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Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
Indian finsncial system
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  • 1. Management of financial services INDIAN FINANCIAL SYSTEM -1-
  • 2. CHAPTER-1 INDIAN FINANCIAL SYSTEMMEANING & DEFINITION OF FINANCIAL SYSTEM:Definition“In finance, the financial system is the system that allows the transfer of money between saversand borrowers. It comprises a set of complex and closely interconnected financial institutions,markets, instruments, services, practices, and transactions.” -2-
  • 3. According to Robinson, the primary function of the system is “To provide a link betweensaving and investment for the creation of new wealth and to permit portfolio adjustment incomposition of existing wealth”The word "system", in the term "financial system", implies a set of complex and closelyconnected or interlined institutions, agents, practices, markets, transactions, claims, and liabilitiesin the economy. The financial system is concerned about money, credit and finance-the threeterms are intimately related yet are somewhat different from each other. Indian financial systemconsists of financial market, financial instruments and financial intermediation.There are areas or people with surplus funds and there are those with a deficit. A financialsystem or financial sector functions as an intermediary and facilitates the flow of funds from theareas of surplus to the areas of deficit. A Financial System is a composition of variousinstitutions, markets, regulations and laws, practices, money manager, analysts, transactions andclaims and liabilities. -3-
  • 4. The economic development of a nation is reflected by the progress of the various economic units,broadly classified into corporate sector, government and household sector. While performingtheir activities these units will be placed in a surplus/deficit/balanced budgetary situations.In finance, the financial system is the system that allows the transfer of money between saversand borrowers it comprises a set of complex and closely interconnected financial institutions,markets, instruments, services, practices, and transactions. Financial systems are crucial to theallocation of resources in a modern economy. They channel household savings to the corporatesector and allocate investment funds among firms. The functions are common to the financialsystems of most developed economies. Yet the form of these financial systems varies widely.In finance, the financial system is the system that allows the transfer of money between saversand borrowers it comprises a set of complex and closely interconnected financial institutions,markets, instruments, services, practices, and transactions. Financial systems are crucial to theallocation of resources in a modern economy. They channel household savings to the corporatesector and allocate investment funds among firms. The functions are common to the financialsystems of most developed economies. Yet the form of these financial systems varies widely.The financial system or the financial sector of any country consists of:- (A) Specialized & non specialized financial institution. (B) Organized &unorganized financial markets and, (C) Financial instruments & services which facilitate transfer of funds.Procedure & practices adopted in the markets, and financial inter relationships are also the partsof the system. These parts are not always mutually exclusive. The word system in the termfinancial system implies a set of complex and closely connected or inters mixed institution,agent‟s practices, markets, transactions, claims, & liabilities in the economy. The financialsystem is concerned about money, credit, & finance – the terms intimately related yet somewhatdifferent from each other. Money refers to the current medium of exchange or means ofpayment. Credit or Loan is a sum of money to be returned normally with interest it refers to a -4-
  • 5. debt of economic unit. Finance is a monetary resources comprising debt & ownership fund of thestate, company or person.DEFINITION“In finance, the financial system is the system that allows the transfer of money between saversand borrowers. It comprises a set of complex and closely interconnected financial institutions,markets, instruments, services, practices, and transactions.”Features of Financial System  It provides an Ideal linkage between depositor‟s savers and investors Therefore it encourages savings and investment.  Financial system facilitates expansion of financial markets over a period of time.  Financial system should promote deficient allocation of financial resources of socially desirable and economically productive purpose.  Financial system influence both quality and the pace of economic development.Role of Financial SystemThe role of the financial system is to promote savings & investments in the economy. It has avital role to play in the productive process and in the mobilization of savings and theirdistribution among the various productive activities. Savings are the excess of currentexpenditure over income. The domestic savings has been categorized into three sectors,household, government & private sectors.The function of a financial system is to establish a bridge between the savers and investors. Ithelps in mobilization of savings to materialize investment ideas into realities. It helps to increasethe output towards the existing production frontier. The growth of the banking habit helps toactivate saving and undertake fresh saving. The financial system encourages investment activityby reducing the cost of finance risk. It helps to make investment decisions regarding projects bysponsoring, encouraging, export project appraisal, feasibility studies, monitoring & execution ofthe projects -5-
  • 6. COMPONENTS/ CONSTITUENTS OF INDIAN FINANCIAL SYSTEMA. FORMAL FINANCIAL SYSTEM 1. Financial institutions/intermediaries 2. Financial Markets 3. Financial Instruments/Assets/Securities 4. Financial Services.B. INFORMAL FINANCIAL SYSTEM: Like, Moneylenders, Local Bankers, Traders,Landlords, and Pawn Broker etc.1. FINANCIAL INSTITUTIONSIn financial economics, a financial institution is an institution that provides financialservices for its clients or members. Probably the most important financial service provided byfinancial institutions is acting as financial intermediaries. Most financial institutions arehighly regulated by government -6-
  • 7. Financial institutions provide service as intermediaries of the capital and debt markets. They areresponsible for transferring funds from investors to companies in need of those funds. Financialinstitutions facilitate the flow of money through the economy. To do so, savings a risk brought toprovide funds for loans. Such is the primary means for depository institutions to developrevenue. Should the yield curve become inverse, firms in this arena will offer additional fee-generating services including securities underwriting.The financial institutions in India are divided in two categories. The first type refers to theregulatory institutions and the second type refers to the intermediaries. The regulators areassigned with the job of governing all the divisions of the Indian financial system. Theseregulatory institutions are responsible for maintaining the transparency and the national interestin the operations of the institutions under their supervision.The regulatory bodies of the financial institutions in India are as follows:  Reserve Bank of India (RBI)  Securities and Exchange Board of India (SEBI)  Central Board of Direct Taxes (CBDT)  Central Board of Excise & CustomsApart from the Regulatory bodies, there are the Intermediaries that include the banking and non-banking financial institutions. Some of the specialized financial institutions in India are asfollows:  Unit Trust of India (UTI)  Securities Trading Corporation of India Ltd. (STCI)  Industrial Development Bank of India (IDBI)  Industrial Reconstruction Bank of India (IRBI), now (Industrial Investment Bank of India)  Export - Import Bank of India (EXIM Bank)  Small Industries Development Bank of India (SIDBI)  National Bank for Agriculture and Rural Development (NABARD)  Life Insurance Corporation of India (LIC) -7-
  • 8. Intermediary Market RoleStock Exchange Capital Market Secondary Market to securities Corporate advisory services, Issue ofInvestment Bankers Capital Market, Credit Market securities Subscribe to unsubscribed portion ofUnderwriters Capital Market, Money Market securities Issue securities to the investors on behalfRegistrars, Depositories, Custodians Capital Market of the company and handle share transfer activityPrimary Dealers Satellite Dealers Money Market Market making in government securitiesForex Dealers Forex Market Ensure exchange ink currenciesThus, it can be concluded that a financial institution is that type of an institution, whichperforms the collection of funds from private investors and public investors and utilizes thosefunds in financial assets. The functions of financial institutions are not limited to a particularcountry, instead they have also become popular in abroad due to the growing impact ofglobalization.2. FINANCIAL MARKETSFinancial Markets are an important component of financial system in an economy financialsystem aims at establishing a regular, smooth, efficient and cost effective link between savers &investors. Thus, it helps encouraging both saving and investment. All system facilitatesexpansion of financial markets over space 8 times and promotes efficient allocation of financial -8-
  • 9. resources .For socially desirable and economically productive purposes. They influence both thequality and the pace of economic development.Various constituents of financial system are financial, institutions, financial services, financialinstruments and financial markets. These constituents of financial system are closely inter-mixedand operate in conjunction with each other. For eg. Financial institutions operate in financialmarkets generating, purchasing and selling financial instruments and rendering various financialservices in accordance with the practices and procedures established by law or tradition.Financial markets are the centre or arrangements facilitating buying and selling of financialclaims, assets, services and the securities. Banking and non – banking financial institutions,dealers, borrowers and lenders, investors and savers, and agents are the participants on demandand supply side in these markets. Financial market may be specific place or location, e.g. stockexchange or it may be just on over – the –phone market. Financial markets in India are classified into four parts, viz.:-  Money Market  Capital Market  Debt Market  Forex MarketINTRODUCTION TO MONEY MARKETWhenever a bear market comes along, investors realize that the stock market is a risky place fortheir savings. Its a fact we tend to forget while enjoying the returns of a bull market!Unfortunately, this is part of the risk-return tradeoff. To get higher returns, you have to take on ahigher level of risk. For many investors, a volatile market is too much to stomach - the moneymarket offers an alternative to this higher-risk investment.The money market is better known as a place for large institutions and government to managetheir short-term cash needs. However, individual investors have access to the market through avariety of different securities. In this tutorial, well cover various types of money marketsecurities and how they can work in your portfolio. -9-
  • 10. The money market is a subsection of the fixed income market. We generally think of the termfixed income as being synonymous to bonds. In reality, a bond is just one type of fixed incomesecurity. The difference between the money market and the bond market is that the moneymarket specializes in very short-term debt securities (debt that matures in less than one year).Money market investments are also called cash investments because of their short maturities.The easiest way for us to gain access to the money market is with money market mutual funds,or sometimes through a money market bank account. These accounts and funds pool together theassets of thousands of investors in order to buy the money market securities on their behalf.However, some money market instruments, like Treasury bills, may be purchased directly.Failing that, they can be acquired through other large financial institutions with direct access tothese markets.MONEY MARKET INSTRUMENTSThe money market is a market for short-term financial assets that are close substitutes of money.The most important feature of a money market instrument is that it is liquid and can be turnedover quickly at low cost and provides an opportunity for balancing the short-term surplus fundsof lenders and the requirements of borrowers. By convention, the term "Money Market" refers tothe market for short-term requirement and deployment of funds. Money market instruments arethose instruments, which have a maturity period of less than one year. The most active part of themoney market is the market for overnight call and term money between banks and institutionsand repo transactions. Call Money / Repo are very short-term Money Market products. There is awide range of participants (banks, primary dealers, financial institutions, mutual funds, trusts,provident funds etc.) dealing in money market instruments. Money Market Instruments and theparticipants of money market are regulated by RBI and SEBI.As a primary dealer SBI DFHI isan active player in this market and widely deals in Short Term Money Market Instruments. T hebelow mentioned instruments is normally termed as money market instruments:  Call/ Notice Money  Treasury Bill  Inter-Bank Term Money  Certificate of Deposit - 10 -
  • 11.  Commercial Paper  Inter-Corporate Deposits  Repo/Reverse RepoCall /Notice-Money MarketCall/Notice money is the money borrowed or lent on demand for a very short period. Whenmoney is borrowed or lent for a day, it is known as Call (Overnight) Money. Interveningholidays and/or Sunday are excluded for this purpose. Thus money, borrowed on a day andrepaid on the next working day, (irrespective of the number of intervening holidays) is "CallMoney". When money is borrowed or lent for more than a day and up to 14 days, it is "NoticeMoney". No collateral security is required to cover these transactions.Treasury Bills:The Treasury bills are short-term money market instrument that mature in a year or less thanthat. The purchase price is less than the face value. At maturity the government paysthe Treasury bill holder the full face value. The Treasury Bills are marketable, affordable andrisk free. The only downside to T-bills is that you wont get a great return because Treasuries areexceptionally safe.Inter-Bank Term MoneyInter-bank market for deposits of maturity beyond 14 days is referred to as the term moneymarket. The entry restrictions are the same as those for Call/Notice Money except that, as perexisting regulations, the specified entities are not allowed to lend beyond 14 days.Certificate of Deposit (CD)The certificates of deposit are basically time deposits that are issued bythe commercial banks with maturity periods ranging from 3 months to five years. The return onthe certificate of deposit is higher than the Treasury Bills because it assumes a higher level ofrisk.Commercial Paper - 11 -
  • 12. Commercial Paper is short-term loan that is issued by a corporation use for financing accountsreceivable and inventories. The maturity period of Commercial Papers is a maximum of 9months. They are very safe since the financial situation of the corporation can be anticipated overa few months.Inter-Corporate DepositsInter-corporate deposits are deposits made by one company with another company, and usuallycarry a term of six months. The three types of inter-corporate deposits are: three month deposits,six month deposits, and call deposits. The biggest advantage of inter-corporate deposits is thatthe transaction is free from bureaucratic and legal hassles.Repo/Reverse RepoRepo is short for repurchase agreement. Those who deal in government securities use repos as aform of overnight borrowing. They are usually very short-term, from overnight to 30 days ormore. The reverse repo is the complete opposite of a repo. In this case, a dealer buys governmentsecurities from an investor and then sells them back at a later date for a higher price.INTRODUCTION TO CAPITAL MARKETCapital market is market for long term securities. It contains financial instruments of maturityperiod exceeding one year. It involves in long term nature of transactions. It is a growing elementof the financial system in the India economy. It differs from the money market in terms ofmaturity period & liquidity. It is the financial pillar of industrialized economy. The developmentof a nation depends upon the functions & capabilities of the capital market. Capital market is themarket for long term sources of finance. It refers to meet the long term requirements of theindustry. Generally the business concerns need two kinds of finance:- 1. Short term funds for working capital requirements. 2. Long term funds for purchasing fixed assets.Therefore the requirements of working capital of the industry are met by the money market. Thelong term requirements of the funds to the corporate sector are supplied by the capital market. Itrefers to the institutional arrangements which facilitate the lending & borrowing of long termfunds.On the basis of financial instruments the capital markets are classifieds intoTwo kinds:- - 12 -
  • 13. a) Equity marketb) Debt marketRecently there has been a substantial development of the India capital market. It comprisesvarious 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 equitymarket can be divided into two categories(a) Primary market(b) Secondary market.PRIMARY MARKETThe primary market is that part of the capital markets that deals with the issue ofnew securities. Companies, governments or public sector institutions can obtain funding throughthe sale of a new stock or bond issue. This is typically done through a syndicate of securitiesdealers. The process of selling new issues to investors is called underwriting. In the case of anew stock issue, this sale is an initial public offering (IPO). Dealers earn a commission that isbuilt into the price of the security offering, though it can be found in the prospectus. Primarymarkets create long term instruments through which corporate entities borrow from capitalmarket. 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 funddirect from the public.Right Issue:-Right issue is the method of raising additional finance from existing members by offeringsecurities to them on pro rata basis.Bonus Issue:- - 13 -
  • 14. Some companies distribute profits to existing shareholders by way of fully paid up bonus sharein lieu of dividend. The shareholder does not have to any additional payment for these shares.Private Placement:-Private placement market financing is the direct sale by a public limited company or privatelimited company of private as well as public sector of its securities to the intermediaries likecredit rating agencies and trustees and financial advisors such as merchant bankers.SECONDARY MARKETThe secondary market is that segment of the capital market where the outstanding securities aretraded from the investors point of view the secondary market imparts liquidity to the long – termsecurities held by them by providing an auction market for these securities. The secondarymarket operates through the medium of stock exchange which regulates the trading activity inthis market and ensures a measure of safety and fair dealing to the investors. India has a longtradition of trading in securities going back to nearly 200 years. The first India stock exchangeestablished at Mumbai in 1875 is the oldest exchange in Asia. The main objective was to protectthe character status and interest of the native share and stock broker.The Indian stock markets can be divided into further categories depending on various aspectslike the mode of operation and the diversification in services. First of the two largest stockexchanges in India can be divided on the basis of operation. While the Bombay stock exchangeor BSE is a conventional stock exchange with a trading floor and operating through mostlyoffline trades, the National Stock Exchange or NSE is a completely online stock exchange andthe first of its kind in the country. The trading is carried out at the National Stock Exchangethrough the electronic limit order book or the LOB. With the immense popularity of the processand online trading facility other exchanges started to take up the online route including the BSEwhere you can trade online as well. But the BSE is still having the offline trading facility that iscarried out at the trading floor of the exchange at its Dalal Street facility.INTRODUCTION TO DEBT MARKET - 14 -
  • 15. Debt market refers to the financial market where investors buy and sell debt securities, mostly inthe form of bonds. These markets are important source of funds, especially in a developingeconomy like India. India debt market is one of the largest in Asia. Like all other countries, debtmarket in India is also considered a useful substitute to banking channels for finance. The fixedreturn on the bond is often termed as the coupon rate or the interest rate.The debt market often goes by other names, based on the types of debt instruments that aretraded. In the event that the market deals mainly with the trading of municipal and corporatebond issues, the debt market may be known as a bond market. If mortgages and notes are themain focus of the trading, the debt market may be known as a credit market. When fixed ratesare connected with the debt instruments, the market may be known as a fixed income market.The instruments traded can be classified into the following segments based on the characteristicsof the identity of the issuer of these securities:Market Segment Issuer InstrumentsGovernment Central Government Zero Coupon Bonds, Coupon Bearing Bonds,Securities Treasury Bills, STRIPS State Governments Coupon Bearing Bonds.Public Sector Government Agencies / Govt. Guaranteed Bonds, DebenturesBonds Statutory Bodies Public Sector Units PSU Bonds, Debentures, Commercial PaperPrivate Sector Corporate Debentures, Bonds, Commercial Paper, Floating RateBonds Bonds, Zero Coupon Bonds, Inter-Corporate Deposits Banks Certificates of Deposits, Debentures, Bonds Financial Institutions Certificates of Deposits, BondsINTRODUCTION TO FOREX MARKETIn India, foreign exchange has been given a statutory definition. Section 2 (b) of ForeignExchange Regulation Act, 1973 states: - 15 -
  • 16. „Foreign exchange‟ means foreign currency and includes:“All deposits, credits and balances payable in any foreign currency and any drafts, traveler‟scheques, letters of credit and bills of exchange , expressed or drawn in Indian currency butpayable in any foreign currency.”Particularly for foreign exchange market there is no market place called the foreign exchangemarket. It is mechanism through which one country‟s currency can be exchange i.e. bought orsold for the currency of another country. The foreign exchange market does not have anygeographic location. The market comprises of all foreign exchange traders who are connected toeach other throughout the world. They deal with each other through telephones, telexes andelectronic systems. With the help of Reuters Money 2000-2, it is possible to access any trader inany corner of the world within a few seconds.Participants 1. Customers The customers who are engaged in foreign trade participate in foreign exchange markets by availing of the services of banks. 2. Commercial banks Commercial banks dealing with international transactions offer services for conversion of one currency in to another. 3. Central Bank In all countries central banks have been charged with the responsibility of maintaining the external value of the domestic currency.3. FINANCIAL INSTRUMENTSFinancial instrument is a claim against a person or an institution for payment, at a future date, ofa sum of money and/or a periodic payment in the form of interest or dividend. Financialinstrument can be classified according to Term and Type. - 16 -
  • 17. Under term wise it is classified by Short-term, Long-term and Medium term. While under typewise it is classified as Primary security and Secondary security. Primary securities are termed asdirect security as they are directly issued by the ultimate borrowers of fund to the ultimatesavers. Primary security includes equity share, preference shares and debentures. Secondarysecurities are referred to as indirect securities, as they are issued by the financial intermediariesto the ultimate savers. It includes insurance policy, Mutual Fund Units, Term Deposits etc.THE MAJOR TYPES OF FINANCIAL PRODUCTS ARE:Shares:These represent ownership of a company. While shares are initially issued by corporations tofinance their business needs, they are subsequently bought and sold by individuals inthe share market. They are associated with high risk and high returns. Returns on shares can bein the form of dividend payouts by the company or profits on the sale of shares in the stockmarket. Shares, stocks, equities and securities are words that are generally used interchangeably.Bonds:These are issued by companies to finance their business operations and by governments to fundexpenses like infrastructure and social programs. Bonds have a fixed interest rate, making therisk associated with them lower than that with shares. The principal or face value of bonds isrecovered at the time of maturity.Treasury BillsThese are instruments issued by the government for financing its short term needs. They areissued at a discount to the face value. The profit earned by the investor is the difference betweenthe face or maturity value and the price at which the Treasury Bill was issued.OptionsOptions are rights to buy and sell shares. An option holder does not actually purchase shares.Instead, he purchases the rights on the shares.Mutual FundsThese are professionally managed financial instruments that involve the diversification ofinvestment into a number of financial products, such as shares, bonds and government securities.This helps to reduce an investor‟s risk exposure, while increasing the profit potential. - 17 -
  • 18. Credit Default Swaps (CDS)Credit default swaps are highly leveraged contracts that are privately negotiated between twoparties. These swaps insure against losses on securities in case of a default. Since the governmentdoes not regulate CDS related activities, there is no specific central reporting mechanism thatdetermines the value of these contracts.AnnuitiesThese are contracts between investors and insurance companies, wherein the latter makesperiodic payments in exchange for financial protection in the event of an unfortunate incident.4. FINANCIAL SERVICESFinancial intermediaries provide key financial services such as merchant banking, leasing, hirepurchase, credit rating and so on. Financial services rendered by financial intermediaries bridgethe gap between lack of knowledge on part of investors and increasing sophistication of financialinstruments and markets.Financial services encompass a variety of businesses that deal with money management. Theseinclude many different kinds of organizations such as banks, investment companies, credit cardcompanies, insurance companies and even government programs. Financial services can alsorefer to the services and products that money management organizations offer to the public.Banks are one kind of financial services organizations. Banks generally function by providing asheltered and secure place for people to store their money. Usually, banks will invest theirclients stored money for the banks gain, while paying a small amount of interest to those whokeep their money in savings or checking accounts.The Financial services were developed in order to meet the needs of individual as well ascompanies. The financials of companies are expected to improve as a result of these financialservices in the form of lower debt equity ratio, improved liquidity and profitability ratios. Thefinancial service industry has been growing at a rate of 14% per annum.Indian financial services industry was rather unexciting until the early seventies. The financialservices sector was started in mid seventies when a series of innovative services of which leasing - 18 -
  • 19. being the most notable. India has witnessed an explosive growth of leasing companies during theearly eighties.(A)Banking and Financial Services:Banking and financial services can also be further classified as: 1. Fee based financial services  Financial management.  Advisory services  Custody services  Credit card services 2. Securities-related financial services  Securities lending services  Mutual fund services  Securities clearance  Settlement services  Under-writing services(B)Insurance and insurance related services Insurance services include the following: Insurance brokerage Specialty insurance products Reinsurance(C)Fee-based Financial Services Financial services based on fees are as follows: Issue management - 19 -
  • 20. Portfolio management Loan based syndication Mergers and acquisitionsCAPITAL MARKET SERVICESThe following are the financial services rendered by various intermediaries in relation to capitalmarket.1. Issue management Public issue management is the beginning of project financing activity. A company has toappoint public issue managers who are normally merchant bankers. It is a marketing activity.2. Merchant bankingA merchant banker is any person who is engaged in the business of issue management either bymaking arrangements regarding selling, buying or subscribing to securities as manager,consultant or advisor or vendoring corporate advisory services in relation to such issuemanagementServices provided by Merchant Bankers Underwriting of issues Project finance Private placementsROLE/ FUNCTIONS OF FINANCIAL SYSTEM:The role of the financial system is to promote savings & investments in the economy. It has avital role to play in the productive process and in the mobilization of savings and their - 20 -
  • 21. distribution among the various productive activities. Savings are the excess of currentexpenditure over income. The domestic savings has been categorized into three sectors,household, government & private sectors.The function of a financial system is to establish a bridge between the savers and investors. Ithelps in mobilization of savings to materialize investment ideas into realities. It helps to increasethe output towards the existing production frontier. The growth of the banking habit helps toactivate saving and undertake fresh saving. The financial system encourages investment activityby reducing the cost of finance risk. It helps to make investment decisions regarding projects bysponsoring, encouraging, export project appraisal, feasibility studies, monitoring & execution ofthe projects.A financial system performs the following functions: 1. It serves as a link between savers and investors. It helps in utilizing the mobilized savings of scattered savers in more efficient and effective manner. It channelizes flow of saving into productive investment. 2. It assists in the selection of the projects to be financed and also reviews the performance of such projects periodically. 3. It provides payment mechanism for exchange of goods and services. 4. It provides a mechanism for the transfer of resources across geographic boundaries. 5. It provides a mechanism for managing and controlling the risk involved in mobilizing savings and allocating credit. 6. It promotes the process of capital formation by bringing together the supply of saving and the demand for investible funds. 7. It helps in lowering the cost of transaction and increase returns. Reduce cost motives people to save more. 8. It provides you detailed information to the operators/ players in the market such as individuals, business houses, Governments etc.INDIAN FINANCIAL SYSTEM FROM 1950 TO 1980Indian Financial System During this period evolved in response to the objective of plannedeconomic development. With the adoption of mixed economy as a pattern of industrial - 21 -
  • 22. development, a complimentary role was conceived for public and private sector. There was aneed to align financial system with government economic policies. At that time there wasgovernment control over distribution of credit and finance. The main elements of financialorganization in planned economic development are as follows:-1. Public ownership of financial institutionsThe nationalization of RBI was in 1948, SBI was set up in 1956, LIC came in to existence in1956 by merging 245 life insurance companies in 1969, 14 major private banks were broughtunder the direct control of Government of India. In 1972, GIC was set up and in 1980; six morecommercial banks were brought under public ownership. Some institutions were also set upduring this period like development banks, term lending institutions, UTI was set up in publicsector in 1964, provident fund, pension fund was set up. In this way public sector occupiedcommanding position in Indian Financial System.2. Fortification of institutional structureFinancial institutions should stimulate / encourage capital formation in the economy. Theimportant feature of well developed financial system is strengthening of institutional structures.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, Industrialcredit and Investment corporation of India Ltd (ICICI)was set up in 1955. It was pioneer in manyrespects like underwriting of issue of capital, channelization of foreign currency loans fromWorld Bank to private industry. In 1964, Industrial Development of India (IDBI).3. Protection of investorLot 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 ContractRegulation Act, 1956 ; Monopolies and Restrictive Trade Practices Act, 1970 ; ForeignExchange Regulation Act, 1973 ; Securities & Exchange Board of India, 1988.4. Participation in corporate management - 22 -
  • 23. As participation were made by large companies and financial instruments it leads toaccumulation of voting power in hands of institutional investors in several big companiesfinancial instruments particularly LIC and UTI were able to put considerable pressure onmanagement by virtual of their voting power. The Indian Financial System between 1951 andmid80‟s was broad based number of institutions came up. The system was characterized bydiversifying organizations which used to perform number of functions. The Financial structurewith considerable strength and capability of supplying industrial capital to various enterpriseswas gradually built up the whole financial system came under the ownership and control ofpublic authorities in this manner public sector occupy a commanding position in the industrialenterprises. Such control was viewed as integral part of the strategy of planned economydevelopment.INDIAN FINANCIAL SYSTEM POST 1990’SThe organizations of Indian Financial system witnessed transformation after launching of neweconomic policy 1991. The development process shifted from controlled economy to free marketfor these changes was made in the economic policy. The role of government in business wasreduced the measure trust of the government should be on development of infrastructure, publicwelfare and equity. The capital market an important role in allocation of resources. The majordevelopment during this phase is:-1. Privatization of financial institutionsAt this time many institutions were converted in to public company and numbers of privateplayers were allowed to enter in to various sectors: a) Industrial Finance Corporation of India (IFCI): The pioneer development finance institution was converted in to a public company. b) Industrial Development Bank of India & Industrial Finance Corporation of India (IDBI & IFCI): IDBI & IFCI ltd offers their equity capital to private investors. c) Private Mutual Funds have been set up under the guidelines prescribed by SEBI. d) Number of private banks and foreign banks came up under the RBI guidelines. Private institution companies emerged and work under the guidelines of IRDA, 1999. - 23 -
  • 24. e) In this manner government monopoly over financial institutions 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.2. Reorganization of institutional structureThe importance of development financial institutions decline with shift to capital market forraising 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 usedto be 25% is at present 5%. Permission was also given to banks to directly undertake leasing,hire-purchase and factoring business. There was trust on development of primary market,secondary market and money market.3. Investor protectionSEBI is given power to regulate financial markets and the various intermediaries in the financialmarkets.REGULATORY FINANCIAL INSTITUTIONSRegulatory institutions to be ensured that firms provide the goods and services promised and thattheir behaviors, in general, conform to established standards In the county and or abroad.These functions of the institutions are however not always neatly declined in practice. Forexample, regulatory institutions may perform facilitator and / or promotional service to mitigateany unintended negative consequences that their main activities may have for development of thefirms.Financial intermediaries are heavily regulated in comparison to non-financial firms. Financialintermediaries are subject to rules and regulations governing their business. They are also subjectto supervision and monitoring to ensure that rules and regulation are followed.Following are the regulatory authorities which governs the working of financial intermediaries. 1. Securities and exchange board of India(SEBI) 2. The reserve bank of India(RBI) 3. Insurance regulatory and development authority(IRDA) - 24 -
  • 25. SECURITIES AND EXCHANGE BOARD OF INDIA [SEBI]Securities and Exchange Board of India (SEBI) was first established in the year 1988 as a non-statutory body for regulating the securities market. It became an autonomous body in 1992 andmore powers were given through an ordinance. Since then it regulates the market through itsindependent powers.  Established in the year 1988 and became an autonomous body in 1992  Basic Functions “…..to protect the interests of investors in securities and to promote the development of,and to regulate the securities market and for matters connected therewith or incidental thereto”THE BACKGROUND OF SEBISecurities and Exchange Board of India, popularly called SEBI, is a quasi government bodythat was initially formed in 1988 by an administrative order. The Indian capital market hadstarted developing very fast during the 1980s. The amount of capital raised by companies fromthe primary market increased from a modest 200 crores in 1980 to a substantial 6500 crores in1990. This implied a great exposure of public money, which also attracted a number of fly-by-night operators. This necessitated a watchdog that could safeguard the interests of investors.SEBI was provided a statutory status in the immediate aftermath of infamous securities scamperpetrated by Harshad Mehta. The scam shook up the foundations of the Indian financialframework. The stock market, which was making a frenzied climb upwards, collapsed on itsface. Thousands of crores of market equity was destroyed overnight and a number of financialinstitutions and banks were forced to shut shop. That a single individual could twist and tweakthe system, with all is apparent loopholes, for earning tremendous profits became painfullyapparent to everyone.A number of financial institutions and other market players were left high and dry after the scam,but the biggest loser turned out to be the common investor. The economy had just startedopening up after the 1991 economic reforms, and the India market was just taking its first - 25 -
  • 26. tottering steps. At this stage, such a huge scam would not only have damaged the market, butwould have severely damaged investor confidence. In time, investors could have lost trust in thesystem, thus adversely affecting the ability of companies to raise money in stock market. This, inturn, would have severely restricted industrial growth at a time when the economy had startedimproving.The Securities and Exchange Board of India Act was passed in 1992, thus giving the regulatoryteeth to the body. SEBI was entrusted with the primary task of protecting the interests of theinvestors. In addition, SEBI was also entrusted with the twin objectives of developing andregulating the stock market. In this regard, SEBI has done a decent job, though admittedly, therehave been instances when the regulator has been caught napping! But overall, the lot of investorshas definitely improved due to the policies and steps taken by the regulator.OFFICES AND ADMINISTRATIONSEBU has its head office located at Mumbai, the financial capital of India. In addition, SEBI hasfour regional offices, located at New Delhi, Chennai, Kolkata and Ahmedabad. The regionaloffices have jurisdiction over the companies and institutions located on their designated areas.To manage its affairs, SEBI has a five member board, headed by a chairperson. Out of the fivemembers, one member each is taken from the Law and Finance ministries, one member is fromRBI, and the remaining two members can be eminent members of the industry.ENTITY OF SEBIIt was registered with the common seal and with the power to acquire, hold and dispose anypropertyPower to sue or to be sued in its own nameThe Head office is situated in Mumbai; in addition the regional offices were established in thefollowing metropolitan cities viz Kolkata, Chennai and Delhi, to monitor and control the capitalmarket operations across the country - 26 -
  • 27. ROLE OF SEBISEBI has been entrusted with a wide ranging role to develop and regulate the financial markets.The primary task of SEBI is to regulate the affairs of the stock markets. In this respect, SEBI hasintroduced a number of notable reforms such as dematerialization of shares, online share trading,approval for stock indices trading, derivatives trading. This has made the market broad based andeasily approachable by everyone. Over the years, SEBI has also evolved and enforced a code ofconduct for the banks, financial institutions, companies, mutual funds financialintermediaries/brokers and portfolio managers. In addition, SEBI deals with following activitiesrelated to financial markets - 1. Primary market issues 2. Secondary market issues 3. Mutual Funds 4. Takeovers and mergers & acquisition 5. Collective investment schemes 6. Share buy backs 7. Delisting of shares from Stock exchangesSEBI is also entrusted with handling investor grievances and complaints related to any of theabovementioned activities. SEBI also undertakes periodical investor education initiatives,workshops and seminars to raise investment and financial awareness.ORGANIZATIONAL GRID OF THE SEBI 1. Six members in the committee 2. Headed by the chairman 3. One member each from the ministries of Law and Finance 4. One member from the officials of Reserve Bank of India 5. Two nominees from the central government 6. It contains 4 different department viz primary department, issue management and intermediaries department, secondary department and institutional investment department. - 27 -
  • 28. SEBI in Indias capital market:SEBI from time to time have adopted many rules and regulations for enhancing the Indiancapital market. The recent initiatives undertaken are as follows:Under this rule every brokers and sub brokers have to get registration with SEBI and any stockexchange in India.  For Underwriters: For working as an underwriter an asset limit of 20 lakhs has been fixed.  For Share Prices According to this law all Indian companies are free to determine their respective share prices and premiums on the share prices.  For Mutual Funds SEBIs introduction of SEBI (Mutual Funds) Regulation in 1993 is to have direct control on all mutual funds of both public and private sector.FUNCTIONS OF SEBI (A) REGULATORY :  Regulating the business in stock exchange any other securities market;  Registering and regulating the working of stock brokers, sub-brokers, share transfer agents, bankers to an issue, trustees of trust deeds, registrar to an issue, merchant bankers, underwriters and so on;  Registering and regulating the working of collective investment scheme including mutual funds;  Regulating the self- regulatory organizations;  Prohibiting fraudulent and unfair trade practices relating to securities markets;  Prohibiting inside trading in securities;  Regulating substantial acquisition of shares and takeover of companies; - 28 -
  • 29.  Calling for formation from undertaking inspection, conducting inquiries and audits of the stock exchange and intermediaries and self-regulatory organizations in the security market;  Levying fees or other charges for carrying out the purpose of this section. (B) DEVELOPMENTAL :  Promoting investors‟ education;  Promoting self- regulating organizations;  Training of intermediaries of security markets;  Promotion of fair practices and code of conduct for all SROs;  Conducting research and publishing information useful to all market participants.OBJECTIVES OF SEBI  To protect the interests of investors in securities  To promote the development of Securities Market  To regulate the securities market  For matters connected therewith or incidental theretoPOWERS OF SEBIThe important powers of SEBI (Securities and Exchange Board of India) are:-1. Powers relating to stock exchanges & intermediaries SEBI has wide powers regarding thestock exchanges and intermediaries dealing in securities. It can ask information from the stockexchanges and intermediaries regarding their business transactions for inspection or scrutiny andother purpose2. Power to impose monetary penalties SEBI has been empowered to impose monetarypenalties on capital market intermediaries and other participants for a range of violations. It caneven impose suspension of their registration for a short period. - 29 -
  • 30. 3. Power to initiate actions in functions assigned SEBI has a power to initiate actions in regardto functions assigned. For example, it can issue guidelines to different intermediaries or canintroduce specific rules for the protection of interests of investors.4. Power to regulate insider trading SEBI has power to regulate insider trading or can regulatethe functions of merchant bankers.5. Powers under Securities Contracts Act For effective regulation of stock exchange, theMinistry of Finance issued a Notification on 13 September, 1994 delegating several of its powersunder the Securities Contracts (Regulations) Act to SEBI.SEBI is also empowered by the Finance Ministry to nominate three members on the GoverningBody of every stock exchange.6. Power to regulate business of stock exchanges SEBI is also empowered to regulate thebusiness of stock exchanges, intermediaries associated with the securities market as well asmutual funds, fraudulent and unfair trade practices relating to securities and regulation ofacquisition of shares and takeovers of companies. - 30 -
  • 31. RESERVE BANK OF INDIA [RBI]The reserve bank of India is the central bank of country. It has been established by legislation in1934 as body corporate under the Reserve Bank of India Act 1934. It has started functioningfrom 1st April, 1935. The Reserve Bank was started as shareholder bank with a paid-up capital ofRs 5 crores. Though originally privately owned, since nationalization in 1949, it is fully ownedby Government of India.  Established on 1st April 1935  Apex financial institution of the country‟s financial system  Entrusted with the task of control, supervision, promotion, development and planningThe reserve bank of India carries on itsoperations according to provisions of thereserve bank of India act, 1934. The act hasbeen amended from time to time.STRUCTURE OF RBIThe organization of RBI can be divided intothree parts:1) Central Board of Directors.2) Local Boards3) Offices of RBI1. Central Board of Directors:The organization and management of RBI is vested on the Central Board of Directors. It isresponsible for the management of RBI. Central Board of Directors consists of 20 members. - 31 -
  • 32. Central board is appointed by the central Government for the period of 4 years. It consists ofofficial directors and non-official directors.It is constituted as follows.  One Governor: It is the highest authority of RBI. He is appointed by the Government of India for a term of 5 years. He can be re-appointed for another term.  Four Deputy Governors: Four deputy Governors are nominated by Central Govt. for a term of 5 years  Fifteen Directors: Other fifteen members of the Central Board are appointed by the Central Government. Out of these, four directors, one each from the four local Boards is nominated by the Government separately by the Central Government.Ten directors nominated by the Central Government are among the experts of commerce,industries, finance, economics and cooperation. The finance secretary of the Government ofIndia is also nominated as Govt. officer in the board. Ten directors are nominated for a period of4 years. The Governor acts as the Chief Executive officer and Chairman of the Central Board ofDirectors. In his absence a deputy Governor nominated by the Governor, acts as the Chairman ofthe Central Board. The deputy governors and government‟s officer nominee are not entitled tovote at the meetings of the Board. The Governor and four deputy Governors are full time officersof the Bank.2. Local Boards:There are 4 local boards, one each for the 4 regions of the country in Mumbai, Kolkata, Chennai,and New Delhi. The membership of each local board consists of 5 members appointed by thecentral Government for the period of 4 years. The functions of the local board is to advise thecentral board on local matters; to represent territorial and economic interns of local cooperativeand indigenous banks‟ interest, and to perform such other functions as delegated by central boardfrom time to time3. Offices of RBI:The Head office of the bank is situated in Mumbai and the offices of local boards are situated inDelhi, Kolkata and Chennai. In order to maintain the smooth working of banking system, RBIhas opened local offices or branches in Ahmedabad, Bangalore, Bhopal, Bhubaneswar,Chandigarh, Guwahati, Hyderabad, Jaipur, Jammu, Kanpur, Nagpur, Patna, Thiruvananthpuram,Kochi, Lucknow and Byculla (Mumbai). The RBI can open its offices with the permission of the - 32 -
  • 33. Government of India. In places where there are no offices of the bank, it is represented by thestate Bank of India and its associate banks as the agents of RBI.OBJECTIVES OF THE RBI  To Regulate the issue of Bank notes  Keeping of reserves with a view to securing monetary stability in India  To Operate the currency and credit system of the country for its advantage  To secure monitory stability within country  To Assist the planned process of development of the Indian economyFEATURE OF RBI 1. RBI formulates implements and monitors the monetary policy 2. RBI maintains public confidence in the system, protect depositors interest and provide cost-effective banking services to public 3. To facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India. 4. To give the public adequate quantity of supplies of currency notes and coins and good quality.FUNCTIONS OF THE RBI  Issuing currency notes, i.e. to act as a currency or monitory authority of the country  Maintaining price stability  Ensuring adequate flow of credit to productive sectors to assist growth  Serving as banker to the Government  Acting as bankers‟ bank and supervisor  Monetary regulation and management  Exchange management and control - 33 -
  • 34.  Collection of data and their publication Miscellaneous developmental and promotional functions and activities Agricultural Finance Industrial Finance Export Finance Institutional promotion - 34 -
  • 35. INSURANCE REGULATORY AND DEVELOPMENT AUTHORITY (IRDA)MISSION To protect the interest of and secure fair treatment to policyholders; To bring about speedy and orderly growth of the insurance industry (including annuity and superannuation payments), for the benefit of the common man, and to provide long term funds for accelerating growth of the economy; To set, promote, monitor and enforce high standards of integrity, financial soundness, fair dealing and competence of those it regulates; To ensure speedy settlement of genuine claims, to prevent insurance frauds and other malpractices and put in place effective grievance redressal machinery; To promote fairness, transparency and orderly conduct in financial markets dealing with insurance and build a reliable management information system to enforce high standards of financial soundness amongst market players; To take action where such standards are inadequate or ineffectively enforced; To bring about optimum amount of self-regulation in day-to-day working of the industry consistent with the requirements of prudential regulation.VISIONOur goal is to have the IRDA recognized nationally by 2016 as a leader in agro-environmentalresearch, development and transfer activities. The IRDA distinguishes itself by its integrativeapproach and by the dynamism of its partners. These factors allow it to anticipate problems anddevelop innovative solutions that meet the needs of agricultural producers and society.The Insurance Regulatory and Development Authority (IRDA) is a national agency ofthe Government of India, based in Hyderabad. It was formed by an act of Indian Parliamentknown as IRDA Act 1999, which was amended in 2002 to incorporate some emergingrequirements. Mission of IRDA as stated in the act is "to protect the interests of thepolicyholders, to regulate, promote and ensure orderly growth of the insurance industry and formatters connected therewith or incidental thereto." - 35 -
  • 36. In 2010, the Government of India ruled that the Unit Linked Insurance Plans (ULIPs) will begoverned by IRDA, and not the market regulator Securities and Exchange Board of IndiaROLE OF IRDA1. To (protect) the interest of and secure fair treatment to policyholders.2. To bring about (speedy) and orderly growth of the insurance industry (including annuity andsuperannuation payments), for the benefit of the common man, and to provide long term fundsfor accelerating growth of the economy.3. To set, promote, monitor and enforce high standards of (integrity), financial soundness, fairdealing and competence of those it regulates.4. To ensure that insurance customers receive precise, clear and correct (information) aboutproducts and services and make them aware of their responsibilities and duties in this regard.5. To ensure speedy settlement of genuine (claims), to prevent insurance frauds and othermalpractices and put in place effective grievance redressed machinery.6. To promote fairness, (transparency) and orderly conduct in financial markets dealing withinsurance and build a reliable management information system to enforce high standards offinancial soundness amongst market players.7. To take (action) where such standards are inadequate or ineffectively enforce d. 8. To bringabout optimum amount of (self-regulation)in day to day working of the industry consistent withthe requirements of prudential regulation.DUTIES/POWER/FUNCTIONS OF IRDASection 14 of IRDA Act, 1999 lays down the duties, powers and functions of IRDA(1) Subject to the provisions of this Act and any other law for the time being in force, theAuthority shall have the duty to regulate, promote and ensure orderly growth of the insurancebusiness and re-insurance business. - 36 -
  • 37. (2) Without prejudice to the generality of the provisions contained in sub-section (1)the powersand functions of the Authority shall include, a. Issue to the applicant a certificate of registration, renew, modify, withdraw, suspend or cancel such registration; b. protection of the interests of the policy holders in matters concerning assigning of policy, nomination by policy holders, insurable interest, settlement of insurance claim, surrender value of policy and other terms and conditions of contracts of insurance; c. Specifying requisite qualifications, code of conduct and practical training for intermediary or insurance intermediaries and agents; d. Specifying the code of conduct for surveyors and loss assessors; e. Promoting efficiency in the conduct of insurance business; f. Promoting and regulating professional organizations connected with the insurance and re-insurance business; g. Levying fees and other charges for carrying out the purposes of this Act h. calling for information from, undertaking inspection of, conducting enquiries and investigations including audit of the insurers, intermediaries, insurance intermediaries and other organizations connected with the insurance business; i. control and regulation of the rates, advantages, terms and conditions that may be offered by insurers in respect of general insurance business not so controlled and regulated by the Tariff Advisory Committee under section 64U of the Insurance Act, 1938 (4 of 1938); j. Specifying the form and manner in which books of account shall be maintained and statement of accounts shall be rendered by insurers and other insurance intermediaries; k. Regulating investment of funds by insurance companies; l. Regulating maintenance of margin of solvency; m. Adjudication of disputes between insurers and intermediaries or insurance in term diaries; n. Supervising the functioning of the Tariff Advisory Committee; - 37 -
  • 38. o. Specifying the percentage of premium income of the insurer to finance scheme s for promoting and regulating professional organizations referred to in clause (f); p. Specifying the percentage of life insurance business and general insurance business to be undertaken by the insurer in the rural or social sector; and q. Exercising such other powers as may be prescribedINSURANCE ADVISORY COMMITTEEIRDA consists of a Chairman and four full time and four part time members. IRDA hasconstituted the Insurance Advisory Committee and in consultation with this committee hasbrought out 17 regulations. In addition, representatives of consumes, industry, insurance agents,women‟s originations, and other interest groups are a part of this committee. It has also formeda Consumer Advisory Committee and Surveyor and Loss Assessors Committee. It has a panelof eligible chartered accountants to carry out investigation, inspection and so onChairman: HariNarayana is the current Chairman of IRDA.The IRDA has issued 17 regulations in the areas of registration of insurers, their conduct ofbusiness, solvency margins, and conduct if reinsurance business, licensing, and code of conductintermediaries. It follows the practice of prior consultation and discussion with the variousinterest groups before issuing regulations and guidelines.CHAIRMAN SELECTION PROCESSGovernment of India has circulated to broad base IRDA chairman selection process. It is felt inthe market that placing of retired civil servants as IRDA Chairman has served the purpose ofadministrative fiefdom of the regulator. Mostly, the regulator has become passive to marketrealities and most of the original public policy intentions have been systematically replaced bypersonal preferences. There seems to be no oversight of public policy erosions. Takingadvantage of the completion of term of current incumbent, there seem to be an attempt tocorrect the future course but people do not perceive any outcome to result as the market doesnot seem to throw up candidates of the stature of Howard Davies for Indian market. But a rightleadership is the solution to the requirement of this booming market. - 38 -
  • 39. IRDA REGULATES PRIVATE INSURANCE COMPANIES IN INDIA SUCH AS; 1. Royal Sundaram Alliance Insurance Company Limited 2. Reliance General Insurance Company Limited. 3. IFFCO Tokio General Insurance Co. Ltd 4. TATA AIG General Insurance Company Ltd. 5. Bajaj Allianz General Insurance Company Limited 6. ICICI Lombard General Insurance Company Limited. 7. Apollo DKV Insurance Company Limited 8. Future Generali India Insurance Company Limited 9. Universal Sompo General Insurance Company Ltd. 10. Cholamandalam General Insurance Company Ltd. 11. Export Credit Guarantee Corporation Ltd. 12. HDFC-Chubb General Insurance Co. Ltd. 13. Bharti Axa General Insurance Company Ltd. 14. Raheja QBE General Insurance Co. Ltd 15. Shriram General Insurance Co. Ltd. - 39 -
  • 40. Money marketTOPICS:- Introduction of money market. Functions of money market. Money market instruments.  Treasury bill  Call notice money market  Commercial paper  Certificates of deposits  Commercial bills Collateralised borrowing and lending obligation. Call/notice money market. Money market intermediaries. Money market mutual fund. Link between the money market and the monetary policy in India. Tool for managing liquidity in the money market. Money market derivatives. Introduction of capital market. Functions of capital market. Primary capital and secondary capital market. Brief history of the rise of equity trading in India. Reforms in capital market. - 40 -
  • 41. THE MONEY MARKETINTRODUCTION:-The money market is a market for financial assets that are close substitutes formoney. It is the market for over night to short term funds and instruments having amaturity period of one or less than one year. It is not a physical auction (like thestock market) but an activity that is conducted over the telephone. The moneymarket constitutes a very important segment of the Indian financial system.The features of the money market are as follows. It is not a single market but a collection of markets for several instruments. It is a wholesale market of a short-term debt instrument Its principal features are honour where the creditworthiness of participant is important. The main players are: the reserve bank of India (RBI), the discount and finance house of India (DFHI), mutual funds, banks, co-operative investors, non-banking financial companies(NBFCs), state governments, provident funds, primary dealers, the security trading corporation of India(STCI) public sector undertakings (PSUs) and non residential Indians. It is need based market wherein the demand and supply of money shape the market.Functions of money market A money market is generally expected to perform broad functions. Provide a balancing mechanism to even out the demand for and supply of short term funds. Provide a focal point for central bank intervention for influencing liquidity and general level of interest rates in the economy. Provide reasonable access to suppliers and users of short term funds to fulfil their borrowings and investment requirements at an efficient market clearing price. Besides the above functions a well functioning money market facilitates the development of a market for long term securities. The interest rates for extremely short-term use of money serve as a benchmark for longer-term financial instruments. - 41 -
  • 42. Benefits of an efficient money market An efficient money market benefits a number of players. It provides a stable source of funds to banks in addition to deposits, allowing alternatives financing structures and completion. It allows banks to manage risks arising from interest rate fluctuations and to manage the maturity structure of their assets and liability. A liquidity market provides an effective source of long-term finance to borrowers. Large borrowers can lower the cost of raising funds and manage short term funding or surplus efficiency. A liquid and vibrant money market is necessary for the development of a capital market, foreign exchange market, and markets in derivatives instruments. The money market supports the long-term debt market by increasing the liquidity of the securities.The Indian money marketThe average turn over of the money market in India is over 40,000crore rupeesdaily. This is more than three percent let out of the system. This implies that 2% ofthe annual GDP of India gets traded in the money market in just one day. Eventhough, the money market is many times larger than the capital market.Reforms in the money market: - 42 -
  • 43. New instruments New participants Changes in the operating procedure of monitoring policy. Fine tuning of liquidity operations managements. Technological infrastructure.The money market centres:There are market centres in India at Mumbai, Delhi, and Kolkata. Mumbai is theonly active money market centre in India with money flowing I from all parts ofthe country getting transacted there. - 43 -
  • 44. MONEY MARKET INSTRUMENTSThe instruments traded in the Indian money marketare: Treasury bills(T-bills) Call/notice money market-call (over night) and short notice (upto14 days) Commercial papers(CPs) Certificate of deposits(CDs) Commercial bills(CBs) Collateral borrowings and lending obligation (CBLO). - 44 -
  • 45. TREASURY BILLSINTRODUCTION:-Treasury Bills are short term money market instruments to finance the short termrequirements of the Government of India. These are discounted securities and thusare issued at a discount to face value. The return to the investor is the differencebetween the maturity value and issue price. This instruments is used by thegovernment it raise short-term funds to bridge seasonal or temporary gaps betweenits receipts (revenue and capital) and expenditure.FEATURES:- They are negotiable securities. They are highly liquid as they are of shorter tenure and there is a possibility of inter-bank repos in them. There is an absence of default risk. They are not issued in the scrip form. The purchase and sales are affected through the subsidiary general ledger (SGL) account. At present there are 91 days, 182 days, and 364 day. 91 days T-bills are auctioned by RBI every Friday and the 364-day T-bill every alternative Wednesday i.e. the Wednesday preceding the reporting Friday. T-bills are available for minimum amount of 25,000 and in multiplies thereof.TYPES OF TREASURY BILLS:-ON TAP BILLS:On tap bills as the name suggest caught be bought from the reserve bank at anytime at any interest yield of4.66%. They were discounted from April 1,1997, asthey had lost much of their relevance. - 45 -
  • 46. AD HOC BILLS:Ad hoc bills were introduced in 1955. It was decided between the government andRBI that the government could maintain cash of 50 crore with the reserve bank onFriday and 4 crore of other days free of obligations to pay interest thereon andwhen ever the balance fell below the minimum the government account would bereplenished by the ad hoc bill in favour of RBI.AUCTIONED T-bills:Auctioned T-bill the most active money market instrument, were first introduced inapril1992. The reserve bank receives bids in an auction from various participantsand issues the bills subject to some cut off limits.BENEFITS OF INVESTMENT IN TREASURY BILLS No tax deducted at source Zero default risk being sovereign paper Highly liquid money market instrument Better returns especially in the short term Transparency Simplified settlement High degree of tradability and active secondary market facilitates meeting unplanned fund requirements. - 46 -
  • 47. PARTICIPANTS IN TRESURY BILLSThe reserve bank of India, banks, mutual funds, financial institutions, primarydealers, provident funds, foreign banks, foreign institutional investor.TYPES OF AUCTIONSThere are two types of auction for treasury bills: Multiple Price Based or French Auction: Under this method, all bids equal to or above the cut-off price are accepted. However, the bidder has to obtain the treasury bills at the price quoted by him. This method is followed in the case of 364days treasury bills and is valid only for competitive bidders. Uniform Price Based or Dutch auction: Under this system, all the bids equal to or above the cut-off price are accepted at the cut- off level. However, unlike the Multiple Price based method, the bidder obtains the treasury bills at the cut-off price and not the price quoted by him. This method is applicable in the case of 91 days treasury bills only. - 47 -
  • 48. COMMERCIAL PAPERSINTRODUCTION:-Commercial paper, or CP as it is popularly known, is in the nature of an unsecuredshort term promissory note, transferable by endorsement and delivery. It is of fixedmaturity.Corporate, primary dealers (PDs) and the all-India financial institutions (FIs) thathave been permitted to raise short-term resources under the umbrella limit fixed byReserve Bank of India are eligible to issue CP. The following are the eligibilitycriteria, as per the extant guidelines:1] The company should have a minimumtangible net worth of Rs. 40mn, as per the latest audited balancesheet.2] Thecompany should have been sanctioned working capital limits by banks/FIs andshould be classified as a Standard Asset by the financing bank(s) / FIs.3] Thecompany should have minimum credit rating from an agency approved by RBIProcess for issuing CPOnce a company decides to issue CP for a specific amount, a resolution is requiredto be passed by the Board of Directors approving the issue and authorising theofficial(s) to execute the relevant documents, as per RBI norms. The CP issue isrequired to be rated by an approved credit rating agency .The company selects theIssuing and Paying Agent, which has to be a scheduled bank. The issuer shoulddisclose to its potential investors its financial position. The company may alsoarrange for dealers for placement of CPs. The issue has to be completed within twoweeks of opening. CP may be issued on a single date or in parts on different datesprovided that in the latter case, each CP shall have the same maturity date. - 48 -
  • 49. COMMERCIAL BILLSINTRODUCTION:-The working capital requirement of business firms is provided by banks throughcash-credits / overdraft and purchase/discounting of commercial bills.Commercial bill is a short term, negotiable, and self-liquidating instrument withlow risk. It enhances liability to make payment in a fixed date when goods arebought on credit. According to the Indian Negotiable Instruments Act, 1881, bill orexchange is a written instrument containing an unconditional order, signed by themaker, directing to pay a certain amount of money only to a particular person, or tothe bearer of the instrument. Bills of exchange are negotiable instruments drawn bythe seller (drawer) on the buyer (drawee) or the value of the goods delivered tohim. Such bills are called trade bills. When trade bills are accepted by commercialbanks, they are called commercial bills. The bank discounts this bill by keeping acertain margin and credits the proceeds. Banks, when in need of money, can alsoget such bills rediscounted by financial institutions such as LIC, UTI, GIC, ICICIand IRBI. The maturity period of the bills varies from 30 days, 60 days or 90 days,depending on the credit extended in the industry. - 49 -
  • 50. Types of Commercial Bills: Commercial bill is an important tool finance credit sales. It may be a demand bill or a usance bill. A demand bill is payable on demand, that is immediately at sight or on presentation by the drawee. A usance bill is payable after a specified time. If the seller wishes to give sometime for payment, the bill would be payable at a future date. These bills can either be clean bills or documentary bills. In a clean bill, documents are enclosed and delivered against acceptance by drawee, after which it becomes clear. In the case of a documentary bill, documents are delivered against payment accepted by the drawee and documents of bill are filed by bankers till the bill is paid. Commercial bills can be inland bills or foreign bills. Inland bills must (1) be drawn or made in India and must be payable in India: or (2) drawn upon any person resident in India. Foreign bills, on the other hand, are (1) drawn outside India and may be payable and by a party outside India, or may be payable in India or drawn on a party in India or (2) it may be drawn in India and made payable outside India. A related classification of bills is export bills and import bills. While export bills are drawn by exporters in any country outside India, import bills are drawn on importers in India by exporters abroad. The indigenous variety of bill of exchange for financing the movement of agricultural produce, called a „hundi‟ has a long tradition of use in India. It is vogue among indigenous bankers for raising money or remitting funds or to finance inland trade. A hundi is an important instrument in India; so indigenous bankers dominate the bill market. However, with reforms in the financial system and lack of availability of funds from private sources, the role of indigenous bankers is declining. With a view to eliminating movement of papers and facilitating multiple rediscounting, RBI introduced an innovation instruments known as „Derivative Usance Promissory Notes,‟ backed by such eligible commercial bills for required amounts and usance period (up to 90 days). Government has exempted stamp duty on derivative usance promissory notes. This has simplified and streamlined bill rediscounting by institutions and made the commercial bill an active instrument in the secondary money market. This instrument, being a negotiable instrument issued by banks, is a sound - 50 -
  • 51. investment for rediscounting institutions. Moreover rediscountinginstitutions can further discount the bills anytime prior to the date ofmaturity. Since some banks were using the facility of rediscountingcommercial bills and derivative usance promissory notes of as short a periodas one day, the Reserve Bank restricted such rediscounting to a minimumperiod of 15 days. The eligibility criteria prescribed by the Reserve Bank forrediscounting commercial bills are that the bill should arise out of a genuinecommercial transaction showing evidence of sale of goods and the maturitydate of the bill should to exceed 90 days from the date of rediscounting. - 51 -
  • 52. Features of Commercial Bills Commercial bills can be traded by offering the bills for rediscounting. Banks provide credit to their customers by discounting commercial bills. This credit is repayable on maturity of the bill. In case of need for funds, and can rediscount the bills in the money market and get ready money. Commercial bills ensure improved quality of lending, liquidity and efficiency in money management. It is fully secured for investment since it is transferable by endorsement and delivery and it has high degree of liquidity. The bills market is highly developed in industrial countries but it is very limited in India. Commercial bills rediscounted by commercial banks with financial institutions amount to less than Rs 1,000 crore. In India, the bill market did not develop due to (1) the cash credit system of credit delivery where the onus of cash management rest with banks and (2) an absence of an active secondary market.Measures to Develop the Bills Market: One of the objectives of the Reserve Bank in setting up the Discount and finance House of India was to develop commercial bills market. The bank sanctioned a refinance limit for the DFHI against collateral of treasury bills and against the holdings of eligible commercial bills. With a view to developing the bills market, the interest rate ceiling of 12.5 per cent on rediscounting of commercial bills was withdrawn from May 1, 1989. To develop the bills market, the Securities and Exchange Board of India (SEBI) allowed, in 1995-96, 14 mutual funds to participate as lenders in the bills rediscounting market. During 1996-97, seven more mutual funds were permitted to participate in this market as lenders while another four primary dealers were allowed to participate as both lenders and borrowers. - 52 -
  • 53. In order to encourage the „bills‟ culture, the Reserve Bank advised banks in October 1997 to ensure that at least 25 percent of inland credit purchases of borrowers be through bills.Size of the Commercial Bills market: The size of the commercial market is reflected in the outstanding amount of commercial bills discounted by banks with various financial institutions. The share of bill finance in the total bank credit increased from 1993-94 to 1995-96 but declined subsequently. This reflects the underdevelopment state of the bills market. The reasons for the underdevelopment are as follows: The Reserve Bank made an attempt to promote the development of the bill market by rediscounting facilities with it self till 1974. Then, in the beginning of the 1980s, the availability of funds from the Reserve Bank under the bill rediscounting scheme was put on a discretionary basis. It was altogether stopped in 1981. The popularity of the bill of exchange as a credit instrument depends upon the availability of acceptance sources of the central bank as it is the ultimate source of cash in times of a shortage of funds. However, it is not so in India. The Reserve Bank set up the DFHI to deal in this instrument and extends refinance facility to it. Even then, the business in commercial bills has declined drastically as DFHI concentrates more on other money market instruments such as call money and treasury bills. It is mostly foreign trade that is financed through the bills market. The size of this market is small because the share of foreign trade in national income is small. Moreover, export and import bills are still drawn in foreign currency which has restricted their scope of negotiation. A large part of the bills discounted by banks are not genuine. They are bills created by converting the cash-credit/overdraft accounts of their customers. - 53 -
  • 54. The system of cash-credit and overdraft from banks is cheaper and moreconvenient than bill financing as the procedures for discounting andrediscounting are complex and time consuming.This market was highly misused in the early 1990s by banks and financecompanies which refinanced it at times when it could to be refinanced. Thisled to channelling of money into undesirable use - 54 -
  • 55. CERTIFICATE OF DEPOSITEINTRODUCTION:-Certificates of deposit are unsecured, negotiable, short term instrument in bearerform, issued by commercial banks and development financial institutes.Certificates of deposits were introduced in 1989. Only scheduled commercialbanks excluding regional rural banks and local area banks were allowed to issuethem initially. Financial institutions were permitted to issue certificates of depositwithin the umbrella limit fixed by the reserve bank in 1992.GUIDELINES FOR ISSUE OF CERTIFICATE OF DEPOSITEEligibility:-CDs can be issued by scheduled commercial banks and excluding regional ruralbanks. Local area banks (2) and select all India financial institution that have beenpermitted by RBI.Aggregate amount:-Should not exceed 100% of its net owned funds.Minimum size of issue and denomination:-Minimum amount of CDs should be 1 lacks i.e. the minimum deposit that can beaccepted from a single subscriber should not be less than 1 lacks.Who can subscribe:-CDs can be issued to entities like individuals, corporations, companies, trusts,funds, and association. - 55 -
  • 56. Maturity:-Not less than 7 days and not more than 1 year. and not exceeding 3 years from thedate of issue. - 56 -
  • 57. COMPARISION OF CERTIFICATE OF DEPOSITE AND COMMERCIAL PAPERSCDs and commercial papers are both forms of money market instruments and areissued in the money markets by organizations that wish to raise funds, and aretraded by investors who wish to profit from the interest rate fluctuations.However, there are many differences between these two forms of instruments,since CDs commercial papersCDs are issued as a proof of an Commercial papers are issued to aninvestment of funds in the bank by a investor as a proof of purchase of thedepositor while issuer‟s debt (purchasing debt means providing funds like a bank gives out a loan).While a CD is usually for a longer term. A promissory note is for a shorter periodThe issuance of a CD, owing to this The issuance of commercial papersdifference in maturity, entails higher entails lower responsibility of theresponsibility on the issuer‟s part issuer‟s part. - 57 -
  • 58. COLLATERALISED BORROWING AND LENDING OBLIGATIONThe clearing corporation of India limited (CCIL) launched a new product-collateralised borrowing and lending obligation (CBLO) on January 20 2003. Toprovide liquidity to non bank entities. Hit by restrictions on access to call moneymarket. The minimum order lot for auction market is fixed rs.50,000 and inmultiples of 500000 thereof.The minimum order for normal market is fixed at 500000 and in multiples of500000 there of. The reserve bank has prescribed the mode of operation in theCBLO segment. In the auction market, on the platform provided by CCIL theborrowers will submit their offers and the lenders will give their bids. Specifyingthe discount rate and maturity period. - 58 -
  • 59. CALL/NOTICE MONEY MARKETINTRODUCTION:-The call/notice/term money market is a market for trading very short term liquidfinancial assets that are readily convertible into cash at low cost. The moneymarket primarily facilitates lending and borrowing of funds between banks andentities like Primary Dealers. An institution which has surplus funds may lendthem on an uncollateralized basis to an institution which is short of funds. Theperiod of lending may be for a period of 1 day which is known as call money andbetween 2 days and 14 days which is known as notice money. Term money refersto borrowing/lending of funds for a period exceeding 14 days. The interest rates onsuch funds depend on the surplus funds available with lenders and the demands forthe same which remains volatile.This market is governed by the Reserve Bank of India which issues guidelines forthe various participants in the call/notice money market. The entities permitted toparticipate both as lender and borrower in the call/notice money market areScheduled Commercial Banks (excluding RRBs), Co-operative Banks other thanLand Development BanksScheduled commercial banks are permitted to borrow to the extent of 125% oftheir capital funds in the call/notice money market, however their fortnightlyaverage borrowing outstanding should not exceed more than 100% of their capitalfunds (Tier I and Tier II capital). At the same time SCBs can lend to the extent of50% of their capital funds on any day, during a fortnight but average fortnightlyoutstanding lending should not exceed 25% of their total fundsCo-operative Banks are permitted to borrow up to 2% of their aggregate depositsas end of March of the previous financial year in the call/notice money marketPrimary Dealers can borrow on average in a reporting fortnight up to 200% of thetotal net owned funds (NOF) as at end-March of the previous financial year andlend on average in a reporting - 59 -
  • 60. The average daily turnover in the call money market is around Rs. 12,000-13,000cr every day and trading occurs between 9.30 am to 5.00 pm on Monday to Friday.The trades are conducted both on telephone as well as on the NDS Call system,which is an electronic screen based system set up by the RBI for negotiatingmoney market deals between entities permitted to operate in the money market.The settlement of money market deals is by electronic funds transfer on the RealTime Gross Settlement (RTGS) system operated by the RBI. The repayment of theborrowed money also takes place through the RTGS system on the due date ofrepayment.Participants in the call money market:-Participants in the call money market are scheduled commercial banks, non-scheduled commercial banks, foreign banks, state, district and urban, cooperativebanks, Discount and Finance House of India (DFHI) and Securities TradingCorporation of India (STCI). The DFHI and STCI borrow as well as lend, likebanks and primary dealers, in the call market. At one time, only a few large banks.Over time, however, the market has expanded and now small banks and non-scheduled banks also participate in this market. However, now their participationas borrowers has increased for meeting CRR requirements.Difficulties in tapping deposits through branch expansion, and an increase in thecost of servicing (FCNR) deposits have also compelled foreign banks to borrow inthe call money market.Among the large commercial banks, the SBI kept away from the call market till1970 after which it has been regularly participating in this market. Because of itslarge size and formidable cash position, its participation made the market moreactive. The SBI group is a major lender but a small borrower in the call market. - 60 -
  • 61. Call rate:-The interest rate on a type of short-term loan that banks gives to brokers who inturn lend the money to investors to fund margin accounts. For both brokers andinvestors, this type of loan does not have a set repayment schedule and must berepaid on demand.MIBOR:-The Committee for the Development of the Debt Market that had studied andrecommended the modalities for the development for a benchmark rate for the callmoney market. Accordingly, NSE had developed and launched the NSE MumbaiInter-bank Bid Rate (MIBID) and NSE Mumbai Inter-bank Offer Rate (MIBOR)for the overnight money market on June 15, 1998.Call rate volatility:-In India money and credit situation is subject to seasonal fluctuation every year. Adecrease in call money requirement is greater in the slack season (mid April to midOctober) than in a buy session (mid October to mid April). - 61 -
  • 62. Factors influencing call money market rate:-The National Stock Exchange (NSE) developed and launched the NSE MumbaiInter bank Bid the (MIBID) and NSE Mumbai Inter-bank Offer Rate (MIBOR) orthe overnight money markets on June 15, 1998, NSE MIBID/ MIBOR are based onrates pooled by NSE from a representative panel of 31 banks/institutions/primarydealers. Currently, quotes are polled and processed daily by the exchange at 9:40(IST) for the overnight rate and at 11:30 (IST) for the 14 day, 1 month, and 24month rates. The rates pooled are then processed using the boost trap method toarrive at an efficient estimate of the references rates. This rate is used as abenchmark rate or majority of the deals stuck for floating rate debentures and termdeposits. Benchmark is rate at which money is raised in financial markets. Theserates are used in hedging strategies as reference points in forwards and swaps.Reuters MIBOR (Mumbai Inter-bank Overnight Average) is arrived at byobtaining weighted average of call money transactions of 22 banks and otherplayers.MIBOR is a better official benchmark rate for interest rate swaps (IRs) andforward rate agreements (FRAs). MIBOR is transparent, market determined andmutually acceptable to counterparties as reference.Call Rates Volatility:In India, money and credit situation is subject to seasonal fluctuation every year.The volume of call money transactions and the amount as well as call rate levelscharacterize seasonal fluctuation/volatility. A decrease in the call/notice moneyrequirements is greater in the slack season (mid-April to mid-October) than in thebuy season (mid-October to mid-April).Liquidity conditions:Liquidity conditions are governed by factors on both the demand and supply sideof money. Liquidity conditions are governed by deposit mobilization, capital flowsand reserve requirements on the supply side, and tax outflows, governmentborrowings programs, non-food credit off take and seasonal fluctuations on thedemand side. When easy liquidity conditions prevail, call rates move around the - 62 -
  • 63. Reserve Bank‟s repo rate. During times of tight liquidity, call rates tend to moveup towards the bank rate.Reserve requirement prescriptions andstipulations regarding average reservemaintenance:A cut in CRR reduces call rates while an increase in CRR increases call rates.Moreover, banks do not plan the demand for funds to meet their reserverequirements which increase call rate volatility.Till April 1997, inter-bank transactions were included in the reserve calculation.This led to a halt in money market activity every second Friday (reservecalculation day) when banks tried to reduce their reserve requirements byeliminating inter-bank borrowing. Due to this, the overnight call rates fell to zeroper cent very second Friday. This inhibited the development of liquid moneymarket yield curve beyond 13 days.Structural factors:Structural factors refer to government legislation, conditions of the stock marketsand so on which affect the volatility of the call money rate.Investment policy of non-bank participants in the call market who are the majorlenders of funds in the call market: money market is asymmetrical in the sensethere are few lenders and chronic borrowers. This asymmetry leads to fluctuationsin the call money market rate.Liquidity changes and gaps in the foreign exchangemarket:Call rates increase during volatile forex market conditions. This increase is a resultof monetary measures for tightening liquidity conditions and short position takenby market agents in domestic currency against long positions in US dollars inanticipation of higher profits through depreciation of the rupee. Banks fund foreigncurrency positions by withdrawing from the inter bank call money market whichleads to a hike in the call money rates. - 63 -
  • 64. Steps to convert Call Money market into apure Inter-bank Market A four phased exit of non bank institutions from the call money market commenced from May 5, 2001. As part of stage in non-bank institutions, were permitted to lend, on an average up to 85 per cent of their average daily call money lending during 2000-01. This would be followed by reductions in their access to 75 per cent in stage II when the clearing corporation is made fully operational. Subsequently such limits would be reduced to 40 percent and 10 per cent in stage III and stage IV respectively, before affecting a complete withdrawal of non-bank participants from the call money market. Moreover access to other short term instruments for non-bank institutions were made attractive. In 2000-01, the minimum maturity of certificates of deposit was reduced to 15 days and restriction on the transferability period for CDs issued by banks and financial institutions was withdrawn. Prudential limits on exposure to call/notice money lending of primary dealers have been issued by RBI. With effect from October 5, 2002, primary dealers will be permitted to lend in call/notice money market up to 25 per cent of their net owned funds (NOF). Access of primary dealers to borrow in call/notice money market would be gradually reduced in two stages. In stage I primary dealers would be allowed to borrow up to 200 percent of their net owned funds as at end-March of the preceding financial year. In stage II primary dealers would be allowed to borrow up to 100 per cent of their net owned funds. The limits under both the stages would not be applicable for days on which government dated securities are issued in the market. In order to reduce market participants‟ reliance on call/notice money market, collateralized borrowing and lending obligation (CBLO) has started operations as a money market instrument through Clearing Corporation of India (CCIL) on January 20,2003. The RBI has issued prudential norms to reduce the chronic reliance of banks on call money market. With effect from the fortnight beginning December 14, 2002, lending of scheduled commercial banks on a fortnightly average - 64 -
  • 65. basis should not exceed 25 per cent of their owned funds (paid-up capitaland reserves); however banks are allowed to lend a maximum of 50 per centon any day during a fortnight. Similarly borrowings by scheduledcommercial banks should not exceed 100 per cent of their owned funds or 2per cent of aggregate deposits, whichever is higher however banks areallowed to borrow a maximum of 125 percent of their owned funds on anyday during a fortnight.The repo market was expanded later to non-bank entities holding bothcurrent and SGL accounts with the Reserve Bank. The minimum repo tenorwas reduced to one day and state government securities were made eligiblefor repos.The development of the repo market would help in transforming the callmoney market into a pure inter-bank market. - 65 -
  • 66. Term Money Market:Introduction:-Beyond the call/notice market is the term money market. This money market is onebeyond the overnight tenor, with maturity ranging between three months to oneyear. In other words, a term money market is one where funds are traded up toperiod three to six months. The term money market in India is still not developed.The turnover in this market remained mostly below Rs 200 crore in 2001-02. Thevolumes are quite small in this segment as there is little participation from largeplayers and a term money yield curve is yet to develop. Banks do not want to takea view on term money rates as they feel comfortable with dealing only in theovernight money market. Foreign and private sector banks are in deficit in respectof short term resources; hence they depend heavily call/notice money market. Thepublic sector banks are generally in surplus and they exhaust their exposure limit toterm there by constraining the growth of the term money market. Corporate prefer„cash credit‟ rather than „loan credit‟ which forces banks to deploy a large amountof resources in the call/notice money market rather than in term money market tomeet their demands.The Reserve bank has permitted select financial institutions such as IDBI, IOCICI,IFCI, HBI, SIDBI, EXIM Bank, NABARD, IDFC and NHB to borrow from theterm money market from the three to six months. - 66 -
  • 67. Money market intermediariesThe discount and finance house of India (DFHI)The DFHI was set up in April 1988 by the Reserve Bank with the objective ofdeepening and activating the money market. It has commenced its operations fromJuly 28, 1988.It is a joint stock company in form and is jointly owned by the Reserve Bank,public sector banks and all-India financial institutions which have contributed to itspaid-up capital of Rs200crore in the proportion of 5:3:2. In addition to refinancefacility with the Reserve Bank and a credit of Rs100crore from 28 public sectorbanks on a consortium basis are the sources of its funds.The role of the DFHI is to function as a specialized money market intermediary forstimulating activity in money market instruments and develop secondary market inthese instruments. It also undertakes short-term buy-back operations in thegovernment and approved dated securities. DFHI mobilizes funds/resources fromcommercial/cooperative banks, financial institutions, and corporate entities havingresources to lend (which individually may not represent tradable volumes inwholesale market) which are pooled and lent in the money market. The two-wayregular quotes in money market instruments provided by DFHI serve as a base tobroaden the secondary market and give an assured liquidity to the instruments.DFHI was categorized as an eligible institution under the relevant provisions of theRBI Act, 1934, in November 1989 so that the placement of funds with DFHI canbe included as an asset with the banking system for netting purposes whilecalculating the net demand and time liabilities for reserve purposes. DFHI is alsoan authorized institution to undertake repo transactions in treasury bills and alldated government securities to impart greater liquidity to these instruments.Since November 13, 1995, DFHI is an accredited primary dealer. With thisaccreditation, its role has undergone a transformation. Now it acts as a marketmaker, giving two-way quotes and takes large positions on its account ingovernment securities.The DFHI deals in treasury bills, commercial bills, certificates of deposits,commercial paper, short-term deposits, call/notice money market and governmentsecurities. The presence of the DFHI as an intermediary in the money markethas helped the corporate entities, banks, and financial institutions to raise - 67 -
  • 68. short-term money and invest short-term surpluses. The DFHI also extends repos,that is, buy-back facility up to 14 days, to banks and financial institutions inrespect of money market instruments.The cumulative turnover of the DFHI in all financial transactions increased fourfold in a span of nine years. The major part of the turnover was in call moneyfollowed by government dated securities and treasury bills. Its business in CDs andCPs was negligible and business in commercial bills declined sharply in the 1990s.Its dealings in government securities exceeded those in treasury bills after beingaccredited as a primary dealer.The DFHI has been concentrating on the call money market rather than activatingother money market instruments like CPs, CDs and CBs. These instruments needto be developed further for activating and deepening the money market.Money Market Mutual Funds (MMMFs):-MMMFs were introduced in April 1991 to provide an additional short-term avenuefor investment and bring money market investment within the reach of individuals.These mutual funds would invest exclusively in money market instruments.MMMFs bridge the gap between small individual investors and the money market.MMMF mobilizes savings from small investors and invests them in short-termdebt instruments or money market instruments.A Task Force was constituted to examine the broad framework outlined in April1991 and consider the implications of the scheme. Based on the recommendationsof the Task Force, a detailed scheme of MMMFs was announced by the ReserveBank in April 1992.The MMMFs portfolio consists of short-term money market instruments. Aninvestor investing in MMMFs gets a yield close to short-term money. - 68 -
  • 69. Link between Money Market and MonetaryPolicy in IndiaThe monetary policy represents policies objectives and instruments directedtowards regulating money supply and the cost and availability of credit in theeconomy. In the monetary policy framework broad objectives are prescribed andan operating framework of policy instruments to achieve them is formulated. Themonetary policy in India is an adjunct of the economic policy. The objectives ofthe monetary policy are not different from those of the economic policy. The threemajor objectives of economic policy in India have been growth price stability andsocial justice. The emphasis between the first two objectives has changed fromyear to year, depending upon the conditions prevailing in that year and thepervious year. The objectives of the monetary policy are also price stability andgrowth. The government of India tries to manipulate its monetary policy throughthe Reserve Bank, the monetary authority in India. The objectives of the monetarypolicy are pursued by ensuring credit availability with stability in the externalvalue of the rupee as well as an overall financial stability.The Reserve Bank seeks to influence monetary conditions through management ofliquidity by operating in varied instruments. These instruments can be categorizedas direct and indirect market based instruments.In an administered or controlled regime of money and financial markets, theReserve bank directly influences the cost, availability and direction of fundsthrough direct instruments. The management of liquidity is essentially throughdirect instruments such as varying cash reserve requirements, limits, on refinanceadministered interest rates, and qualitative and quantitative restrictions on credit.Since 1991, the market environment has been deregulated and liberalized whereinthe interest rates are largely determined by market forces. The objective of themonetary policy operations is to make the interest rate regime more flexible andresponsive to the economic fundamentals. In such an environment, the ReserveBank influences monetary conditions through market based, indirect instrumentssuch as open market operations and refinance / discount / repo windows.The success of market based indirect instruments depends upon the existence of avibrant liquid and efficient money market that is well integrated with the othersegments financial markets such as government securities market an foreign - 69 -
  • 70. exchange market. The effectiveness of the monetary policy depends on the marketand institutional framework available for transmitting monetary policy impulses.The financial sector in India is still in a state of transition because of ongoingreforms. However, a growing integration among the different segments of thefinancial markets has been witnessed. Still, the markets do not have adequate depthand liquidity – a major constraint in the conduct of the monetary policy. TheReserve Bank therefore still relies on the cash reserve ratio as an operatinginstrument. The bank activated the bank rate on 1997 as a reference rate and as asignalling device to reflect the stance of the monetary policy. The interest rates ondifferent types of accommodation from the reserve bank including refinance arelinked the banks rate. The announcement impact of bank rate changes has beenpronounced in the prime lending rates (PLRs) of commercial banks.The Reserve bank also set up a framework of interim liquidity (ILAP) whichhelped in injecting liquidity through collateralized lending facility (CLF) to banks,export credit refinance to banks, and liquidity support to primary dealers. All thesefacilities were formula based and depended on the bank rate. The ILAF wasgradually converted into a full-fledged LAF. The liquidity adjustment facility(LAF) has evolved as an effective mechanism for absorbing and/or injectingliquidity on a day-to-day basis. - 70 -
  • 71. Tools for Managing Liquidity in the MoneyMarketReserves requirements:-Reserve requirements are of two types: (i) cash reserve requirements and (ii)statutory liquidity ratio (SLR). They are techniques of monetary control used bythe Reserve Bank to achieve specific macro-economic objectives. CRR refers tothe cash that banks have to maintain with the Reserve Bank as a certain percentageof their total demand and time liabilities (DTL) while statutory liquidity ratio refersto the mandatory investment that banks have to make in government securities.The statute governing the CRR under section 42(1) of the Reserve Bank of IndiaAct requires every bank in the second schedule to maintain an average dailybalance with the Reserve Bank of India, the amount of which shall not be less than3% of the total demand and time liabilities. CRR is an instrument to influenceliquidity in the system as and when required. SLR is the reserve that is set aside bythe banks for investment in cash, gold, or unencumbered approved securities. It ismandatory under section 24(2A) of the Banking Regulation Act, 1949, as amendedby the Banking Laws (Amendment) Act, 1983 for banks to maintain this reserve.The reserve is supposed to provide a buffer in case of a run on the bank.The CRR has been brought down from 15% in March 1991 to 4.75% in October2002 and 4.5% in April 2003 while the SLR was brought down from its peak of38.5% in April 1992 to 25% on October25, 1997. Thus, till the early 1990s, boththe CRR and SLR were pre-empting around 63.5% of the incremental deposits.Even though the SLR has been brought down to 25%, most banks currently hold avolume of government securities higher than required under the SLR as the interestrate on government securities is increasingly market-determined.The daily minimum CRR was reduced from 85% to 65% to enable a smoothadjustment of liquidity between the surplus and the deficit segment and better cashmanagement to avoid a sudden increase in the overall call rates.The Reserve Bank has announced that it would like to see the CRR level down to3%. The key constraint in reducing the CRR is the continuing high level of fiscaldeficit which cannot be financed entirely by the market and, therefore, requiressubstantial support by the Reserve Bank. - 71 -
  • 72. A cut in CRR increases the liquidity in the economy. It also means lower cost forthe banks which translates into lower prime lending rates. It also sets a broaddirection for interest rates in the future. Since October 2001, the interest rate paidon eligible balances under CRR was linked to the bank rate. From August 11,2001, the inter-bank term liabilities with an original maturity of 15days and up toone year were exempted from the prescription of minimum CRR requirement of3%. The CRR will continue to be used in both directions for liquidity managementin addition to other instruments.Interest rates:-Interest rate is one of the distinct monetary transmission channels. An administeredinterest rate structure was the central feature of the Indian monetary and creditsystem during the 1980s. The rationale behind the administered rate structure wasto enable certain preferred or priority sectors to obtain funds at concessional ratesof interest. This brought about an element of cross-subsidization resulting in higherlending rates for the non-concessional commercial sector. The deposit rates alsohad to be maintained at a low level. This system became complex with theproliferation of sectors and segments to which concessional credit was to beprovided.Repos :-The major function of the money market is to provide liquidity. To achieve thisfunction and to even out liquidity changes, the Reserve Bank uses repos. Repo is auseful money market instrument enabling the smooth adjustment of short termliquidity among varied market participants such as banks, financial institutions,and so on.Repo refers to a transaction in which a participant acquires immediate funds byselling securities and simultaneously agrees to the repurchase of the same orsimilar securities after a specified time at a specified price. In other words, itenables collateralized short term borrowing and lending through sale/purchaseoperations in debt instruments. It is a temporary sale of debt involving full transferof ownership of the securities, that is, the assignment of voting and financial rights.Repo is also referred to as a ready forward transaction as it is means of funding byselling a security held on a spot basis and repurchasing the same on a forwardbasis. - 72 -
  • 73. Reverse repo is exactly the opposite of repo – a party buys a security from anotherparty with a commitment to sell it back to the latter at a specified time and price. Inother words, while for one party the transaction is repo, for another party it isreverse repo. A reverse repo is undertaken to earn additional income on idle cash.In India, repo transactions are basically fund management/SLR managementdevices used by banks.The different between the price at which the securities are bought and sold is thelender‟s profit or interest earned for lending the money. The transaction combineselements of both securities purchase/sale operation and also a money marketborrowing/lending operation. It signifies lending on a collateral basis. It is also agood hedge tool because the repurchase price is locked in at the time of the saleitself. The terms of contract are in terms of a „repo rate‟, representing the moneymarket borrowing/lending rate. Repo rate is the annual interest rate for the fundstransferred by the lender to the borrower. The repo rate is usually lower than thatoffered on unsecured inter-bank rate as it is fully collateralized. The factors whichaffect the repo rate are the creditworthiness of the borrower, liquidity of thecollateral, and comparable rates of other money market instruments.Importance of repos: Repos are safer than pure call/notice/term money and inter-corporate deposit markets which are non-collateralized; repos are backed bysecurities and are fully collateralized. Thus, the counter party risks are minimum.Since repos are market based instruments, they can be utilized by central banks asan indirect instrument of monetary control for absorbing or injecting short termliquidity. Repos help maintain an equilibrium between demand and supply of shortterm funds. The repos market serves as equilibrium between the money market andsecurities market and provides liquidity and depth to both the markets. Monetaryauthorities can transmit policy signals through repos to the money market whichhas a significant influence on the government securities market and foreignexchange market. Hence, internationally it is versatile and the most popular moneymarket instrument. In India, too, it was a rapidly developing and thriving marketuntil the scam of 1992-93 where this facility was grossly misused.Two types of repos are currently in operation – inter-bank repos and RBI repos.Inter bank repos: The Reserve Bank itself, allowed it resort to repo transactionsamong themselves and with DFHI, and STCI. Inter bank repos were popular in1991-92 as banks did not wish to buy the securities outright because of the risk ofdepreciation. Moreover, since there were not many money market instruments ofdifferent maturities repos served as a hedge for interest rate fluctuations. - 73 -
  • 74. The reserve repos: The Reserve Bank also undertakes repo/reverse repo operationwith primary dealers and scheduled commercial banks as part of its open marketoperations. The Reserve Bank introduced repo operations (selling governmentsecurities to repurchase later) on December 10, 1992 to influence short termliquidity. The Reserve Bank provides liquidity support to primary dealers, and 100percent gilt mutual funds in the form of reverse repo facility. The Reserve bankindirectly interferes in the market through reverse repo operations to ease unduepressure on overnight call money rates. This also enables the repo market to forgeclose links between the money market and security market. - 74 -
  • 75. Definition of Interest Rate SwapAn agreement between two parties (known as counterparties) where one stream offuture interest payments is exchanged for another based on a specified principalamount. Interest rate swaps often exchange a fixed payment for a floating paymentthat is linked to an interest rate (most often the LIBOR). A company will typicallyuse interest rate swaps to limit or manage exposure to fluctuations in interest rates,or to obtain a marginally lower interest rate than it would have been able to getwithout the swap.Definition of Plain Vanilla SwapThe most basic type of forward claim that is traded in the over-the-counter marketbetween two private parties, usually firms or financial institutions. There areseveral types of plain vanilla swaps, such as the plain vanilla interest rate swap, theplain vanilla commodity swap and the plain vanilla foreign currency swap. - 75 -
  • 76. THE CAPITAL MARKETINTRODUCTION:-Capital Market is one of the significant aspects of every financial market. Hence itis necessary to study its correct meaning. Broadly speaking the capital market is amarket for financial assets which have a long or indefinite maturity. Unlike moneymarket instruments the capital market instruments become mature for the periodabove one year. It is an institutional arrangement to borrow and lend money for alonger period of time. It consists of financial institutions like IDBI, ICICI, UTI,LIC, etc. These institutions play the role of lenders in the capital market. Businessunits and corporate are the borrowers in the capital market. Capital market involvesvarious instruments which can be used for financial transactions. Capital marketprovides long term debt and equity finance for the government and the corporatesector. Capital market can be classified into primary and secondary markets. Theprimary market is a market for new shares, where as in the secondary market theexisting securities are traded. Capital market institutions provide rupee loans,foreign exchange loans, consultancy services and underwriting.Functions and role of the capital market. 1. Mobilization of Savings: Capital market is an important source for mobilizing idle savings from the economy. It mobilizes funds from people for further investments in the productive channels of an economy. In that sense it activates the ideal monetary resources and puts them in proper investments. 2. Capital Formation: Capital market helps in capital formation. Capital formation is net addition to the existing stock of capital in the economy. Through mobilization of ideal resources it generates savings; the mobilized savings are made available to various segments such as agriculture, industry, etc. This helps in increasing capital formation. 3. Provision of Investment Avenue: Capital market raises resources for longer periods of time. Thus it provides an investment avenue for people who wish to invest resources for a long period of time. It provides suitable interest rate returns also to investors. Instruments such as bonds, equities, units of mutual funds, insurance policies, etc. definitely provides diverse investment avenue for the public. - 76 -
  • 77. 4. Speed up Economic Growth and Development: Capital market enhances production and productivity in the national economy. As it makes funds available for long period of time, the financial requirements of business houses are met by the capital market. It helps in research and development. This helps in, increasing production and productivity in economy by generation of employment and development of infrastructure.5. Proper Regulation of Funds: Capital markets not only helps in fund mobilization, but it also helps in proper allocation of these resources. It can have regulation over the resources so that it can direct funds in a qualitative manner.6. Service Provision: As an important financial set up capital market provides various types of services. It includes long term and medium term loans to industry, underwriting services, consultancy services, export finance, etc. These services help the manufacturing sector in a large spectrum.7. Continuous Availability of Funds: Capital market is place where the investment avenue is continuously available for long term investment. This is a liquid market as it makes fund available on continues basis. Both buyers and seller can easily buy and sell securities as they are continuously available. Basically capital market transactions are related to the stock exchanges. Thus marketability in the capital market becomes easy. - 77 -
  • 78. Primary and secondary capital marketThe term capital market refers to facilities and institutional arrangements throughwhich long-term funds; both debt and equity are raised and invested. It consists ofa series of channels through which savings of the community are made availablefor industrial and commercial enterprises and for the public in general. It directsthese savings into their most productive use leading to growth and development ofthe economy. The capital market consists of development banks, commercialbanks and stock exchanges. An ideal capital market is one where finance isavailable at reasonable cost.The process of economic development is facilitated by the existence of a wellfunctioning capital market. In fact, development of the financial system is seen as anecessary condition for economic growth. It is essential that financial institutionsare sufficiently developed and that market operations are freed, fair, competitiveand transparent. The capital market should also be efficient in respect of theinformation that it delivers, minimize transaction costs and allocate capital mostproductively. The Capital Market can be divided into two parts – Primary Marketand Secondary MarketPrimary MarketThe primary market is also known as the new issues market. It deals with newsecurities being issued for the first time. The essential function of a primary marketis to facilitate the transfer of investable funds from savers to entrepreneurs seekingto establish new enterprises or to expand existing ones through the issue ofsecurities for the first time. The investors in this market are banks, financialinstitutions, insurance companies, mutual funds and individuals.A company can raise capital through the primary market in the form of equityshares, preference shares, debentures, loans and deposits. Funds raised may be forsetting up new projects, expansion, diversification, modernization of existingprojects, mergers and takeovers etc. - 78 -
  • 79. Secondary marketIt is a market for the purchase and sale of existing securities. It helps existinginvestors to disinvest and fresh investors to enter the market. It also providesliquidity and marketability to existing securities. It also contributes to economicgrowth by channelizing funds towards the most productive investments through theprocess of disinvestment and reinvestment.Securities are traded, cleared and settled within the regulatory frameworkprescribed by SEBI. Advances in infosrmation technology have made tradingthrough stock exchanges accessible from anywhere in the country through tradingterminals. Along with the growth of the primary market in the country, thesecondary market has also grown significantly during the last ten years.History of the Indian Capital marketThe history of the capital market in India dates back to the eighteenth centurywhen East India Company securities were traded in the country. Until the end ofthe nineteenth century securities trading was unorganized and the main tradingcentres were Bombay (now Mumbai) and Calcutta (now Kolkata). Of the two,Bombay was the chief trading centre wherein bank shares were the major tradingstock During the American Civil War (1860-61). Bombay was an important sourceof supply for cotton. Hence, trading activities flourished during the period,resulting in a boom in share prices. This boom, the first in the history of the Indiancapital market lasted for a half a decade. The bubble burst on July 1, 1865 whenthere was tremendous slump in share prices.Trading was at that time limited to a dozen brokers; their trading place was under abanyan tree in front of the Town hall in Bombay. These stock brokers organizedinformal association in 1897 – Native Shares and Stock Brokers Association,Bombay. The Stock exchanges in Calcutta ad Ahmadabad also industrial andtrading centres came up later. The Bombay Stock Exchange was recognized inMay 1927 under the Bombay Securities Contracts Control Act, 1925. - 79 -
  • 80. The capital market was not well organized and developed during the British rulebecause the British government was not interested in the economic growth of thecountry. As a result many foreign companies depended on the London capitalmarket for funds rather than in the Indian capital market.In the post independence period also, the size the capital market remained small.During the first and second five year plans, the government‟s emphasis was on thedevelopment of the agricultural sector and public sector undertakings. The publicsector undertakings were healthier than the private undertakings in terms of paidup capital but shares were not listed on the stock exchanges. Moreover, theController of Capital Issues (CI) closely supervised and controlled the timing,composition; interest rates pricing allotment and floatation consist of new issues.These strict regulations de-motivated many companies from going public foralmost four and a half decades.In the 1950s,Century textiles, Tata Steel, Bombay Dyeing, National Rayon,Kohinoor mills were the favourite scripts of speculators. As speculation becamerampant, the stock market came to be known as Satta Bazaar. Despite speculationnon-payment or defaults were very frequent. The government enacted theSecurities Contracts (regulation) Act in 1956 to regulate stock markets. TheCompanies Act, 1956 was also enacted. The decade of the 1950s was alsocharacterized by the establishment of a network for the development of financialinstitutions and state financial corporations.The 1960s was characterized by the wars and droughts in the country which ledbearish trends. These trends were aggravated by the ban in 1969 on forwardtrading and Badla technically called contracts for clearing Badla provided amechanism for carrying forward positions as well as for borrowing funds.Financial institutions such as LIC and GIC helped to revive the sentiment byemerging as the most important group of investors. The first mutual fund of India,the Unit Trust of India (UTI) came into existence in 1964.In the 1970s Badla trading was resumed under the disguised forms of handdelivery contracts – A group. This revived the market. However, the capital marketreceived another severe setback on July 6, 1974, when the governmentpromulgated the Dividend Restriction ordinance, restricting the payment ofdividend by companies to 12 per cent of the face value or one-third of the profit ofthe companies that can be distributed as computed under section 369 of theCompanies Act, whichever was lower. This lead to a slump in market capitalism atthe BSE by about 20 per cent overnight and the stock market did not open for - 80 -
  • 81. nearly a fortnight. Later came buoyancy in the stock markets when themultinational companies (MNCs) were forced to dilute their majority stocks intheir Indian ventures in favor of the Indian public under FERA 1973. SeveralMNCs opted out of India. One hundred and twenty three MNCs offered sharesworth Rs 150 crore, creating 1.8 million shareholders within four years. The offerprices of FERA shares were lower than their intrinsic worth. Hence, for the firstthe FERA dilution created an equity cult in India. It was the spate of FERA issuesthat gave a real fillip to the Indian stock markets. For the first time, many investorsgot an opportunity to invest in the stocks of such MNCs as Colagte and HindustanLiver Limited. Then in 1977, a little known entrepreneur, Dhirubhai Ambanitapped the capital market. The scrip Reliance Textiles is still a hot favorite anddominates trading at all stock exchanges. - 81 -
  • 82. History of the Indian Stock Market - The OriginOne of the oldest stock markets in Asia, the Indian Stock Markets have a 200years old history.18th East India Company was the dominant institution and by end of theCentury century, busyness in its loan securities gained full momentum1830s Business on corporate stocks and shares in Bank and Cotton presses started in Bombay. Trading list by the end of 1839 got broader1840s Recognition from banks and merchants to about half a dozen brokers1850s Rapid development of commercial enterprise saw brokerage business attracting more people into the business1860s The number of brokers increased to 601860-61 The American Civil War broke out which caused a stoppage of cotton supply from United States of America; marking the beginning of the "Share Mania" in India1862-63 The number of brokers increased to about 200 to 2501865 A disastrous slump began at the end of the American Civil War (as an example, Bank of Bombay Share which had touched Rs. 2850 could only be sold at Rs. 87)Pre-Independence Scenario - Establishment of Different Stock Exchanges1874 With the rapidly developing share trading business, brokers used to gather at a street (now well known as "Dalal Street") for the purpose of transacting business.1875 "The Native Share and Stock Brokers Association" (also known as "The Bombay Stock Exchange") was established in Bombay1880s Development of cotton mills industry and set up of many others1894 Establishment of "The Ahmadabad Share and Stock Brokers Association"1880 - Sharp increase in share prices of jute industries in 1870s was90s followed by a boom in tea stocks and coal1908 "The Calcutta Stock Exchange Association" was formed1920 Madras witnessed boom and business at "The Madras Stock Exchange" was transacted with 100 brokers. - 82 -
  • 83. 1923 When recession followed, number of brokers came down to 3 and the Exchange was closed down1934 Establishment of the Lahore Stock Exchange1936 Merger of the Lahoe Stock Exchange with the Punjab Stock Exchange1937 Re-organisation and set up of the Madras Stock Exchange Limited (Pvt.) Limited led by improvement in stock market activities in South India with establishment of new textile mills and plantation companies1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited was established1944 Establishment of "The Hyderabad Stock Exchange Limited"1947 "Delhi Stock and Share Brokers Association Limited" and "The Delhi Stocks and Shares Exchange Limited" were established and later on merged into "The Delhi Stock Exchange Association Limited" - 83 -
  • 84. Reforms of Capital MarketThe 1991-92 securities scam prompted the governments to increase the pace ofreforms in the capital market. Several reform measures have been undertaken sincethen in both the primary and secondary segments of the equity market.Primary Capital Market1) The Securities and Exchange Board of India was set up in early 1988 as a non-statutory body under an administrative arrangement. It was given statutory powersin January 1992 through the enactment of the SEBI Act, 1992 for regulating thesecurities market. The two objectives mandated in the SEBI Act are investorprotection and orderly development of the money market 2) The Capital Issues(Control) Act, 1947 was repealed in May 1992, allowing issuers of securities toraise capital from the market without requiring the consent of nay authority eitherfor floating an issue or pricing it. Restrictions on right and bonus issues were alsoremoved. The interest rate on debentures was freed. However, the new issue ofcapital has now been brought under SEBI‟s purview and issuers are required tomeet the SEBI guidelines for disclosure and investor protection, which are beingstrengthened from.3) The requirement to issue shares at a par value of Rs 10 and Rs 100 waswithdrawn. This gave companies the freedom to determine a fixed value per share.This facility is available to companies which have dematerialized their shares.Moreover, the shares cannot be issued in the decimal of a rupee. The companieswhich have already issued shares at Rs 10 or Rs 100 per value also eligible forsplitting and consolidation.4) To reduce the cost of issue, underwriting by issuer was made optional, subject tothe condition that if an issue was not underwritten and in case it failed to secure 90per cent of the amount offered to the public, the entire amount so collected wouldbe refunded.5) One of the significant steps towards integrating the Indian capital market withthe international capital markets was the permission given to foreign institutional - 84 -
  • 85. investors such as mutual funds, pension funds, and country funds, to operate in theIndian market. Foreign institutional investors were initially allowed to invest onlyin equity shares; later, they were allowed to invest in the debt market, includingdated government securities and treasury bills. The ceiling for investment byforeign institutional investors was increased from 40 per cent to 49 per cent in2000-01. This increase can be made with the approval of shareholders through.a special resolution in the general body meeting.6) Indian companies have also been allowed to raise capital from the internationalcapital markets through issues of Global Depository Receipts, AmericanDepository Receipts, Foreign Currency Convertible Bonds (FCCBs) and ExternalCommercial Borrowings (ECBs). Companies were permitted to invest all ADR /GDR proceeds abroad. Two way fungibility was announced for ADRs/ GDRs in2000-01 for persons residing outside India. Converted local shares could bereconverted into ADRs / GDRs while being subject to sect oral caps.7) Merchant bankers are prohibited from carrying on fund based activities otherthan those related exclusively to the capital market. Multiple categories ofmerchant bankers have been abolished and there is only one entity the merchantbanker.8) Besides merchant bankers, various other intermediaries such as mutual funds,portfolio managers, registrars to an issue, share transfer agents, underwriters,debentures trustees, bankers to an issue, custodian of securities, venture capitalfunds and issues have also been brought under the preview of SEBI..9) It is mandatory for listed companies to announce quarterly results. This enablesinvestors to keep a close track of the scrip in their portfolios. The declaration ofquarterly results is in line with the practice prevailing in the stock market indeveloped countries.10) To check price manipulation mandatory client code and minimum floatinglisting stipulated in200111) The government amended the Securities Contracts (Regulation) Rules, 195712) The central government has notified the establishment of the InvestorEducation and Protection Fund (IEPF) with effect from October 1, 2001. The IEPFwill be utilized for the promotion of awareness amongst investors and protection of - 85 -
  • 86. their interest13) The restriction on short sales announced in March 7, 2001 was withdrawn witheffect from July 2, 2001, as all deferral products stand banned after the date.Secondary Capital Market 1. Since the establishment of Securities and Exchange Board of India (SEBI) in 1992, the decade‟s old trading system in stock exchanges has been under review. The main deficiencies of the system were found in two areas: (i) the clearing and settlement system in stock exchanges whereby physical delivery of shares by the seller and the payment by the buyer was made, and (ii) procedure for transfer of shares in the name of the purchaser by the company. The procedure was involving a lot of paper work, delays in settlement and non-transparency in costs and prices of the transactions. The prevalence of „Badla‟ system had often been identified as a factor encouraging speculative activities. As a part of the process of establishing transparent rules for trading, the „Badla‟ system was discontinued in December 1993. The SEBI directed the stock exchanges at Mumbai, Kolkata, Delhi and Ahmadabad to ensure that all transactions in securities are concluded by delivery and payments and not to allow any carry forward of the transactions. 2. The floor-based open outcry system has been replaced by on-line electronic system. The period settlement system has given way to the rolling settlement system. Physical share certificates system has been outdated by the electronic depository system. The risk management system has been made more comprehensive with different types of margins introduced. FII‟s have been allowed to participate in the capital market. Stringent steps have been taken to check insider trading. The interest of minority shareholders has been protected by introducing takeover code. Several types of derivative instilments have been introduced for hedging. 3. As a result of the reforms/initiatives taken by Government and the Regulators, the market structure has been refined and modernized. The investment choices for the investors have also broadened. The securities market moved from T+3 settlement periods to T+2 rolling settlement with effect from April 1, 2003. Further, straight through processing has been made mandatory for all institutional trades executed on the stock exchange. - 86 -
  • 87. Real time gross settlement has also been introduced by RBI to settle inter-bank transactions online real time mode. - 87 -
  • 88. What is Primary Market?Primary market is the part of capital market where issue of new securities takes place.Public sector institutions, companies and governments obtain funds for further growth ofthe company after the sale of their securities or bonds in primary market. The sellingprocess of new issues in primary market is called as Underwriting and this process isdone by a group of people called underwriters or security dealers. From a retailinvestor’s point of view, investing in the primary market is the first step towards tradingin stocks and shares.Role of Primary MarketCapital formation - It provides attractive issue to the potential investors and with thiscompany can raise capital at lower costs.Liquidity - As the securities issued in primary market can be immediately sold insecondary market the rate of liquidity is higher.Diversification - Many financial intermediaries invest in primary market; therefore thereis less risk if there is failure in investment as the company does not depend on a singleinvestor. The diversification of investment reduces the overall risk.Reduction in cost - Prospectus containing all details about the securities are given tothe investors hence reducing the cost is searching and assessing the individualsecurities.Features of Primary Market It is the new issue market for the new long term capital. Here the securities are issued by company directly to the investors and not through any intermediaries. On receiving the money from the new issues, the company will issue the security certificates to the investors. The amount obtained by the company after the new issues are utilized for expansion of the present business or for setting up new ventures. External finance for longer term such as loans from financial institutions is not included in primary market. There is an option called ‘going public’ in which the borrowers in new issue market raise capital for converting private capital into public capital. - 88 -
  • 89. Prerequisites for Investor to Participate in Primary market Activities: PAN Number Bank Account Demat AccountTypes of issuesPublic issues can be classified into 3 types:Initial Public Offering (IPO) – Fresh issue of shares or selling existing securities by anunlisted company for the first time is known as IPO. Listing and trading of securities of acompany takes place in IPO.Rights Issue – Rights issue is when the listed company issues new securities andprovides special rights to its existing shareholders for buying the securities beforeissuing it to public. The rights are issued on particular ratio based on the number ofsecurities currently held by the share holder.Preferential Issue – It is the fresh issue of securities and shares by listed company. Itis called as preferential as the shareholders with preferential shares get the preferencewhen it comes to dividend disbursement.Benefits Price manipulation is very less in primary market compared to secondary market. There is no payment of brokerage, transaction fees, and stamp duty or service tax. Investors get the shares at same prices so market fluctuations do not affect it.Disadvantages The shares are allotted proportionately if there is over subscription which means, the small investors may not get any allotment. Money is locked in for longer time, as it is a long term investment. The shares allotment for the investor takes few days in primary market compared to secondary market where it takes only 3 days to allot the shares.Primary MarketAs you know, business requires money in order to grow and expand and they can raise money inthe form of equity or debt. Such business entities may then approach public at large/institutionalinvestors (banks, financial institution, MF House) for raising money. Business entity raisesmoney from investors by issuing newly created securities or may sell securities already held by - 89 -
  • 90. some investors. This is Primary Market transaction. 1. Public IssueWhen a company raises funds by selling (issuing) its shares (or debenture / bonds) to the publicthrough issue of offer document (prospectus), it is called a public issue.IPO(Initial Public Offer)As the name suggests, IPO‟s are fresh issue of shares to the public. When a (unlisted) companymakes a public issue for the first time and gets its shares listed on stock exchange, the public - 90 -
  • 91. issue is called as initial public offer (IPO). This process is undertaken at the primary market.Sarvajeet: Uncle, how do I apply to public Issue?Uncle: Sarvo, when a company comes with an IPO, it prints and circulate/distribute IPO applica-tion forms among the investors. To subscribe to an IPO, Investors have to fill an applicationform. These forms are available with syndicate members, brokers, sub-brokers, investment advi-sors and stalls outside stock exchanges, banks and with vendors in various other areas. Once youget the forms, you have to fill it, remit the amount after calculating the number of shares appliedfor the bank that is designated in the form as collecting centre for that IPO. Investors have to pro-vide the details of their demat account and bank account in the form.Amit: How do I decide on a good new issue?Uncle: This is important, especially when a large number of new companies are floating publicissues. While a large number of these companies are genuine, quite a few may want to exploitinvestors. An investor must therefore, identify the exploit investors. An investor must therefore,identify the future potential of a company before applying for its issue.A part of the guidelines issued by the SEBI (Securities and Exchange Board of India– Regulator)is the disclosure of information to the public. This disclosure allows the public to know the rea-son for raising the money, the new way the money is proposed to be spent, the returns expectedon the money and so on.This information is in the form of a prospectus, which includes information regarding the size ofthe issue, the current status of the company and its credibility, its equity capital, its current andpast performance, promoters, the project, cost of the project, means of financing, product andcapability.New issue also contains a lot of mandatory information regarding underwriting and statutorycompliances. This gives the investor a fair chance to evaluate the prospectus of the company inthe short and lot term period and make investment decision.Sarvajeet: Uncle what should a layman look for in the prospectus?Uncle: The important factors to be considered are: Promoters, their credibility and track record Past performance of the company Products of the company and future potential of a products Technology tie-up, if any, and the reputation of the collaborators Project cost, means of financing and profitable projections Risk factors Rating given by a credit rating agency - 91 -
  • 92. FPO (Further public offer)Existing companies, who have already issued shares, may require additional money for furtherexpansion. If they wish, they can tap if from the primary market. Such share issues will be called„follow on issues‟.2. Offer for sale Institutional investors like venture funds, private equity funds etc. invest in unlisted companywhen it is very small or at an early stage. Subsequently, when the company becomes large, theseinvestors sell their shares to the public, through issue of offer document and the company‟sshares are listed in stock exchange. This is called as offer for sale. The proceeds of this issue gothe existing investors and not to the company.3. Rights issue (RI) When a company raises funds from its existing shareholders by selling (issuing) them newshares / debentures, it is called as rights issue. The offer document for a rights issue is called asthe Letter of Offer and the issue is kept open for 30–60 days.Existing shareholders are entitled to apply for new shares in proportion to the number of sharesalready held. For e.g. in a rights issue of 1:5 ratio, the investors have the right to subscribe toone (new) share of the company for every 5 shares held by the investor.This is all about primary market. Now let‟s discuss in brief about secondary market. - 92 -
  • 93. Secondary marketSecondary market refers to a market where securities are traded after being initially offered tothe public in the primary market. Secondary market comprises of equity markets and debt mar-kets. Secondary market provides liquidity for shares issued in the primary market and determinesthe fair prices of the security. The platform for trading is provided by the stock exchanges whichare recognized by SEBI. - 93 -
  • 94. Primary Markets: The initial market that securities come from is called the “primary market.”The companies that the securities come from, the federal government and whatever other entitiesdistribute the securities that they create are included in this category. Now, I know you‟re asking“Well, don‟t stocks have to come from companies in the first place?” Indeed, they do. But inorder for a stock to be considered in the primary market, the company or other entity mustdistribute it themselves. Usually these groups rely on secondary markets to distribute theirstocks, but companies will often offer new securities or expand old ones through the primarymarket first.The primary market is also unique that the initial buyer is the only person who can exchange thesecurities for funds. So, basically, primary markets are not “exchanges” like you will see on WallStreet. They‟re from the company, you don‟t trade them, you keep them until you decide to sellthem back. Very simple. - 94 -
  • 95. Secondary MarketsSecondary Markets: When you hear about the New York Stock Exchange or other exchangesthat operate on Wall Street, you are talking about secondary markets. These markets are used fortrading stocks between persons and other entities that may purchase them. Needless to say,people involved in the secondary market usually are the ones who buy the securities in theprimary markets anyway.So, if primary markets can just sell the securities themselves, then why do they put securities intothe secondary market? Wouldn‟t it be more profitable to just sell the securities?Possibly. But, the reasoning is this: the American economic system requires the secondarymarket in order to maintain efficiency. The biggest reason? Rising and falling stocks allow forinvestors to accumulate more money. In this process, it assists the companies which originallysold the securities in receiving some sort of profit that they can put back into the company orcreate more securities.Also, secondary markets assist with market liquidity. What‟s the point of investing if there‟s nota possibility of making some sort of profit? You‟d sooner put the money in a bank account. So,the liquidity attract potential investors; the solid increase that a bank account provides is nice, butwhat if I could double or triple that profit by investing in some stock? The appeal and the riskhelp in the decision that one may make.So, now we know a little bit more as we continue on our journey through the stock market.Understanding the difference between these two is important when deciding how and what toinvest your money into, and understanding why both are important is vital to having a more richunderstanding of the stock market as a whole.What is meant by Secondary market?Secondary market refers to a market where securities are traded after being initially offeredto the public in the primary market and/or listed on the Stock Exchange. Majority of thetrading is done in the secondary market. Secondary market comprises of equity marketsand the debt markets.What is the role of the Secondary Market?For the general investor, the secondary market provides an efficient platform for trading ofhis securities. For the management of the company, Secondary equity markets serve as amonitoring and control conduit—by facilitating value-enhancing control activities, enablingimplementation of incentive-based management contracts, and aggregating informationthat guides management decisions. - 95 -
  • 96. What is the difference between the Primary Market and the Secondary Market?In the primary market, securities are offered to public for subscription for the purpose ofraising capital or fund. Secondary market is an equity-trading venue in which alreadyexisting/pre-issued securities are traded among investors. Secondary market could beeither auction or dealer market. While stock exchange is the part of an auction market,Over-the-Counter (OTC) is a part of the dealer market.Functions of Secondary MarketFunctionSecondary marketing is vital to an efficient and modern capital market.[citation needed] In thesecondary market, securities are sold by and transferred from one investor or speculator toanother. It is therefore important that the secondary market be highly liquid (originally, the onlyway to create this liquidity was for investors and speculators to meet at a fixed place regularly;this is how stock exchanges originated, see History of the Stock Exchange). As a general rule,the greater the number of investors that participate in a given marketplace, and the greater thecentralization of that marketplace, the more liquid the market.Fundamentally, secondary markets mesh the investor‟s preference for liquidity (i.e., theinvestor‟s desire not to tie up his or her money for a long period of time, in case the investorneeds it to deal with unforeseen circumstances) with the capital user‟s preference to be able touse the capital for an extended period of time.Accurate share price allocates scarce capital more efficiently when new projects are financedthrough a new primary market offering, but accuracy may also matters in the secondary marketbecause: 1) price accuracy can reduce the agency costs of management, and make hostiletakeover a less risky proposition and thus move capital into the hands of better managers, and 2)accurate share price aids the efficient allocation of debt finance whether debt offerings orinstitutional borrowing.Importance of Secondary Market:Secondary Market has an important role to play behind the developments of an efficient capital market.Secondary market connects investors favoritism for liquidity with the capital users wish of using theircapital for a longer period.For example, in a traditional partnership, a partner can not access the other partners investment butonly his or her investment in that partnership, even on an emergency basis. Then he or she can breakthe ownership of equity into parts and sell his or her respective proportion to another investor. This kindof trading is facilitated only by the secondary market. - 96 -
  • 97. What is the role of the Secondary Market?1. INVESTMENT BASICS2. SECURITIES3. PRIMARY MARKET4. SECONDARY MARKET5. DERIVATIVES6. DEPOSITORY7. MUTUAL FUNDS8. MISCELLANEOUS9. CONCEPTS & MODES OF ANALYSIS10. RATIO ANALYSIS - 97 -
  • 98. REPO MARKETDefinitionA form of short-term borrowing for dealers in government securities. The dealer sells thegovernment securities to investors, usually on an overnight basis, and buys them back thefollowing day.MeaningRepo or repurchase agreement is a window which enables a bank or a financial institution toborrow money in the short-term. In the transaction, the entity in question sells governmentsecurities or bonds to the lender with an agreement to buy the securities back after specified timeand price. It is also called a repurchase agreement.Advantages 1. Repo entails instanneous legal transfer of ownership of the legible securities . 2. It helps to promote greater integrations between the money market and the government securities 3. Repo can be used to facilitate government „s cash management 4. Repo is a very powerful and flexible money market instrument for modeling market liquidity 5. Repo also seers the purpose of an indirect instrument of monetary policy at the short end of the yield curve.Significance of repo transactionsRepo or repurchase agreement is a window which enables a bank or a financial institution toborrow money in the short-term.In the transaction the entity in question sells government securities or bonds to the lender(another bank or institution), with an agreement to buy the securities back after a specified timeand price.How is it different from other kinds of borrowing?A repo transaction is in the nature of secured borrowing; the difference between the sale andrepurchase price is the borrowing cost.It is usually very short-term in nature with the market practice being to conclude the sale andrepurchase within a timeframe of one day, to a fortnight. - 98 -
  • 99. How is the interest on a repo calculated?Although there is no separate interest pay-out, there is an implicit interest cost in the form of ahigher repurchase price. Thus, interest cost on the repo is calculated by dividing the differencebetween the sale and repurchase price by the initial sale price.Who can execute a repo/reverse repo?In India, only select institutions in the financial sector have RBIs permission to enter into repoand reverse repo transactions. Significantly, in the April 28 policy, RBI has for the first timeallowed listed corporate to participate in the repo market as lenders. - 99 -
  • 100. GOVERNMENT SECURITY MARKETIntroductionThe Govt sec. market is at the core of financial markets in most countries. It deals with tradabledebt instruments issued by the Govt. for meeting its financial requirement.Meaning of government security marketA Government security is a tradable instrument issued by the Central Government or the StateGovernments. It acknowledges the Government‟s debt obligation. Such securities are short term(usually called treasury bills, with original maturities of less than one year) or long term (usuallycalled Government bonds or dated securities with original maturity of one year or more). InIndia, the Central Government issues both, treasury bills and bonds or dated securities while theState Governments issue only bonds or dated securities, which are called the State DevelopmentLoans (SDLs). Government securities carry practically no risk of default and, hence, are calledrisk-free gilt-edged instruments. Government of India also issues savings instruments (SavingsBonds, National Saving Certificates (NSCs), etc.) or special securities (oil bonds, FoodCorporation of India bonds, fertilizer bonds, power bonds, etc.).Trading in government security marketTrading in government security is refered to as the gilt edged market. This is mostly over thecounter market and trading is confide to bank , financial institution and pfs . The role of brokersis to intermediate as between the above institutions through their contacts with the moneymarket .The government sector is a major borrower in Indian and government security representgovernment debt to the other sector of the economy .The government sector include the central and state government. These agencies or bodiesborrow every year from capital market in the form of new loans and bond floatation . - 100 -
  • 101. PRINCIPLE FUNCTION GILT EDGED MARKET PRIMARY SECONDARY MARKET MARKET WHOLESELL MARKET RETAIL MARKET RBI , BANKS FSI RBI BROKERS LIC GIC PFS OTHERS BANKS FIS PFS ETC OPERATIONS OPERATIONS LOAN ISSUE UNDERWRITING ETC . RBI BAN BROK - 101 - KS FSI , ERS PFS , ETC
  • 102. ETC ,FSI ,PFS ANKSSalient feature of government securities B1. These securities are normally issued in denomination of Rs.1,000.2. The interest on Government securities is payable half yearly. Interest in respect of Central andState Government securities exempt from income tax subject to certain limits.3. Central Government securities are more liquid than State Government and Semi-Governmentsecurities. The market activity in respect of semi-Government securities is very less.4. There are three forms of Central and State Government Securities, (i) Inscribed stock or Stockcertificate (SC) (ii)Promissory note (PN) and (iii) Bearer bond. However, at present mostgovernment securities are in the form of promissory notes(PN). Promissory notes of any loan canbe converted into stock certificates of any other loan or vice versa.5. The specific features of stock certificates (SC) are. They are safer than PN as the name of theholder is registered in the books of the Public Debt office (PDO).ii. The half-yearly interest isremitted to the holder directly by an interest warrant drawn at par on Treasury or SBI. On theother hand, interest on PN is payable only on the presentation of the note at the office at which itis enfaced.iii. Stock Certificates (SC) are not easily transferable and degree of negotiability isless. PN is a superior instrument in transferability. The title is transferable by endorsement anddelivery and it is a negotiable financial instrument. Thus,PNs are mostly preferred by Banks andSCs are preferred by LIC etc.6. Government Securities are issued through the Public Debt Office (PDO) of the RBI.7. The RBI does have its approved brokers for marketing of government securities.8. The gilt-edged market is an „over-the counter‟ market and each sale and purchase has to beseparately negotiated. Orders received locally by members of the stock exchange are passed onto the security brokers and dealers who then try various sources, among which are banks.9. Maturity Structure of Debt : With the developments taken place in the financial system, thematurity structure of government debt has considerably shortened. The longest maturity is kept atten years. Further, with the funding of Treasury Bills into maturities of less than ten years, theoverall term structure of debt has shortened. However, institutional investors like LIC preferrelatively longer maturities of more than 15 years.10. Market Structure: Government Securities are deemed to be listed on stock exchanges and assuch there is no separate listing requirement for them. The primary issues of government - 102 -
  • 103. securities are notified to the public through issue of government notification and presscommunication. SEBI has also been granted „No objection‟ to these issues without insisting onvetting of offer document. The RBI has advised the banks that, securities transactions should beundertaken directly between banks and no bank should engage the services of any brokers. Insuch transactions banks may however undertake securities transactions among themselves orwith non-bank clients through members of the NSE wherein transactions are transparent.11. Tax Deduction at Source (TDS) Interest on government securities is subject to tax deductedat source. This has led to the unhealthy practice of voucher trading around interest paymentsdates purely to gain tax advantage. The Union of Budget of 1997 has removed TDS on interestincome of government securities. This helps in improving the secondary market for governmentsecurities. - 103 -
  • 104. FOREIGN EXCHANGE MARKETINTRODUCTION The foreign exchange market is one of the important components of the internationalfinancial system. Especially, for the developing economy, the foreign exchange market isnecessary for the conversion of currencies for short- term capital flows or long term investmentsin the financial physical assets of another country. The service of the foreign exchange markets isnecessary not only for trade truncation but also other financial receipts or payments betweencountries involving a foreign exchange truncation. globally, operations in the foreign exchange market started in a major „way after thebreakdown of the bretton woods system in 1971, which also marked the beginning of floatingexchange rate regimes in several countries. Over the years, the foreign exchange market hasemerged as the largest market in the world. The decade of the 1990s witnessed a perceptiblepolicy shifts in many emerging markets towards reorientation of their financial markets in termof new products and instrument of regulatory structure consistent with the liberalized operationalframework.DEFINITION According to dr.paul elinzing “foreign exchange is the system or process of convertingone national currency into another, and of transferring money from one country to another.The market where foreign exchange transaction takes place is called a foreign exchange market.It does not refer to a market place in the physical sense of the term. In fact, it consists of anumber a dealers, banks and brokers engaged in the business of buying and selling foreignexchange. Those engaged in the foreign exchange biasness are controlled by the foreignexchange maintenance act (fema) - 104 -
  • 105. EVOLUTION OF THE FOREIGN EXCHANGE MARKET IN INDIA The origin of the foreign exchange market in india could be traced to the year 1978 whenbanks in india were permitted to undertake intra-day trade in foreign exchange. However, it wasin the 1990s, that the indian foreign exchange market witnessed far reaching changes along withthe shifts in the currency regime in india. There exchange rate of the rupee that was peggedearlier was floated partially in march 1992 and fully in march 1990, following therecommendation of the report of the high level committee on balance of payments. A further impetus to the development of the foreign exchange market in India wasprovided with the setting up of an expert group on foreign exchange markets in India, whichsubmitted its report in June 1995.the group made several recommendations for deepening andwidening of the Indian foreign exchange market. Consequently beginning from January 1996,wide –ranging reforms have been undertaken in the Indian foreign exchange market. The momentous developments over the past few years are reflected in the enhanced risk-bearing capacity of banks along with rising foreign exchange trading volumes and finer margins.The foreign exchange market has acquired depth. The conditions in the foreign exchange markethave also generally remained orderly.FUNCTIONSThe most important function of this market are: 1. To make necessary arrangements to transfer purchasing power from one country to another. 2. To provide adequate credit facilities for the promotion of foreign trade. 3. To cover foreign exchange risks by providing hedging facilities. In india, the foreign exchange business has a three –tiered structure consisting of : a. Trading between banks and their commercial customers b. Trading between banks through authorized brokers. - 105 -
  • 106. c. Trading with banks abroad.STRUCTURE OF THE FOREIGN EXCHANGE MARKET RESERVE BANK OF INDIA Foreign exchange AUTHORISED dealers association of india DEALERS (FEDAI) CUSTO MERS FOREIGN EXCHNAGE MONEY CHANGESThe foreign exchange market is a three – tier structure comprising a. The reserve bank at the apex. b. Authorized dealers licensed by the reserve bank c. Customer such as exports and imports, corporate and other foreign exchange earners.Dealing in the foreign exchange market include transaction between authorized dealers and theexports, importers and other customers, transaction among authorized dealers themselves,transactions with overseas banks and transaction between authorized dealers and the reservebank. - 106 -
  • 107. MARKET PLAYERSThe players in the Indian market include a. Ads, mostly banks who are authorized to deal in foreign exchange. b. Foreign exchange brokers who act as intermediaries, and c. Customer –individuals, corporate, who need foreign exchange for their transactions.INSTRUMENT OF CREDIT TRADEDIn addition to conversion of foreign currency notes and cash, a number of instruments of creditare used for effecting conversion in the foreign exchange market. These instruments are: 1. Telegraphic transfer (tt) 2. Mail transfer (mt) 3. Drafts and cheques 4. Bills of exchangeFOREIGN EXCHANGE MARKET COMPONENTSThere are three major components in this market, depending upon the transaction: 1. Transaction between the public and the banks at the base level: 2. Transaction between the banks dealing in foreign exchange involving conversion of currencies: and 3. Transaction between banks and the central bank involving purchase and sale of foreign currencies. - 107 -
  • 108. ASIAN CLEARING UNIONS For many years now, regional co-operation for benefiting trade and payments has been a subject of serious consideration all over the world. In the Asian region, the initiative on these matters was taken by the ecafe (since renamed as economics and social council for Asia and pacific) and as a first step for securing regional co-operation amongst its members, the Asian clearing unions was established on 9th December 1974. ACU was set up with the objectives of- 1. Facilitating payments for current international transactions within the ecafe region on a multilateral basis: 2. Reducing the use of extra –regional reserve currencies to settle such transaction by promoting the use of the participants currencies or asian monetary units 3. Effecting their by economies in the use of foreign exchange and a reduction in the cost of making payment foe such transaction and 4. Contributing to the expansion of trade and promotion of monetary co- operation among the countries of the area.DOLLAR CERTIFICATES OF DEPOSIT an extension to the eurodollar market began in 1966 with the issue in London of negotiable dollar certificate of deposit. These are interest –bearing securities of six month or one year but with a maximum of five years. Cds were an American innovation introduced on a wide scale in the United States 1961. Their success, notably with corporate customers of united sates banks, promoted New York based banks to issue them on the London market. - 108 -

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