Financial System in India: Assets, Institutions, Markets, and Regulation - Prof. Chandru, Study notes of Finance

Download Financial System in India: Assets, Institutions, Markets, and Regulation - Prof. Chandru and more Study notes Finance in PDF only on Docsity! Principles & Practices of Banking Module A Indian Financial System K Chockalingam IIBF Financial System  An institutional framework existing in a country to enable financial transactions  Three main parts  Financial assets (loans, deposits, bonds, equities, etc.)  Financial institutions (banks, mutual funds, insurance companies, etc.)  Financial markets (money market, capital market, forex market, etc.)  Regulation is another aspect of the financial system (RBI, SEBI, IRDA, FMC) Money Market Instruments (2)  Commercial Paper (CPs) are issued by corporates to raise short term money  Issued in multiple of Rs.25 lakhs, can be issued by companies with a net worth of at least Rs. 5 crores  CP is an unsecured promissory note privately placed with investors at a discount rate to face value. The maturity of CP is between 3 and 6 months Financial Institutions  Includes institutions and mechanisms which  Affect generation of savings by the community  Mobilisation of savings  Effective distribution of savings  Institutions are banks, insurance companies, mutual funds- promote/mobilise savings  Individual investors, industrial and trading companies- borrowers Financial Markets  Money Market- for short-term funds (less than a year)  Organized (Banks)  Unorganized (money lenders, chit funds, etc.)  Capital Market- for long-term funds  Primary Issues Market  Stock Market  Bond Market Call money market (2)  Call loans are generally made on a clean basis- i.e. no collateral is required  The main function of the call money market is to redistribute the pool of day-to-day surplus funds of banks among other banks in temporary deficit of funds  The call market helps banks earn interest and yet improve their liquidity  It is a highly competitive and sensitive market  It acts as a good indicator of the liquidity position Bill Market  Treasury Bill market- Also called the T-Bill market – These bills are short-term liabilities (91-day, 182- day, 364-day) of the Government of India – It is an IOU of the government, a promise to pay the stated amount after expiry of the stated period from the date of issue – They are issued at discount to the face value and at the end of maturity, the face value is paid – The rate of discount and the corresponding issue price are determined at each auction  Commercial Bill market- Not as developed in India as the T-Bill market Indian Banking System  Central Bank (Reserve Bank of India)  Commercial banks  Co-operative banks  Banks can be classified as:  Scheduled (Second Schedule of RBI Act, 1934)  Non-Scheduled  Scheduled banks can be classified as:  Public Sector Banks  Private Sector Banks (Old and New)  Foreign Banks  Regional Rural Banks RBI and indigenous bankers (2)  IB should have their accounts audited by certified chartered accountants  Submit their accounts to RBI periodically  As against these obligations the RBI promised to provide them with privileges offered to commercial banks including – Being entitled to borrow from and rediscount bills with RBI  The IB declined to accept the restrictions as well as compensation from the RBI  Therefore, the IB remain out of RBI’s purview Development Oriented Banking  Historically, close association between banks and some traditional industries- cotton textiles in the west, jute textiles in the east  Banking has not been mere acceptance of deposits and lending money to include development banking  Lead Bank Scheme- opening bank offices in all important localities  Providing credit for development of the district  Mobilising savings in the district. ‘Service area approach’ Progress of banking in India (1)  Nationalisation of banks in 1969: 14 banks were nationalised  Branch expansion: Increased from 8260 in 1969 to 68500 in 2005  Population served per branch has come down from 64000 to 15000  A rural branch office serves 15 to 25 villages within a radius of 16 kms  Still only 32,180 villages out of 5 lakh have been covered Profitability of Banks(1)  Reforms has shifted the focus of banks from being development oriented to being commercially viable  Prior to reforms, banks were not profitable and in fact made losses for the following reasons:  Declining interest income  Increasing cost of operations Profitability of banks (2)  Declining interest income was for the following reasons:  High proportion of deposits impounded for CRR and SLR, earning relatively low interest rates  System of directed lending  Political interference- leading to huge NPAs  Rising costs of operations for banks was because of several reasons: economic and political Profitability of Banks (3)  As per the Narasimham Committee (1991), the reasons for rising costs of banks were:  Uneconomic branch expansion  Heavy recruitment of employees  Growing indiscipline and inefficiency of staff due to trade union activities  Low productivity  Declining interest income and rising cost of operations of banks led to low profitability in the 90s NPA Management  The Narasimham Committee recommendations were made, among other things, to reduce the Non- Performing Assets (NPAs) of banks  To tackle this, the government enacted the Securitization and Reconstruction of Financial Assets and Enforcement of Security Act (SARFAESI) Act, 2002  Enabled banks to realise their dues without intervention of courts SARFAESI Act  Enables setting up of Asset Management Companies to acquire NPAs of any bank or FI (SASF, ARCIL are examples)  NPAs are acquired by issuing debentures, bonds or any other security  As a second creditor can serve notice to the defaulting borrower to discharge his/her liabilities in 60 days  Failing which the company can take possession of assets, takeover the management of assets and appoint any person to manage the secured assets  Borrowers have the right to appeal to the Debts Tribunal after depositing 50% of the amount claimed by the second creditor The Indian Capital Market (1)  Market for long-term capital. Demand comes from the industrial, service sector and government  Supply comes from individuals, corporates, banks, financial institutions, etc.  Can be classified into:  Gilt-edged market  Industrial securities market (new issues and stock market) Financial Intermediaries (1)  Mutual Funds- Promote savings and mobilise funds which are invested in the stock market and bond market  Indirect source of finance to companies  Pool funds of savers and invest in the stock market/bond market  Their instruments at saver’s end are called units  Offer many types of schemes: growth fund, income fund, balanced fund  Regulated by SEBI Financial Intermediaries (2)  Merchant banking- manage and underwrite new issues, undertake syndication of credit, advise corporate clients on fund raising  Subject to regulation by SEBI and RBI  SEBI regulates them on issue activity and portfolio management of their business.  RBI supervises those merchant banks which are subsidiaries or affiliates of commercial banks  Have to adopt stipulated capital adequacy norms and abide by a code of conduct Conclusion  There are other financial intermediaries such as NBFCs, Venture Capital Funds, Hire and Leasing Companies, etc.  India’s financial system is quite huge and caters to every kind of demand for funds  Banks are at the core of our financial system and therefore, there is greater expectation from them in terms of reaching out to the vast populace as well as being competitive.