currency is mostl mostly y US dollar dollar.. Under Underwri writin ting g banks banks are commit committed ted either either to

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 purchase any notes which the borrower b unable to sell or to provide standing credit. These can be re-issued periodically.

c)

MEDI MEDIUM UM-T -TER ERM M NOTE NOTES S (MTN (MTNss):

MTNs are defined as sequentially issued fixed interest securities which have a maturity of over one year. A typical MTN program enables an issuer to issue Euronotes for different maturities. From over ov er on onee year year up to the the desi desire red d leve levell of matu maturi rity ty.. Th Thes esee are are essentially fixed rate funding arrangements as the price of each  preferred maturity is determined and fixed up front at the time of  launching. These are conceived as non-underwritten facilities, even though though intern internati ationa onall market marketss have have starte started d offeri offering ng und underw erwrit riting ing support in specific instances.

A Global MTN (G-MTN) is issued worldwide by tapping Euro as well as the- US markets under the same program.

Under G-MTN programs, issuers of different credit ratings are able to raise finance by accessing retail as well as institutional investors. In view view of flexib flexible le access access,, speed speed and effici efficienc ency, y, and enhanc enhanced ed investor base G-MTN programs afford numerous benefits to the issuers.

Sprea Spreads ds paid paid on MTNs MTNs depend depend on credit credit ratin ratings, gs, treasu treasury ry yield yield curve and the familiarity of the issuers among investors. Investors include Private Banks, Pension Funds, Mutual Funds and Insurance Companies.

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FOR FOREIG EIGN

EXCH XCHANGE NGE

AND AND

FOR FOREIGN IGN

EXCHA XCHANG NGE E

MARKETS –  OVERVIEW In today’s world no country is self sufficient, so there is a need for exchange of goods and services amongst the different countries. However, unlike in the primitive age the exchange of goods and services is no longer carried out on barter basis. Every sovereign country in the world has a currency which is a legal tender in its territory and this currency does not act as money outside its boundaries. So whenever a country buys or sells goods and services from or to another country, the residents of two countries have to exchange currencies. So we can imagine that if all countries have the same currency then there is no need for foreign exchange.

FOREIGN EXCHANGE IN INDIA In India, foreign exchange has been given a statutory definition. Section 2 (b) of Foreign Exchange Regulation Act, 1973 states: ‘Foreign exchange’ means foreign currency and includes: •

All deposits, credits and balances payable in any foreign currency and any drafts, traveler’s cheques, letters of credit and bills of exchange , expressed or drawn in Indian currency but payable in any foreign currency,

•

Any instrument payable, at the option of drawee or holder thereof or  any any othe otherr part party y ther theret eto, o, eith either er in Indi Indian an curr curren ency cy or in fore foreig ign n currency or partly in one and partly in the other.

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For India we can conclude that foreign exchange refers to foreign money, whic which h incl includ udes es no note tes, s, cheq cheque ues, s, bill billss of exch exchan ange ge,, bank bank bala balanc nces es and and deposits in foreign currencies.

ABOUT FOREIGN EXCHANGE MARKET Particularly for foreign exchange market there is no market place called the foreign exchange market. It is mechanism through which one country’s currency can be exchange i.e. bought or sold for the currency of another  coun countr try. y. Th Thee fore foreig ign n exch exchan ange ge mark market et do does es no nott have have any any geog geogra raph phic ic location. The market comprises of all foreign exchange traders who are connected to each other through out the world. They deal with each other  through telephones, telexes and electronic systems. With the help of Reuters Money 2000-2, it is possible to access any trader in any corner of the world within a few seconds.

WHO

ARE

THE

PARTICIPANTS

IN

FOREIGN

EXCHANGE MARKETS? The main players in foreign exchange markets are as follows: 1.

CUSTOMERS The customers who are engaged in foreign trade participate in foreign exchange markets by availing of the services of banks. Exporters requ requir iree conv conver erti ting ng the the do doll llar arss in to rupe rupeee and and impo import rter erss requ requir iree converting rupee in to the dollars as they have to pay in dollars for the goods/services they have imported.

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2.

COMMERCIAL BANKS They are most active players in the forex market. Commercial banks dealing with international transactions offer services for conversion of  one currency in to another. They have wide network of branches. Typi Ty pica call lly y bank bankss bu buy y fore foreig ign n exch exchan ange ge from from expo export rter erss and and sell sellss foreign exchange to the importers of the goods. As every time the foreign exchange bought and sold may not be equal banks are left with the overbought or oversold position. The balance amount is sold or bought from the market.

  No Nowada waday ys,

in

inte intern rnat atio iona nall

fore oreign ign

exch xchang ange

mark markeets, ts,

the

international trade turnover accounts for a fraction of huge amounts dealt, i.e. bought and sold. The balance amount is accounted for either   by financial transactions or speculation. Banks have enough financial strength and wide experience to speculate the market and banks does so. Which is popularly known as the trading in the forex market.

Commercial banks have following objectives for being active in the foreign exchange markets.

•

They They rende renderr better better servic servicee by offeri offering ng compet competiti itive ve rates rates to their  their  customers engaged in international trade;

•

They are in a better position to manage risks arising out of exchange rate fluctuations;

•

Foreign exchange business is a profitable activity and thus such banks are in a position to generate more profits for themselves;

Indian Financial System

•

They can manage their integrated treasury in a more efficient manner.

•

In India Reserve Bank of India has given license to the commercial  banks to deal in foreign exchange under section 6 Foreign Exchange Regulation Act, 1973, which are called the Authorized Dealers (ADs).

3.

CENTRAL BANK 

In all countries central banks have been charged with the respon responsib sibili ility ty of mainta maintaini ining ng the extern external al value value of the domest domestic ic currency. Generally this is achieved by the intervention of the bank. Apart from this central banks deal in the foreign exchange market for  the following purposes: 1) Exchange Exchange rate manage management: ment: It is is achieved achieved by the interven intervention tion thou though gh some someti time mess bank bankss have have to main mainta tain in exte extern rnal al rate rate of the the domestic currency at a level or in a band so fixed. 2)

Reserv Reservee manageme management: nt: Centra Centrall bank of the count country ry is mainly mainly

concerned with the investment of countries foreign exchange reserve in a stable proportions in range of currencies and in a range of assets in each currency. For this bank has to involve certain amount of  switching between currencies.

4.

EXCHANGE BROKERS

Forex brokers play a very important role in the foreign exchange markets. However the extent to which services of forex brokers are utilized depends on the tradition and practice prevailing at a particular  forex market center. In India as per FEDAI guidelines the A Ds are free to deal directly among themselves without going through brokers.

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The forex brokers are not allowed to deal on their own account all over the world and also in India.

.

5.

OVERSEAS FOREX MARKETS

Today the daily global turnover is guestimated to be more than US $ 1.5 trillion a day. The international trade however constitutes hardly 5 to 7 % of this total turnover. The rest of trading in world forex markets is constituted of financial transactions and speculation. As we know that the forex market is 24-hour market, the day begins with Tokyo and thereafter Singapore opens, thereafter India, followed by Bahrain, Frankfurt, Paris, London, New York, Sydney, and back to Tokyo.

FORWARD EXCHANGE CONTRACT WHAT IS THE NEED FOR FORWARD EXCHANGE CONTRACT? The risk on account of exchange rate fluctuations, in international trade tran transa sact ctio ions ns inc increas reases es if the the time time peri period od need needed ed for for comp comple leti tion on of  transaction is longer. It is not uncommon in international trade , on account of logi logist stic ics, s, the the time time fram framee can can no nott be fore foreto told ld with with cloc clock k prec precis isio ion. n. Exporters and importers alike, can not be precise as to the time when the

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shipment will be made as sometimes space on the ship is not available, while at the other, there are delays on account of congestion of port etc.

In international trade there is considerable time lag between entering in to a sales/purchase contract, shipment of goods, and payment. In the meantime, if exchange rate moves against the party who has to exchange his home currency in to foreign currency, he may end up in loss. Consequently,  buyers and sellers want to protect them against exchange rate risk. One of  the methods by which they can protect themselves is entering in to a foreign exchange forward contract.

We can see from the daily report of the Vadilal Industries Limited (Forex division) that the rupee fell down nearly 25 paise in a day. The date of this fluctuation is 25th May 2000. Now let suppose that the exporter has dealt

FORWARD EXCHANGE FORWARD CONTRACT Forward exchange forward contract is a contract wherein two parties agree to deliver certain amount of foreign exchange at an agreed rate either at a fixed future date or during a fixed future period. If the merchants are sure about about the remittance remittance or the payment of the foreign exchange exchange then they can choose the fix date forward exchange contract, in which they are bound by the date on which they have to meet their part of liability in the agreement. If the customers are not sure about the date of remittance or the payment of  the the fore foreig ign n exch exchan ange ge they they can can ente enterr in to the the op opti tion on peri period od forw forwar ard d exchange contract. Both the types are explained below.

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1. FIXED DATE DATE FOREIGN FOREIGN EXCHA EXCHANGE NGE FORWAR FORWARD D CONTRACT If under the foreign exchange forward contract, foreign exchange is to  be delivered at fixed date, the contract is known as fixed date foreign exchange forward contract.

2. OPTION OPTION FOREIGN FOREIGN EXCHA EXCHANGE NGE FORWA FORWARD RD CONTRACT If under the foreign exchange forward contract, foreign exchange is to  be delivered in future, during a specified period, the contract is known as option foreign exchange forward contract. In this type of contract there is no option for taking/ delivery of foreign exchange. Such contracts provide for option as far as date of delivery of foreign exchange is concerned. While entering in to a option forward contract first date and the last date for exercising option for giving /taking delivery of foreign exchange is always fixed.

In India, like developed countries, there are not many instruments available for hedging foreign exchange risk. As a result the merchants have have to hedge hedge their their foreig foreign n exchan exchange ge exposu exposures res throug through h forwa forward rd contracts only. For merchants this is the only tool available to minimize the risk due to adverse foreign exchange fluctuation .

Indian Financial System

DERIVATIVES INTRODUCTION: INTRODUCTION: Thee emer Th emerge genc ncee of the the mark market et for for deri deriva vati tive ve prod produc ucts ts,, most most no nota tabl bly y forwards, futures and options, can be traced back to the willingness of riskaverse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets are marked by a very high degree of volatility. Through the use of derivative  products, it is possible to partially or fully transfer price risks by locking-in asset prices.

Introduction of derivatives in the Indian Capital market is the beginning of a new era, which is truly exciting. Index futures were introduced as the first exchange traded derivatives product in the Indian Capital Market in June 2000. 200 0. With With introd introduct uction ion of index index option options, s, indivi individua duall stock stock future futuress and option options, s, India Indian n deriva derivativ tives es market market has turned turned multi multi-pr -produ oduct ct deriv derivati atives ves market, at par with the global standards.

Derivatives, worldwide are recognized as Risk Management products. These  products have a long history in India in the unorganized sector, especially in currency and commodity markets. The availability of these products on orga organi nize zed d exch exchan ange gess has has prov provid ided ed the the mark market et with with broa broadd-ba base sed d risk  risk  management tools.

Deriva Derivativ tives es also also facili facilitat tatee the creati creation on of new financ financial ial produc products ts in an econom economy. y. Today, Today, financ financial ial marke markets ts around around the the world world are und underg ergoin oing g a   pro profo foun und d chan change ge in term termss of the the fina financ ncia iall inno innova vati tion on.. New New fina financ ncia iall

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 products are being architected, on a day-to-day basis, to cater to the specific need needss of bo both th the the issu issuer erss and and inve invest stor ors. s. To keep keep pace pace with with the the glob global al marke markets, ts, India Indian n Securi Securitie tiess Market Market also also needs needs to develo develop p new finan financia ciall   produ products cts in all the dimens dimension ionss of the econom economy y includ including ing commod commoditi ities, es, securities, currency etc.

In recent years, the market for financial derivatives has grown tremendously  both in terms of variety of instruments available, their complexity and also turnover. In the class of equity derivatives, futures and options on stock  indices have gained more popularity than on individual stocks, especially among individual investors, who are major users of index-linked derivatives. Even small investors find this useful due to high correlation of the popular  indices with various portfolios and ease of use. The lower costs associated with index derivativ derivatives es vis-à-vis vis-à-vis derivative derivative products products based on individual individual securities is another reason for their growing use.

DEFINITION OF DERIVATIVES:

Derivative is a product whose value is derived from the value of one or more  basic variables called bases (underling asset, index, or reference rate), in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. For example wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by that date. Such a transaction is an example of a derivative. The price of this derivative is driven by the spot price of wheat which is the “underlying”.

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T YPES

OF DERIVATIVES

The most commonly used derivatives contracts are forwards, futures and options and since this project revolves around futures and options, it will be discussed in greater detail later on. For now we take a brief look at the various derivatives contracts that have come to be used.



FORWARDS: A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at today’s preagreed price.



FUTURES: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. In simpler words, futures are forward contracts quoted in an exchange.



OPTIONS: Options are of two types: - Calls and Puts. Calls give the buyer the right  but not the obligation to buy a given quantity of the underlying asset at a given price on or before a given future date. Puts give the buyer the right,  but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date.

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

WARRANTS: Options generally have lives of up to one year, the majority of options traded on options exchanges having a maximum maturity of nine months. Longer dated warrants are called warrants and are generally traded over  the counter.



LEAPS: The acronym LEAPS mean Long-Term Equity Anticipation Securities. These are options having a maturity of up to three years.



BASKETS: Bask Basket et op opti tion onss are are op opti tion onss on po port rtfo foli lios os of un unde derl rlyi ying ng asse assets ts.. Th Thee underlying asset is usually a moving average or a basket of assets. Equity index options are a form of basket options.



SWAPS: Swaps are private agreements between two parties to exchange cash flow flowss in the the futu future re acco accord rdin ing g to prea prearr rran ange ged d form formul ula. a. Th They ey can can be regarded as portfolios of forward contracts. The two commonly used swaps are:

(A) INTEREST RATE SWAPS: Thes Th esee enta entail il swap swappi ping ng on only ly the the inte intere rest st rela relate ted d cash cash flow flowss  between the parties in the same currency.

(B) CURRENCY SWAPS:

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These entail swapping both principal and interest between the  parties, with the cash flows in one direction being in a different currency than those in the opposite direction.



SWAPTIONS: Swaptions are options to buy or sell a swap that will become operative at the expiry of the options. Thus a swaption is an option on a forward swap. Rather than have calls and puts, the swaptions market has receiver  swaptions and payer swaptions. A receiver swaption is an option to receive fixed and pay floating. A payer swaption is to pay fixed and receive floating.

FORWARD CONTRACT INTRODUCTION: A forward contract, as it occurs in both forward and futures markets, always involves a contract initiated at one time; performance in accordance with the terms of the contract occurs at a subsequent time. It is a simple derivative that involves an agreement to buy/ sell an asset on a certain future date at an agreed price. This is a contract between two parties, one of which takes a long  position and agrees to buy the underlying asset on a specified future

date for a certain specified price. The other party takes a  short  position, agreeing to sell the asset at the same date for the same price.

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For example, when one orders a car, which is not in stock, from a dealer, he is bu buyi ying ng a forw forwar ard d cont contra ract ct for for the the deli delive very ry of a car. car. Th Thee pric pricee and and description of the car are specified.

The mutually agreed price in a forward contract is known as the delivery   price. The delivery price is chosen in such a way that the value of the forward contract to both the parties is zero, so that it costs nothing to take either either a long or a short short position. On maturity, maturity, the contract contract is settled settled so that the holder of the short position delivers the asset to the holder of the long  position, who in turn pays a cash amount equal to the delivery price. The value of a forward contract is determined, chiefly by the market price of the underlying asset.

Forward contracts are being used in India on a large scale in the foreign exchan exchange ge market market to hedge hedge the curren currency cy risk. risk. Forwa Forward rd contra contracts cts,, being being nego negoti tiat ated ed by the the part partie iess on on onee to on onee basi basis, s, offe offerr them them trem tremen endo dous us flexibility to articulate the contract in terms of price, quantity, quality (in case of commodities), delivery time and place.

From the simplicity of the contract and its obvious usefulness in resolving uncertainty about the future, it is not surprising that forward contracts have had a very long history.

THE FORWARD PRICE The forward price of a contract is the delivery price, which would render a zero value to the contract. Since upon initiation of the contract, the delivery

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 price is so chosen that the value of the contract is nil, it is obvious that when a forward contract is entered into, the delivery price and forward price are identical. As time passes the forward price could change but the delivery  price would remain unchanged. Generally, the forward price at any given time varies with the maturity of the contract so that the forward price of a contract to buy or sell in one month would be typically different from that of  a contract with time of three months or six months to maturity.

FUTURES CONTRACT INTRODUCTION A futures contract is a type of forward contract with highly standardized and closel closely y specif specified ied contra contract ct terms terms.. As in all forwa forward rd contra contracts cts,, a futur futures es contract calls for the exchange of some good at a future date for cash, with the payment for the good to occur at a future date. The purchaser of a futures contract undertakes to receive delivery of the good and pay for it, while the seller of a future promises to deliver the good and receive payment. The  price of the good is determined at the initial time of contracting.

In a crude sense, futures markets are an extension of forward markets. These markets, being organized/ standardized, are very liquid by their own nature. Therefore, liquidity problem, which persists in the forward market, does not exist in the futures market. In futures market, clearing corporation/ house   becomes the counter-party to all the trades or provides the unconditional guarantee for their settlement i.e. assumes the financial integrity of the entire system. In other words, we may say that in futures market, the credit risk of 

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the transactions is eliminated by the exchange through the clearing corporation/ house.

OPTIONS

INTRODUCTION INTRODUCTION TO OPTIONS We now come to the next derivative product that is traded, namely Options. Options are fundamentally different from forward and future contracts. An option gives the holder of the option the right to do something. The holder  need not exercise this right. In contrast, in a forward or futures contract, the two parties are committed and have to fulfill this commitment. Also it costs nothing (except margin requirement) to enter into a futures contract whereas the purchase of the option requires an upfront payment called the option  premium.

TYPES OF OPTION CONTRACTS: CONTRACTS: 1. CALL CALL OPTI OPTION ON:: A call option gives the buyer the right to purchase a specified number of shares of a particular company from the option writer  (seller) at a specified price (called the exercise price) up to the expiry of the option. In other words the option buyer gets a right to call upon the option seller to deliver the contracted shares anytime up to the expiry of the option. The contract thus is only a one-way

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obligation, i.e. the seller is obliged to deliver the contracted shares while the buyer has the choice to exercise the option or let the contract lapse. The buyer is not obliged to perform.

POSITION GRAPH:

Intrinsic value

+

+

Premium b

Premium

Stock Price _

b Stock 

_  Intrinsic value Lines

(a) Buy A Call

(b) Write a Call

An option buyer starts with a loss equivalent to the premium paid. He has to carry on with the loss till the stock market price equals the exercise price as shown in (a). The intrinsic value of the option up to this price remains zero, and thus runs along the X-axis. As the stock price increases further, the loss starts reducing and gets wiped out as soon as the increase equals the

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 premium, represented on the graph by point ‘b’, also called the break even  point. The profitability line starts climbing up at an inclination of 45 degrees after crossing the X-axis at b and from thereon moves into the positive side of the graph. The inclined line beyond the point ‘ b’ indicates that the option acquires intrinsic value and is, thus referred to as the intrinsic value line.

The position graph (b) represents the profitability status of the writer who does not own the stock i.e. naked or an uncovered writer. The graph is logically the inverse of that for the option buyer.

1. PUT PUT OPTI OPTION ON A put option gives a buyer the right to sell a specified number of  shares of a particular stock to the option of the writer at a specific  price (called exercise price) any time during the currency of the opti op tion on.. Th Thee sell seller er of a pu putt op opti tion on has has the the ob obli liga gati tion on to take take delivery of underlying asset. When put position is opened, the  buyer pays premium to the put seller. If the price of underlying asset rises above the strike price and stays there, the put will expire worthless. The seller of put will keep the premium as his profit and the put buyer will have a cost to purchase right.

Put buyers are bearish, they believe that the price of the underlying asset will fall and they may not be able to sell the asset at a higher price. Put sellers are bullish, as they believe that the price of the underlying asset will rise.

Position Graph:

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Intrinsic Value Line +

Stock Price

 

_

Premium

SWAPS Swap can be defined as a financial transaction in which two counter parties agree to exchange streams of payments, or cash flows, over time. Two types of swaps are generally seen i.e. interest rate swaps and currency swaps. Two more swaps being introduced are commodity swaps and the tax rate swaps, which are seen to be an extension of the conventional swaps. A swap results in reducing the borrowing cost of both parties.

Indian Financial System

FINANCIAL INSTITUTION

ALL INDIA DEVELOPMENT BANK  

    

Industrial Development Bank  Industrial Finance Corporation of India Industrial Investment Bank of India Export Import Bank of India State Financial Corporation State Industrial Development Corporation

INVESTMENT INSTITUTIONS    

Life insurance Corporation General Insurance Corporation Unit trust of India Mutual Funds

BANKS   

Reserve Bank of India Commercial Banks Scheduled Banks

Indian Financial System 

Regional Rural Banks

 NON BANKING FINANCIAL CORPORATION Investment Trust   NIDHIS  Merchant Banks  Hire Purchases Finance Company  Lease Finance Company  Housing Finance Companies   National Housing Bank   Venture Capital Funding Companies 

ALL INDIA DEVELOPMEN T BANKS INDUSTRIAL DEVELOPMENT DEVELOPMENT BANK OF INDIA IDBI was establishe established d in 1964 as a subsidiar subsidiary y of the RBI by an act of the the  parliament and was made a wholly owned govt. of India undertaking in 1975. It was established with the main objective of serving as an apex financ financial ial instit instituti ution on to coordi coordinat natee the functi functioni oning ng of all other other financ financial ial institutio institution. n. Planning Planning ,promoti ,promoting ng and developin developing g functioni functioning ng of all other  financial institution .industries to fill the gaps in the industrial structure of  the country providing technical administrative assistance for promoting or  expansion of industry industry . undertaking market and investment investment research research survey n connec connectio tion n with with the develo developme pment nt of indust industry ry and to provid providee

financ financee

keeping in view national priorities irrespective of the financial attractiveness of project are its other objective IDBI finance industries directly & also supp suppor ortt stat statee fina financ ncia iall corp corpor orat atio ion n and and stat statee indu indust stri rial al deve develo lopm pmen entt corporations by providing refinance and through the bill rediscounting scale IDBI was transformed from finance institution to commercial bank in the year 2004.

Indian Financial System

INDUSTRIAL FINANCE CORPORATION OF INDIA IFCI is the first financial institution to be established in India in 1948 by an act of parliament with objective of providing medium and long term finance to industrial concerns eligible for financing under the act. The sector for  which the IFCI provides finance extend through the industrial spectrum of  the country.

INDUSTRIAL INVESTMENT BANK OF INDIA The IIBI first came into existence as a central government corporation with the name Industrial Reconstruction Corporation of India in 1971. Its basic objective was to finance the reconstruction and rehabilitation of sick and closed industrial unit. Its name was changed to Industrial reconstruction  bank of India and it was made the principal credit and reconstruction agency in the country in 1985 through the RBI act 1984. The bank started coordinary similar work of the institutions and banks preparing schemes for  recons reconstru tructi ctions ons by recons reconstru tructi cting ng the liabil liabiliti ities es apprai appraisin sing g scheme schemess of  merger & amalgamation of sick company and providing financial assistance for modernization expansion, diversification and technological up gradation of sick units. In March 1987, in line with the ongoing policies of financial and economic reform reforms, s, IRBI IRBI was conver converted ted into into a fullfull-fl fledg edged ed develo developme pment nt finan financia ciall institution. It was renamed as Industrial Investment Bank of India ltd. And was incorporated as company under the companies act 1956. Its entire

Indian Financial System

equity is finance for the establishment of new industrial project as well as for for expans expansion ion divers diversifi ificat cation ion and modern moderniza izatio tion n of existi existing ng indust industria riall enterp enterpris rises. es. It provid provides es financ financial ial assist assistanc ancee in the form form of term term loans, loans, subscription to debenture equity shares and deferred payment guarantees. IIBI is now also active ion merchant banking and its services includes inter alia, structuring suitable instrument for public rights issues preparation of 

 prospective offer documents and working as a lead manager it also offers its serv servic ices es for for debt debt synd syndic icat atio ion n and and pack packag agee of serv servic ices es for for merg merger er and and acquisition.

THE EXPORT IMPORT BANK OF INDIA . The EXIM Bank was was set up in 1982 to to coordinate the activity of the various institutional engaged in trade finance it helps Indian exporter in extending credit to their overseas customer by providing long term finance to them it also provides financial assistance to bank in extending credit for export and export linked imports it also provides advisory services and information to exports.

STATE FINANCIAL CORPORATION . At the the begi beginn nnin ing g of the the fift fiftie iess the the go govt vt.. foun found d that that of achi achiev evin ing g rapi rapid d industrialization separate institution should be set up that cater exclusively to the needs of the small medium sector therefore the SFC was act passed by the parliament in 1951 to enable the state govt. establish SFC the basic objective objective for which the SFC was set up was to provide provide financial financial assistance assistance to small and medium scale industries estates. The SFC provides finance in the form of log term term loan, by underwriti underwriting ng issue of share share and debentures debentures

Indian Financial System

and standing guarantee for loans raised from other institution and form the general public.

STATE INDUSTRIAL DEVELOPMENT DEVELOPMENT CORPORATIONS. CORPORATIONS. The SIDCS have been set up to facilitate rapid industrial growth in the respective state. In addition to providing finance , the SIDC identify and sponsor project in the participation of private entrepreneurs.

INVESTEMENT INSTITUITONS LIFE INSURANCE CORPORATION OF INDIA . The LIC was established established in 1956 by amalgamatio amalgamation n and nationalizati nationalization on of  245 private insurance companies by an enactment of parliament . the main  business of LIC is to provide life insurance and it has almost a monopoly in this this busin busines ess. s. The LIC

act act perm permit itss it inves investt up to 10 perce percent nt of the the

investable funds in the private sector . it provides finance by participating in a consortium with other institution and does not undertake independent appraisal of projects.

GENERAL INSURANCE CORPORATION OF INDIA

The GIC was establish in 1974 with the nationalization of general insurance  business in country it can invest up to 30 % of the fresh accrual of funds in the the priv privat atee sect sector or . like like the LIC LIC

the the GIC GIC also also prov provid ides es fina financ ncee by

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 participating in consortium based on the appraisal made by other financial institutions but does not independently provide the finance.

UNIT TRUST OF INDIA The UTI was founded in 1964 under the UTI act 1963. Initially 50% of the capital of the trust was contributed by the RBI while the rest was brought in  by the SBI and its associates, LIC ,GIC, and other financial institutions. In 1974 the holding holding of of RBI was transferre transferred d to the IDBI making making the UTI an associate of IDBI . the primary objective of UTI is to mobilize the savings in the countries and channelize them in to productive corporate investments. UTI provides assistance by underwriting debenture and share , subscription to public and right issue of share and debenture subscription to provide  private placement and bridge finance. In January . 2003 UTI split in to two  part UTI – 1 and UTI-2 . UTI-1 UTI-1 has given all the assured return return scheme and unit un it sche scheme me 64 and and it is bein being g admi admini nist stra rate ted d by cent centra rall go govt vt.. UTIUTI-2 2 entrusted with the task of managing NAV-based schemes. UTI -2 is being managed by SBI, PNB,BOB and LIC.

MUTUAL FUNDS Mutu Mu tual al fund fundss serv serves es the the pu purp rpos osee of mobi mobili lizi zing ng of fund fundss from from vari variou ouss categories of investors and channelizing them into productive investment. Apart Apart form form UTI. UTI. Mutual Mutual fund fund sponso sponsored red by variou variouss bank bank subsid subsidiar iaries ies,, insurance organizations private sector financial institutions DFI and FII have come up . these mutual fund work within the framework of SEBI regulation which prescribe the mechanism for setting up of a mutual fund , procedure of registration its constitution and the duties, functions and responsibility of  the various parties involved.

Indian Financial System

Indian Financial System

BANK  THE RESERVE BANK OF INDIA The Reserve Bank of India is the central bank of the country entrusted with monetary stability, the management of currency and the supervision of the financial as well as the payments system.

Established in 1935, its functions and focus have evolved in response to the chan changi ging ng econ econom omic ic envi enviro ronm nmen ent. t. Its Its hist histor ory y is no nott on only ly intr intrin insi sica call lly y interwoven with the economic and financial history of the country, but also give givess insi insigh ghts ts into into the the thou though ghtt proc proces esse sess that that have have help helped ed shap shapee the the country's economic policies.

The Reserve Bank of India is the central bank of the country. Central banks are a relatively recent innovation and most central banks, as we know them today, were established around the early twentieth century.

The Reserve Bank of India was set up on the basis of the recommendations of the Hilton Young Commission. The Reserve Bank of India Act, 1934 (II of 1934) provides the statutory basis of the functioning of the Bank, which commenced operations on April 1, 1935.

The RBI has 22 regional offices, most of them in state capitals like Bhopal, Hyderabad, Jaipur, Nagpur, Kolkata etc.

Indian Financial System

HISTORY OF THE RBI The Bank began its operations by taking over from the Government the functions so far being performed by the Controller of Currency and from the Imperial Bank of India, the management of Government accounts and public debt. The existing currency offices at Calcutta, Bombay, Madras, Rangoon, Karach Karachi, i, Lahore Lahore and Cawnpo Cawnpore re (Kanpu (Kanpur) r) became became branch branches es of the Issue Issue Depa Depart rtme ment nt.. Offi Office cess of the the Bank Bankin ing g Depa Depart rtme ment nt were were esta establ blis ishe hed d in Calcutta, Bombay, Madras, Delhi and Rangoon.

Burma (Myanmar) seceded from the Indian Union in 1937 but the Reserve Bank Bank cont contin inue ued d to act act as the the Cent Centra rall Bank Bank for for Burm Burmaa till till Japa Japane nese se Occupation of Burma and later up to April, 1947. After the partition of  India, the Reserve Bank served as the central bank of Pakistan up to June 1948 when the State Bank of Pakistan commenced operations. The Bank, which was originally set up as a shareholder's bank, was nationalized in 1949.

The RBI was established by legislation in 1934, through the RBI Act of  1934. The RBI started functioning from April 1 st 1935. This represented the culmination of a long series of efforts to set up an institution of this kind in the country. The RBI was originally constituted as a Shareholders’ Bank  with a share capital of Rs.5 Crore. In view of the need of close integration  between its policies and those of the government, it was nationalized in 1949.

Indian Financial System

With liberalization, the Bank's focus has shifted back to core central banking funct function ionss like like Mon Moneta etary ry Polic Policy, y, Bank Bank Superv Supervisi ision on and Regula Regulatio tion, n, and Overseeing the Payments System and onto developing the financial markets.

The sequences of events leading to the formation of the RBI are summarized in the figure:

Presidency Bank  Imperial Bank of India Central Banking Enquiry Committee, 1931 Reserve Bank of India Act, 1934 Constitution of RBI, April 1st 1935  Nationalization of the RBI. 1949

ESTABLISHMENT ESTABLISHMENT OF THE RESERVE BANK OF INDIA In India, the urgent need for a central banking institution was recognized when the 3 presidency banks – Bank of Madras, Bank of Bombay & Bank  of Bengal were amalgamated in 1921 to form the Imperial Bank.

Indian Financial System

In 1926, the Hilton-Young Commission recommended the establishment of  a central bank. A bill was passed in the Central Legislature in January 1927  but was dropped. A fresh bill was introduced on September 8 th, 1923 and was received. Thus the Reserve Bank of India was established by legislation in 1934 through the Reserve Bank of India Act 1934. The Act provides the statutory  basis of functioning of the bank which commenced operations on April 1 st, 1935.

CENTRAL BOARD The Reserve Bank's affairs are governed by a central board of directors. The Board is appointed by the Government of India in keeping with the Reserve Bank of India Act. The Board of Directors is comprised of: 1. A governor governor and not more more that 4 deputy deputy govern governor orss appoin appointed ted by the Central Government. 2. Four Directo Directors rs nominated nominated by the Central Central Governme Government, nt, one from each each of the 4 Local Boards. 3. Ten Directo Directors rs nominate nominated d by the Centra Centrall Governm Government ent 4. One governme government nt official official nominate nominated d by the Central Central Governmen Government. t. Thee Gove Th Govern rnor or & Depu Deputy ty Gove Govern rnor or ho hold ld offi office ce for for such such peri period odss no nott exceeding 4 years as may be fixed by the Central Government at the time of  their their appoin appointme tment nt and are are eligib eligible le for reappo reappoint intmen ment. t. The Govern Governmen mentt official holds office during the pleasure of the Central Government. The Governor, in his absence, appoints a deputy Governor to be the chairman on

Indian Financial System

the Central Board. Meetings of the Central Board are required to be held not less than 6 times in each year & at least once in a quarter.

Central Board of RBI

4 Local Boards at Chennai, Kolkata, Mumbai & New Delhi

18 branches in major cities of the country.

Internal Organization & Management: This consists of about 25 departments training establishments & research institutions.

LOCAL BOARDS For each of the 4 regional areas of the country, there is a Local Board with headquarters in Kolkata, Chennai, and Mumbai & New Delhi. Local Boards consist of 5 members each, appointer by the Central Government for a term of 4 years. The Local Board members elect from amongst themselves the chai chairm rman an of the the Boar Board. d. Th Thee Regi Region onal al Dire Direct ctor orss of the the bank bank offi office cess in Kolkata, Chennai, and Mumbai & New Delhi are the ex-officio secretaries of the Local Boards at the Centers. The functions of Local Boards are reviewed by the Central Board from time to time.

Indian Financial System

Its Its func functi tion onss incl includ udee advi advisi sing ng the the Cent Centra rall Boar Board d on loca locall matt matter erss and and repres represent enting ing terri territor torial ial and econom economic ic intere interests sts of local local cooper cooperati ative ve and indigenous banks & to perform such other functions as delegated by Central Board from time to time.

INTERNAL ORGANIZATION & MANAGEMENT

The Governor is the Chief Executive Architect of the RBI. The Governor  has the powers powers of genera generall superi superinte ntende ndence nce and direct direction ion of affair affairss and  business of the Bank. The Executive General Managers are in between the Depu eputy Gov over ern nors ors and and Chie hief Gene Generral Manag anageers of cent centrral office fice departments.

Formulating of policies concerning monetary management, regulation and supervision of banks, non banking institutions, financial institutions, and cooperative banks, extension of exchange resources and rendering of advice to the Government on economic and financial matters are also done by the RBI.

MAIN FUNCTIONS The Reserve Bank of India was constituted to: •

Regulate the issue of banknotes

•

Maintain reserves with a view to securing monetary stability

•

Operate the credit and currency system of the country to its advantage

Indian Financial System

•

Promote financial and economic development jeopardizing monetary stability

•

Set up many financial institutes provide development of finance and foster financial markets.

CORE FUNCTIONS: Following are the core functions of the Reserve Bank of India: •

Operat Operating ing monet monetary ary policy policy for maint maintain aining ing price price stabil stability ity and

ensuring adequate financial resources for development process. •

Promotion of an efficient financial system.

•

Meeting currency requirement of the public

•

Reserve Bank of India

Issue of  Currency  Notes

Banker to Government

Banker to Banks

Monetary & Credit Policy

Foreign Exchange Management

Clearing Hose Agent

P S Man

Indian Financial System

MONETARY AUTHORITY: The Reserv Reservee Bank Bank of India India consta constantl ntly y works works towar towards ds keepin keeping g inflat inflation ion under check and ensuring adequate supply of liquidity for the productive sector as also towards financial stability. It also formulates, implements and monitors the monetary policy.

REGULA REGULATOR TOR AND AND SUPER SUPERVIS VISOR OR OF THE FINANC FINANCIAL IAL SYSTEM: •

Prescribes broad parameters of banking operations within which the country's banking and financial system functions.

•

Obje Object ctiv ive: e: main mainta tain in pu publ blic ic conf confid iden ence ce in the the syst system em,, prot protec ectt depositors' interest and provide cost-effective banking services to the  public.

•

Permitting banks to fix their own position limits as per international terms & aggregating gap limits.

DEVELOPMENTAL DEVELOPMENTAL ROLE •

Performs a wide range of promotional functions to support national objectives.

•

Provides rural credit.

•

Setting up of institutional framework.

•

Service area approach.

•

Financing the industries.

•

Provision of finance to information technology and software industry.

•

Infrastructure financing

Indian Financial System

ISSUER OF CURRENCY The Reserve Bank of India ensures good quality coins and currency notes in adequate quantity by: •

Issuin Issuing g and exchan exchanges ges or destro destroys ys curren currency cy and coins coins not fit for  for  circulation.

•

Mopping up notes and coins unfit for circulation

•

Advising the Government on designing of currency notes with the latest security features.

MANAGER OF FOREIGN EXCHANGE The Reserve Bank of India is mainly empowered with authority under the Forei Foreign gn Exchan Exchange ge Manage Managemen mentt Act (FEMA (FEMA)) 199 1999 9 to regula regulate te foreig foreign n exchange operation. As such, rules and regulations relating to non-resident acco accoun unts ts are are issu issued ed by the the RBI. RBI. Th Thee RBI RBI also also form formul ulat ates es po poli lici cies es to facilitate facilitate external trade trade and payments, payments, facilitates facilitates foreign foreign investmen investments ts in India and Indian investments abroad and promotes orderly development of  foreign exchange markets

BANKER TO THE GOVERNMENT The RBI acts as a Banker to the Government under section 20 of the RBI Act of 1934. Section 21 provides that the Government should entrust its money remittance, exchange and banking transactions in India to the RBI.

Indian Financial System

The RBI maintains accounts of central and state governments. It performs merchant banking function for the central and the state governments. It also: •

Encour Encourage agess develo developme pment nt and orderl orderly y functi functioni oning ng of Gover Governme nment nt securities market

•

Advises central and state governments in better cash management.

PAYMENT SYSTEMS •

•

 Negotiated dealing system for security dealing. Esta Establ blis ishm hmen entt of clea cleari ring ng corp corpor orat atio ion n of Indi Indiaa Ltd. Ltd. (CCI (CCIL) L) for  for  settlement of security deals.

•

Introduction of Real Time Gross Settlement (RTGS)

•

Electronic payment facilities like Electronic Clearing System (ECS), Electr Electroni onicc Funds Funds Transf Transfer er (EFT), (EFT), and Nation National al Electr Electroni onicc Funds Funds Transfer (NEFT) and Cheque truncation.

•

Providing messaging network and encryption facilities for secured messaging through the Institute for Development and Research in Banking Technology (IDRBT).

BANKERS' BANK  Thee Rese Th Reserv rvee Bank Bank of Ind ndia ia acts acts as a bank banker er to all all sche schedu dule led d bank banks. s. Commercial banks including foreign banks, co-operative banks & regional rural banks are eligible to be included in the second schedule of the Reserve Bank of India Act subject to fulfilling conditions laid down under Section 42 (6) of the Reserve Bank of India Act 1934..

Indian Financial System

SUPERVISOR OF THE FINANCIAL SYSTEM Pres Prescr crib ibes es regu regula lati tion onss for for soun sound d func functi tion onin ing g of bank bankss and and fina financ ncia iall institutions, including non-banking finance companies •

Promotes best practices in risk management and corporate governance to protect depositors' interest and to enhance public confidence in the financial system of the country

•

Encour Encourage agess use of techno technolog logy y in banks banks to provid providee cost-e cost-effe ffecti ctive ve service to consumers.

BOARD FOR FINANCIAL SUPERVISION The Reserve Bank of India performs this function under the guidance of the Board Board for Financ Financial ial Superv Supervisi ision on (BFS) (BFS).. The Board Board was consti constitut tuted ed in   November 1994 as a committee of the Central Board of Directors of the Reserve Bank of India.

OBJECTIVE Primary objective of BFS is to undertake consolidated supervision of the financial financial sector sector comprising comprising commercia commerciall banks, banks, financia financiall institutio institutions ns and non-banking finance companies.

CONSTITUTION CONSTITUTION OF THE BOARD The Board is constituted by co-opting four Directors from the Central Board as members for a term of two years and is chaired by the Governor. The

Indian Financial System

Deputy Governors of the Reserve Bank are ex-officio members. One Deputy Governor, usually, the Deputy Governor in charge of banking regulation and supervision, is nominated as the Vice-Chairman of the Board.

BFS MEETINGS The Board is required to meet normally once every month. It considers inspec inspectio tion n repor reports ts and other other superv superviso isory ry issues issues placed placed before before it by the supervisory departments. BFS through the Audit Sub-Committee also aims at upgrading the quality of  the the stat statut utor ory y audi auditt and and inte intern rnal al audi auditt func functi tion onss in bank bankss and and fina financ ncia iall instit instituti utions ons.. The audit audit sub-co sub-comm mmitt ittee ee includ includes es Deputy Deputy Govern Governor or as the chairman and two Directors of the Central Board as members. The BFS oversees the functioning of Department of Banking Supervision (DBS), (DBS), Departme Department nt of Non-Banki Non-Banking ng Supervisio Supervision n (DNBS) (DNBS) and Financial Financial Insti Institut tution ionss Divisi Division on (FID) (FID) and gives gives direc directio tions ns on the regula regulator tory y and supervisory issues.

FUNCTIONS OF THE BFS Some of the initiatives taken by BFS include: i.

rest restru ruct ctur urin ing g of the the syst system em of of bank bank ins inspe pect ctio ions ns

ii. ii.

intr introd oduc ucti tion on of offoff-si site te surv survei eill llan ance ce,,

iii. iii.

stre streng ngth then enin ing g of the the rol rolee of sta statu tuto tory ry aud audit itor orss and

iv.

Streng Strengthe thenin ning g of the the inter internal nal defe defense nsess of super supervis vised ed insti institut tution ions. s.

Indian Financial System

Thee Audi Th Auditt SubSub-co comm mmit itte teee of BFS BFS has has revi review ewed ed the the curr curren entt syst system em of  concur concurren rentt audit, audit, norms norms of empane empanelme lment nt and appoin appointme tment nt of statut statutory ory audi audito tors rs,, the the qu qual alit ity y and and cove covera rage ge of stat statut utor ory y audi auditt repo report rts, s, and and the the impor importan tantt issue issue of greate greaterr transp transpare arency ncy and disclo disclosur suree in the pub publis lished hed accounts of supervised institutions.

COMMERCIAL BANK  Commercial banks ordinarily are simple business or commercial concern which provides various types of financial services to consumers in return for   payments in one form or another such as interest discount, fees, commission, and so on . their objective is to make profits. However, what distinguish them from other business concerns ( financial as well as manufacturing ) is the the degr degreee to whic which h the they have ave to bala alance nce the the princ rinciipal pal of profit ofit maximization with certain other principal . in India especially . banks are required to modify the performance in profit making if that clashes with thei theirr ob obli liga gati tion onss in such such area areass as soci social al welf welfar aree , soci social al just justic icee , and and  promotion of regional balances in development . bank in general have to pay much more attention to balancing profitability with liquidity.

SCHEDULED BANKS Scheduled banks are which are included in the second schedule of The Banking Regulation Act 1949, other are non schedule bank  (a) must have paid up capital and reserve not less than Rs 5 lakh. (b) it must also satisfy the RBI that its affairs are not conducted in a manner  detrimental t the interests of its depositors. Scheduled banks are required to maintain a certain amount amount of reserves with the RBI they in return , enjoy the

Indian Financial System

facility of financial accommodation and remittance at concessional rates from the RBI.

REGIONAL RURAL BANKS. A beginning to set up the RRB was made in later half of 1975 in accordance with the recommendations recommendations of banking banking commission commission it was intended intended that the RRB would operate exclusively in rural areas and would provide credit and other facility to small and marginal farmers , agricultural laborer , artisans , and small entrepreneurs. They now carry all types of banking business generally within one to five districts. The RRB can be set up provided by  public sector bank sponsor them . the ownership capital of these banks is held held by the centra centrall govt. (50 %) ,concer ,concerned ned state state govt. govt. (15 %), and the sponsor sponsor bank (35%) (35%) . they are in effect effect owned by the govt. govt. and there is a little local participation in ownership and administration of these bank also . further they have a large large number of branches.

Indian Financial System

CLASSIFICTION OF NBFC:

The various NBFC can be classified as follows:

•

Housing Finance Institution (companies)

•

Venture Capital Funds

•

Factors or Factoring companies

INVESTMENT TRUST OR INVESTMENT COMPANIES

Investment trust are close ended organization, unlike UTI and they have a fixed amount of authorized capital and a stated amount of issued capital. Investment trust provides useful service through conserving and managing property for those who, for some reasons or other cannot mana manage ge thei theirr own own affa affair irs. s. Inve Invest stor or of mode modera rate te mean meanss are are prov provid idee facilities for diversification of investment, expert advice on lucrative investment channels, and supervision of their investment. From the point of view of the economy, they help to mobilize small savings and direct tem to fruitful channels. Thy also have a stabilizing effect on stock  market. Unlike in other countries, they render manifold function such as financing, underwriting, promoting and banking.

Indian Financial System

Most Mo st of thes thesee comp compan anie iess are are no nott inde indepe pend nden ent, t, they they are are inve invest stme ment nt holding companies, formed by the former managing agents, or business houses. As such, they provide finance mainly to such companies as are associated with these business houses.

NIDHIS: Mutual benefit funds or nidhis, as they are called in India, are joint stock  companies companies operating operating mainly mainly in south India, particularly particularly in Tamil Nadu. The source of their funds are share capital, deposits from their members, and and the the pu publ blic ic.. Th Thee depo deposi sitt are are fixe fixed d and and recu recurr rrin ing. g. Unli Unlike ke othe other  r   NBFC’S nidhis also accepts demand deposit to some extent. The loans given by this institution are mainly for consumption purposes. These loans are usually secured loans, given against the security of tangible asse assett such such as ho hous usee prop proper erty ty , go gold ld jewe jewelr lry, y, or agai agains nstt shar sharee of  companies, LIC policies, and so on. The terms on which loans are given are quite moderate. The notable points about these institutions are :

a) Th They ey offer fer sav saving ing sche chemes mes whic which h are are link inked with ith the the assurance to make credit available when required by saver’s   b) b) Th They ey make ake the the cred redit ava availab ilable le to tho those to who hom m the the comm commer erci cial al bank bankss may may hesi hesita tate te to give give cred credit it or whom whom commercial banks have not been able to reach, c) They possess characteristics such as their local character,

easy easy appr approa oach chab abil ilit ity, y, and and the the abse absenc ncee of cumb cumber erso some me  procedures, which make them suitable for small areas and,

Indian Financial System

d) Interest rates on their deposit and the loans are comparable to

those of commercial banks, and they work on the sound  principal of the banking. Their operations are similar to those of unit banks. They are incorporate bodies and are governed  by the directives of the RBI.

MERCHANT BANKS: It woul would d help help in un unde ders rsta tand ndin ing g the the natu nature re of merc mercha hant nt bank bankin ing g if we compar comparee it with with comme commerci rcial al bankin banking. g. The MBs offer offer mainly mainly financ financial ial advice and service for a fee, while commercial banks accepts deposit and lend money. When MBs do functions essentially as wholesale bankers rather  than retail bankers. It means that they deals with selective large industrial clients and not with the general public in their fund based activities. The merchant banks are different from security dealers, trades and brokers also. They deal mainly in new issues, while the latter deal mainly in existing securities.

The range of activities undertaken by merchant banks can be understood from recent advertisement of one of the merchant bankers in India which mentioned the following service offered by it:

1) Manageme Management, nt, marketing marketing and underwrit underwriting ing of new issues, issues, 2) Project Project promotio promotion n services services and project project finance, finance, 3) Syndicati Syndication on of credit credit and and other facili facilities, ties, 4) Leasing, Leasing, inclu including ding project project leasin leasing, g,

Indian Financial System

5) Corporat Corporatee advisory advisory services, services, 6) Investmen Investmentt advis advisory ory services, services, 7) Bought Bought-ou -outt deals, deals, 8) Vent Ventur uree capit capital al,, 9) Mutual Mutual fund fund and and offsho offshore re funds, funds, 10)

Investment

management

including

dictionary

management, 11) Investment service for non- resident Indians, 12) Management of and dealing in commercial papers,

In India the merchant banking service are provided by the commercial banks, All Indian Indian Financ Financial ial Instit Instituti utions ons,, privat privatee consul consultan tancy cy firms firms & techni technical cal consultation organizations.

In March 1991, SEBI granted permission to VMC project technologies to act as the merchant banker and to undertake public issue management, portfolio management, lead management, and so on. It may be noted that in India, the  permission of the SEBI is required to do merchant banking business.

HIRE PURCHASE FINANCE COMPANIES Hire purchase involves a system under which term loan for purchases of  good go odss and and serv servic ices es are are adva advanc nced ed to be liqu liquid idat ated ed in stag stages es thro throug ugh h a

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contractual obligation. The goods whose purchases are thus financed may be a consumer goods or producer goods or may be simply services such as air  travel.

Hire-purchase credit may be provided by the seller himself or by any financial institution.

Hire-purchase credit is available in India for a wide range of services. Product like automobile, sewing machines, radios, refrigerators, TV sets, bicycles, machinery and equipment, other capital goods, industrial shades, services like educational fees, medical fees, and so on are now financed with help of such credit. However unlike in other countries the emphasis in India is on the  provision of installment credit for productive goods & services rather than for   purely consumer goods.

Other Other suppli suppliers ers of hirehire-pur purcha chase se financ financee are retail retail and wholes wholesale ale trader traders, s, commercial banks, IDBI, ICICI,NSIC,NSIDC, SFCS,SIDCS, Argo-industries corporations (AICs), and so on.

In the recent past, banks also have increased their business in his field of  installment credit and loans.

IDBI indirectly participate in financing hire purchase business by way of  redi redisc scou ount ntin ing g usan usance ce bill bills/ s/pr prom omis isso sory ry no note tess aris arisin ing g ou outt of indi indige geno nous us machinery on deferred payment basis.

Indian Financial System

LEASE FINANCE COMPANIE:

A lease is a form of financing employed to acquire the use of asset, through which firm can acquire the use of asset for a stated period without owing them. Every lease involves two parties : user of asset is known as lessee, and the owner of the asset is known as the lessor. While these companies may unde un dert rtak akee othe otherr acti activi viti ties es like like cons consum umer er cred credit it,, car car fina financ nce, e, etc. etc. thei their  r   predominant activity is leasing.

Leas Leasee fina financ ncin ing g orga organi niza zati tion onss in Indi Indiaa incl includ udee many many priv privat atee sect sector  or  manuf manufact acturi uring ng compan companies ies,, infras infrastru tructu cture re leasin leasing g and

financ financial ial servic servicee

limi limite ted. d.(I (IL& L&FS FS), ), ICIC ICICI, I, IRCI IRCI,, capi capita tall mark market et subs subsid idia iari ries es of lead leadin ing g nati nation onal aliz ized ed

bank banks, s,

IFC, IFC,LI LIC, C,

GIC, IC,

Hous Housin ing g

Deve Develo lopm pmen entt

Fina Financ ncee

Corporation (HDFC), certain SIDCs and SIICs, and other organizations. The lessee companies include many leading corporation in both public and private sectors, and small manufacturing companies.

HOUSING FINANCE COMPANIES:

Housing finance is provide in the form of mortgage loan i.e. it is provided against the security of immovable property of land and buildings. basically hous ho usin ing g fina financ ncee loan loan are are give given n by Hosi Hosing ng and and Urba Urban n Deve Develo lopm pmen entt Corporation, the apex Co-operative Housing Financing Societies and housing   brand brand in differ different ent states states,, centra centrall and state state gov govern ernmen ment, t, LIC, LIC, Commer Commercia ciall  banks, GIC, and a few private housing companies and nidhis.the government   pro provi vide de dire direct ct loan loan main mainly ly to thei theirr empl employ oyee ees. s. Th Thee part partic icip ipat atio ion n of 

Indian Financial System

commercial and urban co-operative banks in direct in mortgage loans has  been marginal till recently. LIC has been a major supplier of mortgage loan in indirect and direct forms. It has been giving loans to the state government, apex cooperative housing societies, HUDCO and so on. In addition it has   bee been n prov provid idin ing g mort mortga gage ge loan loan dire direct ctly ly to indi indivi vidu dual alss un unde derr its its vari variou ouss mortgage schemes.

NATIONAL HOUSING BANK:

It was set up in July, 1988 as an apex level housing finance institution as wholly owned subsidiary of the RBI. It began its operation with the total capital of Rs.170 crore (Rs 100 crore as share capital, Rs 50 crore as long term loan from RBI and Rs 20 crore through sale of bounds). In September, 1989 it share capital was raised to Rs150 crore. During 1989-90, it issued its second series of bonds whose total subscription amounted to Rs60 crore. These bonds are guaranteed by the central government, and carry an interest rate of 11.5% per annum. The RBI sanctioned it a long-term loan of Rs25 crore in 1989-90. Further, it can borrow in the USA capital market US$50 million under the USAID government guarantee program. Thus the resources  base of NHB has been made quite quite strong. The explicit and the the primary aim of   NHB is to promote housing finance institution at local and regional levels in the private & joint sector by providing financial and other support.

Indian Financial System

VENTURE CAPITAL FUNDING COMPANIES:

The term “venture capital” suggest taking risk in supplying capital. However  supply of risk capital may not be a prime function in certain cases the emphasis may be on supporting technocrats in setting up projects or on  portfolio management. The term venture capital fund is usually used to denote mutual fund or institutional investors that provide equity finance or risk little known, kno wn, unregi unregiste stered red highly highly risky, risky, small small priva private te busine businesse sses, s, especi especiall ally y in technology-oriented and knowledge intensive business or industries which have have long long deve develo lopm pmen entt cycl cycles es and and whic which h usua usuall lly y do no nott have have acce access ss to conventional source of capital because of the absence of suitable collateral and the presence of high risk. VCFs play an important role in supplying management and marketing expertise to such units.