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$$ Final indian finanacial system 2$

  1. 1. Indian Financial System1 Thakur College Of Science & Commerce
  2. 2. Indian Financial System E XECUTIVE S UMMARYIn 1990s, the balance of payments position facing the country had becomecritical and foreign exchange reserves had depleted to dangerously lowlevels i.e. $585 million, which was sufficient for financing just one week ofIndias exports.Since the initiation of reforms in the early 1990s, the Indian economy hasachieved high growth in an environment of macroeconomic and financialstability.The period has been marked by broad based economic reform that hastouched every segment of the economy. These reforms were designedessentially to promote greater efficiency in the economy through promotionof greater competition.The story of Indian reforms is by now well-documented, nevertheless, whatis less appreciated is that India achieved this acceleration in growth whilemaintaining price and financial stability.As a result of the growing openness, India was not insulated fromexogenous shocks since the second half of the 1990s. These shocks, globalas well as domestic, included a series of financial crises in Asia, Brazil andRussia, 9/11 terrorist attacks in the US, border tensions, sanctions imposedin the aftermath of nuclear tests, political uncertainties, changes in theGovernment, and the current oil shock. Nonetheless, stability could bemaintained in financial markets. 2 Thakur College Of Science & Commerce
  3. 3. Indian Financial SystemIndeed, inflation has been contained since the mid-1990s to an average ofaround five per cent, distinctly lower than that of around eight per cent perannum over the previous four decades. Simultaneously, the health of thefinancial sector has recorded very significant improvement.Indias path of reforms has been different from most other emerging marketeconomies: it has been a measured, gradual, cautious, and steady process,devoid of many flourishes that could be observed in other countries.Reforms in these sectors have been well-sequenced, taking into account thestate of the markets in the various segments.The main objective of the financial sector reforms in India initiated in theearly 1990s was to create an efficient, competitive and stable financial sectorthat could then contribute in greater measure to stimulate growth.For efficient price discovery of interest rates and exchange rates in theoverall functioning of financial markets, the corresponding development ofthe money market, Government securities market and the foreign exchangemarket became necessary. Reforms in the various segments, therefore, hadto be coordinated. In this process, growing integration of the Indianeconomy with the rest of the world also had to be recognized and providedfor.Till the early 1990s the Indian financial system was characterized byextensive regulations such as administered interest rates, directed creditprogrammes, weak banking structure, lack of proper accounting and risk 3 Thakur College Of Science & Commerce
  4. 4. Indian Financial Systemmanagement systems and lack of transparency in operations of majorfinancial market participants. Such a system hindered efficient allocation ofresources.Financial sector reforms initiated in the early 1990s have attempted toovercome these weaknesses in order to enhance efficiency of resourceallocation in the economy.Simultaneously, the Reserve Bank took a keen interest in the developmentof financial markets, especially the money, government securities and forexmarkets in view of their critical role in the transmission mechanism ofmonetary policy. As for other central banks, the money market is the focalpoint for intervention by the Reserve Bank to equilibrate short-term liquidityflows on account of its linkages with the foreign exchange market.Similarly, the Government securities market is important for the entire debtmarket as it serves as a benchmark for pricing other debt marketinstruments, thereby aiding the monetary transmission process across theyield curve.The Reserve Bank had, in fact, been making efforts since 1986 to developinstitutions and infrastructure for these markets to facilitate price discovery.These efforts by the Reserve Bank to develop efficient, stable and healthyfinancial markets accelerated after 1991. There has been close co-ordinationbetween the Central Government and the Reserve Bank, as also betweendifferent regulators, which helped in orderly and smooth development of thefinancial markets in India. 4 Thakur College Of Science & Commerce
  5. 5. Indian Financial System INDIAN FINANCIAL SYSTEM Introduction Features of Financial System Role of Financial System Back Drop of Financial System Indian Financial System from 1950 – 1980 Indian Financial System Post 1990’s 5 Thakur College Of Science & Commerce
  6. 6. Indian Financial SystemINTRODUCTIONThe 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 interrelationships are also the parts of the system. These parts are not alwaysmutually exclusive. For example, the financial institution operate infinancial market and are, therefore a part of such market. The word systemin the term financial system implies a set of complex and closely connectedor inters mixed institution, agents practices, markets, transactions, claims, &liabilities in the economy. The financial system is concerned about money,credit, & finance – the terms intimately related yet some what different fromeach other. Money refers to the current medium of exchange or means ofpayment. Credit or Loan is a sum of money to be returned normally withInterest it refers to a debt of economic unit. Finance is a monetary resourcescomprising debt & ownership fund of the state, company or person. 6 Thakur College Of Science & Commerce
  7. 7. Indian Financial SystemFEATURES OF FINANCIAL SYSTEM -: 1. It provides an Ideal linkage between depositors savers and Investors Therefore it encourages savings and investment. 2. Financial system facilitates expansion of financial markets over a period of time. 3. Financial system should promote deficient allocation of financial resources of socially desirable and economically productive purpose. 4. Financial system influence both quality and the pace of economic development.ROLE OF FINANCIAL SYSTEM: The role of the financial system is to promote savings & investments in the economy. It has a vital role to play in the productive process and in the mobilization of savings and their distribution among the various productive activities. Savings are the excess of current expenditure over income. The domestic savings has been categorized into three sectors, household, government & private sectors. The savings from household sector dominates the domestic savings component. The savings will be in the form of currency, bank deposits, non bank deposits, life insurance funds, provident funds, pension funds, shares, debentures, bonds, units & trade debts. All of these currency & deposits are voluntary transactions & precautionary measures. The 7 Thakur College Of Science & Commerce
  8. 8. Indian Financial Systemsavings in the household sector are mobilized directly in the form ofunits, premium, provident fund, and pension fund. These are thecontractual forms of savings. Financial actively deals with theproduction, distribution & consumption of goods and services. Thefinancial system will provide inputs to productive activity. Financialsector provides inputs in the form of cash credit & assets in financialfor production activities.The function of a financial system is to establish a bridge between thesavers and investors. It helps in mobilization of savings to materializeinvestment ideas into realities. It helps to increase the output towardsthe existing production frontier. The growth of the banking habit helpsto activate saving and undertake fresh saving. The financial systemencourages investment activity by reducing the cost of finance risk. Ithelps to make investment decisions regarding projects by sponsoring,encouraging, export project appraisal, feasibility studies, monitoring &execution of the projects. 8 Thakur College Of Science & Commerce
  9. 9. Indian Financial System An overview of Financial System and Financial Markets in India MINISTRY OF FINANCEFinancial Institutions RBI SEBI IRDA Insurance company Mutual Fund Venture Capital Capital Market Fund LIC & GIC & Other Other Commercial NBFC Money Market Banks Primary Secondary Market MarketDevelopment Investment Sectoral State Level Banks Banks Banks Financial Institution Government Stock Security Exchange Market 9 Thakur College Of Science & Commerce
  10. 10. Indian Financial SystemBACK DROP OF INDIAN FINANCIAL SYSTEMAt the time of independence, India had a reasonably diversified financialsystem in terms of intermediaries but a somewhat narrow focus on terms of Industry’s share in credit doubled, agriculture, rural areas, SSI, exports still RRBs setup neglected 1980s 1990s 1947 1970s 1960s NABARD, EXIM, SIDBI, Nationalisation of Banks to NHB setup Credit to Industry / Govt ensure credit allocation as per doubledNeglected: long term, agricultural, and rural area credit plan priorities Highly segmented financialNeed for specialized FIs felt. market, highly restrictedDFIs, SFCs, UTI, Co-op Banks setup.intermediation, i.e., a lack of a long term capital market and the relativeneglect of agriculture in particular and rural areas in general.As India embarked on a process of industrialization and growth, RBI set upDevelopment Financial Institutions (DFI’s) and State Finance Corporations(SFC’s) as providers of long term capital. Agriculture’s need for credit wasmet by cooperative banks. UTI was set up to canalize resources from retailinvestors to the capital market.In essence, the understanding that requirement of financial needs foraccelerated growth and development was best met by specialized financial 10 Thakur College Of Science & Commerce
  11. 11. Indian Financial Systemintermediaries who performed specialized functions influenced financialmarket architecture.To ensure that these specializations were adhered to, financial intermediariesdeveloped and promoted by the Reserve Bank of India had significantrestrictions on both the asset and liabilities side of their balance sheets.In the 1950s and 1960s, despite an expansion of the commercial bankingsystem in terms of both reach and mobilization of resources, agriculture stillremained under funded and rural areas under banked. Whereas industry’sshare in credit disbursed almost doubled between 1951 and 1968, from 34 to67.5%, agriculture got barely 2% of available. Credit to exports and smallscale industries were relatively neglected as well.In view of the above, it was decided to nationalize the banking sector so thatcredit allocation could take place in accordance in plan priorities.Nationalization took place in two phases, with a first round in 1969 followedby another in 1980.By the mid-seventies it was felt that commercialized banks did not havesufficient expertise in rural banking and hence in 1975 Regional RuralBanks (RRBs) were set up to help bring rural India into the ambit of thefinancial network. This effort was capped in 1980 with the formation ofNational Bank for Agriculture and Rural Development (NABARD), whichwas to function as an apex bank for all cooperative banks in the country,helping control and guide their activities. NABARD was also given theremit of regulating rural credit cooperatives. 11 Thakur College Of Science & Commerce
  12. 12. Indian Financial SystemFollowing with the logic of specialization, the 1980s saw other DFIs withspecific remits being set up – e.g. The EXIM Bank for export financing, theSmall Industries Development Bank of India (SIDBI) for small scaleindustries and the National Housing Bank (NHB) for housing finance.Long term finance for the private sector came from DFIs and institutionalinvestors or through the capital market. However both price and quantity ofcapital issues was regulated by the Controller of Capital Issues.At least one indicator of the fact that the strategy paid off in deepeningfinancial intermediation is the near doubling of the M3/GDP (see For moredetails on various types of money supplies) ratio from 24.1% in 1970/71 to48.5 in 1990/91. Over the same period, bank credit to the commercial sectoras a proportion of GDP more than doubled from 14.3 to 30.2%. Howevernet bank credit to government (including lending by the Reserve Bank)doubled as well, from 12 to 24.6%.Therefore the deepening of financial intermediation had occurred with anincrease in the draft by both the commercial sector and the government onfinancial resources mobilized.At the end of the 1980s then the Indian financial system was characterizedby segmented financial markets with significant restrictions on both theasset and liability side of the balance sheet of financial intermediaries aswell as the price at which financial products could be offered. 12 Thakur College Of Science & Commerce
  13. 13. Indian Financial SystemIn the Indian context segmentation meant that competition was muted. In ascenario where price was determined from outside the system and targetswere set in terms of quantities, there was no pressure for non-pricecompetition as well. As a result the financial system had relatively hightransaction costs and political economy factors meant that asset quality wasnot a prime concern. Therefore even though the Indian financial system atthe end of 1980s had achieved substantial expansion in terms of access, thishad come at the cost of asset quality. In addition, was the fact that the draftof the government on resources of the financial system had increasedsignificantly. This in itself need necessarily was not a problem but over thisperiod, i.e., the 1980s, the composition of government expenditure waschanging as well, with shift towards current rather than capital expenditure.In addition, in the absence of a reasonably liquid market for governmentsecurities, an increase in net bank lending to the government meant that theasset side of banks’ balance sheets tended to become increasingly illiquid.The impetus for change came from one expected and one unexpectedquarter - first, the importance of prudential capital adequacy ratios wasunderlined by the announcement of BaselI norms (see ) That banks wereexpected to adhere to; second the macroeconomic crisis of 1990-91.The reform process that followed accelerated the process of liberalizationalready begun in the 1980s and began a series of measured and deliberatesteps to integrate India into the global economy, including the globalfinancial network. 13 Thakur College Of Science & Commerce
  14. 14. Indian Financial SystemBriefly however, given the problems facing the financial system andkeeping in mind the institutional changes necessary to help India financiallyintegrate into the global economy, financial reform focused on thefollowing: improving the asset quality on bank balance sheets in particularand operational efficiency in general; increasing competition by removingregulatory barriers to entry; increasing product competition by removingrestrictions on asset and liability sides of financial intermediaries; allowingfinancial intermediaries freedom to set their prices; putting in place a marketfor government securities; and improving the functioning of the call moneymarket.The government security market was particularly important not onlybecause it was decided the RBI would no longer monetize the fiscal deficit,which would now be financed by directly borrowing from the market, butalso monetary policy would be conducted through open market operationsand a large liquid bond market would help the RBI sterilise, if necessary,foreign exchange movements. 14 Thakur College Of Science & Commerce
  15. 15. Indian Financial System INDIAN FINANCIAL SYSTEM FROM 1950 TO 1980 – Indian Financial System During this period evolved in response to theobjective of planned economic development. With the adoption of mixedeconomy as a pattern of industrial development, a complimentary role wasconceived for public and private sector. There was a need to align financialsystem with government economic policies. At that time there wasgovernment control over distribution of credit and finance. The mainelements of financial organization in planned economic development are asfollows:-1. Public ownership of financial institutions –The nationalization of RBI was in 1948, SBI was set up in 1956, LIC camein to existence in 1956 by merging 245 life insurance companies in 1969, 14major private banks were brought under the direct control of Government ofIndia. In 1972, GIC was set up and in 1980; six more commercial bankswere brought under public ownership. Some institutions were also set upduring this period like development banks, term lending institutions, UTIwas set up in public sector in 1964, provident fund, pension fund was set up.In this way public sector occupied commanding position in Indian FinancialSystem.2. Fortification Of Institutional structure –Financial institutions should stimulate / encourage capital formation in theeconomy. The important feature of well developed financial system is 15 Thakur College Of Science & Commerce
  16. 16. Indian Financial Systemstrengthening of institutional structures. Development banks was set up withthis objective like industrial finance corporation of India (IFCI) was set upin 1948, state financial corporation (SFCs) were set up in 1951, Industrialcredit and Investment corporation of India Ltd (ICICI)was set up in 1955. Itwas pioneer in many respects like underwriting of issue of capital,channelisation of foreign currency loans from World Bank to privateindustry. In 1964, Industrial Development of India (IDBI).3. Protection of Investors –Lot many acts were passed during this period for protection of investors infinancial markets. The various acts Companies Act, 1956 ; Capital IssuesControl Act, 1947 ; Securities Contract Regulation Act, 1956 ; Monopoliesand Restrictive Trade Practices Act, 1970 ; Foreign Exchange RegulationAct, 1973 ; Securities & Exchange Board of India, 1988.4. Participation in Corporate Management –As participation were made by large companies and financial instruments itleads to accumulation of voting power in hands of institutional investors inseveral big companies financial instruments particularly LIC and UTI wereable to put considerable pressure on management by virtual of their votingpower. The Indian Financial System between 1951 and mid80’s was broadbased number of institutions came up. The system was characterized bydiversifying organizations which used to perform number of functions. TheFinancial structure with considerable strength and capability of supplyingindustrial capital to various enterprises was gradually built up the wholefinancial system came under the ownership and control of public authoritiesin this manner public sector occupy a commanding position in the industrial 16 Thakur College Of Science & Commerce
  17. 17. Indian Financial Systementerprises. Such control was viewed as integral part of the strategy ofplanned economy development. INDIAN FINANCIAL SYSTEM POST 1990’SThe organizations of Indian Financial system witnessed transformation afterlaunching of new economic policy 1991. The development process shiftedfrom controlled economy to free market for these changes were made in theeconomic policy. The role of government in business was reduced themeasure trust of the government should be on development of infrastructure,public welfare and equity. The capital market an important role in allocationof resources. The major development during this phase are:-1. Privatisation of Financial Institutions – At this time many institutions were converted in to public company andnumber of private players were allowed to enter in to various sectors: a) Industrial Finance Corporation on 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. 17 Thakur College Of Science & Commerce
  18. 18. Indian Financial System 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. 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 Structure –The importance of development financial institutions decline with shift tocapital market for raising finance commercial banks were give more fundsto investment in capital market for this. SLR and CRR were produced; SLRearlier @ 38.5% was reduced to 25% and CRR which used to be 25% is atpresent 5%. Permission was also given to banks to directly undertakeleasing, hire-purchase and factoring business. There was trust ondevelopment of primary market, secondary market and money market.3. Investors Protection – SEBI is given power to regulate financial markets and the variousintermediaries in the financial markets. 18 Thakur College Of Science & Commerce
  19. 19. Indian Financial System FINANCIAL MARKET Money Market Call Money Market Commercial Paper Certificate of Deposit Treasury Bill Market Money Market Mutual Fund Capital Market International Capital Market 19 Thakur College Of Science & Commerce
  20. 20. Indian Financial SystemMONEY MARKET AND GOVT. SECURITIES MARKETMoney market deal with short term monetary assets and claims, which aregenerally from one day to one year duration.Govt. securities on the other hand are also called dated securities to denotethat they are generally long term in nature and are issued by state and centralgovt. under their borrowing programmes and duration of more than oneyear, generally of 5 years and above.These securities being long term in nature are also traded in govt. securitiesmarket between institution and banks also on the stock exchanges- debtsegments.MONEY MARKETOne of the important function of a well developed money market is tochannelize saving into short term productive investments like workingcapital. Call money market, treasury bills market and markets forcommercial paper and certificate of deposit are some of the example ofmoney market.CALL MONEY MARKETThe call money markets form a part of the national money market, whereday –to- day surplus funds, mostly of banks are traded . The call moneyloans are very short term in nature and the maturity period of this vary from1 to 15 days. The money which is lent for one day in this market is known as 20 Thakur College Of Science & Commerce
  21. 21. Indian Financial System“call money”, and if it exceeds one day (but less than 15 days), is referred as“notice money” in this market any amount could be lent or borrowed at aconvenient interest rate . Which is acceptable to both borrower and lender.these loans are consider as highly liquid as they are repayable on demandat the option of ether the lender or borrower.PURPOSECall money is borrowed from the market to meet various requirements ofcommercial bill market and commercial banks. Commercial bill marketborrower call money for short period to discount commercial bills.Banks borrower in call market to:1:- Fill the temporary gaps, or mismatches that banks normally face.2:- Meet the cash Reserve Ratio requirement.3: - Meet sudden demand for fund, which may arise due to large paymentand remittance.Banks usually borrow form the market to avoid the penal interest rate for notmeeting CRR requirement and high cost of refinance from RBI. Call moneyhelps the banks to maintain short term liquidity position at comfortablelevel.LOCATIONIn India call money markets are mainly located in commercial centers andbig industrial centers and industrial center such as Mumbai, Calcutta,Chennai, Delhi and Ahmedabad. As BSE and NSE and head office of RBI 21 Thakur College Of Science & Commerce
  22. 22. Indian Financial Systemand many other banks are situated in Mumbai; the volume of funds involvedin call money market in Mumbai is far bigger than other cities.PARTICIPANTSInitially, only few large banks were operating in the bank market. howeverthe market had expanded and now scheduled , non scheduled commercialbanks foreign banks ,state , district, and urban cooperative banks , financialinstitution such as LIC,UTI,GIC, and its subsidiaries , IDBI, NABARD,IRBI, ECGC, EXIM Bank, IFCI, NHB , TFCI, and SIDBI, Mutual fundsuch as SBI Mutual fund . LIC Mutual funds. And RBI Intermediaries likeDFHI and STCI are participants in local call money markets. However RBIhas recently introduced restriction on some of the participants to phase themout of call money market in a time bound manner.Participant in call money market are split into two categories1:- BORROWER AND LENDER:-This comprises entities those who can both borrower and lend in thismarket, such as RBI, intermediaries like DFHI, and STCI and commercialbanks.2:- ONLY LENDER: -This category comprises of entities those who can act only as lender, likefinancial institution and mutual funds. 22 Thakur College Of Science & Commerce
  23. 23. Indian Financial SystemCALL RATESThe interest paid on call loan is known as the call rates. Unlike in the case ofother short and long rates. The call rate is expected to freely reflect the dayto day availability and long rates. These rates vary highly from day to day.Often from hour to hour. While high rates indicate a tightness of liquidityposition in market. The rate is largely subject to be influenced by sources ofsupply and demand for funds.The call money rate had fluctuated from time to time reflecting the seasonalvariation in fund requirements. Call rates climbs high during busy seasons inrelation to those in slack season. These seasonal variations were high due toa limited number of lender and many borrowers. The entry of financialinstitution and money market mutual funds into the call market has reducedthe demand supply gap and these fluctuations gradually came down inrecent years.Though the seasonal fluctuations were reduced to considerable extent, thereare still variations in the call rates due to the following reason:1:- large borrower by banks to meet the CRR requirements on certain datescause a gate demand for call money. These rates usually go up during thefirst week to meet CRR requirements and decline afterwards.2:- the sanction of loans by banks, in excess of their own resources compelthe bank to rely on the call market. Banks use the call market as a source offunds for meeting dis-equilibrium of inflow and out flow of fund s. 23 Thakur College Of Science & Commerce
  24. 24. Indian Financial System3:- the withdrawal of funds to pay advance tax by the corporate sector leadsto steep increase in call money rates in the market.COMMERCIAL PAPERCommercial paper are short term, unsecured promissory notes issued at adiscount to face value by well- known companies that are financial strongand carry a high credit rating . They are sold directly by the issuers toinvestor, or else placed by borrowers through agents like merchant banksand security houses the flexible maturity at which they can be issued are oneof the main attraction for borrower and investor since issues can be adaptedto the needs of both. The CP market has the advantage of giving highly ratedcorporate borrowers cheaper fund than they could obtain from the bankswhile still providing institutional investors with higher interest earning thanthey could obtain form the banking system the issue of CP imparts a degreeof financial stability to the systems as the issuing company has an incentiveto remain financially strong.THE FEATURES OF CP 1. They are negotiable by endorsement and delivery. 2. They are issued in multiple of Rs 5 lakhs. 3. The maturity varies between 15 days to a year. 4. No prior approval of RBI is needed for CP issued. 5. The tangible net worth issuing company should not be less than 4 lakhs 6. The company fund based working capital limit should not less than Rs 10 crore. 24 Thakur College Of Science & Commerce
  25. 25. Indian Financial System7. The issuing company shall have P2 and A2 rating from CRISIL and ICRA.CERTIFICATE OF DEPOSITCertificate of Deposits,. Instruments such as the Certificates of Deposit(CDs introduced in 1989), Commercial Paper (CP introduced in 1989),inter-bank participation certificates (with and without risk) wereintroduced to increase the range of instruments. Certificates of Depositare basically negotiable money market instruments issued by banks andfinancial institutions during tight liquidity conditions. Smaller bankswith relatively smaller branch networks generally mobilise CDs. As CDsare large size deposits, transaction costs on CDs are lower than retaildepositsFEATURES OF CD 1. All scheduled bank other than RRB and scheduled cooperative bank are eligible to issue CDs. 2. CDs can be issued to individuals, corporation, companies, trust, funds and associations. NRI can subscribe to CDs but only on a non- repatriation basis. 3. They are issued at a discount rate freely determined by the issuing bank and market. 4. They issued in the multiple of Rs 5 lakh subject to minimum size of each issue of Rs is 10 lakh. 25 Thakur College Of Science & Commerce
  26. 26. Indian Financial System 5. The bank can issue CDs ranging from 3 month t 1 year , whereas financial institution can issue CDs ranging from 1 year to 3 years.TREASURY BILLS MARKET:-Treasury bills are the main financial instruments of money market. Thesebills are issued by the government. The borrowings of the government aremonitored & controlled by the central bank. The bills are issued by the RBIon behalf of the central government. The RBI is the agent of UnionGovernment. They are issued by tender or tap. The bills were sold to thepublic by tender method up to 1965. These bills were put at weeklyauctions. A treasury bill is a particular kind of finance bill. It is a promissorynote issued by the government. Until 1950 these bills were also issued bythe state government. After 1950 onwards the central government has theauthority to issue such bills. These bills are greater liquidity than any otherkind of bills. They are of two kinds: a) ad hoc, b) regular.Ad hoc treasury bills are issued to the state governments, semi governmentdepartments & foreign ventral banks. They are not marketable. The ad hocbills are not sold to the banks & public. The regular treasury bills are sold tothe general public & banks. They are freely marketable. These bills are soldby the RBI on behalf of the central government.The treasury bills can be categorized as follows:- 26 Thakur College Of Science & Commerce
  27. 27. Indian Financial System1) 14 days treasury bills:- The 14 day treasury bills has been introduced from 1996-97. These bills are non-transferable. They are issued only in book entry system they would be redeemed at par. Generally the participants in this market are state government, specific bodies & foreign central banks. The discount rate on this bill will be decided at the beginning of the year quarter.2) 28 days treasury bills:- These bills were introduced in 1998. The treasury bills in India issued on auction basis. The date of issue of these bills will be announced in advance to the market. The information regarding the notified amount is announced before each auction. The notified amount in respect of treasury bills auction is announced in advance for the whole year separately. A uniform calendar of treasury bills issuance is also announced.3) 91 days treasury bills:- The 91 days treasury bills were issued from July 1965. These were issued tap basis at a discount rate. The discount rates vary between 2.5 to 4.6% P.a. from July 1974 the discount rate of 4.6% remained uncharged the return on these bills were very low. However the RBI provides rediscounting facility freely for this bill.4) 182 days treasury bills:- The 182 days treasury bills was introduced in November 1986. The chakravarthy committee made recommendations regarding 182 day 27 Thakur College Of Science & Commerce
  28. 28. Indian Financial System treasury bills instruments. There was a significant development in this market. These bills were sold through monthly auctions. These bills were issued without any specified amount. These bills are tailored to meet the requirements of the holders of short term liquid funds. These bills were issued at a discount. These instruments were eligible as securities for SLR purposes. These bills have rediscounting facilities.5) 364 days treasury bills:- The 364 treasury bills were introduced by the government in April 1992. These instruments are issued to stabilise the money market. These bills were sold on the basis of auction. The auctions for these instruments will be conducted for every fortnight. There will be no indication when they are putting auction. Therefore the RBI does not provide rediscounting facility to these bills. These instruments have been instrumental in reducing, the net RBI credit to the government. These bills have become very popular in India.Money Market Mutual Funds (MMMFs) The benefits of developments in the various in the money market like cell money loans. Treasury bills, commercial papers and certificate of deposits were available only to the few institutional participants in the market. The main reason for this was that huge amounts were required to be invested in these instruments, the minimum being Rs. 10 lack, which was beyond the means of individual money markets to small investors. 28 Thakur College Of Science & Commerce
  29. 29. Indian Financial SystemMMMFs are mutual funds that invest primarily in money marketinstruments of very high quality and of very short maturities.MMMFs can be set up by very high quality and of very shortmaturities. MMMFs can be set up by commercial bank, RBI andpublic financial institution either directly or through their existingmutual fund subsidiaries. The guidelines with respect to mobilizationof funds by MMMFs provide that only individuals are allowed toinvest in such funds.Earlier these funds were regulated by the RBI. But RBI withdrew itsguidelines, with effect form March 7, 2001 and now they aregoverned by SEBI.The schemes offered by MMMfs can either by open – ended or close-ended. In case of open- ended schemer, the units are available forpurchase on a continuous basis and the MMMFs would be willing torepurchase the units. A close –ended scheme is available forsubscription for a limited period and is redeemed at maturity.The guidelines on the on MMMfs specify a minimum lock – in periodof 15 days during which the investor cannot redeem his investment.The guidelines also stipulate the minimum size of the MMMF to beRs. 50 crore and this should not exceed 2% of the aggregate depositsof the latest accounting year in the case of banks and 2% of the long-term domestic borrowings in the case of public financial institutions. 29 Thakur College Of Science & Commerce
  30. 30. Indian Financial System Structure of capital market CAPITAL MARKET Secondary Market Primary Market Listing Trading Practices of Settlements & ClearingMethod of Quantum Costs ofIssue of Issue IssuePublic Right Issue Bonus PrivateIssue Issue Placement Players Operation 30 Thakur College Of Science & Commerce
  31. 31. Indian Financial System Companies (Issuer) Instruments Interest RatesIntermediaries (Merchant Banks FIIs & Broker) Procedures Investor (Public) CAPITAL MARKET Capital market is market for long term securities. It contains financial instruments of maturity period exceeding one year. It involves in long term nature of transactions. It is a growing element of the financial system in the India economy. It differs from the money market in terms of maturity period & liquidity. It is the financial pillar of industrialized economy. The development of a nation depends upon the functions & capabilities of the capital market. Capital market is the market for long term sources of finance. It refers to meet the long term requirements of the industry. Generally the business concerns need two kinds of finance:- 1. Short 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. The long term requirements of the funds to the corporate sector are supplied by the capital market. It refers to the institutional arrangements which facilitate the lending & borrowing of long term funds. IMPORTANCE OF CAPITAL MARKET 31 Thakur College Of Science & Commerce
  32. 32. Indian Financial SystemCapital market deals with long term funds. These funds are subject touncertainty & risk. Its supplies long term funds & medium term funds to thecorporate sector. It provides the mechanism for facilitating capital fundtransactions. It deals I ordinary shares, bond debentures & stocks &securities of the governments. In this market the funds flow will come fromsavers. It converts financial assets in to productive physical assets. Itprovides incentives to savers in the form of interest or dividend to theinvestors. It leads to the capital formation. The following factors play animportant role in the growth of the capital market:- • A strong & powerful central government. • Financial dynamics • Speedy industrialization • Attracting foreign investment • Investments from NRI’s • Speedy implementation of policies • Regulatory changes • Globalization • The level of savings & investments pattern of the household sectors • Development of financial theories • Sophisticated technological advances.PLAYERS IN THE CAPITAL MARKETCapital market is a market for long term funds. It requires a well structuredmarket to enhance the financial capability of the country. The market consista number of players. They are categorized as:- 1. Companies 32 Thakur College Of Science & Commerce
  33. 33. Indian Financial System 2. Financial intermediaries 3. Investors.I. COMPANIES: Generally every company which is a public limited company can access the capital market. The companies which are in need of finance for their project can approach the market. The capital market provides funds from the savers of the community. The companies can mobilize the resources for their long term needs such as project cost, expansion & diversification of projects & other expenditure of India to raise the capital from the market. The SEBI is the most powerful organization to monitor, control & guidance the capital market. It classifies the companies for the issue of share capital as new companies, existing unlisted companies& existing listed companies. According to its guidelines a company is a new company if it satisfies all the following:- a) The company shall not complete 12 months of commercial operations. b) Its audited operative results are not available. c) The company may set up by entrepreneurs with or without track record. A company which can be treated as existing listed company, if its shares are listed in any recognized stock exchange in India. A company is said to be an existing unlisted company if it is a closely held or private company.II. FINANCIAL INTERMEDIARIES: Financial intermediaries are those who assist in the process of converting savings into capital formation in the country. A strong 33 Thakur College Of Science & Commerce
  34. 34. Indian Financial System capital formation process is the oxygen to the corporate sector. Therefore the intermediaries occupy a dominant role in the capital formation which ultimately leads to the growth of prosperous to the community. Their role in this situation cannot be. The government should encourage these intermediaries to build a strong financial empire for the country. They are also being called as financial architectures of the India digital economy. Their financial capability cannot be measured. They take active role in the capital market. The major intermediaries in the capital market are:- a) Brokers. b) Stock brokers & sub brokers c) Merchant bankers d) Underwriters e) Registrars f) Mutual funds g) Collecting agents h) Depositories i) Agents j) Advertising agenciesIII. INVESTORS: The capital market consists many numbers of investors. All types of investor’s basic objective is to get good returns on their investment. Investment means, just parking one’s idle fund in a right parking place for a stipulated period of time. Every parked vehicle shall be taken away by its owners from parking place after 34 Thakur College Of Science & Commerce
  35. 35. Indian Financial System a specific period. The same process may be applicable to the investment. Every fund owner may desire to take away the fund after a specific period. Therefore safety is the most important factor while considering the investment proposal. The investors comprise the financial investment companies & the general public companies. Usually the individual savers are also treated as investors. Return is the reward to the investors. Risk is the punishment to the investors for being wrong selection of their investment decision. Return is always chased by the risk. An intelligent investor must always try to escape the risk & attract the return. All rational investors prefer return, but most investors are risk average. They attempt to get maximum capital gain. The return can be available to the investors in two types they are in the form of revenue or capital appreciation. Some investors will prefer for revenue receipt & others prefer capital appreciation. It depends upon their economic status & the effect of tax implications.STRUCTURE OF THE CAPITAL MARKET IN INDIAThe structure of the capital market has undergone vast changes in recentyears. The Indian capital market has transformed into a new appearance overthe last four & a half decades. Now it comprises an impressive network offinancial institutions & financial instruments. The market for already issuedsecurities has become more sophisticated in response to the different needsof the investors. The specialized financial institutions were involved inproviding long term credit to the corporate sector. Therefore the premierfinancial institutions such as ICICI, IDBI, UTI, and LIC & GIC constitute 35 Thakur College Of Science & Commerce
  36. 36. Indian Financial Systemthe largest segment. A number of new financial instruments & financialintermediaries have emerged in the capital market. Usually the capitalmarkets are classified in two ways:- A. On the basis of issuer B. On the basis of instrumentsOn the basis of issuer the capital market can be classified again two types:- a) Corporate securities market b) Governments securities marketOn the basis of financial instruments the capital markets are classifieds intotwo kinds:- a) Equity market b) Debt marketRecently there has been a substantial development of the India capitalmarket. It comprises various submarkets.Equity market is more popular in India. It refers to the market for equityshares of existing & new companies. Every company shall approach themarket for raising of funds. The equity market can be divided into twocategories (a) primary market (b) secondary market. Debt market representsthe market for long term financial instruments such as debentures, bonds,etc.PRIMARY MARKETTo meet the financial requirement of their project company raise theircapital through issue of securities in the company market. 36 Thakur College Of Science & Commerce
  37. 37. Indian Financial SystemCapital issue of the companies were controlled by the capital issue controlact 1947. Pricing of issue was determined by the controller of capital issuethe main purpose of control on capital issue was to prevent the diversion ofinvestible resources to non- essential projects. Through the necessity ofretaining some sort of control on issue of capital to meet the above purposestill exist . The CCI was abolished in 1992 as the practice of governmentcontrol over the capital issue as well as the overlapping of issuing has lostits relevance in the changed circumstances. SECURITIES & EXCHANGE BOARD OF INDIAINTRODUCTION:It was set up in 1988 through administrative order it became statutory bodyin 1992. SEBI is under the control of Ministry of Finance. Head office is atMumbai and regional offices are at Delhi, Calcutta and Chennai. Thecreation of SEBI is with the objective to replace multiple regulatorystructures. It is governed by six member board of governors appointed bygovernment of India and RBI.OBJECTIVES OF SEBI: 1. To protect the interest of investors in securities. 2. To regulate securities market and the various intermediaries in the market. 3. To develop securities market over a period of time.POWERS AND FUNCTIONS OF SEBI: 37 Thakur College Of Science & Commerce
  38. 38. Indian Financial System(1)ISSUE GUIDELINES TO COMPANIES:- SEBI issues guidelines to the companies for disclosing information and to protect the interest of investor. The guidelines relates to issue of new shares, issue of convertible debentures, issue by new companies, etc. After abolition of capital issues control act, SEBI was given powers to control and regulate new issue market as well as stock exchanges.(2)REGULATION OF PORTFOLIO MANAGEMENT SERVICES:- Portfolio Management services were brought under SEBI regulations in January 1993. SEBI framed regulations for portfolio management keeping securities scams in mind. SEBI has been entrusted with a job to regulate the working of portfolio managers in order to give protections to investors.(3)REGULATION OF MUTUAL FUNDS:- The mutual funds were placed under the control of SEBI on January 1993. Mutual funds have been restricted from short selling or carrying forward transactions in securities. Permission has been granted to invest only in transferable securities in money market and capital market.(4)CONTROL ON MERCHANT BANKING:- Merchant bankers are to be authorized by SEBI, they have to follow code of conduct which makes them responsible towards the investors 38 Thakur College Of Science & Commerce
  39. 39. Indian Financial System in respect of pricing, disclosure of/ in the prospectus and issue of securities, merchant bankers have high degree of accountability in relation to offer documents and issue of shares.(5)ACTION FOR DELAY IN TRANSFER AND REFUNDS:- SEBI has prosecuted many companies for delay in transfer of shares and refund of money to the applicants to whom the shares are not allotted. These also gives protection to investors and ensures timely payment in case of refunds.(6)ISSUE GUIDELINES TO INTERMEDIARIES:- SEBI controls unfair practices of intermediaries operating in capital market, such control helps in winning investors confidence and also gives protection to investors.(7)GUIDELINES FOR TAKEOVERS AND MERGERS:- SEBI makes guidelines for takeover and merger to ensure transparency in acquisitions of shares, fair disclosure through public announcement and also to avoid unfair practices in takeover and mergers.(8)REGULATION OF STOCK EXCHANGES FUNCTIONING:- SEBI is working for expanding the membership of stock exchanges to improve transparency, to shorten settlement period and to promote 39 Thakur College Of Science & Commerce
  40. 40. Indian Financial System professionalism among brokers. All these steps are for the healthy growth of stock exchanges and to improve their functioning.(9) REGULATION OF FOREIGN INSTITUTIONALINVESTMENT (FIIS):- SEBI has started registration of foreign institutional investment. It is for effective control on such investors who invest on a large scale in securities.TYPES OF ISSUEA company can raise its capital through issue of share and debenture bymeans of :-PUBLIC ISSUE :-Public issue is the most popular method of raising capital and involvesraising capital and involve raising of fund direct from the public .RIGHT ISSUE :-Right issue is the method of raising additional finance from existingmembers by offering securities to them on pro rata basis. A company proposing to issue securities on right basis should send aletter of offer to the shareholders giving adequate discloser as to howthe additional amount received by the issue is used by the company.BONUS ISSUE:- 40 Thakur College Of Science & Commerce
  41. 41. Indian Financial SystemSome companies distribute profits to existing shareholders by way offully paid up bonus share in lieu of dividend. Bonus share are issued inthe ratio of existing share held. The shareholder do not have to nayadditional payment for these share .PRIVATE PLACEMENT :-private placement market financing is the direct sale by a public limitedcompany or private limited company of private as well as public sectorof its securities to a limited number of sophisticated investors like UTI ,LIC , GIC state finance corporation and pension and insurance funds theintermediaries are credit rating agencies and trustees and financialadvisors such as merchant bankers. And the maximum time – framerequired for private placement market is only 2 to 3 months. Privateplacement can be made out of promoter quota but it cannot be madewith unrelated investors.SECONDRY MARKETThe secondary market is that segment of the capital market where theoutstanding securities are traded from the investors point of view thesecondary market imparts liquidity to the long – term securities held bythem by providing an auction market for these securities.The secondary market operates through the medium of stock exchangewhich regulates the trading activity in this market and ensures a measureof safety and fair dealing to the investors. 41 Thakur College Of Science & Commerce
  42. 42. Indian Financial System India has a long tradition of trading in securities going back to nearly 200 years. The first India stock exchange established at Mumbai in 1875 is the oldest exchange in Asia. The main objective was to protect the character status and interest of the native share and stock broker.BOMBAY STOCK EXCHANGEBombay Stock Exchange is the oldest stock exchange in Asia with a richheritage, now spanning three centuries in its 133 years of existence. What isnow popularly known as BSE was established as "The Native Share & StockBrokers Association" in 1875.BSE is the first stock exchange in the country which obtained permanentrecognition (in 1956) from the Government of India under the SecuritiesContracts (Regulation) Act 1956. BSEs pivotal and pre-eminent role in thedevelopment of the Indian capital market is widely recognized. It migratedfrom the open outcry system to an online screen-based order driven tradingsystem in 1995. Earlier an Association of Persons (AOP), BSE is now acorporatised and demutualised entity incorporated under the provisions ofthe Companies Act, 1956, pursuant to the BSE (Corporatisation andDemutualisation) Scheme, 2005 notified by the Securities and ExchangeBoard of India (SEBI). With demutualisation, BSE has two of worlds bestexchanges, Deutsche Börse and Singapore Exchange, as its strategicpartners.Over the past 133 years, BSE has facilitated the growth of the Indiancorporate sector by providing it with an efficient access to resources. There 42 Thakur College Of Science & Commerce
  43. 43. Indian Financial Systemis perhaps no major corporate in India which has not sourced BSEs servicesin raising resources from the capital market.Today, BSE is the worlds number 1 exchange in terms of the number oflisted companies and the worlds 5th in transaction numbers. The marketcapitalization as on December 31, 2007 stood at USD 1.79 trillion . Aninvestor can choose from more than 4,700 listed companies, which for easyreference, are classified into A, B, S, T and Z groups.The BSE Index, SENSEX, is Indias first stock market index that enjoys aniconic stature , and is tracked worldwide. It is an index of 30 stocksrepresenting 12 major sectors. The SENSEX is constructed on a free-floatmethodology, and is sensitive to market sentiments and market realities.Apart from the SENSEX, BSE offers 21 indices, including 12 sectoralindices. BSE has entered into an index cooperation agreement withDeutsche Börse. This agreement has made SENSEX and other BSE indicesavailable to investors in Europe and America. Moreover, Barclays GlobalInvestors (BGI), the global leader in ETFs through its iShares® brand, hascreated the iShares® BSE SENSEX India Tracker which tracks theSENSEX. The ETF enables investors in Hong Kong to take an exposure tothe Indian equity market.BSE has tied up with U.S. Futures Exchange (USFE) for U.S. dollar-denominated futures trading of SENSEX in the U.S. The tie-up enableseligible U.S. investors to directly participate in Indias equity markets for the 43 Thakur College Of Science & Commerce
  44. 44. Indian Financial Systemfirst time, without requiring American Depository Receipt (ADR)authorization. The first Exchange Traded Fund (ETF) on SENSEX, called"SPIcE" is listed on BSE. It brings to the investors a trading tool that can beeasily used for the purposes of investment, trading, hedging and arbitrage.SPIcE allows small investors to take a long-term view of the market.BSE provides an efficient and transparent market for trading in equity, debtinstruments and derivatives. It has a nation-wide reach with a presence inmore than 450 cities and towns of India. BSE has always been at par withthe international standards. The systems and processes are designed tosafeguard market integrity and enhance transparency in operations. BSE isthe first exchange in India and the second in the world to obtain an ISO9001:2000 certification. It is also the first exchange in the country andsecond in the world to receive Information Security Management SystemStandard BS 7799-2-2002 certification for its BSE On-line Trading System(BOLT).BSE continues to innovate. In recent times, it has become the first nationallevel stock exchange to launch its website in Gujarati and Hindi to reach outto a larger number of investors. It has successfully launched a reportingplatform for corporate bonds in India christened the ICDM or IndianCorporate Debt Market and a unique ticker-cum-screen aptly named BSEBroadcast which enables information dissemination to the common man onthe street. 44 Thakur College Of Science & Commerce
  45. 45. Indian Financial SystemIn 2006, BSE launched the Directors Database and ICERS (IndianCorporate Electronic Reporting System) to facilitate information flow andincrease transparency in the Indian capital market. While the DirectorsDatabase provides a single-point access to information on the boards ofdirectors of listed companies, the ICERS facilitates the corporates in sharingwith BSE their corporate announcements.BSE also has a wide range of services to empower investors and facilitatesmooth transactions:Investor Services: The Department of Investor Services redresses grievancesof investors. BSE was the first exchange in the country to provide an amountof Rs.1 million towards the investor protection fund; it is an amount higherthan that of any exchange in the country. BSE launched a nationwideinvestor awareness programme- Safe Investing in the Stock Market underwhich 264 programmes were held in more than 200 cities.The BSE On-line Trading (BOLT): BSE On-line Trading (BOLT) facilitateson-line screen based trading in securities. BOLT is currently operating in25,000 Trader Workstations located across over 450 cities in India.BSEWEBX.com: In February 2001, BSE introduced the worlds firstcentralized exchange-based Internet trading system, BSEWEBX.com. This 45 Thakur College Of Science & Commerce
  46. 46. Indian Financial Systeminitiative enables investors anywhere in the world to trade on the BSEplatform.Surveillance: BSEs On-Line Surveillance System (BOSS) monitors on areal-time basis the price movements, volume positions and memberspositions and real-time measurement of default risk, market reconstructionand generation of cross market alerts.BSE Training Institute: BTI imparts capital market training and certification,in collaboration with reputed management institutes and universities. Itoffers over 40 courses on various aspects of the capital market and financialsector. More than 20,000 people have attended the BTI programmesAwards • The World Council of Corporate Governance has awarded the Golden Peacock Global CSR Award for BSEs initiatives in Corporate Social Responsibility (CSR). • The Annual Reports and Accounts of BSE for the year ended March 31, 2006 and March 31 2007 have been awarded the ICAI awards for excellence in financial reporting. • The Human Resource Management at BSE has won the Asia - Pacific HRM awards for its efforts in employer branding through talent management at work, health management at work and excellence in HR through technologyDrawing from its rich past and its equally robust performance in the recenttimes, BSE will continue to remain an icon in the Indian capital market. 46 Thakur College Of Science & Commerce
  47. 47. Indian Financial SystemNATIONAL STOCK EXCHANGEThe National Stock Exchange of India Limited has genesis in the report ofthe High Powered Study Group on Establishment of New Stock Exchanges,which recommended promotion of a National Stock Exchange by financialinstitutions (FIs) to provide access to investors from all across the countryon an equal footing. Based on the recommendations, NSE was promoted byleading Financial Institutions at the behest of the Government of India andwas incorporated in November 1992 as a tax-paying company unlike otherstock exchanges in the country.On its recognition as a stock exchange under the Securities Contracts(Regulation) Act, 1956 in April 1993, NSE commenced operations in theWholesale Debt Market (WDM) segment in June 1994. The Capital Market(Equities) segment commenced operations in November 1994 andoperations in Derivatives segment commenced in June 2000.NSEs mission is setting the agenda for change in the securities markets inIndia. The NSE was set-up with the main objectives of: • establishing a nation-wide trading facility for equities, debt instruments and hybrids, 47 Thakur College Of Science & Commerce
  48. 48. Indian Financial System • ensuring equal access to investors all over the country through an appropriate communication network, • providing a fair, efficient and transparent securities market to investors using electronic trading systems, • enabling shorter settlement cycles and book entry settlements systems, and • Meeting the current international standards of securities markets.The standards set by NSE in terms of market practices and technology havebecome industry benchmarks and are being emulated by other marketparticipants. NSE is more than a mere market facilitator. Its that forcewhich is guiding the industry towards new horizons and greateropportunities.The logo of the NSE symbolises a single nationwide securities tradingfacility ensuring equal and fair access to investors, trading members andissuers all over the country. The initials of the Exchange viz., N, S and Ehave been etched on the logo and are distinctly visible. The logo symbolisesuse of state of the art information technology and satellite connectivity tobring about the change within the securities industry. The logo symbolises 48 Thakur College Of Science & Commerce
  49. 49. Indian Financial Systemvibrancy and unleashing of creative energy to constantly bring about changethrough innovation.CORPORATE STRUCTURENSE is one of the first de-mutualised stock exchanges in the country, wherethe ownership and management of the Exchange is completely divorcedfrom the right to trade on it. Though the impetus for its establishment camefrom policy makers in the country, it has been set up as a public limitedcompany, owned by the leading institutional investors in the country.From day one, NSE has adopted the form of a demutualised exchange - theownership, management and trading is in the hands of three different sets ofpeople. NSE is owned by a set of leading financial institutions, banks,insurance companies and other financial intermediaries and is managed byprofessionals, who do not directly or indirectly trade on the Exchange. Thishas completely eliminated any conflict of interest and helped NSE inaggressively pursuing policies and practices within a public interestframework.The NSE model however, does not preclude, but in fact accommodatesinvolvement, support and contribution of trading members in a variety ofways. Its Board comprises of senior executives from promoter institutions,eminent professionals in the fields of law, economics, accountancy, finance,taxation, and etc, public representatives, nominees of SEBI and one full timeexecutive of the Exchange. 49 Thakur College Of Science & Commerce
  50. 50. Indian Financial SystemWhile the Board deals with broad policy issues, decisions relating to marketoperations are delegated by the Board to various committees constituted byit. Such committees includes representatives from trading members,professionals, the public and the management. The day-to-day managementof the Exchange is delegated to the Managing Director who is supported bya team of professional staff. STRUCTURE OF INTERNATIONAL CAPITAL MARKET 50 Thakur College Of Science & Commerce
  51. 51. Indian Financial System INTERNATIONAL CAPITAL MARKETS INTERNATIONAL INTERNATIONAL BOND MARKET EQUITY MARKET FOREIGN EURO FOREIGN EURO BONDS BOND EQUITY EQUITY AMERICAN GLOBALYANKEE EURO/ DEPOSITORY DEPOSITORY BONDS DOLLAR RECIEPTS RECIEPTSSAMURAI EURO/ IDR/ BONDS YEN EDRBULLDOG EURO/ BONDS POUNDS INTERNATIONAL CAPITAL MARKETS ORIGIN 51 Thakur College Of Science & Commerce
  52. 52. Indian Financial SystemThe genesis of the present international markets can be teased to 1960s,when there was a real demand for high quality dollar-denominated bondsform wealthy Europeans (and others) who wished to hold their assets theirhome countries or in currencies other then their own. These investors weredriven by the twin concerns of avoiding taxes in their home country andprotecting themselves against the falling value of domestic currencies. Thebonds which were then available for investment were subjected towithholding tax. Further it is was also necessary to register to address theseconcerns. These were issued in bearer forms and so, there was no ofownership and tax was withheld.Also, until 1970, the International Capital Market focused on debt financingand the equity finances were raised by the corporate entities primarily in thedomestic markets. This was due to the restrictions on cross-border equityinvestments prevailing unit then in many countries. Investors too preferredto invest in domestic equity issued due to perceived risks implied in foreignequity issues either related to foreign currency exposure or related toapprehensions of restrictions on such investments by the regulator.Major changes have occurred since the ‘70s which have witnessedexpanding and fluctuating trade volumes and patterns with various blocksexperiencing extremes in fortunes in their exports/imports. This was the wasthe period which saw the removal of exchange controls by countries like theUK, franc and Japan which gave a further technology of markets haveplayed an important role in channelizing the funds from surplus unit todeficit units across the globe. The international capital markets also becomea major source of external finance for nations with low internal saving. The 52 Thakur College Of Science & Commerce
  53. 53. Indian Financial Systemmarkets were classified into euro markets, American Markets and OtherForeign Markets.THE PLAYERSBorrowers/Issuers, Lenders/ Investors and Intermediaries are the majorplayers of the international market. The role of these players is discussedbelow.BORROWERS/ISSUERSThese primarily are corporates, banks, financial institutions, government andquasi government bodies and supranational organizations, which need forexfunds for various reasons. The important reasons for corporate borrowingsare, need for foreign currencies for operation in markets abroad,dull/saturated domestic market and expansion of operations into othercountries.Governments borrow in the global financial market to adjust the balance ofpayments mismatches, to gain net capital investments abroad and to keep asufficient inventory of foreign currency reserves for contingencies likesupporting the domestic currency against speculative pressures.LENDERS/INVESTORSIn case of Euro-loans, the lenders are mainly banks who possess inherentconfidence in the credibility of the borrowing corporate or any other entitymention above in case of GDR it is the institutional investor and high net 53 Thakur College Of Science & Commerce
  54. 54. Indian Financial Systemworth individuals (referred as Belgian Dentists) who subscribe to the equityof the corporates. For an ADR it is the institutional investor or the individualinvestor through the Qualified Intuitional Buyer who put in the money in theinstrument depending on the statutory status attributed to the ADR as perstatutory requirements of the land.INTERMEDIARIESLEAD MANGERSThey undertake due diligence and preparation of offer circular, marketingthe issues and arranger for road shows.UNDERWRITERSUnderwriters of the issue bear interest rate/market risks moving againstthem before they place bonds or Depository Receipts. Usually, the lendmanagers and co-managers act as underwriters for the issue.CUSTODIANOn behalf of DRs, the custodian holds the underlying shares, and collectsrupee dividends on the underlying shares and repatriates the same to thedepository in US dollars/foreign equity.Apart from the above, Agents and Trustees, Listing Agents and DepositoryBanks also play a role in issuing the securities.THE INSTRUMENTS 54 Thakur College Of Science & Commerce
  55. 55. Indian Financial SystemThe early eighties witnessed liberalization of many domestic economies andglobalization of the same. Issuers form developing countries, where issue ofdollar/foreign currency denominated equity shares were not permitted, couldaccess international equity markets through the issue of an intermediateinstrument called ‘Depository Receipt’.A Depository Receipt (DR) is a negotiable certificate issued by a depositorybank which represents the beneficial interest in shares issued by a company.These shares are deposited with the local ‘custodian’ appointed by thedepository, which issues receipts against the deposit of shares.The various instruments used to raise funds abroad include: equity, straightdebt or hybrid instruments. The following figure shows the classification ofinternational capital markets based on instruments used and market(s)accessed. EURO EQUITYGLOBAL DEPOSITORY RECEIPTS (GDR):A GDR is a negotiable instrument which represents publicly traded local-currency equity share. GDR is any instrument in the from of a depositoryreceipt or certificate created by the Overseas Depository Bank outside Indiaand issued to non-resident investors against the issue of ordinary shares orforeign currency convertible bonds of the issuing company. Usually, atypical GDR is denominated in US dollars whereas the underlying shareswould be denominated in the local currency of the Issuer. GDRs may be – at 55 Thakur College Of Science & Commerce
  56. 56. Indian Financial Systemthe request of the investor – converted into equity shares by cancellation ofGDRs through the intermediation of the depository and the sale ofunderlying shares in the domestic market through the local custodian.GDRs, per se, are considered as common equity of the issuing company andare entitled to dividends and voting rights since the date of its issuance. Thecompany transactions. The voting rights of the shares are exercised by theDepository as per the understanding between the issuing Company and theGDR holders.FOREIGN EQUTIYAMERICAN DEPOSITORY RECEIPTS (ADR):ADR is a dollar denominated negotiable certificate, it represents a non-UScompany’s publicly traded equity. It was devised in the last 1920s to helpAmericans invest in overseas securities and assist non-US companieswishing to have their stock traded in the American Markets. ADRs aredivided into 3 levels based on the regulation and privilege of eachcompany’s issue. I. ADR LEVEL – I: It is often step of an issuer into the US public equity market. The issuer can enlarge the market for existing shares and thus diversify to the investor base. In this instrument only minimum disclosure is required to the sec and issuer need not comply with 56 Thakur College Of Science & Commerce
  57. 57. Indian Financial System the US GAAP (Generally Accepted Accounting Principles). This type of instrument is traded in the US OTC Market. The issuer is not allowed to raise fresh capital or list on any one of the national stock exchanges. II. ADR LEVEL – II: Through this level of ADR, the company can enlarge the investor base for existing shares to a greater extent. However, significant disclosures have to be made to the SEC. The company is allowed to List on the American Stock Exchange (AMEX) or New York Stock Exchange (NYSE) which implies that company must meet the listing requirements of the particular exchange. III. ADR LEVEL – III: This level of ADR is used for raising fresh capital through Public offering in the US Capital with the EC and comply with the listing requirements of AMEX/NYSE while following the US- GAAP.DEBT INSTRUMENTS 57 Thakur College Of Science & Commerce
  58. 58. Indian Financial SystemEUROBONDSThe process of lending money by investing in bonds originated during the19th century when the merchant bankers began their operations in theinternational markets. Issuance of Eurobonds became easier with noexchange controls and no government restrictions on the transfer of fundsin international markets.THE INSTRUMENTSEUROBONDSAll Eurobonds, through their features can appeal to any class of issuer orinvestor.The characteristics which make them unique and flexible are: a) No withholding of taxes of any kind on interests payments b) They are in bearer form with interest coupon attached c) They are listed on one or more stock exchanges but issues are generally traded in the over the counter market.Typically, a Eurobond is issued outside the country of the currency inwhich it is denominated. It is like any other Euro instrument and throughinternational syndication and underwriting, the paper is sold without anylimit of geographical boundaries. Eurobonds are generally listed on theworlds stock exchanges, usually on the Luxembourg Stock Exchange. a) FIXED-RATE BONDS/STRAIGHT DEBT BONDS: 58 Thakur College Of Science & Commerce
  59. 59. Indian Financial System Straight debt bonds are fixed interest bearing securities which are redeemable at face value. The bonds issued in the Euro-market referred to as Euro-bonds, have interest rates fixed with reference to the creditworthiness of the issuer. The interest rates on dollar denominated bonds are set at a margin over the US treasury yields. The redemption of straights is done by bullet payment, where the repayment of debt will be in one lump sum at the end of the maturity period, and annual servicing. b) FLOATING RATE NOTES (FRNs): FRNs can be described as a bond issue with a maturity period varying from 5-7 years having varying coupon rates - either pegged to another security or re-fixed at periodic intervals. Conventionally, the paper is referred to as notes and not as bonds. The spreads or margin on these notes will be above 6 months USOR for Eurodollar deposits.FOREIGN BONDS 59 Thakur College Of Science & Commerce
  60. 60. Indian Financial SystemThese are relatively lesser known bonds issued by foreign entities forraising medium to long-term financing from domestic money centers intheir domestic currencies. A brief note on the various instruments in thiscategory is given below: a) YANKEE BONDS: These are US dollar denominated issues by foreign borrowers (usually foreign governments or entities, supranational and highly rated corporate borrowers) in the US bond markets. A bond denominated in U.S. dollars and is publicly issued in the U.S. by foreign banks and corporations. According to the Securities Act of 1933, these bonds must first be registered with the Securities and Exchange Commission (SEC) before they can be sold. Yankee bonds are often issued in trenches and each offering can be as large as $1 billion. Due to the high level of stringent regulations and standards that must be adhered to, it may take up to 14 weeks (or 3.5 months) for a Yankee bond to be offered to the public. Part of the process involves having debt-rating agencies evaluate the creditworthiness of the Yankee bonds underlying issuer. Foreign issuers tend to prefer issuing Yankee bonds during times when the U.S. interest rates are low, because this enables the foreign issuer to pay out less money in interest payments. 60 Thakur College Of Science & Commerce
  61. 61. Indian Financial Systemb) SAMURAI BONDS: A yen-denominated bond issued in Tokyo by a non-Japanese company and subject to Japanese regulations. Other types of yen- denominated bonds are Euro/yens issued in countries other than Japan. Samurai bonds give issuers the ability to access investment capital available in Japan. The proceeds from the issuance of samurai bonds can be used by non-Japanese companies to break into the Japanese market, or it can be converted into the issuing companys local currency to be used on existing operations. Samurai bonds can also be used to hedge foreign exchange rate risks. These are bonds issued by non-Japanese borrowers in the domestic Japanese markets.c) BULLDOG BONDS: These are sterling denominated foreign bond which are raised in the UK domestic securities market. A sterling denominated bond that is issued in London by a company that is not British. These sterling bonds are referred to as bulldog bonds as the bulldog is a national symbol of England.d) SHIBOSAI BONDS: 61 Thakur College Of Science & Commerce
  62. 62. Indian Financial System These are the privately placed bonds issued in the Japanese markets.EURONOTESEuronotes as a concept is different from syndicated bank credit and isdifferent from Eurobonds in terms of its structure and maturity period.Euronotes command the price of a short-term instrument usually a fewbasic points over LIBOR and in many instances at sub – LIBOR levels.The documentation formalities are minimal (unlike in the case ofsyndicated credits or bond issues) and cost savings can be achieved on thatscore too. The funding instruments in the form of Euronotes possessflexibility and can be tailored to suit the specific requirements of differenttypes of borrowers. There are numerous applications of basic concepts ofEuronotes. These may be categorized under the following heads: a) COMMERCIAL PAPER: These are short-term unsecured promissory notes which repay a fixed amount on a certain future date. These are normally issued at a discount to face value. b) NOTE ISSUANCE FACILITIES (NIFs): The currency involved is mostly US dollars. A NIF is a medium- term legally binding commitment under which a borrower can issue short-term paper, of up to one year. The underlying currency is mostly US dollar. Underwriting banks are committed either to 62 Thakur College Of Science & Commerce
  63. 63. Indian Financial System purchase any notes which the borrower b unable to sell or to provide standing credit. These can be re-issued periodically.c) MEDIUM-TERM NOTES (MTNs): MTNs are defined as sequentially issued fixed interest securities which have a maturity of over one year. A typical MTN program enables an issuer to issue Euronotes for different maturities. From over one year up to the desired level of maturity. These are essentially fixed rate funding arrangements as the price of each preferred maturity is determined and fixed up front at the time of launching. These are conceived as non-underwritten facilities, even though international markets have started offering underwriting support in specific instances. A Global MTN (G-MTN) is issued worldwide by tapping Euro as well as the- US markets under the same program. Under G-MTN programs, issuers of different credit ratings are able to raise finance by accessing retail as well as institutional investors. In view of flexible access, speed and efficiency, and enhanced investor base G-MTN programs afford numerous benefits to the issuers. Spreads paid on MTNs depend on credit ratings, treasury yield curve and the familiarity of the issuers among investors. Investors include Private Banks, Pension Funds, Mutual Funds and Insurance Companies. 63 Thakur College Of Science & Commerce
  64. 64. Indian Financial SystemFOREIGN EXCHANGE AND FOREIGN EXCHANGEMARKETS –OVERVIEWIn today’s world no country is self sufficient, so there is a need for exchangeof goods and services amongst the different countries. However, unlike inthe primitive age the exchange of goods and services is no longer carried outon barter basis. Every sovereign country in the world has a currency whichis a legal tender in its territory and this currency does not act as moneyoutside its boundaries. So whenever a country buys or sells goods andservices from or to another country, the residents of two countries have toexchange currencies. So we can imagine that if all countries have the samecurrency then there is no need for foreign exchange.FOREIGN EXCHANGE IN INDIAIn India, foreign exchange has been given a statutory definition. Section 2(b) of Foreign Exchange Regulation Act, 1973 states:‘Foreign exchange’ means foreign currency and includes: • All deposits, credits and balances payable in any foreign currency and any drafts, traveler’s cheques, letters of credit and bills of exchange , expressed or drawn in Indian currency but payable in any foreign currency, • Any instrument payable, at the option of drawee or holder thereof or any other party thereto, either in Indian currency or in foreign currency or partly in one and partly in the other. 64 Thakur College Of Science & Commerce
  65. 65. Indian Financial SystemFor India we can conclude that foreign exchange refers to foreign money,which includes notes, cheques, bills of exchange, bank balances anddeposits in foreign currencies.ABOUT FOREIGN EXCHANGE MARKETParticularly for foreign exchange market there is no market place called theforeign exchange market. It is mechanism through which one country’scurrency can be exchange i.e. bought or sold for the currency of anothercountry. The foreign exchange market does not have any geographiclocation. The market comprises of all foreign exchange traders who areconnected to each other through out the world. They deal with each otherthrough telephones, telexes and electronic systems. With the help of ReutersMoney 2000-2, it is possible to access any trader in any corner of the worldwithin a few seconds.WHO ARE THE PARTICIPANTS IN FOREIGNEXCHANGE MARKETS?The main players in foreign exchange markets are as follows: 1. CUSTOMERS The customers who are engaged in foreign trade participate in foreign exchange markets by availing of the services of banks. Exporters require converting the dollars in to rupee and importers require converting rupee in to the dollars as they have to pay in dollars for the goods/services they have imported. 65 Thakur College Of Science & Commerce
  66. 66. Indian Financial System2. COMMERCIAL BANKS They are most active players in the forex market. Commercial banks dealing with international transactions offer services for conversion of one currency in to another. They have wide network of branches. Typically banks buy foreign exchange from exporters and sells foreign exchange to the importers of the goods. As every time the foreign exchange bought and sold may not be equal banks are left with the overbought or oversold position. The balance amount is sold or bought from the market. Nowadays, in international foreign exchange markets, the international trade turnover accounts for a fraction of huge amounts dealt, i.e. bought and sold. The balance amount is accounted for either by financial transactions or speculation. Banks have enough financial strength and wide experience to speculate the market and banks does so. Which is popularly known as the trading in the forex market. Commercial banks have following objectives for being active in the foreign exchange markets.• They render better service by offering competitive rates to their customers engaged in international trade;• They are in a better position to manage risks arising out of exchange rate fluctuations;• Foreign exchange business is a profitable activity and thus such banks are in a position to generate more profits for themselves; 66 Thakur College Of Science & Commerce
  67. 67. Indian Financial System• They can manage their integrated treasury in a more efficient manner.• In India Reserve Bank of India has given license to the commercial banks to deal in foreign exchange under section 6 Foreign Exchange Regulation Act, 1973, which are called the Authorized Dealers (ADs).3. CENTRAL BANK In all countries central banks have been charged with the responsibility of maintaining the external value of the domestic currency. Generally this is achieved by the intervention of the bank. Apart from this central banks deal in the foreign exchange market for the following purposes: 1) Exchange rate management: It is achieved by the intervention though sometimes banks have to maintain external rate of the domestic currency at a level or in a band so fixed. 2) Reserve management: Central bank of the country is mainly concerned with the investment of countries foreign exchange reserve in a stable proportions in range of currencies and in a range of assets in each currency. For this bank has to involve certain amount of switching between currencies.4. EXCHANGE BROKERS Forex brokers play a very important role in the foreign exchange markets. However the extent to which services of forex brokers are utilized depends on the tradition and practice prevailing at a particular forex market center. In India as per FEDAI guidelines the A Ds are free to deal directly among themselves without going through brokers. 67 Thakur College Of Science & Commerce
  68. 68. Indian Financial System The forex brokers are not allowed to deal on their own account all over the world and also in India.. 5. OVERSEAS FOREX MARKETS Today the daily global turnover is guestimated to be more than US $ 1.5 trillion a day. The international trade however constitutes hardly 5 to 7 % of this total turnover. The rest of trading in world forex markets is constituted of financial transactions and speculation. As we know that the forex market is 24-hour market, the day begins with Tokyo and thereafter Singapore opens, thereafter India, followed by Bahrain, Frankfurt, Paris, London, New York, Sydney, and back to Tokyo. FORWARD EXCHANGE CONTRACTWHAT IS THE NEED FOR FORWARD EXCHANGECONTRACT?The risk on account of exchange rate fluctuations, in international tradetransactions increases if the time period needed for completion oftransaction is longer. It is not uncommon in international trade, on accountof logistics, the time frame can not be foretold with clock precision.Exporters and importers alike, can not be precise as to the time when the 68 Thakur College Of Science & Commerce

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