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Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
Financial markets and institutions notes as per BPUT syllabus for MBA 4th
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Financial markets and institutions notes as per BPUT syllabus for MBA 4th

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lecture notes Financial markets and institutions notes as per BPUT syllabus for MBA 4th

lecture notes Financial markets and institutions notes as per BPUT syllabus for MBA 4th

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  • 1. Financial Institutions and Markets (MBA 406B) Module - I: Financial Markets 1. Financial System- Meaning It is a complex and well integrated set of sub system of financial institutions, financial markets, and financial intermediaries, services which facilitate transfer and allocation of funds effectively and efficiently. It also consists of regulations, laws and practices followed in the system.
  • 2. 2. Financial Markets- Meaning Financial market refers to those centers and arrangements which facilitate buying & selling of financial assets / instruments. Whenever a financial transaction takes place, it is deemed to have taken place in financial market. There is no specific place or location to indicate a financial market. Financial markets consist of agents, brokers, institutions, and intermediaries transacting purchases and sales of securities. The many persons and institutions operating in the financial markets are linked by contracts, communications networks which form an externally visible financial structure, laws, and friendships. The financial market is divided between investors and financial institutions. The term financial institution is a broad phrase referring to organizations which act as agents, brokers, and intermediaries in financial transactions. Agents and brokers contract on behalf of others; intermediaries sell for their own account. Financial intermediaries purchase securities for their own account and sell their own liabilities and common stock. For example, a stockbroker buys and sells stocks for us as our agent, but a savings and loan borrows our money (savings account) and lends it to others (mortgage loan). The stockbroker is classified as an agent and broker, and savings and loan is called a financial intermediary. Brokers and savings and loans, like all financial institutions, buy and sell securities, but they are classified separately, because the primary activity of brokers is buying and selling rather than buying and holding an investment portfolio. Financial institutions are classified according to their primary activity, although they frequently engage in overlapping activities. Financial markets provide our specialized, interdependent economy with many financial services, including time preference, distribution of risk, diversification of risk, transactions economy, transmutation of contractual arrangements, and financial management 3. Types, Classification of Financial Markets: Types of financial markets are given in the diagram below:
  • 3. The financial markets are classified into two groups: A. Capital Market 1. Corporate Securities Market  Primary Market  Secondary Market 2. Government Securities Markets 3. Long Term Loans Markets  Term Loan Markets  Mortgages Markets  Financial Guarantees Markets B. Money Market 1. Unorganized Market  Money Lenders  Indigenous Bankers  Chit Funds 2. Organized Money Market  Treasury Bills  Commercial Paper (CP)  Certificate Of Deposit (CD) etc  Call Money Market  Commercial Bill Market Classification of Financial Markets There are five ways that one can classify financial markets: (1) Nature of the claim: The claims traded in a financial market may be either for a fixed rupee amount or a residual amount and financial markets can be classified according to the nature of the claim. As explained earlier, the former financial assets are referred to as debt instruments, and the financial market in which such instruments are traded is referred to as the debt market. The latter financial assets are called equity instruments and the financial market where such instruments are traded is referred to as the equity market or stock market. Preferred stock represents an equity claim that entitles the investor to receive a fixed rupee amount. Consequently, preferred stock has in common characteristics of instruments classified as part of the debt market and the equity market. Generally, debt instruments and preferred stock are classified as part of the fixed income market. (2) Maturity of the claims: A second way to classify financial markets is by the maturity of the claims. For example, a financial market for shortterm financial assets is called the money market, and the one for longer maturity financial assets is called the capital market. The traditional cutoff between short term and long term is one year. That is, a financial asset with a maturity of one year or less is considered short term and therefore part of the money market. A financial asset with a maturity of more than one year is part of the capital market. Thus, the debt market can be divided into debt instruments that are part of the money market, and those that are part of the capital market, depending on the number of years to maturity. (3) New versus seasoned claims: Because equity instruments are generally perpetual, a third way to classify financial markets is by whether the financial claims are newly issued. When an issuer sells a new financial asset to the public, it is said to “issue” the financial asset. The market for newly issued financial assets is called the primary market. After a certain period of time, the financial asset is bought and sold (i.e., exchanged or traded) among investors. The market where this activity takes place is referred to as the secondary market.
  • 4. (4) Cash versus derivative instruments: Some financial assets are contracts that either obligate the investor to buy or sell another financial asset or grant the investor the choice to buy or sell another financial asset. Such contracts derive their value from the price of the financial asset that may be bought or sold. These contracts are called derivative instruments and the markets in which they trade are referred to as derivative markets. The array of derivative instruments includes options contracts, futures contracts, forward con- tracts, swap agreements, and cap and floor agreements. (5) Organizational structure of the market: Although the existence of a financial market is not a necessary condition for the creation and exchange of a financial asset, in most economies financial assets are created and subsequently traded in some type of organized financial market structure. A financial market can be classified by its organizational structure. These organizational structures can be classified as auction markets and over-the-counter markets. (6) Exchanges and Over-the-Counter Markets Exchange = buyers and sellers meet in a central location. Example: Bombay Stock Exchange. Over-the-Counter (OTC) Market = dealers at different locations trade via computer and telephone networks. Examples: Over the counter exchange of India (OTCEI). 4. Money Market: Money market is concerned with the supply and the demand for investible funds. Essentially, it is a reservoir of short-term funds. Money market provides a mechanism by which short-term funds are lent out and borrowed; it is through this market that a large part of the financial transactions of a country are cleared. It is place where a bid is made for short-term investible funds at the disposal of financial and other institutions by borrowers comprising institutions, individuals and the Government itself. It is a market for dealing with financial assets and securities which have a maturity period of up to one year. Hence, it is a market for purely short term funds. Thus, money market covers money, and financial assets which are close substitutes for money. The money market is generally expected to perform following three broad functions: (i) To provide an equilibrating mechanism to even out demand for and supply of short term funds. (ii) To provide a focal point for Central bank intervention for influencing liquidity and general level of interest rates in the economy. (iii) To provide reasonable access to providers and users of short-term funds to fulfill their borrowing and investment requirements at an efficient market clearing price. Functions and importance of Money Market A well-developed money market is essential for a modern economy. Though, historically, money market has developed as a result of industrial and commercial progress, it also has important role to play in the process of industrialization and economic development of a country. Importance of a developed money market and its various functions are discussed below: 1. Financing Trade: Money Market plays crucial role in financing both internal as well as international trade. Commercial finance is made available to the traders through bills of exchange, which are discounted by the bill market. The acceptance houses and discount markets help in financing foreign trade. 2. Financing Industry: Money market contributes to the growth of industries in two ways: (a) Money market helps the industries in securing short-term loans to meet their working capital requirements through the system of finance bills, commercial papers, etc. (b) Industries generally need long-term loans, which are provided in the capital market. However, capital market depends upon the nature of and the conditions in the money market. The short-term interest rates of the money market influence the long-term interest rates of the capital market. Thus, money market indirectly helps the industries through its link with and influence on long-term capital market.
  • 5. 3. Profitable Investment: Money market enables the commercial banks to use their excess reserves in profitable investment. The main objective of the commercial banks is to earn income from its reserves as well as maintain liquidity to meet the uncertain cash demand of the depositors. In the money market, the excess reserves of the commercial banks are invested in near-money assets (e.g. short-term bills of exchange) which are highly liquid and can be easily converted into cash. Thus, the commercial banks earn profits without losing liquidity. 4. Self-Sufficiency of Commercial Bank: Developed money market helps the commercial banks to become self-sufficient. In the situation of emergency, when the commercial banks have scarcity of funds, they need not approach the central bank and borrow at a higher interest rate. On the other hand, they can meet their requirements by recalling their old short-run loans from the money market. 5. Help to Central Bank: Though the central bank can function and influence the banking system in the absence of a money market, the existence of a developed money market smoothens the functioning and increases the efficiency of the central bank. Money market helps the central bank in two ways: (a) The short-run interest rates of the money market serves as an indicator of the monetary and banking conditions in the country and, in this way, guide the central bank to adopt an appropriate banking policy, (b) The sensitive and integrated money market helps the central bank to secure quick and widespread influence on the sub-markets, and thus achieve effective implementation of its policy. Money market can be further sub divided into:  Call money market  Commercial bill market  Treasury bill market  Short term loan market  Commercial paper market  Certificate of deposit market The key objective of money market is to provide balancing mechanism for short term surpluses and deficits. 5. Call money Market: The most active segment of the money market has been the call money market, where the day to day imbalances in the funds position of scheduled commercial banks are eased out. The call notice money market has graduated into a broad and vibrant institution .Call/Notice money is the money borrowed or lent on demand for a very short period. When money is borrowed or lent for a day, it is known as Call (Overnight) Money. Intervening holidays and/or Sunday are excluded for this purpose. Thus money, borrowed on a day and repaid on the next working day, (irrespective of the number of intervening holidays) is "Call Money". When money is borrowed or lent for more than a day and up to 14 days, it is "Notice Money". No collateral security is required to cover these transactions. It is also known as Inter-bank money market. In this, day to day surplus funds mostly of banks are traded. It is a market for extremely short period loans say one day to fourteen days. Such loans are repayable on demand at the option of either the lender or the borrower. Interest rates changes hour to hour or day to day based on the demand and supply of money. The entry into this field is restricted by RBI. Commercial Banks, Co-operative Banks and Primary Dealers are allowed to borrow and lend in this market. Specified All-India Financial Institutions, Mutual Funds, and certain specified entities are allowed to access to Call/Notice money market only as lenders. Reserve Bank of India has recently taken steps to make the call/notice money market completely inter-bank market. Hence the non-bank entities will not be allowed access to this market beyond December 31, 2000.
  • 6. From May 1, 1989, the interest rates in the call and the notice money market are market determined. Interest rates in this market are highly sensitive to the demand - supply factors. Within one fortnight, rates are known to have moved from a low of 1 - 2 per cent to dizzy heights of over 140 per cent per annum. Large intra-day variations are also not uncommon. Hence there is a high degree of interest rate risk for participants. In view of the short tenure of such transactions, both the borrowers and the lenders are required to have current accounts with the Reserve Bank of India. This will facilitate quick and timely debit and credit operations. The call market enables the banks and institutions to even out their day to day deficits and surpluses of money. Banks especially access the call market to borrow/lend money for adjusting their cash reserve requirements (CRR). The lenders having steady inflow of funds (e.g. LIC, UTI) look at the call market as an outlet for deploying funds on short term basis 6. Govt. Securities Market ( Govt. Securities Market /GILT-EDGED MARKET) The gilt edged market is the market is government securities or the securities guaranteed (as to both principle and interest) by the government. Since the government cannot default on its payment obligations, the government securities are risk free and hence are known as gilt-edged (which means ‘of the best quality’). 1. It is a risk free market and returns are guaranteed. Accordingly there is no uncertainty regarding yield, payment on time, etc. and there is no scope for speculation and manipulation ') of the market. 2. The government securities market consists of two parts - the new issues market and the secondary market. Since it is the Reserve Bank of India that manages entirely the public debt operations of the Central as well as the State governments, it is responsible for all the new issues of government loans. The secondary market deals in old issues of government loans and operates largely through a few large stockbrokers who keep in touch with the Reserve Bank and other prospective buyers and sellers. 3. Reserve Bank of India plays a dominant role in the government securities market. As noted by S.B. Gupta, "there are only brokers or investors in the market and no dealers or jobbers (other than the RBI) who would make a market in government loans by standing ready to buy and sell any amount of government securities on their own account." 4. Government securities are the most liquid debt instruments. 5. The transactions in the government securities market are very large and each transaction may run into several crores of rupees. 7. Capital Market: The capital market is the place where the short, medium-term and long-term financial needs of business and other undertakings are met by financial institutions which supply medium and long-term resources to borrowers. Capital market is a market for financial assets which have a long or indefinite maturity. Generally it deals with long term securities having a maturity period of above one year. Capital market may be further divided into three parts, i.e. (i) Industrial security market (ii) Govt. securities market (iii) Long term loan market Capital market serves as a important source for the productive use of economy’s savings and investment. These savings and investments facilitate capital formation and through this facilitates increase in production and productivity in the economy. A capital market thus serves as an important link between those who saves and those who aspire to invest their savings. Capital markets – Types
  • 7. (i) Industrial Security Market – It is market where industrial concerns raise their capital or debt by issuing instruments like equity hares or ordinary shares, preference shares, debentures or bonds. This market can be sub divided into: (a) Primary Market or new issue market (b) Secondary Market or stock Exchange Primary Market is a market for new issues and hence it is called new issue market. It deals with securities which are issued to the public for the first time. There are three ways through which capital is raised in primary market. These are: - Public issue - Right Issue - Private placement Secondary market is a market for secondary sale of securities i.e. securities which already passed through the new issue market are traded in this secondary market. Generally, such securities are quoted in stock exchange and it provides a continuous; and regular market for buying and selling of securities. (ii) Govt. Security Market – It is a market where Long term Govt securities are traded which are issued by central Govt, State Govt, Semi Govt authorities like City Corporations, Port Trusts, Improvement Trusts, State Electricity Boards, All India and State level financial institutions and public sector organizations/enterprises are dealt in this market. Govt. Securities are in many forms such as : - Stock Certificates or inscribed stock - Promissory Notes - Bearer bonds. Govt securities are sold through public debt office of RBI. Interest on these securities influences price and yield in market. (iii) Long Term loan market – Commercial banks and development banks play a significant role in this market by supplying long term loans to corporate customers. Long term loan market may further be classified into: - Term loan market - Mortgage Market - Financial guarantee Market. Term Loan Market – In India many industrial finance institutions have been created by Central and State Govts., which provide medium and long term loans to corporate customers. Institutions like IDBI, IFCI, ICICI and other state financial corporations come in this category. Mortgage Market – Refers to those centres which supply mortgage loan mainly to individual customers against security of immovable property like real estate. Financial guarantee Market – Refers to centres where finance is provided against the guarantee of reputed person in financial circle. This guarantee may be in the form of (i) Performance guarantee or (ii) Financial guarantee. Performance guarantee covers the payment of earnest money retention money, advance payments and non compilation of contracts etc. The financial guarantee covers only financial contracts. Functions and importance of Capital Market Capital market plays an important role in mobilizing resources, and diverting them in productive channels. In this way, it facilitates and promotes the process of economic growth in the country. Various functions and significance of capital market are discussed below: 1. Link between Savers and Investors: The capital market functions as a link between savers and investors. It plays an important role in mobilizing the savings and diverting them in productive investment. In this way, capital market plays a vital role in transferring the financial resources from surplus and wasteful areas to deficit and productive areas, thus increasing the productivity and prosperity of the country.
  • 8. 2. Encouragement to Saving: With the development of capital, market, the banking and non-banking institutions provide facilities, which encourage people to save more. In the less- developed countries, in the absence of a capital market, there are very little savings and those who save often invest their savings in unproductive and wasteful directions, i.e., in real estate (like land, gold, and jewellery) and conspicuous consumption. 3. Encouragement to Investment: The capital market facilitates lending to the businessmen and the government and thus encourages investment. It provides facilities through banks and non-banking financial institutions. Various financial assets, e.g., shares, securities, bonds, etc., induce savers to lend to the government or invest in industry. With the development of financial institutions, capital becomes more mobile, interest rate falls and investment increases. 4. Promotes Economic Growth: The capital market not only reflects the general condition of the economy, but also smoothens and accelerates the process of economic growth. Various institutions of the capital market, like non-banking financial intermediaries, allocate the resources rationally in accordance with the development needs of the country. The proper allocation of resources results in the expansion of trade and industry in both public and private sectors, thus promoting balanced economic growth in the country. 5. Stability in Security Prices: The capital market tends to stabilize the values of stocks and securities and reduce the fluctuations in the prices to the minimum. The process of stabilization is facilitated by providing capital to the borrowers at a lower interest rate and reducing the speculative and unproductive activities. 6. Benefits to Investors: The credit market helps the investors, i.e., those who have funds to invest in longterm financial assets, in many ways: (a) It brings together the buyers and sellers of securities and thus ensure the marketability of investments, (b) By advertising security prices, the Stock Exchange enables the investors to keep track of their investments and channelize them into most profitable lines, (c) It safeguards the interests of the investors by compensating them from the Stock Exchange Compensating Fund in the event of fraud and default. Difference between Money Market and Capital Market Money market is distinguished from capital market on the basis of the maturity period, credit instruments and the institutions: 1. Maturity Period: The money market deals in the lending and borrowing of short-term finance (i.e., for one year or less), while the capital market deals in the lending and borrowing of long-term finance (i.e., for more than one year). 2. Credit Instruments: The main credit instruments of the money market are call money, collateral loans, acceptances, bills of exchange. On the other hand, the main instruments used in the capital market are stocks, shares, debentures, bonds, securities of the government. 3. Nature of Credit Instruments: The credit instruments dealt with in the capital market are more heterogeneous than those in money market. Some homogeneity of credit instruments is needed for the operation of financial markets. Too much diversity creates problems for the investors. 4. Institutions: Important institutions operating in the' money market are central banks, commercial banks, acceptance houses, non-bank financial institutions, bill brokers, etc. Important institutions of the capital market are stock exchanges, commercial banks and non-bank institutions, such as insurance companies, mortgage banks, building societies, etc.
  • 9. 5. Purpose of Loan: The money market meets the short-term credit needs of business; it provides working capital to the industrialists. The capital market, on the other hand, caters the long-term credit needs of the industrialists and provides fixed capital to buy land, machinery, etc. 6. Risk: The degree of risk is small in the money market. The risk is much greater in capital market. The maturity of one year or less gives little time for a default to occur, so the risk is minimized. Risk varies both in degree and nature throughout the capital market. 7. Basic Role: The basic role of money market is that of liquidity adjustment. The basic role of capital market is that of putting capital to work, preferably to long-term, secure and productive employment. 8. Relation with Central Bank: The money market is closely and directly linked with central bank of the country. The capital market feels central bank's influence, but mainly indirectly and through the money market. 9. Market Regulation: In the money market, commercial banks are closely regulated. In the capital market, the institutions are not much regulated. 8. Debt Market: It is a market meant for trading (i.e. buying or selling) fixed income instruments. Fixed income instruments could be securities issued by Central and State Governments, Municipal Corporations, Govt. Bodies or by private entities like financial institutions, banks, corporates, etc. The bond market (also debt market or credit market) is a financial market where participants can issue new debt, known as the primary market, or buy and sell debt securities, known as the secondary market. This is usually in the form of bonds, but it may include notes, bills, and so on. The primary goal of the bond market is to provide a mechanism for long term funding of public and private expenditures. Maturity is the date on which the investor is repaid the principal by the issuer. The tenure for the maturity of an instrument can range from one day to 30 years. Generally, for a longer the time period towards maturity the issuer pays a higher interest rate on the instrument. Instruments with a maturity under 364 days are termed as short-term instruments. Debt markets are vital to the sustained growth of any economy since they offer efficient mobilization and allocation of financial resources. Debt instruments are used to finance developmental activities undertaken by the Government. They also aid in managing the liquidity in the economy. Borrowings from the debt market allow the Government to reduce its dependence on external sources of funding. It also reduces the pressure on institutional financing to fund public sector or private sector projects. The issue & trade of securities in India are regulated by either RBI or SEBI. Government securities and bonds, instruments issued by banks and financial institutions are regulated by RBI while issues of nongovernment securities (i.e. issue by corporates) are regulated by SEBI. The corporate debt market can be classified into Primary market and Secondary market. In the primary market, corporate debt is via private placements like corporate bonds placed with wholesale investors like banks, financial institutions, mutual funds, etc. The Secondary market for corporate debt is available on platforms offered by various exchanges in the country. The secondary debt market in India can be broadly categorized into –  Wholesale Debt Market – comprising of investors like Banks, financial institutions, RBI, insurance companies, Mutual funds, corporates and FIIs.  Retail Debt Market – comprising of investors like individuals, pension funds, private trusts, NBFCs and other legal entities. 9. Primary and Secondary Market: Primary Market is a market for new issues and hence it is called new issue market. It deals with securities which are issued to the public for the first time. There are three ways through which capital is raised in primary market. These are: - Public issue
  • 10. - Right Issue - Private placement Secondary market is a market for secondary sale of securities i.e. securities which already passed through the new issue market are traded in this secondary market. Generally, such securities are quoted in stock exchange and it provides a continuous; and regular market for buying and selling of securities. 10. Interlinking Financial Market-Indian and Global Financial Markets: Integration The term “integration” refers to the establishment of close connections or effective linkages between different constituents and between different parts of the financial system. Financial integration is the opposite of the maturity wise, geographical, institutional, seasonal, instrumental, segmentation or Compartmentalization of the financial markets. The integration process has helped the financial markets both at national and international levels to enhance their efficiency and it has also facilitated in globalization of financial services. The flow of foreign capital from the industrialized countries to the developing countries has been the significant outcome of this integration process. Global Integration of Financial Markets In terms of international trade and financial flows, Indian economy is to a very great extent an open economy, though the extent of its openness may not be as great as in countries like USA, UK, Germany, Japan, Philippines. The foreign exchange markets are cleared at a conversion price, i.e. at the exchange rate. The foreign exchange rates are an important part of financial analysis. Though the exchange rate is apparently determined by the supply of and demand for foreign exchange, the complex forces of exports and imports lie behind the whole process of exchange rate determination. The international aspects of savings and investments flows are reflected in the volume of capital flows between nations. The world economy has witnessed significant changes in recent years. India has already opened up its economic frontiers and presently expects increasing gains from the new world trade order and the world finance system. Since 1990, the global economy has emerged very swiftly requiring significant changes. The openness of the economy is also apparent in the projections of the Eight Plan. While exports are expected to grow by 13.6% p.a. in volume terms to reach a level of US $33.55 billion by the year 1996-97, imports are projected to increase by 8.4% in volume terms. The trade policy reforms have been made part of overall reform process for he realization of aforesaid objectives. The GATT played a significant role in facilitating the rapid expansion in global trade through a succession of rounds which culminated in the Uruguay Round and resulted in the transformation of GATT into World Trade Organization. The Uruguay Round has been the most ambitious and comprehensive multilateral trade negotiations in history. During the 1996-1994, international transaction sin good and non-factor services as a proportion of GDP enhance from 33% to 43% for the developing world as a whole. The General Agreement on Trade in services is the first multilaterally agreed and legally enforceable rules to cover international trade in services. Share of services in global trade has increased to over 22% in 1994 against 15% in 1980. The way the Indian Corporate sector reacted to the domestic liberalization process as well as to the Uruguay Round results disclose that a large segment is quite conscious that this liberalization process is desirable, possibly also irreversible and the world trade liberalization through the Uruguay Round can be a position factor that will facilitate the adjustments needed to be done at the corporate level in response to the domestic reforms process. Thus global integration of financial markets resulted from de-regulatory measures, technological and information explosion and financial innovations. The Indian Corporate Sector has appreciated the concept of globalization of economy and has been initiating measures to emerge as Indian multinationals. The measures include improved quality products, establishment of overseas distribution and marketing channels, capacity utilization, cost consciousness, strategic alliances for both domestic and international operations and so forth.
  • 11. Module - II: Financial Institutions 1. Financial Institutions The financial institutions in any country are significant financial and commercial organizations responsible for providing proper facilitation to the flow of money and finances through the economy, through acting as major and main financial intermediaries between the potential lenders or investors and the borrowers of all categories. In most of the countries all across the world, these financial institutions operate under heavily and stringently regulated environment, usually by the governments, because of being magnificent and critical part of country's economy. By dint of these facts and privileges, the financial institutions of all over the world, therefore, deserve our special attention and selective legal services. 1.1: Broad Categories The structure of financial institutions (FIs) in India is widely diversified and includes National and State level development financial institutions, insurance corporations and investment institutions. For purposes of classification, the financial institutions can be classified into three broad heads: (a) All-India Financial Institutions, (b) State-level Institutions (SFCs and SIDCs), and (c) Other Institutions (ECGC and DICGC). All-India Financial Institutions can be further reclassified under four broad heads – All-India Development Banks (IDBI, ICICI, SIDBI, IIBI and IFCI); Specialized-Financial Institutions (EXIM Bank, RCTC, ICICI Venture, TFCI and IDFC); Investment Institutions (UTI, LIC and GIC and its subsidiaries); and Refinance Institutions (NABARD and NHB). In the case of investment institutions, UTI, being a mutual fund, is discussed under the section on capital markets while for the LIC and the GIC and its subsidiaries. Special Characteristics 1. To reduce transaction costs by specializing in the issuance of standardized securities. 2. To reduce the information costs of screening and monitoring borrowers. They curb asymmetries, helping resources flow to most productive uses. 3. To give savers ready access to their funds. 4. Financial intermediation and leverage have shifted away from traditional banks and toward other financial institutions less subject to government regulations. 5. Brokerages, insurers, hedge funds, etc. 6. Provide services that compete with banks but do not accept deposits. 7. Take on more risk than traditional banks and are less. 8. Rapid growth in some financial instruments made it easier to conceal leverage and risk-taking. 2. Money Market Institutions /PARTICIPANTS IN MONEY MARKET The major participants who supply the funds and demand the same in the money market are as follows: i) Reserve Bank of India: Reserve Bank of India is the regulator over the money market in India. As the Central Bank, it injects liquidity in the banking system, when it is deficient and contracts the same in opposite situation. ii) Banks: Commercial Banks and the Co-operative Banks are the major participants in the Indian money market. They mobilize the savings of the people through acceptance of deposits and lend it to business houses for their short term working capital requirements. While a portion of these deposits is invested in medium and long-term Government securities and corporate shares and bonds, they provide short-term funds to the Government by investing in the Treasury Bills. They employ the short-term surpluses in various money market instruments. iii) Discount and Finance House of India Ltd. (DFHI): DFHI deals both ways in the money market instruments. Hence, it has helped in the growth of secondary market, as well as those of the money market instruments. iv) Financial and Investment Institutions: These institutions (e.g. LIC, UTI, GIC, Development Banks, etc.) have been allowed to participate in the call money market as lenders only. v) Corporates: Companies create demand for funds from the banking system. They raise short-term funds directly from the money market by issuing commercial paper. Moreover, they accept public deposits and also indulge in inter corporate deposits and investments. vi) Mutual Funds: Mutual funds also invest their surplus funds in various money market instruments for short periods. They are also permitted to participate in the Call Money Market. Money Market Mutual Funds have been set up specifically for the purpose of mobilization of short-term funds for investment in money market instruments.
  • 12. 3. Capital Market Institutions These institutions may further be classified into investing institutions and development banks on the basis of the nature of their activities and the financial mechanism adopted by them. Investing institutions comprise those financial institutions which garner the savings of the people by offering their own shares and stocks, and which provide long-term funds, especially in the form of direct investment in securities and underwriting capital issues of business enterprises. These institutions include investment banks, merchant banks, investment companies and the mutual funds and insurance companies. Development banks include those financial institutions which provide the sinews of development, i.e. capital, enterprise and know-how, to business enterprises so as to foster industrial growth. 4. Financial Services Institutions, Functions and structure introduced: Financial institutions or institutions offer various types of transformation services. They issue claims to their customers that have characteristics different from those of their own assets. For example, banks accept deposits as liability and convert them into assets such as loans. This is known as “liability-asset transformation” function. Similarly they choose and manage portfolios whose risk and return they alter by applying resources to acquire better information and to reduce or overcome transaction costs. They are able to do so through economies of scale in lending and borrowing. They provide large volumes of finance on the basis of small deposits or unit capital. This is called “size-transformation” function. Further, they distribute risk through diversification and thereby reduce it for savers as in the case of mutual funds. This is called “risk-transformation” function. Finally they offer savers alternate forms of deposits according to their liquidity preferences, and provide borrowers with loans of requisite maturities. This is known as “maturity-transformation” function. A financial system also ensures that transactions are effected safely and swiftly on an on-going basis. It is important that both buyers and sellers of goods and services should have the confidence that instruments used to make payments will be accepted and honored by all parties. The financial system ensures the efficient functioning of the payment mechanism. In short, financial markets can be said to perform proximate functions such as: 1. Enabling economic units to exercise their time preference, 2. Separation, distribution, diversification, and reduction of risk, 3. Efficient operation of the payment mechanism, 4. Transmutation or transformation of financial claims so as to suit the preferences of both savers and borrowers, 5. Enhancing liquidity of financial claims through securities trading, and 6. Portfolio management. 5. Stock Exchanges: “Stock Exchange means any body or individuals whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities”. It is an association of member brokers for the purpose of self-regulation and protecting the interests of its members. It can operate only if it is recognized by the Government under the Securities Contracts (Regulation)Act, 1956. The recognition is granted under Section 3 of the Act by the Central Government, Ministry of FinanceStock Exchange Division.
  • 13. The Powers of the Central Government under the Act are far-reaching and include the following in particular: (1) Grant and withdrawal of recognition, approval or change of byelaws. (2) Call for periodical returns from the Stock Exchange. (3) Direct enquiries on the members or on the Stock Exchange. (4) Liability of the Exchange to submit annual reports. (5) Directing the Stock Exchange to make certain rules. (6) Supersede the Governing Board of the Exchange. (7) Suspend the Governing Board of the Exchange. (8) Impose any other conditions or regulations for trading. Constitution: A Governing Board comprising of 9 elected director (one third of them retire every year by rotation), an Executive Director, three Government nominees, a Reserve Bank of India nominee and five public representatives, is the apex body which regulates the Exchange and decides its policies. A President, a VicePresident and an honorary Treasurer are annually elected from among the elected directors, by the Governing Board following the election of directors. The Executive Directors as the Chief Executive Officer is responsible for the day-to-day administration of the Exchange. Earliest records of securities trading in India are available from the end of the eighteenth century. Before 1850, there was business conducted in Mumbai in shares of banks and the securities of the East India Company which were considered as securities for buying, selling and exchange. The shares of the Commercial Bank, Mercantile Bank and Bank of Bombay were some of the prominent shares traded. The business was conducted under sprawling banyan tree in front of the Town Hall, which is now in the Horniman Circle Park. In 1850, the Companies Act was passed and that heralded the commencement of joint stock companies in India, It was the American civil war that helped Indians to establish broking business. The leading broker, Shri Premchand Roychand was responsible for developing conventions and procedures. In 1874, the Dalal Street became the prominent place of meeting of the brokers to conduct their business. The brokers organized and Association on 9th July 1875 known as the Native Share Brokers Association to protect character, status and interest of the Native Brokers and that was the foundation of the Stock Exchange, Mumbai. The Exchange was established with 318 members. The number increased to 333 in 1896 and a present, it is 641. The membership fee has increased gradually from Rs. 1 in 1887 to Rs. 1,000.- in 1896, Rs. 48,000/- in 1920, Rs. 7.51 lakhs in 1986 and Rs. 55 lakhs at present. In 1950, Stock Exchanges became an exclusively Central Government subject following adoption of the Constitution of India. In 1956, the Securities Contracts (Regulation) Act was passed. In 1992, the Securities and Exchange Board of India Act was passed though the Securities Exchange Board of India (SEBI) came into existence in 1988. In the last three years, SEBI has been empowers by the Central Government to regulate and develop capital markets in India. In 1992, the Over the Counter Exchange of India (OTCEI) came into existence where equities of small Companies are listed. In 1994, birth of the National Stock Exchange took place, in 1995, the Exchange rapidly computerized its trading operations and thus the open cut-cry system of share trading was replaced by screen based trading in the Stock Exchange, Mumbai. In January 1996, the revised carry forward system was introduced. In September 1997, BSE On-Line Trading System network went nationwide. The recognized stock exchanges at Mumbai, Ahmadabad, Indore are voluntary non-profit-making associations, while the Calcutta, Delhi, Bangalore, Cochin, Kanpur, Ludhiana, Guwahati and Kanara Stock Exchanges are join-stock companies limited by shares and the Mumbai, Hyderabad and Pune stock Exchanges are companies limited by guarantee. Since the Rules of Articles of Association defining the constitution of the recognized stock exchanges are approved by the Central Government, there is an uniformity in their organisation.
  • 14. Control: The governing body of a recognized stock exchange has wide governmental and administrative powers and is the decision – taking body. It has the power, subject to governmental approval, to make, amend and suspend the operation of the rules, byelaws and regulations of the exchanges. It also has complete jurisdiction over all members and in practice, its power of management and control are almost absolute. Under the constitution, the governing body has the power to admit and expel members, to warn, censure, fine and suspend members and their partners, attorneys, remisiers, authorized clerks and employees, to approve the formation and dissolution of partnerships and appointment of attorney, remisiers and authorized clerks, to enforce attendance and information, adjudicate disputes and impose penalties, to determine the mode and conditions of stock exchange business and regulate stock exchange trading all its aspects and generally to supervise, direct and control all matters and activities affecting the stock exchange. The organisation of Mumbai Stock Exchange is typical. The members on roll elect 16 members to be Directors on the Governing Board, who in turn elect a President. Vice-President and Treasurer. The Executive Director is appointed by the government on the recommendation of the Governing Board to the Chief Administrator of the Exchange. There are also three representatives from the Government, three from the public and one from the RBI on the Board to represent their interests. As per the SEBI guidelines, the Exchanges have agreed to have 50% representation to non-members on the Governing Board. FUNCTIONS OF A STOCK EXCHANGE The functions of stock exchange can be enumerated as follows: 1. Provides ready and continuous market: By providing a place where listed securities can be bought and sold regularly and conveniently, a stock exchange ensures a ready and continuous market for various shares, debentures, bonds and government securities. This lends a high degree of liquidity to holdings in these securities as the investor can encash their holdings as and when they want. 2. Provides information about prices and sales: A stock exchange maintains complete record of all transactions taking place in different securities every day and supplies regular information on their prices and sales volumes to press and other media. In fact, now-a-days, you can get information about minute to minute movement in prices of selected shares on TV channels like CNBC, Zee News, NDTV and Headlines Today. This enables the investors in taking quick decisions on purchase and sale of securities in which they are interested. Not only that, such information helps them in ascertaining the trend in prices and the worth of their holdings. This enables them to seek bank loans, if required. 3. Provides safety to dealings and investment: Transactions on the stock exchange are conducted only amongst its members with adequate transparency and in strict conformity to its rules and regulations which include the procedure and timings of delivery and payment to be followed. This provides a high degree of safety to dealings at the stock exchange. There is little risk of loss on account of non-payment or non-delivery. Securities and Exchange Board of India (SEBI) also regulates the business in stock exchanges in India and the working of the stock brokers. Not only that, a stock exchange allows trading only in securities that have been listed with it; and for listing any security, it satisfies itself about the genuineness and soundness of the company and provides for disclosure of certain information on regular basis. Though this may not guarantee the soundness and profitability of the company, it does provide some assurance on their genuineness and enables them to keep track of their progress. 4. Helps in mobilization of savings and capital formation: Efficient functioning of stock market creates a conducive climate for an active and growing primary market. Good performance and outlook for shares in the stock exchanges imparts buoyancy to the new issue market, which helps in mobilizing savings for investment in industrial and commercial establishments. Not only that, the stock exchanges provides liquidity and profitability to dealings and investments in shares and debentures. It also educates people on where and how to invest their savings to get a fair return. This encourages the habit of saving, investment and risk-taking among the common people. Thus it helps mobilizing surplus savings for investment in corporate and government securities and contributes to capital formation. 5. Barometer of economic and business conditions: Stock exchanges reflect the changing conditions of economic health of a country, as the shares prices are highly sensitive to changing economic, social and
  • 15. political conditions. It is observed that during the periods of economic prosperity, the share prices tend to rise. Conversely, prices tend to fall when there is economic stagnation and the business activities slow down as a result of depressions. Thus, the intensity of trading at stock exchanges and the corresponding rise on fall in the prices of securities reflects the investors’ assessment of the economic and business conditions in a country, and acts as the barometer which indicates the general conditions of the atmosphere of business. 6. Better Allocation of funds: As a result of stock market transactions, funds flow from the less profitable to more profitable enterprises and they avail of the greater potential for growth. Financial resources of the economy are thus better allocated. 6. Prudential Norms: SEBI – Market Regulator and Investors’ Protector • SEBI is required to create a proper and conducive atmosphere required for raising money from the capital market. The atmosphere includes the rules, regulations, trade practices, customs and relations among institutions, brokers, investors and companies. it shall endeavor to restore the trust of investors and particularly to safeguard the interest of the small investors. This can be achieved by meeting the needs of the persons connected with the security market and establishing proper coordination among the three main groups directly connected with its operations, namely, (a) investors, (b) corporate sectors and (c) intermediaries. • SEBI is expected to educate investors and make them aware of their rights in clear and specific terms. It shall provide investors with information and see that the market maintains liquidity, safety and profitability of the securities which are crucial for any investments. • SEBI shall create a proper investments climate and enable the corporate sector to raise industrial securities easily, efficiently and at affordable minimum cost. • SEBI shall develop a proper infrastructure so that the market automatically facilitate expansion and growth of business to middlemen like brokers, jobbers, commercial banks, merchant bankers, mutual funds, etc, Thus, it will ensure that they provide efficient service to their constituents, namely, investors and the corporate sector at a competitive price. • SEBI shall make more effective the law in the existing status as far as they relate to the industrial securities, mutual funds, investments in Units, LIC savings plan. Chit-Fund companies and securities issued by housing/industrial societies and corporations with the purpose of making investments in housing/industrial projects. • SEBI shall create the framework for more open, orderly, and unprejudiced conduct in relation to takeover and mergers in the corporate sector to ensure fair and equal treatment to all the security holders, and to facilitate such takeovers and mergers in the interest of efficient by prescribing a mechanism for more orderly conduct. 7. SEBI Regulations (REGULATIONS OF STOCK EXCHANGES) As indicated earlier, the stock exchanges suffer from certain limitations and require strict control over their activities in order to ensure safety in dealings thereon. Hence, as early as 1956, the Securities Contracts (Regulation) Act was passed which provided for recognition of stock exchanges by the central Government. It has also the provision of framing of proper bylaws by every stock exchange for regulation and control of their functioning subject to the approval by the Government. All stock exchanges are required submit information relating to its affairs as required by the Government from time to time. The Government was given wide powers relating to listing of securities, make or amend bylaws, withdraw recognition to, or supersede the governing bodies of stock exchange in extraordinary/abnormal situations. Under the Act, the Government promulgated the Securities Regulations (Rules) 1957, which provided inter alia for the procedures to be followed for recognition of the stock exchanges, submission of periodical returns and annual returns by
  • 16. recognized stock exchanges, inquiry into the affairs of recognized stock exchanges and their members, and requirements for listing of securities. ROLE OF SEBI As part of economic reforms programme started in June 1991, the Government of India initiated several capital market reforms, which included the abolition of the office of the Controller of Capital Issues (CCI) and granting statutory recognition to Securities Exchange Board of India (SEBI) in 1992 for: (a) protecting the interest of investors in securities; (b) promoting the development of securities market; (c) regulating the securities market; and (d) matters connected there with or incidental thereto. SEBI has been vested with necessary powers concerning various aspects of capital market such as:  regulating the business in stock exchanges and any other securities market;  registering and regulating the working of various intermediaries and mutual funds;  promoting and regulating self regulatory organisations;  promoting investors education and training of intermediaries;  prohibiting insider trading and unfair trade practices;  regulating substantial acquisition of shares and take over of companies;  calling for information, undertaking inspection, conducting inquiries and audit of stock exchanges, and intermediaries and self regulation organisations in the stock market; and  performing such functions and exercising such powers under the provisions of the Capital Issues (Control) Act, 1947 and the Securities Contracts (Regulation) Act, 1956 as may be delegated to it by the Central Government. As part of its efforts to protect investors’ interests, SEBI has initiated many primary market reforms, which include improved disclosure standards in public issue documents, introduction of prudential norms and simplification of issue procedures. Companies are now required to disclose all material facts and risk factors associated with their projects while making public issue. All issue documents are to be vetted by SEBI to ensure that the disclosures are not only adequate but also authentic and accurate. SEBI has also introduced a code of advertisement for public issues for ensuring fair and truthful disclosures. Merchant bankers and all mutual funds including UTI have been brought under the regulatory framework of SEBI. A code of conduct has been issued specifying a high degree of responsibility towards investors in respect of pricing and premium fixation of issues. To reduce cost of issue, underwriting of issues has been made optional subject to the condition that the issue is not under-subscribed. In case the issue is under-subscribed i.e., it was not able to collect 90% of the amount offered to the public, the entire amount would be refunded to the investors. The practice of preferential allotment of shares to promoters at prices unrelated to the prevailing market prices has been stopped and private placements have been made more restrictive. All primary issues have now to be made through depository mode. The initial public offers (IPOs) can go for book building for which the price band and issue size have to be disclosed. Companies with dematerialized shares can alter the par value as and when they so desire. As for measures in the secondary market, it should be noted that all statutory powers to regulate stock exchanges under the Securities Contracts (Regulation) Act have now been vested with SEBI through the passage of securities law (Amendment) Act in 1995. SEBI has duly notified rules and a code of conduct to regulate the activities of intermediaries in the securities market and then registration in the securities market and then registration with SEBI is made compulsory. It has issued guidelines for composition of the governing bodies of stock exchanges so as to include more public representatives. Corporate membership has also been introduced at the stock exchanges. It has notified the regulations on insider trading to protect and preserve the integrity of stock markets and issued guidelines for mergers and acquisitions. SEBI has constantly reviewed the traditional trading systems of Indian stock exchanges and tried to simplify the procedure, achieve transparency in transactions and reduce their costs. To prevent excessive speculations and volatility in the
  • 17. market, it has done away with badla system, and introduced rolling settlement and trading in derivatives. All stock exchanges have been advised to set-up Clearing Corporation / settlement guarantee fund to ensure timely settlements. SEBI organizes training programmes for intermediaries in the securities market and conferences for investor education all over the country from time to time. 8. Sensitive Indices: Security market Index measures the behaviour of the security prices and the stock market. Indicators represent the entire stock market and its segments which measure the movement of the stock market. The most popular index in India are the Bombay stock exchange sensitivity Index (BSE Sensex or BSE – 100) and the National Stock Exchange Nifty. The two prominent Indian market indexes are Sensex and Nifty. Sensex is the oldest market index for equities; it includes shares of 30 firms listed on the BSE, which represent about 45% of the index's free-float market capitalization. It was created in 1986 and provides time series data from April 1979, onwards. Another index is the S&P CNX Nifty; it includes 50 shares listed on the NSE, which represent about 62% of its free-float market capitalization. It was created in 1996 and provides time series data from July 1990, onward. Purpose of Index Security Index is helpful to show the economic health and analyzing the movement of price of various securities listed into the stock exchange.  Helpful to evaluate the Risk – return portfolio analysis.  Helpful to measure the growth of the secondary market.  Index can be used to compare a given share prices behaviour with its movement.  It is helpful to the investor to make their Investment decision.  Funds can be allocated more rationally between stocks with knowledge of the relationship of price of individual with the movements in the market.  Market indices act as sensitive barometer of the changes in trading pattern in the stock market. Factors that influence the construction of Index numbers  Selecting the shares for inclusion in the index making.  Determine the relative importance of each share included in the sample weighting  Average the included share into single share measure. Sample List of Indices BSE- SENSEX BSE100 Index BSE200 Dollex BSE 500 and Sectoral Indices INDO text S&P CNX 50 CNX Nifty Junior OTCEI – Composite Index 9. Services given by Stock Exchange to Investors: Stock exchange provides liquidity: (i.e. easy convertibility to cash) to investment in securities. An investor can sell his securities at any time because of the ready market provided by the stock exchange. Stock exchange provides easy marketability to corporate securities. Provides collateral value to securities: Stock exchange provides better value to securities as collateral for a loan. This facilitates borrowing from a bank against securities on easy terms. Offers opportunity to participate in the industrial growth: Stock exchange provides capital for industrial growth. It enables an investor to participate in the industrial development of the country.
  • 18. Estimates the worth of securities: Stock exchange provides the facility of knowing the worth (i.e true market value) of investment due to quotations (i.e. price list) and reports published regularly by the exchange. This type of information guides investors as regards their future investments. They can purchase or sell securities as per the price trends (i.e. latest price value) in the market. Offers safety in corporate investment: An investor can invest his surplus money (i.e. extra money) in the listed securities with reasonable safety. The risk in such investment is reduced considerably due to the supervision of stock exchange authorities on listed companies. Moreover, securities are listed only when the exchange authorities are satisfied as regards legality and solvency of company concerned. Such scrutiny (detailed checking) avoids listing, of securities of unsound companies (i.e. companies with bad financial status). Services given by Stock Exchange to Companies: Widens market for securities: Stock exchange widens the market for the listed securities and enables the companies to collect capital for promotion, expansion and modernization purpose. It indirectly provides financial support to companies / corporations. Creates goodwill and reputation: Stock exchange enhances the goodwill and the reputation of the companies whose securities are listed. Listing acts as a character certificate given to a company. It gives prestigious position to company. Facilitates fair pricing of listed securities: The market price of listed securities tends to be slightly higher in relation to earnings and property values. Provides better response from investors: Listed securities get better response from the investor due to safety and security. Listing of securities is a unique service which stock exchanges offer to companies. It is a moral support given to stable companies. Facilitates quick selling of securities: Stock exchange enables companies to sell their securities easily and quickly. This is natural as investors always prefer to invest money in listed securities. 10. Grievance Redressal Measures: (Investor Grievance Redressal) Securities and Exchange Board of India (SEBI) has been established with the prime mandate to protect the interest of investors in securities. It is also mandated to promote the development of and to regulate the securities market. An investor enjoys investing, if     he knows how to invest; he has full knowledge of the market; the market is safe and there are no miscreants; and There are arrangements to redress the grievances. Accordingly, SEBI’s investor protection strategy has four elements.  First, build the capacity of investors through education and awareness to enable an investor to take informed investment decisions. SEBI endeavors to ensure that the investor learns investing, that is, he obtains and uses information required for investing, evaluates various investment options to suit his specific goals, ascertains his rights and obligations in a particular investment, deals through registered intermediaries, takes necessary precautions, seeks help if he gets into any problem, etc.  Towards this end, SEBI has been organizing investor education and awareness workshops directly, and through investor associations and market participants, and also been encouraging market participants to organize similar programmes. It maintains an updated, comprehensive web site for education of investors. It publishes various kinds of cautions through media. It responds to the queries of investors through telephone, e-mails, letters, and in person for those who visit SEBI office.
  • 19.  Second, make available every detail relevant for investment in public domain. SEBI has adopted disclosure based regulatory regime. Under this framework, issuers and intermediaries disclose relevant details about themselves, the products, the market and the regulations so that the investor can take informed investment decisions based on such disclosures. SEBI has prescribed and monitors various initial and continuous disclosures.  Third, ensure that the market has systems and practices which make transactions safe. SEBI has taken various measures, such as, dematerialization of securities; screen based trading system, T+2 rolling settlement, etc. The dematerialization of securities eliminated a large number of investor grievances emanating from servicing of paper based securities such as bad delivery of shares, delay/non-transfer of shares, etc. This facilitated migration from account period settlement to T+2 rolling settlement which reduced settlement risk substantially.  Fourth, help an investor in problem. SEBI has a comprehensive mechanism to facilitate redressal of investor grievances against intermediaries and listed companies. It follows up with the companies and intermediaries who do not redress investors’ grievances, by sending reminders to them and having meetings with them. It takes appropriate enforcement actions (adjudication, prosecution proceedings, directions, etc.), as provided under the law where progress in redressal of investor grievances is not satisfactory. It has provided for a comprehensive arbitration mechanism in stock exchanges and depositories for resolution of disputes of the investors with brokers and depository participants. It has instituted investor protection funds at Exchanges to compensate investors where a broker is declared a defaulter. Depository indemnifies investors for loss due to negligence of depository or depository participant. Recently, SEBI has realized a receipt of unlawful gain of about Rs. 30 crore and so far disbursed about Rs. 24 crore among the investors who lost out in the IPO irregularities. While SEBI has been taking various measures for the investor protection, this memorandum focuses on the investor grievance redressal mechanism available in SEBI, its performance, measures taken in recent years for expediting the redressal of investors’ grievances, difficulties in the existing system and improvements planned. Redressal of Investors’ Grievances  The Office of Investor Assistance and Education (OIAE) acts as the single window interface, interacting with investors seeking assistance of SEBI. Investors can submit grievances either by post or hand delivery at any of the SEBI office or by electronic mode (web or e-mail). All grievances received by SEBI (excluding those which refer/pertain to investigation) are individually acknowledged with unique number, which facilitates tracking.  Dedicated investor helpline telephone numbers (022-26449188 & 26449199) are available for investors seeking general guidance pertaining to securities markets and to provide assistance in filing grievances. Dedicated personnel manning the helpline also guide the investors in filing up the grievance submission forms as well as in determining the appropriate authority for their first recourse. Guidance is also provided to approach the appropriate authority if their grievance is outside the purview of SEBI.  Grievances against listed companies: The grievances lodged by investors are taken up with the respective listed company and are continuously monitored. The company is required to respond in prescribed format in the form of Action Taken Report (ATR). Upon the receipt of ATR, the status of grievances is updated. Where the response of the company is insufficient / inadequate, follow up action is initiated.
  • 20.  Grievances against stock brokers and depository participants: Grievances pertaining to stock brokers and depository participants are taken up with concerned stock exchange and depository for redressal and monitored by the concerned department through periodic report obtained from them.  Grievances against other intermediaries: Grievances pertaining to other intermediaries are taken up with them directly for redressal and are continuously monitored by concerned Department of SEBI. Improvements planned        SEBI is in the process of upgrading the investor grievance redressal mechanism. The upgraded mechanism SCORES (SEBI Complaints Redress System) would be a web-based, centralized grievance redress system for SEBI. The salient features of the new system are: Centralized grievances tracking system for the entire SEBI. Grievance pertaining to any of the Regional Offices of SEBI can be lodged from anywhere. All grievances and Action Taken Report to be in electronic mode Action taken and the current status of the grievance can be accessed online by the investors. Facility for online updation of Action Taken Reports.  SCORES will reduce grievance process time at SEBI since physical movements of grievances are not required. Similarly the grievance redressal time will be reduced since the entire process is in electronic mode, including action taken report submitted by the company/intermediary. The problems arising from loss/misplacement of grievance records would be eliminated since grievances are available in electronic format. Similarly, the problem of physical storage, maintenance and redressal has also been addressed due to the proposed conversion of physical grievances into electronic mode. Each grievance will be treated as resolved /closed only after SEBI’s satisfaction. As investors can track their grievance redressal status online, multiple correspondences from investors to know the status of their grievances are avoided.  The software for the new system is being developed by the National Informatics Centre (NIC), Ministry of Information Technology, New Delhi.  Presentation on SCORES was given to representatives of Stock Exchanges, Depositories, Stock Brokers, Registrars and Depository Participants to create awareness and get suggestions/ comments from the participants. Feedback and suggestions were obtained from the various departments of SEBI on SCORES.  As a comprehensive list of listed companies is currently not available with SEBI, it is essential to have this list for lodging grievances against them on SCORES. In view of the above, a separate database is being developed based on the data obtained from Stock Exchanges. Formats for various categories of grievances received by SEBI, Action Taken Reports by the companies /intermediaries and flow of grievances within SEBI, its regional offices and intermediaries have been developed.  A demonstration on SCORES was given to the division chiefs and dealing officers of various departments of SEBI on the modules developed viz. how to lodge a grievance, the Action taken report format, etc. A similar demonstration was also given to Stock Exchanges, Depositories, RTAs and companies forming part of NIFTY and SENSEX.
  • 21.  Subsequent to the demonstration, parallel processing in SCORES has commenced for grievances against stock brokers and depository participants since September 15, 2010 and for NIFTY and SENSEX companies from December 12, 2010 for testing the software.  The development of various query modules, MIS reports and standardized letters to be issued to the complainants for different status of grievances are in progress.  This memorandum is submitted for information of and guidance from the Board. Financial Services Institutions: 11. Clearing Corporation of India Limited (CCIL) The CCIL is the clearing agency for Government securities. It acts as a Central Counter Party (CCP) for all transactions in Government securities by interposing itself between two counterparties. In effect, during settlement, the CCP becomes the seller to the buyer and buyer to the seller of the actual transaction. All outright trades undertaken in the OTC market and on the NDS-OM platform are cleared through the CCIL. Once CCIL receives the trade information, it works out participant-wise net obligations on both the securities and the funds leg. The payable / receivable position of the constituents (gilt account holders) is reflected against their respective custodians. CCIL forwards the settlement file containing net position of participants to the RBI where settlement takes place by simultaneous transfer of funds and securities under the ‘Delivery versus Payment’ system. CCIL also guarantees settlement of all trades in Government securities. That means, during the settlement process, if any participant fails to provide funds/ securities, CCIL will make the same available from its own means. For this purpose, CCIL collects margins from all participants and maintains ‘Settlement Guarantee Fund’. 12. Discount and Finance House of India Ltd: DISCOUNT & FINANCE HOUSE OF INDIA (DFHI) DHFI has been set up as a specialized money market institution with the object of providing liquidity to money market instruments and to develop a secondary market. The DFHI is a joint stock company owned by RBI, public sector banks and All India Financial Institutions which have contributed towards its paid up capital of Rs.150 crores. Main functions of DFHI - To discount, rediscount, buy, sell, underwrite or acquire or sell marketable securities and negotiable instruments. - To undertake buy back arrangements in trade and Treasury Bills. - To carry on business as a lender, borrower broker or as a broking house in the inter-bank call money market. - To promote development of short term money market. - To advise banks, govt, financial institutions or business houses in evolving schemes of growth, development and expansion of money market The operations of DFHI aimed at imparting greater flexibility to banks in their fund management. It participates in call, notice and term market as a borrower and lender. It also purchases and sells TBs at auction, commercial bills, commercial papers and certificate of deposits. All transactions are done through exchange of cheques drawn on RBI to facilitate same day settlement. 13. National Securities Depository Ltd NSDL, the first and largest depository in India, established in August 1996 and promoted by institutions of national stature responsible for economic development of the country has since established a national infrastructure of international standards that handles most of the securities held and settled in dematerialized form in the Indian capital market.
  • 22. Although India had a vibrant capital market which is more than a century old, the paper-based settlement of trades caused substantial problems like bad delivery and delayed transfer of title till recently. The enactment of Depositories Act in August 1996 paved the way for establishment of NSDL, the first depository in India. This depository promoted by institutions of national stature responsible for economic development of the country has since established a national infrastructure of international standard that handles most of the trading and settlement in dematerialised form in Indian capital market. Using innovative and flexible technology systems, NSDL works to support the investors and brokers in the capital market of the country. NSDL aims at ensuring the safety and soundness of Indian marketplaces by developing settlement solutions that increase efficiency, minimise risk and reduce costs. At NSDL, we play a quiet but central role in developing products and services that will continue to nurture the growing needs of the financial services industry. In the depository system, securities are held in depository accounts, which is more or less similar to holding funds in bank accounts. Transfer of ownership of securities is done through simple account transfers. This method does away with all the risks and hassles normally associated with paperwork. Consequently, the cost of transacting in a depository environment is considerably lower as compared to transacting in certificates Basic Services Under the provisions of the Depositories Act, NSDL provides various services to investors and other participants in the capital market like, clearing members, stock exchanges, banks and issuers of securities. These include basic facilities like account maintenance, dematerialisation, rematerialisation, settlement of trades through market transfers, off market transfers & inter-depository transfers, distribution of non-cash corporate actions and nomination/ transmission. The depository system, which links the issuers, depository participants (DPs), NSDL and Clearing Corporation/ Clearing house of stock exchanges, facilitates holding of securities in dematerialised form and effects transfers by means of account transfers. This system which facilitates scripless trading offers various direct and indirect services to the market participants. 14. Securities Trading Corporation of India Ltd: STCI was set up as a subsidiary of Reserve Bank of India in May 1994 with the objective of fostering an active secondary market in Government of India Securities and Public Sector bonds. Securities Trading Corporation of India Ltd (STCI) was established in 1994 as a subsidiary of RBI with the objective of developing an active secondary market for GoI securities and public sector bonds. In 1996, STCI was authorized by RBI as one of the first Primary Dealers in India. In 1997, RBI divested a part of its holding in STCI which reduced its shareholding to 14.41%. In 2002, RBI sold its remaining shareholding in STCI to the existing shareholders. During 2007, the company hived off it is primary dealership business to its subsidiary STCI Primary Dealer Ltd. STCI is a registered Systemically Important-Non Deposit taking NBFC. STCI’s primarily undertakes investment and loan activities. Under its loan business STCI grants loans to its customers against the collateral of equity shares and undertakes funding for subscription of shares offered by companies under IPOs. Under investment activities, the company runs a proprietary book in equity trading, fixed income securities and commodities futures trading. The company provides financial services for individuals, HNIs, firms and corporates. 15. Credit Rating Institutions. Credit Rating: Meaning Credit rating is a codified rating assigned to an issue by authorized credit-rating agencies like CRISIL, CARE and ICRA. These agencies have been promoted by well-established financial Institutions like IDBI, ICICI. Unit Trust of India and reputed banks/finance companies, Credit-rating is a relative ranking arrived at by a
  • 23. systematic analysis of the strengths and weaknesses of a company and debt instrument issued by the company, based on financial statements, project analysis, creditworthiness factors and future prospectus of the project and the company appraised at a point of time. Objectives of Credit Rating Credit rating alms to (i) provide superior information to the investors at a low cost; (ii) provide a sound basis for proper risk-return structure; (iii) subject borrowers to a healthy discipline, and (iv) assist in the framing of public policy guidelines on institutional investment. Thus, credit rating financial services represent anexercise in faith building for the development of a healthy financial System. Credit Rating Information Services of India Limited (CRISIL) CRISIL was set up by ICICI and UTI in 1988. CRISIL rates debentures, fixed deposits, commercial paper, preference shares and structured obligations. The rating methodology followed by CRISIL involves and analysis of the following factors: (i) Business Analysis (a) Industry risk, including analysis of the structure of the industry, the Demand -supply position, a study of the key success factors, the nature and basis of competition, the impact of government policies, cyclic and seasonality of the industry. (b) Market position of the company within the industry including market shares, product and customer diversity, competitive advantages, selling and distribution arrangements. (c) Operating efficiency of the company like locational advantages, labour relationships, technology, manufacturing efficiency as compared to competitors. (d) Legal position including the terms of the prospectus, trustees and their responsibilities an systems for timely payments. (ii) Financial Analysis (a) Accounting quality like any overstatement or understatement of profits, auditors‟ qualifications in their reports, methods of valuation of inventory, depreciation policy (b) Earnings protection in terms of future earning growth for the company and future profitability. (c) Adequacy of cash flows to meet debt servicing requirements in addition to fixed and working capital needs. An opinion would be formed on the sustainability of cash flows in the future and the working capital management of the company. (d) Financial flexibility including the company’s ability to source finds from other sources like group companies, ability to defer capital expenditure and alternative financing plans in times of stress. (iii) Management Evaluation: The quality and ability of the management would be judged on the basis of the past track record, their goals, philosophies and strategies their ability to overcome difficult situations, etc. In addition to ability to repay, an assessment would be made of the management’s willingness to pay debt. This would involve an opinion of integrity of the management. (iv) Regulatory and competitive environment and regulatory framework of the financial system would be examined keeping in view their likely impact on the company. Trends in regulation / deregulation are also examined keeping in view their likely impact on the company. (v) Fundamental Analysis a) Capital adequacy, i.e. the true net work as compared to the volume of business and risk profile assets. b) Asset quality including the company’s credit risk management, systems for monitoring credit, exposure to individual borrowers and management of problem credits. c) Liquidity management. Capital structure, term matching of assets and liabilities and policy on liquid assets in relation to financial commitments would be some of the areas examined.
  • 24. d) Profitability and financial position in terms of past historical profits, the spread of funds deployed and accretion to reserves. e) Exposure to interest rate changes and tax law changes. The rating process begins at the request of the company. A professionally qualified team of analysis visits the company’s plants and meets with different levels of the management including the CEO. On completion of the assignment, the team interacts with a back-up team that has separately collected additional industry information and prepares a report. This report is placed before an internal committee and there is an open discussion to arrive at the rating. The rating is presented to an external committee which then takes the final decision which is communicated to the company. Should the company volunteer any further information at that point which could affect the rating is passed on to the external committee. Therefore, the company has the option to request for a review of rating. CRISIL publishes the CRISIL ratings in SCAN which is a quarterly publication in Hindi and Gujarathi besides English. CRISIL can rate mutual funds, banks and chit funds. Rating of mutual funds has assumed importance after the poor performance of mutual fund industry in 1995 to 1996. CRISIL Ventured into mutual fund rating market in 1997. It may also start rating real estate developers and governments. CRISIL is equipped to do equity grading. CRISIL Rating Symbols Debenture AAA Highest Safety AA High safety A Adequate safety BBB Moderate safety BB Inadequate safety B High risk C Substantial risk D Default (Debentures rated “D” are in default and in arrears of interest or principal payment or are expected to default on maturity. Such debentures are extremely speculative and returns from these debentures may be realized only on reorganization or liquidation), Crisil may apply plus or minus signs for ratings from AA to D to reflect comparative standing within the category. For rating preference shares, the letters pf are prefixed to the debentures rating symbols, e.g. pfAAA (Triple A) Fixed Deposit Program FAAA Highest Safety FAA High Safety FA Adequate safety FB Inadequate safety FC High risk FD Default or likely to be in default Short – term Instruments P-1 Very Strong degree of safety P-2 Strong degree of safety P-3 adequate degree of safety P-4 inadequate degree of safety Structured Obligations AAA (SO) Highest Safety
  • 25. AA (SO) Higher Safety A (SO) Adequate safety BBB (SO) Moderate safety BB (SO) Inadequate safety B(SO) High risk C(SO) Substantial risk D(SO) Default Investment Information and Credit Rating Agency (ICRA) ICRA which was promoted IFCI in 1991 carries out rating of debt instruments of manufacturing companies, finance companies and financial institutions. The factors that ICRA takes into consideration for rating depend on the nature of borrowing entity. The inherent protective factors, marketing strategies, competitive edge, level of technological development, operational efficiency, competence and effectiveness of management, human resource development policies and practices, hedging of risks, trends in cash flows and potential liquidity, financial flexibility, asset quality and past record of servicing of debt as well as government policies affecting the industry and unit arc examined. ICRA commences work at the request of the prospective issuer. A team of analysts collect data by going through the company’s books, interviewing executives and from the in-house research and data base of ICRA. ICRA offers the company on opportunity to get the instrument rated confidentially and also an option regarding the use of the rating. If, the company decided to use the rating. ICRA monitors it until redemption/repayment. In the case of misstatement by the company ICRA can disclose the correct position. ICRA Rating Symbols Long-term including debentures, bonds and preferences shares LAAA Highest Safety LAA High Safety LA Adequate Safety LBBB Moderate Safety LBB Inadequate safety LB Risk prone LC Substantial risk LD Default Medium – term including fixed deposits MAAA Highest Safety MAA High Safety MA Adequate safety MB Inadequate safety MC Risk prone MD Default A-1 Highest Safety A-2 High Safety A-3 Adequate safety A-4 Risk prone A-5 Default Credit Analysis and Research in Equity Limited (CARE) Credit Analysis and Research in Equity Limited is the third rating agency promoted by IDBI jointly with investment institution, banks and finance companies in 1993. They include Canara Bank, Unit Trust of India, Credit Capital Venture Fund (India) Limited, (since taken over by Infrastructure Leasing and Financial
  • 26. Services Ltd.). Sundaram Finance Limited, The Federal Bank Limited the Vysya Bank Limited, First Leasing Company of India Limited, ITC Classic Finace, Kolak Mahindra Finance among others. CARE commenced its rating operations in October, 1993. Credit rating by CARE covers all types of debt instruments such as debentures, fixed deposits, commercial paper and structured obligations. It also undertakes credit analysis of companies for the use of bankers, other lenders and business enterprises. CARE’s Rating Symbols For long-term and medium-term instruments CARE AAA Best quality investments. CARE AAA (FD)/(CD)/(SO) Debt service payments protected by stable Cash flows with good margin CARE AA (FD)/(CD)/(SO) High quality but rated lower because of Somewhat lower margin of protection CARE A Upper medium grade. CARE AA (FD)/(CD)/(SO) Safety adequate CARE BBB (FD)/(CD)/(SO) Sufficient safety. But adverse changes in assumptions likely to weaken the debt servicing capabilities CARE BB (FD)/(CD)/(SO) payments. Speculative instruments. Inadequate protection for interest and principal CARE C (FD)/(CD)/(SO) CARE D (FD)/(CD)/(SO) Highest investment risk. Lowest category , Likely to be in default soon In order of increasing risk, the ratings for short-term instruments are PR-1,PR-2, PR-3 and PR-5 and CARE -1, CARE -2, CARE -3, CARE – 4, and CARE – 5 for credit analysis of companies. Duff and Phelps Credit Rating Agency of India Ltd., (DCR) DCR (India) set up in 1996 is one of the credit rating agencies for rating the non-banking financial companies (for fixed deposits). The minimum investment grade credit rating to be assigned by this company which will be acceptable to the RBI has been fixed at Ind-BBB. Since the criteria used by DCR (India) for rating fixed deposits of NBFCs are not available, the factors specific to financial companies may be noted. Financial Instruments: 16. COMMERCIAL PAPER (CP) A CP is unsecured promissory note issued with a fixed maturity, issued by a company approved by RBI negotiable by endorsement and delivery, issued in bearer form and issued at such discount on the face value as may be determined by issuing company. Commercial paper are short term, unsecured promissory notes issued at a discount to face value by well- known companies that are financial strong and carry a high credit rating . They are sold directly by the issuers to investor, or else placed by borrowers through agents like merchant banks and security houses the flexible maturity at which they can be issued are one of the main attraction for borrower and investor since issues can be adapted to the needs of both. The CP market has the advantage of giving highly rated corporate borrowers cheaper fund than they could obtain from the banks while still
  • 27. providing institutional investors with higher interest earning than they could obtain form the banking system the issue of CP imparts a degree of financial stability to the systems as the issuing company has an incentive to remain financially strong. Features of CP are:  Short term money market instrument with a fixed maturity.  Unsecured corporate debt  Issued at discount in interest bearing form  Issuer promises to pay buyer some fixed amount on future period.  Issued directly by a company to investor or through bank/merchant banker. They are negotiable by endorsement and delivery.  They are issued in multiple of Rs 5 lakhs.  The maturity varies between 15 days to a year.  No prior approval of RBI is needed for CP issued.  The tangible net worth issuing company should not be less than 4 lakhs  The company fund based working capital limit should not less than Rs 10 crore.  The issuing company shall have P2 and A2 rating from CRISIL and ICRA. Investors in CPs are: Individuals, banks, corporate,s NRIs, Public sector units. Issued by : Private sector companies, public sector companies, non banking finance companies(NBFCs). In India, CPs were introduced w.e.f. 1.1.1990. The issuing company has to fulfill conditions prescribed by RBI. Only very financially sound companies are permitted to issue CPs. Periods – The CPs are used for a minimum period of 7 days with a maximum period of 6 months and a grace period on maturity. Amount – CPs are issued in the multiples of Rs.25 lacs and a investor has to invest minimum amount of Rs.1 crore. Issuing company : has to comply with provisions of Indian companies Act, Income Tax Act , negotiable instruments Act and guidelines prescribed by RBI in this regard. Advantages : Simple to issue, flexibility, easy to raise funds, high return. 17. CERTIFICATE OF DEPOSIT (CD) CDs are short term deposit instruments issued by banks and financial institutions with a maturity period ranging from 3 months to one year. These CDs are in the form of promissory note and are transferable from one party to another. Due to their negotiable nature, they are also known as negotiable certificate of deposit. CDs are available for subscription by individuals, corporations, trusts, associations etc. They are issued at discount to face value repayable on a fixed date without grace days and are subject to stamp duty. Banks have to maintain CRR & SLR on the issue price of CDs. The RBI has issued detailed guidelines on issue of CDs according to which CD could be in the multiple of Rs. 5 lacs, they are freely transferable by endorsement and delivery after 45 days of issue to a primary investor. Three financial institutions i.e. Industrial Dev. Bank of India, Industrial Credit & Investment Corporation of India and Industrial Finance Corporation of India have been permitted by RBI to issue CDs for more than one year upto 3years. In 1992, RBI also permitted Industrial Reconstruction Bank of India to issue CDs upto a limit of Rs.100 crores. Advantages of CDs – - Most convenient instrument to earn higher return. - Offer maximum liquidity as they are transferable by endorsement and delivery. - It is an ideal instrument for banks with short term surplus funds to invest at attractive rates.
  • 28. FEATURES 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. 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. 18. Treasury Bill (TB) – Treasury bills are the main financial instruments of money market. These bills are issued by the government. The borrowings of the government are monitored & controlled by the central bank. The bills are issued by the RBI on behalf of the central government. The RBI is the agent of Union Government. They are issued by tender or tap. The bills were sold to the public by tender method up to 1965. These bills were put at weekly auctions. A treasury bill is a particular kind of finance bill. It is a promissory note issued by the government. Until 1950 these bills were also issued by the state government. After 1950 onwards the central government has the authority to issue such bills. These bills are greater liquidity than any other kind of bills. They are of two kinds: a) ad hoc, b) regular. Treasury bill represents short term borrowing of the Govt. T.B. is nothing but a promissory note issued by Govt under discount for a specified period stated therein. The Govt. promises to pay the specified amount mentioned therein to the bearer of instrument on the due date. TBs are issued by the RBI on behalf of Govt. for meeting the temporary Govt deficits. The rate of discount on a T.B. is fixed by RBI. . The rate of discount is lowest because of short term maturity, high degree of liquidity and security. Institutional investors like commercial banks, Discount Finance house of India (DFHI) and State Trading Corporation of; India (STCI) maintain subsidiary ledger account (SGL) with RBI through which purchase and sale of TB‟s are automatically recorded through SGL Account. DFHI is actively participated in the auction of TBs on behalf of investors. Various participants in TB market are RBI, SBI, Commercial banks, State Govts, DFHI, STCI, LIC, GIC, Nabard etc. Key advantages of TBs are : Safety, liquidity, ideal short term investment, ideal for fund management meets SLR requirements of banks as per RBI decision, non-inflationary investment. Ad hoc treasury bills are issued to the state governments, semi government departments & foreign ventral banks. They are not marketable. The ad hoc bills are not sold to the banks & public. The regular treasury bills are sold to the general public & banks. They are freely marketable. These bills are sold by the RBI on behalf of the central government. The treasury bills can be categorized as follows:1) 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:-
  • 29. 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 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 stabilize 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. 19. Commercial Bills Bills of exchange are negotiable instruments drawn by the seller (drawer) on the buyer (drawee) for the value of the goods delivered to him. Such bills are called trade bills. When trade bills are accepted by commercial banks, they are called commercial bills. If the seller wishes to give some period for payment, the bill would be payable at a future date (usance bill). During the currency of the bill, if the seller is in need of funds, he may approach his bank for discounting the bill. One of the methods of providing credit to customers by bank is by discounting commercial bills at a prescribed discount rate. The bank will receive the maturity proceeds (face value) of discounted bill from the drawee. In the meanwhile, if the bank is in need of funds, it can rediscount the bill already discounted by it in the commercial bill rediscount market at the market related rediscount rate.
  • 30. 20. Government securities (Gilt edged Securities) are instruments issued by Government of India to raise money. G Secs pays interest at fixed rate on specific dates on half-yearly basis. It is available in wide range of maturity, from short dated (one year) to long dated (up to thirty years). Since it is sovereign borrowing, it is free from risk of default (credit risk). You can subscribe to these bonds through RBI or buy it in stock exchange. 21. Equity Shares (instrument of ownership) Equity shares are instruments issued by companies to raise capital and it represents the title to the ownership of a company. You become an owner of a company by subscribing to its equity capital (whereby you will be allotted shares) or by buying its shares from its existing owner(s). As a shareholder, you bear the entrepreneurial risk of the business venture and are entitled to benefits of ownership like share in the distributed profit (dividend) etc. The returns earned in equity depend upon the profits made by the company, company’s future growth etc. 22. Dematerialisation: Dematerialisation is the process of converting the physical form of shares into electronic form. Prior to dematerialisation the Indian stock markets have faced several problems like delay in the transfer of certificates, forgery of certificates etc. Dematerialisation helps to overcome these problems as well as reduces the transaction time as compared to the physical segment. The article discusses the procedures, advantages and problems of dematerialisation. The Indian Stock markets have seen a major change with the introduction of depository system and scrip less trading mechanism. There were various problems like inordinate delays in the transfer of share certificates, delay in receipt of securities and inadequate infrastructure in banking and postal segments to handle a large volume of application and storage of share certificates .To overcome these problems physical dealing in securities should be eliminated . The Indian stock market introduced the system of dematerialisation recognizing the need for scrip less trading. According to the Depositories Act, 1996, an investor has the option to hold shares either in physical or electronic form .The process of converting the physical form of shares into electronic form is called dematerialisation or in short demats. The converted electronic data is stored with the depository from where they can be traded. It is similar to a bank where an investor opens an account with any of the depository participants. Depository participant is a representative of the depository .The DP maintains the investors securities account balances and intimates him about the status of holdings. Procedure for converting the physical shares into electronic form: To convert the shares into electronic form the investor should open an account with any of the depository participants. For opening an account the investor has to fill up the account opening form. An account number (client ID) will be allotted after signing the agreement which defines the rights and duties of the DP and the investor wishing to open the account. The client ID along with the DP ID gives a unique identification in the depository system. Any number of depository accounts can be opened. After opening an account with the DP the investor should surrender the physical certificates held in his name to a depository participant. These certificates will be sent to the respective companies where they will be cancelled after dematerialization and will credit the investors account with the DP. The securities on dematerialisation will appear as balances in the depository account. These balances can be transferred like the shares held in physical form. Dematerialised shares are in the fungible form and do not have any distinctive or certificate numbers .The securities in the demat can again be converted into physical form which is called as rematerialisation. Safety to the investor * Securities Exchange Board of India (SEBI) has laid down certain rules and regulations for getting registered
  • 31. as a depository participant. With the recommendation of the Depository and SEBI's own independent evaluation a DP will be registered under SEBI. * The investors account will be credited/debited by the DP only on the basis of valid instruction from the client. * The system driven mandatory reconciliation is done between the DP and NSDL. * Periodic inspections of both DP and R&T agent are conducted by NSDL * The data interchange between NSDL and its business partners is protected by standard protection measures such as encryption * No direct communication links exist between two business partners and all communications are routed through NSDL. * A statement of account is received periodically by the investors. NSDL sends statement of account to a random sample of investors a s a counter check. * The investor has the right to approach NSDL if the grievances of the investors are not resolved by the concerned DP. Advantages of dematerialisation * There is no risk due to loss on account of fire, theft or mutilation. * There is no chance of bad delivery at the time of selling shares as there is no signature mismatch. * Transaction costs are usually lower than that in the physical segment. * The bonus /rights shares allotted to the investor will be immediately credited into his account. * Share transactions like sale or purchase and transfer/transmission etc. can be effected in a much simpler and faster way. Problems of Dematerialisation. Prior to dematerialization there was almost a gap of three months between application date and listing of shares .Dematerialisation has reduced this gap to a great extent. But quick money brings with itself a host of problems. Current regulations prohibit multiple bids or applications by a single person.But the investors open multiple demat accounts and make multiple applications to subscribe to IPO's in the hope of getting allotment. The recent IPO allotment scam proves that even a highly automated system is not the solution to prevent malpractices, if there is laxity. The scam of Yes bank and IDFC reveal that the investor banker has failed to weed out multiple applications either direct or benami. Not only the investor banker the DP and the depository failed to detect the large number of demat accounts opened with the same address but different names. Lack of coordination between banks, DP's, brokers depositories, registrars and investment bankers and clarity of their roles has given rise to such problems. Remedial measures * To prevent the sprouting of fictitious demat accounts at DP's the allotment of shares should be checked thoroughly.
  • 32. * The concerned DP should strictly enforce the Know your client (KYC) norms rather than relying on bank documents and verification of brokers. * DP's should be asked to give monthly figure of accounts opened for the public. * Coordination and Clear definition of roles is important to weed out manipulations. Though dematerialisation has several benefits the recent scam has the potential to adversely affect the confidence of retail investors in the capital market .To reap the benefits of dematerialisation SEBI, as a regulator has to place a system that is alert and vigilant against unjust gains. 23. Preferred Stock / Preference shares entitle you to receive dividend at a fixed rate. Importantly, this dividend had to be paid to you before dividend can be paid to equity shareholders. In the event of liquidation of the company, your claim to the company’s surplus will be higher than that of the equity holders, but however, below the claims of the company’s creditors, bondholders / debenture holders. • Cumulative Preference Shares: A type of preference shares on which dividend accumulates if remains unpaid. All arrears of preference dividend have to be paid out before paying dividend on equity shares. • Cumulative Convertible Preference Shares: A type of preference shares where the dividend payable on the same accumulates, if not paid. After a specified date, these shares will be converted into equity capital of the company. • Participating Preference Shares gives you the right to participate in profits of the company after the specified fixed dividend is paid. Participation right is linked with the quantum of dividend paid on the equity shares over and above a particular specified level. 24. Debentures (loan instruments) a. Corporate debt • Debentures are instrument issued by companies to raise debt capital. As an investor, you lend you money to the company, in return for its promise to pay you interest at a fixed rate (usually payable half yearly on specific dates) and to repay the loan amount on a specified maturity date say after 5/7/10 years. Normally specific asset(s) of the company are held (secured) in favour of debenture holders. This can be liquidated, if the company is unable to pay the interest or principal amount. Unlike loans, you can buy or sell these instruments in the market. Types of debentures that are offered are as follows:  Non convertible debentures (NCD) – Total amount is redeemed by the issuer  Partially convertible debentures (PCD) – Part of it is redeemed and the remaining is converted to equity shares as per the specified terms  Fully convertible debentures (FCD) – Whole value is converted into equity at a specified price • Bonds are broadly similar to debentures. They are issued by companies, financial institutions, municipalities or government companies and are normally not secured by any assets of the company. Types of bonds Regular Income Bonds provide a stable source of income at regular, predetermined intervals Tax-Saving Bonds offer tax exemption up to a specified amount of investment, depending on the scheme and the Government notification. Examples are: • Infrastructure Bonds under Section 88 of the Income Tax Act, 1961 • NABARD/ NHAI/REC Bonds under Section 54EC of the Income Tax Act, 1961 • RBI Tax Relief Bonds 25. WARRANTS
  • 33. A warrant is a security issued by a company granting the holder of the warrant the right to purchase a specified number of, shares at a specified price any time prior to an expirable date. Warrants may be issued with debentures or equity shares. The specific rights are set out in the warrant. The main features-of a warrant are number of shares entitled, expiry date and state price / exercise price. Expiry date of warrants, generally in USA, is 5 to 10 years from the original issue date. The exercise price is 10 to 30 percent above the prevailing market price. The Warrants have a secondary market. The minimum value of a warrant represents the exchange value between the current price of the share and the shares purchased at the exercise price. Warrants have no flotation costs and when they are exercised the firm receives additional funds at a price lower than the current market, yet about those prevailing at issue time. New or growing firms and venture capitalists issue warrants. They are also issued in mergers and acquisitions. Warrants are called sweeteners and have been issued in the recent past by several companies in India. Debentures issued with warrants, like convertible debentures, carry lower coupon rates. 26. ADRs and GDRs: AMERICAN DEPOSITORY RECEIPTS (ADR): Depository Receipts issued by a company in USA are known as ADRs. Such receipts are issued in accordance with provisions stipulated by Securities and Exchange Commission of USA. ADRs are dollar dominated and are traded in the same way as are the securities of companies of USA. ADR is a dollar denominated negotiable certificate, it represents a non-US company’s publicly traded equity. It was devised in the last 1920s to help Americans invest in overseas securities and assist non-US companies wishing to have their stock traded in the American Markets. ADRs are divided into 3 levels based on the regulation and privilege of each company’s issue. 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 the US GAAP (Generally Accepted Accounting Principles). This type of instrument is traded in the US OTC Market. he issuer is not allowed to raise fresh capital or list on any one of the national stock exchanges. 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. 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. Global Depository System (GDR’s): A depository receipt is basically a negotiable certificate denominated in US dollars that represent non U.S. company’s publicly traded local currency ( Indian rupee ) equity shares. GDR, a negotiable certificate usually represents company's traded equity/debt. The underlying shares correspond to the GDRs in a fixed ratio say 1 GDR=10 shares. GDRs are essentially equity instruments created by overseas depository banks (ODB) which are authorized by the issuing companies in India to issue GDRs to non-resident investors, outside India to facilitate investment in the shares of issuing companies held with the nominated custodian banks in India. 27. Derivatives- Options and Futures: DEFINITION OF DERIVATIVES:
  • 34. Derivative is a product whose value is derived from the value of one or more basic variables called bases (underling asset, index, or reference rate), in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. For example wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by that date. Such a transaction is an example of a derivative. The price of this derivative is driven by the spot price of wheat which is the “underlying”. Types of derivatives The most commonly used derivatives contracts are forwards, futures and options and since this project revolves around futures and options, it will be discussed in greater detail later on. For now we take a brief look at the various derivatives contracts that have come to be used.  FORWARDS: A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at today’s pre-agreed price.  FUTURES: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. In simpler words, futures are forward contracts quoted in an exchange.  OPTIONS: Options are of two types: - Calls and Puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date.  WARRANTS: Options generally have lives of up to one year, the majority of options traded on options exchanges having a maximum maturity of nine months. Longer dated warrants are called warrants and are generally traded over the counter.  LEAPS: The acronym LEAPS mean Long-Term Equity Anticipation Securities. These are options having a maturity of up to three years.  BASKETS: Basket options are options on portfolios of underlying assets. The underlying asset is usually a moving average or a basket of assets. Equity index options are a form of basket options.  SWAPS: Swaps are private agreements between two parties to exchange cash flows in the future according to prearranged formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are: (A) INTEREST RATE SWAPS: These entail swapping only the interest related cash flows between the parties in the same currency. (B) CURRENCY SWAPS: These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction.
  • 35.  SWAPTIONS: Swaptions are options to buy or sell a swap that will become operative at the expiry of the options. Thus a swaption is an option on a forward swap. Rather than have calls and puts, the swaptions market has receiver swaptions and payer swaptions. A receiver swaption is an option to receive fixed and pay floating. A payer swaption is to pay fixed and receive floating. FORWARD CONTRACT INTRODUCTION: A forward contract, as it occurs in both forward and futures markets, always involves a contract initiated at one time; performance in accordance with the terms of the contract occurs at a subsequent time. It is a simple derivative that involves an agreement to buy/ sell an asset on a certain future date at an agreed price. This is a contract between two parties, one of which takes a long position and agrees to buy the underlying asset on a specified future date for a certain specified price. The other party takes a short position, agreeing to sell the asset at the same date for the same price. For example, when one orders a car, which is not in stock, from a dealer, he is buying a forward contract for the delivery of a car. The price and description of the car are specified. The mutually agreed price in a forward contract is known as the delivery price. The delivery price is chosen in such a way that the value of the forward contract to both the parties is zero, so that it costs nothing to take either a long or a short position. On maturity, the contract is settled so that the holder of the short position delivers the asset to the holder of the long position, who in turn pays a cash amount equal to the delivery price. The value of a forward contract is determined, chiefly by the market price of the underlying asset. Forward contracts are being used in India on a large scale in the foreign exchange market to hedge the currency risk. Forward contracts, being negotiated by the parties on one to one basis, offer them tremendous flexibility to articulate the contract in terms of price, quantity, quality (in case of commodities), delivery time and place. From the simplicity of the contract and its obvious usefulness in resolving uncertainty about the future, it is not surprising that forward contracts have had a very long history. THE FORWARD PRICE The forward price of a contract is the delivery price, which would render a zero value to the contract. Since upon initiation of the contract, the delivery price is so chosen that the value of the contract is nil, it is obvious that when a forward contract is entered into, the delivery price and forward price are identical. As time passes the forward price could change but the delivery price would remain unchanged. Generally, the forward price
  • 36. at any given time varies with the maturity of the contract so that the forward price of a contract to buy or sell in one month would be typically different from that of a contract with time of three months or six months to maturity. FUTURES CONTRACT INTRODUCTION A futures contract is a type of forward contract with highly standardized and closely specified contract terms. As in all forward contracts, a futures contract calls for the exchange of some good at a future date for cash, with the payment for the good to occur at a future date. The purchaser of a futures contract undertakes to receive delivery of the good and pay for it, while the seller of a future promises to deliver the good and receive payment. The price of the good is determined at the initial time of contracting. In a crude sense, futures markets are an extension of forward markets. These markets, being organized/ standardized, are very liquid by their own nature. Therefore, liquidity problem, which persists in the forward market, does not exist in the futures market. In futures market, clearing corporation/ house becomes the counter-party to all the trades or provides the unconditional guarantee for their settlement i.e. assumes the financial integrity of the entire system. In other words, we may say that in futures market, the credit risk of the transactions is eliminated by the exchange through the clearing corporation/ house. OPTIONS INTRODUCTION TO OPTIONS We now come to the next derivative product that is traded, namely Options. Options are fundamentally different from forward and future contracts. An option gives the holder of the option the right to do something. The holder need not exercise this right. In contrast, in a forward or futures contract, the two parties are committed and have to fulfill this commitment. Also it costs nothing (except margin requirement) to enter into a futures contract whereas the purchase of the option requires an upfront payment called the option premium. TYPES OF OPTION CONTRACTS: 1. CALL OPTION: A call option gives the buyer the right to purchase a specified number of shares of a particular company from the option writer (seller) at a specified price (called the exercise price) up to the expiry of the option. In other words the option buyer gets a right to call upon the option seller to deliver the contracted shares anytime up to the expiry of the option. The contract thus is only a one-way obligation, i.e. the seller is obliged to deliver the contracted shares while the buyer has the choice to exercise the option or let the contract lapse. The buyer is not obliged to perform.
  • 37. POSITION GRAPH: Intrinsic value Lines + + Premium b Premium _ b Stock Price Stock Price _ Intrinsic value Lines (a) Buy A Call (b) Write a Call An option buyer starts with a loss equivalent to the premium paid. He has to carry on with the loss till the stock market price equals the exercise price as shown in (a). The intrinsic value of the option up to this price remains zero, and thus runs along the X-axis. As the stock price increases further, the loss starts reducing and gets wiped out as soon as the increase equals the premium, represented on the graph by point ‘b’, also called the break even point. The profitability line starts climbing up at an inclination of 45 degrees after crossing the X-axis at b and from thereon moves into the positive side of the graph. The inclined line beyond the point ‘ b’ indicates that the option acquires intrinsic value and is, thus referred to as the intrinsic value line. The position graph (b) represents the profitability status of the writer who does not own the stock i.e. naked or an uncovered writer. The graph is logically the inverse of that for the option buyer. 1. PUT OPTION A put option gives a buyer the right to sell a specified number of shares of a particular stock to the option of the writer at a specific price (called exercise price) any time during the currency of the option. The seller of a put option has the obligation to take delivery of underlying asset. When put position is opened, the buyer pays premium to the put seller. If the price of underlying asset rises above the strike price and stays there, the put will expire worthless. The seller of put will keep the premium as his profit and the put buyer will have a cost to purchase right.
  • 38. Put buyers are bearish, they believe that the price of the underlying asset will fall and they may not be able to sell the asset at a higher price. Put sellers are bullish, as they believe that the price of the underlying asset will rise. Position Graph: Intrinsic Value Line + Stock Price _ Premium SWAPS: Swap can be defined as a financial transaction in which two counter parties agree to exchange streams of payments, or cash flows, over time. Two types of swaps are generally seen i.e. interest rate swaps and currency swaps. Two more swaps being introduced are commodity swaps and the tax rate swaps, which are seen to be an extension of the conventional swaps. A swap results in reducing the borrowing cost of both parties. Module - III: Indian Financial Institutions 1. Commercial Banks- Commercial Banks are banking institutions that accept deposits and grant short-term loans and Advances to their customers with a profit motive. In addition to giving short-term loans, commercial banks also give Medium-term and long-term loan to business enterprises. Now-a-days some of the commercial Banks are also providing housing loan on a long-term basis to individuals. 2. Role of Commercial Banks towards economy: • Commercial banks play an important and active role in the economic development of a country. • If the banking system in a country is effective, efficient and disciplined it brings about a rapid growth in the various sectors of the economy. • The following is the significance of commercial banks in the economic development of a country:  1. Banks promote capital formation  2. Investment in new enterprises  3. Promotion of trade and industry  4. Development of agriculture  5. Balanced development of different regions  6. Influencing economy activity
  • 39.  7. Implementation of Monetary policy  8. Monetization of the economy  9. Export promotion cells 1. Banks promote capital formation: • Commercial banks accept deposits from individuals and businesses, these deposits are then made available to the businesses which make use of them for productive purposes in the country. • The banks are, therefore, not only the store houses of the country’s wealth, but also provide financial resources necessary for economic development. 2. Investment in new enterprises: • Businessmen normally hesitate to invest their money in risky enterprises. The commercial banks generally provide short and medium term loans to entrepreneurs to invest in new enterprises and adopt new methods of production. • The provision of timely credit increases the productive capacity of the economy. 3. Promotion of trade and industry: • With the growth of commercial banking, there is vast expansion in trade and industry. • The use of bank draft, check, bill of exchange, credit cards and letters of credit etc has revolutionized both national and international trade. 4. Development of agriculture: • The commercial banks particularly in developing countries are now providing credit for development of agriculture and small scale industries in rural areas. • The provision of credit to agriculture sector has greatly helped in raising agriculture productivity and income of the farmers. 5. Balanced development of different regions: • The commercial banks play an important role in achieving balanced development in different regions of the country. • They help in transferring surplus capital from developed regions to the less developed regions. • The traders, industrialists etc of less developed regions are able to get adequate capital for meeting their business needs. • This in turn increases investment, trade and production in the economy. 6. Influencing economic activity: • The banks can also influence the economic activity of the country through its influence on • a. Availability of credit • b. The rate of interest • If the commercial banks are able to increase the amount of money in circulation through credit creation or by lowering the rate of interest, it directly affects economic development. • A low rate of interest can encourage investment. • The credit creation activity can raise aggregate demand which leads to more production in the economy. 7. Implementation of Monetary policy: • The central bank of the country controls and regulates volume of credit through the active cooperation of the banking system in the country. • It helps in bringing price stability and promotes economic growth with in the shortest possible period of time. 8. Monetization of the economy: • The commercial banks by opening branches in the rural and backward areas are reducing the exchange of goods through barter. • The use of money has greatly increased the volume of production of goods. • The non monetized sector (barter economy) is now being converted into monetized sector with the help of commercial banks. 9. Export promotion cells: • In order to increase the exports of the country, the commercial banks have established export promotion cells. • They provide information about general trade and economic conditions both inside and outside the country to its customers. • The banks are therefore, making positive contribution in the process of economic development. Commercial banks engage in the following activities:
  • 40. • Processing of payments by way of telegraphic transfer, internet banking or other means • Issuing bank drafts and bank cheques • Accepting money on term deposit • Lending money by way of overdraft, installment loan or otherwise • Providing documentary and standby letter of credit, guarantees, performance bonds, securities underwriting commitments and other forms of off balance sheet exposures • Safekeeping of documents and other items in safe deposit boxes • Currency exchange • Sale, distribution or brokerage, with or without advice, of insurance, unit trusts and similar financial products as a “financial supermarket”. 3. Role of commercial banks towards customers: BANKER AS A TRUSTEE • Main relation between Banker and Customer – Debtor and Creditor [reversal when bank grants OD facilities] • Remittances made to bank to purchase shares, before buying stipulated no. of shares, bank failed- unspent money bank holding in trust • Banker received money from one party on behalf of another (later not a customer), bank enquired about purpose and intimated money meanwhile being kept in suspense, banker is a trustee • Banker must not be party to appropriation of funds inconsistent with the character in which customer holds them AS AN AGENT • When created • Buying and selling securities of customer • Collection of cheques, dividends, B/E or P/N • Acting as Trustee, Attorney, Executor, correspondent or a representative • Banker in fiduciary capacity for moneys received for a specific purposed, erroneously credited to suspense account • Banker as an agent bound to carry out directions of his principal conduct business of agency with such skill as is generally possessed by persons engaged in similar business AS A BAILEE • `Safe custody ` facility offered by the bank • Bank is under no obligation to accept the property of the customer for safe custody, it is not primary function of bank • Wrong delivery of the articles kept with banker for safe custody to an unauthorized person is conversion (putting goods for ones own use) • Banks take charge of goods, articles, securities as bailee not as trustee or agent • Distinction between bailment and Agency – • bailee does not represent bailor, • bailee has no power to make contracts on bailer’s behalf • He cannot make the bailor liable, for any acts he does AS AN ADVISOR  Banks are specialized agencies of the financial sector, persons seek banks advice on o Wealth management o Project appraisal o Loan syndication o Financial engineering o Portfolio management
  • 41.  In case of securities market operations, registration and holding of valid certificate from SEBI, a prior condition  Lessor-Lessee Relationship- when owns a building and lets it out to a customer 4. Broad Functions of Commercial Banks The broad functions of a commercial bank can be segregated into three main areas: (i) Payment System (ii) Financial Intermediation (iii) Financial Services. (i) Payment System Banks are at the core of the payments system in an economy. A payment refers to the means by which financial transactions are settled. A fundamental method by which banks help in settling the financial transaction process is by issuing and paying cheques issued on behalf of customers. Further, in modern banking, the payments system also involves electronic banking, wire transfers, settlement of credit card transactions, etc. In all such transactions, banks play a critical role. (ii) Financial Intermediation The second principal function of a bank is to take different types of deposits from customers and then lend these funds to borrowers, in other words, financial intermediation. In financial terms, bank deposits represent the banks' liabilities, while loans disbursed, and investments made by banks are their assets. Bank deposits serve the useful purpose of addressing the needs of depositors, who want to ensure liquidity, safety as well as returns in the form of interest. On the other hand, bank loans and investments made by banks play an important function in channeling funds into profitable as well as socially productive uses. (iii) Financial Services In addition to acting as financial intermediaries, banks today are increasingly involved with offering customers a wide variety of financial services including investment banking, insurance-related services, government-related business, foreign exchange businesses, wealth management services, etc. Income from providing such services improves a bank's profitability. Main functions of a Commercial bank The main functions of commercial banks are accepting deposits from the public and advancing them loans. However, besides these functions there are many other functions which these banks perform. All these functions can be divided under the following heads: 1. Accepting deposits 2. Giving loans 3. Overdraft 4. Discounting of Bills of Exchange 5. Investment of Funds 6. Agency Functions 7. Miscellaneous Functions 1. Accepting Deposits: The most important function of commercial banks is to accept deposits from the public. Various sections of society, according to their needs and economic condition, deposit their savings with the banks. For example, fixed and low income group people deposit their savings in small amounts from the points of view of security, income and saving promotion. On the other hand, traders and businessmen deposit their savings in the banks for the convenience of payment. Therefore, keeping the needs and interests of various sections of society, banks formulate various deposit schemes. Generally, there ire three types of deposits which are as follows:
  • 42. (i) Current Deposits: The depositors of such deposits can withdraw and deposit money whenever they desire. Since banks have to keep the deposited amount of such accounts in cash always, they carry either no interest or very low rate of interest. These deposits are called as Demand Deposits because these can be demanded or withdrawn by the depositors at any time they want. Such deposit accounts are highly useful for traders and big business firms because they have to make payments and accept payments many times in a day. (ii) Fixed Deposits: These are the deposits which are deposited for a definite period of time. This period is generally not less than one year and, therefore, these are called as long term deposits. These deposits cannot be withdrawn before the expiry of the stipulated time and, therefore, these are also called as time deposits. These deposits generally carry a higher rate of interest because banks can use these deposits for a definite time without having the fear of being withdrawn. (iii) Saving Deposits: In such deposits, money upto a certain limit can be deposited and withdrawn once or twice in a week. On such deposits, the rate of interest is very less. As is evident from the name of such deposits their main objective is to mobilize small savings in the form of deposits. These deposits are generally done by salaried people and the people who have fixed and less income. 2. Giving Loans: The second important function of commercial banks is to advance loans to its customers. Banks charge interest from the borrowers and this is the main source of their income. Banks advance loans not only on the basis of the deposits of the public rather they also advance loans on the basis of depositing the money in the accounts of borrowers. In other words, they create loans out of deposits and deposits out of loans. This is called as credit creation by commercial banks. Modern banks give mostly secured loans for productive purposes. In other words, at the time of advancing loans, they demand proper security or collateral. Generally, the value of security or collateral is equal to the amount of loan. This is done mainly with a view to recover the loan money by selling the security in the event of non-refund of the loan. At limes, banks give loan on the basis of personal security also. Therefore, such loans are called as unsecured loan. Banks generally give following types of loans and advances: (i) Cash Credit: In this type of credit scheme, banks advance loans to its customers on the basis of bonds, inventories and other approved securities. Under this scheme, banks enter into an agreement with its customers to which money can be withdrawn many times during a year. Under this set up banks open accounts of their customers and deposit the loan money. With this type of loan, credit is created. (iii) Demand loans: These are such loans that can be recalled on demand by the banks. The entire loan amount is paid in lump sum by crediting it to the loan account of the borrower, and thus entire loan becomes chargeable to interest with immediate effect. (iv) Short-term loan: These loans may be given as personal loans, loans to finance working capital or as priority sector advances. These are made against some security and entire loan amount is transferred to the loan account of the borrower. 3. Over-Draft: Banks advance loans to its customer’s upto a certain amount through over-drafts, if there are no deposits in the current account. For this banks demand a security from the customers and charge very high rate of interest. 4. Discounting of Bills of Exchange: This is the most prevalent and important method of advancing loans to the traders for short-term purposes. Under this system, banks advance loans to the traders and business firms by discounting their bills. In this way, businessmen get loans on the basis of their bills of exchange before the time of their maturity.
  • 43. 5. Investment of Funds: The banks invest their surplus funds in three types of securities—Government securities, other approved securities and other securities. Government securities include both, central and state governments, such as treasury bills, national savings certificate etc. Other securities include securities of state associated bodies like electricity boards, housing boards, debentures of Land Development Banks units of UTI, shares of Regional Rural banks etc. 6. Agency Functions: Banks function in the form of agents and representatives of their customers. Customers give their consent for performing such functions. The important functions of these types are as follows: (i) Banks collect cheques, drafts, bills of exchange and dividends of the shares for their customers. (ii) Banks make payment for their clients and at times accept the bills of exchange: of their cus tomers for which payment is made at the fixed time. (iii) Banks pay insurance premium of their customers. Besides this, they also deposit loan installments, income-tax, interest etc. as per directions. (iv) Banks purchase and sell securities, shares and debentures on behalf of their customers. (v) Banks arrange to send money from one place to another for the convenience of their customers. 7. Miscellaneous Functions: Besides the functions mentioned above, banks perform many other functions of general utility which are as follows: (i) Banks make arrangement of lockers for the safe custody of valuable assets of their custom ers such as gold, silver, legal documents etc. (ii) Banks give reference for their customers. (iii) Banks collect necessary and useful statistics relating to trade and industry. (iv) For facilitating foreign trade, banks undertake to sell and purchase foreign exchange. (v) Banks advise their clients relating to investment decisions as specialist (vi) Bank does the under-writing of shares and debentures also. (vii) Banks issue letters of credit. (viii) During natural calamities, banks are highly useful in mobilizing funds and donations. (ix) Banks provide loans for consumer durables like Car, Air-conditioner, and Fridge etc. Regulations: BANKING REGULATIONS ACT 1949 The Banking Regulation Act was passed as the Banking Companies Act 1949 and came into force wef 16.3.49. Subsequently it was changed to Banking Regulations Act 1949 wef 01.03.66. Summary of some important sections is provided hereunder. The section no. is given at the end of each item. For details, kindly refer the bare Act.
  • 44. • • • • • • • • • • • • • • • • • • • • • • • • • • • • • Banking means accepting for the purpose of lending or investment of deposits of money from public repayable on demand or otherwise and withdrawable by cheque, drafts order or otherwise (5 (i) (b)). Banking company means any company which transacts the business of banking (5(i)(c) Transact banking business in India (5 (i) (e). Demand liabilities are the liabilities which must be met on demand and time liabilities means liabilities which are not demand liabilities (5(i)(f) Secured loan or advances means a loan or advance made on the security of asset the market value of which is not at any time less than the amount of such loan or advances and unsecured loan or advances means a loan or advance not secured (5(i)(h). Defines business a banking company may be engaged in like borrowing, lockers, letter of credit, traveler cheques, mortgages etc (6(1). States that no company shall engage in any form of business other than those referred in Section 6(1) (6(2). For banking companies carrying on banking business in India to use at least one word bank, banking, banking company in its name (7). Restrictions on business of certain kinds such as trading of goods etc. (8) Prohibits banks from holding any immovable property howsoever acquired except as acquired for its own use for a period exceeding 7 years from acquisition of the property. RBI may extend this period by five years (9) Prohibitions on employments like Chairman, Directors etc (10) Paid up capital, reserves and rules relating to these (11 & 12) Banks not to pay any commission, brokerage, discount etc. more than 2.5% of paid up value of one share (13) Prohibits a banking company from creating a charge upon any unpaid capital of the company. (14) Section 14(A) prohibits a banking company from creating a floating charge on the undertaking or any property of the company without the RBI permission. Prohibits payment of dividend by any bank until all of its capitalized expenses have been completely written off (15) To create reserve fund and 20% of the profits should be transferred to this fund before any dividend is declared (17 (1)) Cash reserve - Non-scheduled banks to maintain 3% of the demand and time liabilities by way of cash reserves with itself or by way of balance in a current account with RBI (18) Permits banks to form subsidiary company for certain purposes (19) No banking company shall hold shares in any company, whether as pledgee, mortgagee or absolute owners of any amount exceeding 30% of its own paid up share capital + reserves or 30% of the paid up share capital of that company whichever is less. (19(2). Restrictions on banks to grant loan to person interested in management of the bank (20) Power to Reserve Bank to issue directive to banks to determine policy for advances (21) Every bank to maintain a percentage of its demand and time liabilities by way of cash, gold, unencumbered securities 25%-40% as on last Friday of 2nd preceding fortnight (24). Return of unclaimed deposits (10 years and above) (26) Every bank has to publish its balance sheet as on March 31st (29). Balance sheet is to be got audited from qualified auditors (30 (i)) Publish balance sheet and auditors report within 3 months from the end of period to which they refer. RBI may extend the period by further three month (31) Prevents banks from producing any confidential information to any authority under Indl Disputes Act. (34A) RBI authorized to undertake inspection of banks (35). Amendment carried in the Act during 1983 empowers Central Govt to frame rules specifying the period for which a bank shall preserve its books (45-y), nomination facilities (45ZA to ZF) and return a paid instrument to a customer by keeping a true copy (45Z).
  • 45. • Certain returns are also required to be sent to RBI by banks such as monthly return of liquid assets and liabilities (24-3), quarterly return of assets and liabilities in India (25), return of unclaimed deposits i.e. 10 years and above (26) and monthly return of assets and liabilities (27-1). 5. Public Sector Banks These are banks where majority stake is held by the Government of India or Reserve Bank of India. Examples of public sector banks are: State Bank of India Public sector banks are those in which the majority stake is held by the Government of India (GoI). Public sector banks together make up the largest category in the Indian banking system. There are currently 27 public sector banks in India. They include the SBI and its 6 associate banks (such as State Bank of Indore, State Bank of Bikaner and Jaipur etc), 19 nationalised banks (such as Allahabad Bank, Canara Bank etc) and IDBI Bank Ltd. Public sector banks have taken the lead role in branch expansion, particularly in the rural areas. 6. Private Sector Banks In case of private sector banks majority of share capital of the Bank is held by private individuals. These banks are registered as companies with limited Liability. In this type of banks, the majority of share capital is held by private individuals and corporates. Not all private sector banks were nationalized in 1969, and 1980. The private banks which were not nationalized are collectively known as the old private sector banks and include banks such as The Jammu and Kashmir Bank Ltd., Lord Krishna Bank Ltd etc. Entry of private sector banks was however prohibited during the post-nationalization period. In July 1993, as part of the banking reform process and as a measure to induce competition in the banking sector, RBI permitted the private sector to enter into the banking system. This resulted in the creation of a new set of private sector banks, which are collectively known as the new private sector banks. As at end March, 2009 there were 7 new private sector banks and 15 old private sector banks operating in India. For example: The Jammu and Kashmir Bank Ltd., Bank of Rajasthan Ltd., Development Credit Bank Ltd, Lord Krishna Bank Ltd., Bharat Overseas Bank Ltd.,Global Trust Bank, Vysya Bank, etc. 7. Foreign Banks Foreign banks have their registered and head offices in a foreign country but operate their branches in India. The RBI permits these banks to operate either through branches; or through wholly-owned subsidiaries. The primary activity of most foreign banks in India has been in the corporate segment. However, some of the larger foreign banks have also made consumer financing a significant part of their portfolios. These banks offer products such as automobile finance, home loans, credit cards, household consumer finance etc. Foreign banks in India are required to adhere to all banking regulations, including priority-sector lending norms as applicable to domestic banks. In addition to the entry of the new private banks in the mid-90s, the increased presence of foreign banks in India has also contributed to boosting competition in the banking sector. These banks are registered and have their headquarters in a foreign country but operate their branches in our country. Some of the foreign banks operating in our country are Hong Kong and Shanghai Banking Corporation (HSBC), Citibank, American Express Bank, Standard & Chartered Bank, Grindlay’s Bank, etc. The number of foreign banks operating in our country has increased since the financial sector reforms of 1991 Development Banks: Development banks are unique financial institution that act as catalytic agents in promoting balanced development of the country and thereby aid in the economic growth of the country.  Development Bank is a financial institution dedicated to fund new and upcoming businesses and economic development projects by equity capital or loan capital.  Development banks are those financial institutions engaged in the promotion and development of industry, agriculture and other key sectors. Definition
  • 46. “A development bank is like a living organism that reacts to the social-economic environment and its success depends on reacting most aptly to that environment” Development Banks in India: 1. The Industrial finance corporation of India (IFCI)-1948. 2. The industrial Development Bank of India (IDBI)-1964. 3. The Industrial Reconstruction Bank of India (IRBI)-1971. 4. The Industrial Credit and Investment Corporation of India (ICICI)-1955 Etc. Features of a development bank. A development bank has the following features or characteristics: 1) A development bank does not accept deposits from the public like commercial banks and other financial institutions who entirely depend upon saving mobilization. 2) It is a specialized financial institution which provides medium term and long-term lending facilities. 3) It is a multipurpose financial institution. Besides providing financial help it undertakes promotional activities also. It helps enterprises from planning to operational level. 4) It provides financial assistance to both private as well as public sector institutions. 5) The role of a development bank is of gap filler. When assistance from other sources is not sufficient then this channel helps. It does not compete with normal channels of finance. 6) Development banks primarily aim to accelerate the rate of growth. It helps industrialization specific and economic development in general 7) The objective of these banks is to serve public interest rather than earning profits. 8) Development banks react to the socio-economic needs of development. 8. Role of development banks in the Indian economy Capital Formation Support to the Capital Market Foreign Currency Loans Assistance to Backward Areas Promotion of New Entrepreneurs Impact on Corporate Culture 9. Industrial Finance Corporation of India (IFCI) At the same time raw industrial units were to be set up for industrializing the country. Government of India came forward to set up the Industrial Finance Corporation of India (IFCI) in July 1948 under a Special Act. The Industrial Development Bank of India, scheduled banks, insurance companies, investment trusts and cooperative banks are the shareholders of IFCI. The Government of India has guaranteed the repayment of capital and the payment of a minimum annual dividend. Since July I, 1993, the corporation has been converted into a company and it has been given the status of a Ltd. Company with the name Industrial Finance Corporations of India Ltd. IFCI has got itself registered with Companies Act, 1956. Before July I,
  • 47. 1993, general public was not permitted to hold shares of IFCI, only Government of India, RBI, Scheduled Banks, Insurance Companies and Co-operative Societies were holding the shares of IFCI. Functions of IFCI IFCI is authorized to render financial assistance in one or more of the following forms: 1. Granting loans or advances to or subscribing to debentures of industrial concerns repayable within 25 years. Also it can convert part of such loans or debentures into equity share capital at its option. 2. Underwriting the issue of industrial securities i.e. shares, stock, bonds, 0r debentures to be disposed off within 7 years. 3. Subscribing directly to the shares and debentures of public limited companies. 4. Guaranteeing of deferred payments for the purchase of capital goods from abroad or within India. 5. Guaranteeing of loans raised by industrial concerns from scheduled balls or state co-operative banks. 6. Acting as an agent of the Central Government or the World Bank in respect of loans sanctioned to the industrial concerns. IFCI provides financial assistance to eligible industrial concerns regardless of their size. However, now-adays, it entertains applications from those industrial concerns whose project cost is about Rs. 2 crores because upto project cost of Rs. 2 crores various state level institutions (such as Financial Corporations, SIDCs and banks) are expected to meet the financial requirements of viable concerns. While approving a loan application, IFCI gives due consideration to the feasibility of the project, its importance to the nation, development of the backward areas, social and economic viability, etc. The most of the assistance sanctioned by IFCI has gone to industries of national priority such as fertilizers, cement, power generation, paper, industrial machinery etc. The corporation is giving a special consideration to the less developed areas and assistance to them has been stepped up. It has sanctioned nearly 49 per cent of its assistance for projects in backward districts. The corporation has recently been participating in soft loan schemes under which loans on confessional rates are given to units in selected industries. Such assistance is given for modernization, replacement and renovation of plant and equipment. IFCI introduced a scheme for sick units also. The scheme was for the revival of sick units in the tiny and small scale sectors. Another scheme was framed for the self-employment of unemployed young persons. The corporation has diversified not merchant banking also. Financing of leasing and hire purchase companies, hospitals, equipment leasing etc. were the other new activities of the corporation in the last few years. Promotional Activities The IFCI has been playing very important role as a financial institution in providing financial assistance to eligible industrial concerns. However, no less important is its promotional role whereby it has been creating industrial opportunities also. It has been taking up directly as well as indirectly; such steps and activities are regarded necessary for the acceleration of the process of industrialization in the country. The promotional role of IFCI has been to fill the gaps, either in the institutional infrastructure for the promotion and growth of industries, or in the provision of the much needed guidance in project intensification, formulation, implementation and operation, etc. to the new tiny, small-scale or medium scale entrepreneurs or in the efforts at improving the productivity of human and material resources. (a) Development of Backward Areas: – The main thrust of all financial institutions has been to remover regional imbalances by promoting industrialization of backward areas. IFCI introduce a scheme of confessional finance for projects set up in backward areas. The backward-districts were divided into three categories depending upon the state of development there. All these categories were eligible for concessional finance. Nearly 50 per cent of total lending of IFCI has been to develop backward areas.
  • 48. (b) Promotional Schemes:- IFCI has been operating six promotional schemes with the object of helping entrepreneurs to set up new units, broadening the entrepreneurial base, encouraging the adoption of new technology, tackling ‘the problem of sickness and promoting opportunities for self development and . self employment of unemployed persons etc. These schemes are as such: 1. Subsidy for Adopting Indigenous Technology:- The projects which use indigenously developed technology are entitled to a concession in the form of subsidy covering interest payments due to IFCI during the first three years of operations, extendable to five years. 2. Meeting Cost of Market Studies: - The entrepreneurs setting up medium sized industrial projects for the first time can avail 75 per cent of the cost of market survey/study subject to a ceiling of Rs. 15,000 provided it is handled by Technical Consultancy Organization. . 3. Meeting Cost of Feasibility Studies: – IFCI provides subsidy for the fees paid for consultancy assignments relating to feasibility, project reports etc. The amount allowable is 80 per cent of the fees of Rs. 7,500 whichever is less. This limit is Rs. 8,500 or 100 per cent of the total fees whichever is less for handicapped or scheduled caste persons. 4. Promoting Small Scale and Ancillary Industries: – For the identification of products suitable for ancillary or further processing in small scale sector and preparation of feasibility reports a subsidy of Rs.0.1 million per annum for technical consultancy organization is allowed. 5. Revival of Sick Units: – There is a subsidy to the extent of 80 per cent or Rs. 5,000 (whichever is less) for the fees charged by a technical consultancy organization for carrying out a diagnostic study or for the implementation of rehabilitation programme. This facility is allowed to tiny units or units in small scale sector.’ Self-development and Self employment Scheme: - An unemployed person in the age group of 21 to 35 years may be allowed a soft loan for providing margin money for getting a loan from a bank or a financial institution. The soft loan at interest free rate in first year and has confessional interest later on. The amount available under this scheme is 25% of margin money subject to Rs. 5000. 10. Industrial Development Bank of India The Industrial Development Bank of India is the apex financial institution in the field of development banking in the country. It was established in July, 1964 with the twin objectives of: (a) meeting the growing financial needs of rapid industrialization in the country, and (b) coordinating the activities and assisting the growth of all institutions engaged in financing industries. It is an organization with sufficiently large financial resources which not only provides direct financial assistance to the large and medium-large industrial units, but also helps the small and medium industries indirectly by extending refinancing and re-discounting facilities to other industrial financing institutions. Thus, the primary aim of the IDBI has been to integrate the structure of industrial financing institutions and to fill the gap between demand and supply of term finance in the country. Initially, the IDBI was set up as a wholly owned subsidiary of the Reserve Bank of India, but, in 1976, it was taken over by the Government of India and was made an autonomous institution.
  • 49. Functions of Industrial Development Bank of India Various functions of or types of assistance to be provided by the IDBI are as follows: (i) Direct Financial Assistance: The IDBI provides direct financial assistance to the industrial concerns in the form of (a) granting loans and advances; and (b) subscribing to, purchasing or underwriting the issues of stocks, bonds or debentures. (ii) Indirect Financial Assistance: The IDBI provides indirect financial assistance to the small and medium industrial concerns through other financial institution, such as, State Finance Corporations, State Industrial Development Corporations, Cooperative banks, regional rural banks, commercial banks. The Assistance to these institutions include :(a) refinancing of loans given by the institutions; subscribing to their shares and bonds; (c) rediscounting of bills. (iii) Development Assistance: The creation of the Development Assistance Fund is the special feature of the IDBI. The Fund is used to provide assistance to those industries which are not able to obtain funds in the normal course mainly because of heavy investment involved or low expected rate of returns. The financial resources of the Fund mainly come from contributions made by the government in the form of loans, gifts, donations, etc; and from other sources. Assistance from the Fund requires the prior approval by the government. (iv) Promotional Function: Besides providing financial assistance, the IDBI also undertakes various promotional activities such as marketing and investment research, techno- economic surveys. It provides technical and administrative advice for promotion, expansion and better management of the industrial concerns. Types of assistance by IDBI Various types of assistance to be provided by the IDBI are as follows: (i) Direct Financial Assistance: The IDBI provides direct financial assistance to the industrial concerns in the form of (a) granting loans and advances; and (b)subscribing to, purchasing or underwriting the issues of stocks, bonds or debentures. (ii) Indirect Financial Assistance: The IDBI provides indirect financial assistance to the small and medium industrial concerns through other financial institution, such as, State Finance Corporations, State Industrial Development Corporations, Cooperative banks, regional rural banks, commercial banks. The Assistance to these institutions include :(a) refinancing of loans given by the institutions; subscribing to their shares and bonds; (c) rediscounting of bills. (iiI) Development Assistance: The creation of the Development Assistance Fund is the special feature of the IDBI. The Fund is used to provide assistance to those industries which are not able to obtain funds in the normal course mainly because of heavy investment involved or low expected rate of returns. The financial resources of the Fund mainly come from contributions made by the government in the form of loans, gifts, donations, etc; and from other sources. Assistance from the Fund requires the prior approval by the government. (iv) Promotional Function: Besides providing financial assistance, the IDBI also undertakes various promotional activities such as marketing and investment research, techno- economic surveys. It provides technical and administrative advice for promotion, expansion and better management of the industrial concerns. 11. STATE FINANCIAL CORPORATIONS:
  • 50. At the beginning of the fifties the govt. found that of achieving rapid industrialization separate institution should be set up that cater exclusively to the needs of the small medium sector therefore the SFC was act passed by the parliament in 1951 to enable the state govt. establish SFC the basic objective for which the SFC was set up was to provide financial assistance to small and medium scale industries estates. The SFC provides finance in the form of log term loan, by underwriting issue of share and debentures and standing guarantee for loans raised from other institution and form the general public. 12. National Bank of Agriculture and Rural Development (NABARD) National Bank of Agriculture and Rural Development (NABARD) was set up on July 12, 1982 under Act of parliament as a central or apex institutions for financing agricultural and rural sectors. National Bank for Agriculture and Rural Development (NABARD) is an apex development bank in India. It has been accredited with “matters concerning policy, planning and operations in the field of credit for agriculture and other economic activities in rural areas in India”. NABARD was established by an act of Parliament on 12 July 1982 to implement the National Bank for Agriculture and Rural Development Act 1981. It replaced the Agricultural Credit Department (ACD) and Rural Planning and Credit Cell (RPCC) of Reserve Bank of India and Agricultural Refinance and Development Corporation (ARDC). It is one of the premiere agencies to provide credit in rural areas. NABARD is set up as an apex Development Bank with a mandate for facilitating credit flow for promotion and development of agriculture, small-scale industries, cottage and village industries, handicrafts and other rural crafts. It also has the mandate to support all other allied economic activities in rural areas, promote integrated and sustainable rural development and secure prosperity of rural areas. It provides short term finance assistance for period of 18 months to state co-operative banks, commercial banks, RRBs, and so on for wide range of activities in the areas of production, trading, marketing and storage. It also gives loans up to 20 years of maturity to the state government to enable them to subscribe to the share capital of co-operative credit societies. NABARD serves as an apex financing agency for the institutions providing investment and production credit for promoting the various developmental activities in rural areas. NABARD takes measures towards institution building for improving absorptive capacity of the credit delivery system, including monitoring, formulation of rehabilitation schemes, restructuring of credit institutions, training of personnel, etc. NABARD co-ordinates the rural financing activities of all institutions engaged in developmental work at the field level and maintains liaison with Government of India, State Governments, Reserve Bank of India (RBI)and other national level institutions concerned with policy formulation and also undertakes monitoring and evaluation of projects refinanced by it. NABARD’s refinance is available to State Co-operative Agriculture and Rural Development Banks (SCARDBs), State Co-operative Banks (SCBs), Regional Rural Banks (RRBs), Commercial Banks (CBs) and other financial institutions approved by RBI. While the ultimate beneficiaries of investment credit can be individuals, partnership concerns, companies, State-owned corporations or co-operative societies, production credit is generally given to individuals. NABARD provides: • Long term finance for minor irrigation facilities, plantations, horticulture, land development, farm mechanizations, animal husbandry, fisheries etc. • Short term loan assistance fir financing of seasonal agricultural operations, marketing of crops, purchase/procurement/distribution of agricultural inputs etc.
  • 51. • Medium loan facilities for approved agricultural purposes; • Working capital refinance for handloom weavers • Refinance for financing government- sponsored programmes such as IRDP, Rozgar Yogna etc. Besides this pivotal role, NABARD also: • Acts as a coordinator in the operations of rural credit institutions • Extends assistance to the government, the Reserve Bank of India and other organizations in matters relating to rural development • Offers training and research facilities for banks, cooperatives and organizations working in the field of rural development • Helps the state governments in reaching their targets of providing assistance to eligible institutions in agriculture and rural development • Acts as regulator for cooperative banks and RRBs General aspects of NABARD: • NABARD should be a managing agency of Government of India for public investments in rural India. • It should be the chief overseer, grand planner for public investment and ensure that each rupee spent in rural India generates a net positive return for rural India. • NABARD should not resort to passive funding. NABARD has to make things happen by organizing people and providing knowledge. • The strength of NABARD is its good networking capabilities. It can act as a coordinating agency for all the developmental works taking place at the grass roots level. • The greatest comparative advantage of NABARD is its ability to decontaminate the effects of subsidy and making public spending more efficient. • It is a folly for NABARD to become a Commercial Bank. It is the only institution which can handle public finance better than the government. 12. REGIONAL RURAL BANKS. A beginning to set up the RRB was made in later half of 1975 in accordance with the recommendations of banking commission it was intended that the RRB would operate exclusively in rural areas and would provide credit and other facility to small and marginal farmers, agricultural laborer, artisans, and small entrepreneurs. They now carry all types of banking business generally within one to five districts. The RRB can be set up provided by public sector bank sponsor them. the ownership capital of these banks is held by the central govt. (50 %) ,concerned state govt. (15 %), and the sponsor bank (35%) . they are in effect owned by the govt. and there is a little local participation in ownership and administration of these bank also . further they have a large number of branches. 13. Small scale Industrial Development Bank of India (SIDBI) The Small scale Industrial Development Bank of India (SIDBI) was set up in October 1989 under the Act of parliament as a wholly owned subsidiary of the IDBI. It is the central or apex or principal institution which
  • 52. oversees, co-ordinates and further strengthens various arrangements for providing financial and non-financial assistance to small-scale, tiny, and cottage industries. SIDBI objectives are: • To initiate steps for technological up gradation and modernization of existing units • To expand channels for marketing of SSI sector products in India and abroad • To promote employment-oriented industries in semi-urban areas and to check migration of population to big cities. It operates two funds: Small Industries Development Fund and Small Industries Development Assistance Fund. The operation of the former and of National Equity Fund which were earlier looked by IDBI is now handled by the SIDBI. Its financial assistance is channeled through the existing credit delivery system comprising NSIC, SFCs, SIDCs, SSIDCs, commercial banks, co-operative banks and RRBs. The total number of institutions eligible for assistance from SIDBI is 900. It discounts and rediscounts bills arising from the sale of machinery to small units; extends seed capital/soft loan assistance through National Equity Fund and through seed capital schemes of specialized lending institutions; refinance loans; and provide services like factoring, Leasing and so on. The union budget 1996-97 envisaged a number of measures to develop small-scale sector with SIDBI as the focal point. They include: • SIDBI will now refinance the SFCs and commercial banks for modernization projects up to Rs 50 lakhs from unutilized corpus of about Rs 75 crore; • SIDBI’s refinance ceiling of Rs 50 lakhs for single window scheme of SFCs etc. for composite loans will be doubled to Rs 100 lakhs • SIDBI will participate in venture capital funds set up by public sector institutions as well as private companies up to 50 percent of the total corpus of the fund, provided such fund is dedicated to the financing of small-scale industry; • SIDBI will provide refinance lending institutions which are now permitted to lend to SSI units seeking ISO certification of quality. Since its inception SIDBI has provided assistance to the entire SSIs sector including tiny, village, and cottage industries through suitable schemes tailored to meet the requirement of setting up of new products, expansions, diversifications, modernization, and rehabilitation. It has provided equity capital, domestic and foreign currency term loans, working capital finance, etc. SIDBI has entered into MOU with many banks, governmental agencies, international agencies, R&D institutions, and industry associations for developing SSIs. Objectives and functions of Small Industries Development Bank of India Small Industries Development Bank of India (SIDBI) was established as wholly owned subsidiary of Industrial Development Bank of India (IDBI) under the small Industries Development of India Act 1989. It is the principal institution for promotion, financing and development of industries in the small-scale sector. It also coordinates the functions of institutions engaged in similar activities. For this purpose, SIDBI has taken over the responsibility of administrating Small Industries Development Fund and National Equity Fund from IDBI.
  • 53. Capital. SIDBI started its operations from April 1990 with an initial authorised capital of Rs. 250 crore, which could be increased to Rs. 1000 crore. It also took over the outstanding portfolio of IDBI relating to small scale sector held under Small Industries Development Fund as on March 31,1990 worth over Rs. 4000 crore. Objectives of SIDBI In the setting up of SIDBI, the main purpose of the government was to ensure larger flow of assistance to the small-scale units. To meet this objective, the immediate thrust of the SIDBI was on the following measures: (i) initiating steps for technological upgradation and modernisation of existing units; (ii) expanding the channels for marketing the products of the small scale sector; and (iii) promotion of employment-oriented industries, especially in semi- urban areas to create more employment opportunities and thereby checking migration of population to urban areas. Functions of SIDBI SIDBI provides assistance to the small-scale industries sector in the country through the existing banking and other financial institutions, such as, State Financial Corporations, State Industrial Development Corporations, commercial banks, cooperative banks and RRBs. etc. The major functions of SIDBI are given below: (i) It refinances loans and advances provided by the existing lending institutions to the small-scale units. (ii) It discounts and rediscounts bills arising from sale of machinery to and manufactured by small-scale industrial units. (iii) It extends seed capital/soft loan assistance under National Equity Fund, Mahila Udyam Nidhi and Mahila Vikas Nidhi and seed capital schemes. (iv) It grants direct assistance and refinance loans extended by primary lending institutions for financing exports of products manufactured by small-scale units. (v) It provides services like factoring, leasing, etc. to small units. (vi) It extends financial support to State Small Industries Corporations for providing scarce raw materials to and marketing the products of the small-scale units. (vii) It provides financial support to National Small Industries Corporation for providing; leasing, hire purchase and marketing help to the small-scale units. 14. INDUSTRIAL INVESTMENT BANK OF INDIA The IIBI first came into existence as a central government corporation with the name Industrial Reconstruction Corporation of India in 1971. Its basic objective was to finance the reconstruction and rehabilitation of sick and closed industrial unit. Its name was changed to Industrial reconstruction bank of India and it was made the principal credit and reconstruction agency in the country in 1985 through the RBI act 1984. The bank started co-ordinary similar work of the institutions and banks preparing schemes for reconstructions by reconstructing the liabilities appraising schemes of merger & amalgamation of sick
  • 54. company and providing financial assistance for modernization expansion, diversification and technological up gradation of sick units. In March 1987, in line with the ongoing policies of financial and economic reforms, IRBI was converted into a full-fledged development financial institution. It was renamed as Industrial Investment Bank of India ltd. And was incorporated as company under the companies act 1956. Its entire equity is finance for the establishment of new industrial project as well as for expansion diversification and modernization of existing industrial enterprises. It provides financial assistance in the form of term loans, subscription to debenture equity shares and deferred payment guarantees. IIBI is now also active ion merchant banking and its services includes inter alia, structuring suitable instrument for public rights issues preparation of prospective offer documents and working as a lead manager it also offers its services for debt syndication and package of services for merger and acquisition. 15. Non-Banking Financial Institutions / Companies Non-Banking Financial Companies play an important and crucial role in broadening access to financial services, enhancing competition and diversification of the financial sector. There are different types of institutions involved in financial services in India. These include commercial banks, financial institutions (FIs) and non-banking finance companies (NBFCs). Due to the financial sector reforms, NBFCs have been emerged as an integral part of the Indian financial system. Non-banking finance companies frequently act as suppliers of loans & credit facilities and accept deposits, operating mutual funds and similar other functions. They are competitive and complimentary to banks and financial institutions. NBFCs have registered significant growth in recent years both in terms of number and volume of business transactions (Table-2). The equipment leasing and hire purchase finance companies finance productive assets. NBFCs role in financing consumer durables and automobiles are very aggressive. The rapid growth in the business of NBFCs urged for effective regulatory action to protect the interests of investors. The Reserve Bank has started regulating the activities of NBFCs with the twin objectives of ensuring that they sub serve the financial system efficiently and do not jeopardize the interest of depositors. RBI has identified as many as 12 categories of NBFCs. Five of them are regulated by the RBI, Chit funds jointly by the RBI and the Registrar of Chits and two (mutual benefit funds including nidhis and micro finance companies) by the Department of Company Affairs, Government of India. The National Housing Bank (NHB) regulates housing finance companies. Stock Broking and Merchant Banking Companies are regulated by the Securities and Exchange Board of India and insurance companies come under the Insurance Regulatory and Development Authority. Definition of Non-banking Finance Company, A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 and is engaged in the business of loans and advances, acquisition of shares, securities, leasing, hire-purchase, insurance business, and chit business. Difference between banks & NBFCs NBFCs are doing functions similar to that of banks, however there are a few differences: 1) a NBFC cannot accept demand deposits, 2) it is not a part of the payment and settlement system and as such cannot issue cheques to its customers, and 3) deposit insurance facility of DICGC is not available for NBFC depositors unlike in case of banks.
  • 55. Different types of NBFCs There are different categories of NBFC's operating in India under the supervisory control of RBI. They are: 1. Non-Banking Financial Companies (NBFCs) 2. Residuary Non-banking Finance companies(RNBCs). 3. Miscellaneous Non-Banking Finance Companies (MNBCs) and Residuary Non-Banking Company is a class of NBFC, which is a company and has as its principal business the receiving of deposits, under any scheme or arrangement or in any other manner and not being Investment, Leasing, Hire-Purchase, Loan Company. These companies are required to maintain investments as per directions of RBI, in addition to liquid assets. The functioning of these companies is different from those of NBFCs in terms of method of mobilization of deposits and requirement of deployment of depositors' funds. Peerless Financial Company is the example of RNBCs. Miscellaneous Non-Banking Financial Companies are another type of NBFCs and MNBC means a company carrying on all or any of the types of business as collecting, managing, conducting or supervising as a promoter or in any other capacity, conducting any other form of chit or kuri which is different from the type of business mentioned above and any other business similar to the business as referred above. Type of Services provided by NBFCs NBFCs provide range of financial services to their clients. Types of services under non-banking finance services include the following: 1. Hire Purchase Services 2. Leasing Services 3. Housing Finance Services 4. Asset Management Services 5. Venture Capital Services 6. Mutual Benefit Finance Services (Nidhi) The above type of companies may be further classified into those accepting deposits or those not accepting deposits. Role and function of NBFI The role and importance of non-bank financial intermediaries is clear from the various functions performed by these institutions. Major functions of the NBFIs are as follows: 1. Financial Intermediation: The most important function of the non-bank financial intermediaries is the transfer of funds from the savers to the investors. Financial intermediation is economical and less expensive to both small businesses and small savers, (a) It provides funds to small businesses for which it is difficult to sell stocks and bonds because of high transaction costs, (b) It also benefits the small savers by pooling their funds and diversifying their investments.
  • 56. 2. Economic Basis of Financial Intermediation: Handling of funds by financial intermediaries is more economical and more efficient than that by the individual wealth owners because of the fact that financial intermediation is based on (a) the law of large numbers, and (b) economies of scale in portfolio management. (i) Law of Large Numbers: Financial intermediaries operate on the basis of the statistical law of large numbers. According to this law not all the creditors will withdraw their funds from these institutions. Moreover, if some creditors are withdrawing cash, some others may be depositing cash. Again, the financial intermediaries also receive regular interest payments on loans or investments made by them. All these factors enable the financial intermediaries to keep in cash only a small fraction of the funds provided by the creditors and lend or invest the rest. (ii) Economies of Scale: Large size of the asset portfolios enables the financial intermediaries to reap various economies of scale in portfolio management. The main economies are: (a) reduction of risk through portfolio diversification: (b)employment of efficient and professional managers; and (c) low administrative cost of large loans and (d) low costs of establishment, information and transactions. 3. Inducement to Save: Non-bank financial intermediaries play an important role in promoting savings in the country. Savers need stores of value to hold their savings in. These institutions provide a wide range of financial assets as store of value and make available expert financial services to the savers. As stores of value, the financial assets have certain special advantages over the tangible assets (such as, physical capital, inventories of goods, etc.). They are easily storable, more liquid, more easily divisible, and less risky. In fact, saving- income ratio is positively related to both financial institutions and financial assets; financial progress . induces larger savings out of the same level of real income. 4. Mobilisation of Saving: Mobilisation of savings takes place when the savers hold savings in the form of currency, bank deposits, post office savings deposits, life insurance policies, bills, bond's equity shares, etc. NBFI provides highly efficient mechanism for mobilising savings. There are two types of NBFTs involved in the mobilisation of savings; (a) Depository Intermediaries, such as savings and loan associations, credit unions, mutual saving banks etc. These institutions mobilise small savings and provide high liquidity of funds. (b) Contractual Intermediaries, such as life insurance companies, public provident funds, pension funds, etc. These institutions enter into contract with savers and provide them various types of benefits over the long periods.
  • 57. 5. Investment of Funds: The main objective of NBFIs is to earn profits by investing the mobilised savings. For this purpose, these institutions follow different investment policies. For example, savings and loan associations, mutual saving banks invest in mortgages, while insurance companies invest in bonds and securities. 16. Insurance Companies- Public and Private: Life Insurance Corporation (LIC) is a government company. Till the year 2000, the LIC was the sole provider of life insurance policies to the Indian public. However, the Insurance Regulatory & Development Authority (IRDA) has now issued licenses to private companies to conduct the business of life insurance. Some of the major private players in the sector are: • • • • • • • • • • • • • • Bajaj Allianz Life Insurance Corporation Birla SunLife Insurance Co. Ltd. HDFC Standard Life Insurance Co. Ltd. ICICI Prudential Life Insurance Co. Ltd. ING Vysya Life Insurance Co. Pvt. Ltd. MAX New York Life Insurance Co. Ltd. MetLife India Insurance Co. Pvt. Ltd. Kotak Mahindra Old Mutual Life Insurance Co. Ltd. SBI Life Insurance Co. Ltd. TATA AIG Life Insurance Co. Ltd. AMP Sanmar Assurance Co. Ltd. AVIVA Life Insurance Co. Pvt. Ltd. Sahara India Life Insurance Co. Ltd. Shriram Life Insurance Co. Ltd. 17. INVESTMENT POLICY PRINCIPLES AND INVESTMENT POLICY OF Life Insurance Companies: 1. 2. Security of funds, and Maximization of return of investment Investment Policy  Central Govt. marketable securities being not less than 20%  Loans to Housing Bank including above (1) being not less than 25%  State Govt. securities including Govt. Guaranteed marketable securities, inclusive of (2) above being not less than 50%  Socially oriented sectors including public sector, co-operative sector house building by policyholders, own house scheme, inclusive of (3) above not less than 75%  Private corporate sector, loans to policyholders for construction and acquisition of immovable property 25% PRINCIPLES AND INVESTMENT POLICY of General Insurance Companies: 1. 2. Security of funds, and Maximization of return of investment Investment Policy  Central Govt. securities being not less than 20%  State Govt. securities and other government guaranteed securities, including (1) above, being not less than 30%
  • 58.   Loans to HUDCO/DDA/GIC-HF and to state govt’s. For housing and fire fighting equipment, not less than 15% Market sector not more than 55% 17. Regulatory Authority: The IRD Act has established the Insurance Regulatory and Development Authority (“IRDA” or “Authority”) as a statutory regulator to regulate and promote the insurance industry in India and t o protect the interests of holders of insurance policies. The IRD Act also carried out a series of amendments to the Act of 1938 and conferred the powers of the Controller of Insurance on t he IRDA. The members of the IRDA are appointed by the Central Government from amongst persons of ability, integrity and standing who have knowledge or experience in life insurance, general insurance, actuarial science, finance, economics, law, accountancy, administration etc. The Authority consists of a chairperson, not more than five whole-time members and not more than four part-time members. Powers, Duties and Functions of the Authority The Authority has been entrusted with the duty to regulate, promote and ensure the orderly growth of the insurance and re-insurance business in India. In furtherance of this responsibility, it has been conferred with numerous powers and functions which include prescribing regulations on the investments of funds by insurance companies, regulating maintenance of the margin of solvency, adjudication of disputes between insurers and intermediaries, supervising the functioning of the Tariff Advisory Committee, specifying t he percentage of premium income of the insurer to finance schemes for promoting and regulating professional organizations and specifying the percentage of life insurance business and general insurance business to be undertaken by the insurer in the rural or social sector. Tariff Advisory Committee The Tariff Advisory Committee (“Advisory Committee”) is a body corporate, which controls and regulates the rates, advantages, terms and conditions offered by insurers in the general insurance business. The Advisory Committee has the authority to require any insurer to supply such information or statements necessary for discharge of its functions. Any insurer f ailing to comply with such provisions shall be deemed to have contravened the provisions of the Insurance Act. Every insurer is required to make an annual payment of fees to the Advisory Committee of an amount not exceeding in case of reinsurance business in India, one percent of the total premiums in respect of facultative insurance accepted by him in India; and in case of any other insurance business, one percent of the total gross premium written direct by him in India. Insurance Association of India, Councils and Committees All insurers and provident societies incorporated or domiciled in India are members of the Insurance Association of India (“Insurance Association”) and all insurers and provident societies incorporated or domiciled elsewhere than in India are associate members of t he Insurance Association. There are two councils of the Insurance Association, namely the Life Insurance Council and the General Insurance Council. The Life Insurance Council, through its Executive Committee, conducts examinations for individuals wising to qualify themselves as insurance agents. It also fixes the limits for actual expenses by which the insurer carrying on life insurance business or any group of insurers can exceed from the prescribed limits under the Insurance Act. Likewise, the General Insurance Council, through its Executive Committee, may fix the limits by which the actual expenses of management incurred by an insurer carrying on general insurance business may exceed t he limits as prescribed in the Insurance Act. Ombudsmen The Ombudsmen are appointed in accordance with the Redressal of Public Grievances Rules, 1998, to resolve all complaints relating t o settlement of claims on the par t of insurance companies in a cost-effective,
  • 59. efficient and effective manner. Any person who has a grievance against an insurer may make a complaint to an Ombudsman within his jurisdiction, in the manner specified. However, prior to making a complaint, such person should have made a representation to the insurer and either the insurer has rejected the complaint or has not replied to it. Further, the complaint should be made not later than a year from the date of r ejection of the complaint by the insurer and should not be any other proceedings pending in any other court, Consumer Forum or arbitrator pending on the same subject matter. The Ombudsmen are also empowered to receive and consider any partial or total repudiation of claims by an insurer, any dispute in regard to the premium paid in terms of the policy, any dispute on the legal construction of the policies in as much such a dispute relates to claims, delay in settlement of claims and the non-issue of any insurance document to customers after receipt of premium. The Ombudsmen act as a counselor and mediator and make recommendations to both par ties in the event that the complaint is settled by agreement between both the parties. However, if the complaint is not settled by agreement, the Ombudsman may pass an award of compensation within three months of the complaint, which shall not be in excess of which is necessary to cover the loss suffered by the complainant as a direct consequence of the insured peril, or for an amount not exceeding rupees two million (including exgratia and other expenses), whichever is lower. Ombudsman within his jurisdiction, in the manner specified. However, prior to making a complaint, such person should have made a representation to t he insurer and either the insurer has rejected the complaint or has not replied to it. Further, the complaint should be made not later than a year from the date of rejection of the complaint by the insurer and should not be any other proceedings pending in any other court, Consumer Forum or arbitrator pending on t he same subject matter. The Ombudsmen are also empowered to receive and consider any partial or total repudiation of claims by an insurer, any dispute in regard to the premium paid in terms of the policy, any dispute on the legal construction of the policies in as much such a dispute relates to claims, delay in settlement of claims and the non-issue of any insurance document to customers after receipt of premium. The Ombudsmen act as a counselor and mediator and make recommendations to both par ties in the event that the complaint is settled by agreement between both the parties. However, if the complaint is not settled by agreement, the Ombudsman may pass an award of compensation within three months of the complaint, which shall not be in excess of which is necessary to cover the loss suffered by the complainant as a direct consequence of the insured peril, or for an amount not exceeding rupees two million (including exgratia and other expenses), whichever is lower. Registration of insurance companies Every insurer seeking to carry out the business of insurance in India is required to obtain a certificate of registration from the IRDA prior to commencement of business. The pre-conditions for applying for such registration have been set out under t he Act of 1938, the IRD Act and the various regulations prescribed by the Authority. 1. General Registration Requirements The following are some of the import ant general registration requirements that an applicant would need to fulfill: (a) The applicant would need to be a company registered under the provisions of the Indian Companies Act, 1956. Consequently, any person intending to carry on insurance business in India would need to set up a separate entity in India. (b) The aggregate equity participation of a foreign company (either by itself or through its subsidiary companies or its nominees) in the applicant company cannot not exceed twenty six per cent of the paid up
  • 60. capital of the insurance company. However, the Insurance Act and the regulations there under provide for the manner of computation of such twenty-six per cent. (c) The applicant can carry on any one of life insurance business, general insurance business or reinsurance business. Separate companies would be needed if the intent were t o conduct more than one business. (d) The name of the applicant needs to contain the words “insurance company” or “Assurance Company”. 2. Capital Structure Requirements The applicant would need to meet with the following capital structure requirements: (a) A minimum paid up equity capital of rupees one billion in case of an applicant which seeks to carry on the business of life insurance or general insurance. (b) A minimum paid-up equity capital of rupees two billion, in case of a person carrying on exclusively the business of reinsurance. In determining the aforesaid capital requirement, the deposits to be made and any preliminary expenses incurred in the formation and registration of the company would be included. A “promoter” of the company is not permitted to hold, at any time, more than twenty-six per cent of the paid-up capital in any Indian insurance company. However, an interim measure has been permitted percentages higher than twenty six percent are permitted if the promoters divest, in a phased manner, over a period of ten years from the date of commencement of business, the share capital held by them in excess of twenty six per cent. An applicant desiring to carry on insurance business in India is required to make a requisition for a registration application t o the IRDA in a prescribed format along with all the relevant documents. 3. Procedure for obtaining a certificate of registration The applicant is required to make a separate requisition for registration for each class of business i.e. life insurance business consisting of linked business, non-linked business or both, or general insurance business including health insurance business. The IRDA may accept the requisition on being satisfied of the bonafides of the applicant, the completeness of the application and that the applicant will carry on all the functions in respect of the insurance business including management of investments etc. In the event that the aforesaid requirements are not met with, the Authority may after giving the applicant a reasonable opportunity of being heard, reject the requisition. Thereafter, the applicant may apply to the Authority within thirty days of such rejection for reconsideration of its decision. Additionally, an applicant whose requisition for registration has been rejected may approach the Authority with a fresh request for registration application after a period of two years from the date of reject ion, with a new set of promoters and for a class of insurance business different than the one originally applied for. In the event that the Authority accepts the requisition for registration application, it shall direct supply of the application for registration to the applicant. An applicant, whose requisition has been accepted, may make an application along with the relevant documents evidencing deposit, capital and other requirements in the prescribed form for grant of a certificate of registration. If, when considering an application, it appears to the Authority that the assured rates, advantages, terms and conditions offered or t o be offered in connection wit h life insurance business are in any respect not workable or sound, he may require that a statement thereof to be submitted to an actuary appointed by the insurer and the Authority shall order the insurer to make such modifications as reported by the actuary.
  • 61. After considerations of the matters inter alias capital structure, record of performance of each promoters and directors and planned infrastructure of the company, the Authority may grant the certificate of registration. The Authority would, however, give preference in grant of certificate of registration to those applicants w ho propose to carry on the business of providing health covers to individuals or groups of individuals. An applicant granted a certificate of registration may commence the insurance business within twelve months from the date of registration. In the event that the Authority rejects the application for registration, the applicant aggrieved by the decision of the Authority may within a period of thirty days from the date of communication of such rejection, appeal to the Central Government f or reconsideration of the decision and the decision of the Central Government in this regard would be final. 4. Renewal of registration An insurer who has been granted a certificate of registration should renew the registration before the 31 day of December each year, and such application should be accompanied by evidence of fees that should be the higher offifty thousand rupees for each class of insurance business, and one fifth of one per cent of tot al gross premium writ ten direct by an insurer in India during the financial year preceding the year in which the application for renewal of certificate is required to be made, or the application for renewal of certificate is required t o be made, or rupees fifty million whichever is less; (and in case of an insurer carrying on solely re-insurance business, instead of the total gross premium written direct in India, the total premium in respect of facultative re-insurance accepted by him in India shall be taken into account). st This fee may vary according to the total gross premium writ ten direct in India, during the year preceding the year in which the application is required to be made by the insurer in the class of insurance business to which the registration relates but shall not exceed one-fourth of one percent of such premium income or rupees fifty million, whichever is less, or be less, in any case than fifty thousand rupees for each class of insurance business. However, in the case of an insurer carrying on solely re-insurance business, the total premiums in respect of facultative re-insurance accept ed by him in India shall be taken into account. 5. Suspension of registration The registration of an Indian insurance company or insurer may be suspended for a class or classes of insurance business, in addition to any penalty that may be imposed or any action that may be taken, for such period as may be specified by the Authority, in the following cases: 1. conducts its business in a manner prejudicial to the interests of the policy-holders; 2. fails to furnish any information as required by the Authority relating to its insurance business; 3. does not submit periodical returns as required under the Act or by the Authority; 4. does not co-operate in any inquiry conducted by the Authority; 5. indulges in manipulating the insurance business; 6. Fails to make investment in the infrastructure or social sector as specified under the Insurance Act. 6. Cancellation of certificate of registration The Authority, in case of repeated defaults of the grounds for suspension of a certificate of registration, may impose a penalty in the form of cancellation of the certificate. The Authority is compulsorily required to cancel the registration of an insurer either w holly or in so far as it relates to a particular class of insurance business, as the case may be 1. if the insurer fails to comply with t he provisions relating t o deposits; or 2. if the insurer fails, at any time, to comply wit h the provisions relating t o the excess of the value of his assets over the amount of his liabilities; or 3. if the insurer is in liquidation or is adjudged an insolvent; or
  • 62. 4. if the business or a class of the business of the insurer has been transferred to any person or has been transferred to or amalgamated with the business of any other insurer; or 5. if the whole of the deposit made in respect of the insurance business has been returned to the insurer; 6. if, in the case of an insurer, the standing contract is cancelled or is suspended and continues to be suspended for a period of six months, or 7. if the Central Government of India so directs: In addition to the above, the Authority has the discretion to cancel the registration of an insurer 8. if the insurer makes default in complying with, or acts in contravention of , any requirement of the Insurance Act or of any rule or any regulation or order made or, any direction issued there under, or 9. if the Authority has reason to believe that nay claim upon the insurer arising in India under any policy of insurance remains unpaid for three months after final judgment in regular course of law, or 10. if the insurer carries on any business other than insurance business or any prescribed business, or 11. if the insurer makes a default in complying with any direct ion issued or order made, as the case may be, by the Authority under the IRDA Act, 1999. 12. If the insurer makes a default in complying with, or acts in contravention of, any requirement of the Companies Act, or the LIC Act, or the GIC Act or the Foreign Exchange Management Act, 2000. The order of cancellation shall take effect on the date on which notice of t he order of cancellation is served on the insurer. Thereafter, the insurer would be prohibited from entering into any new contracts of insurance, but all rights and liabilities in respect of contracts of insurance entered into by him before the cancellation takes effect shall continue as if the cancellation had not taken place. The Authority may, after the expiry of six months from the date on which the cancellation order takes effect, apply to t he Court for an order to wind up the insurance company, or to wind up the affairs of the company in respect of a class of insurance business, unless the registration of the insurance company has been revived or an application for winding up has already been presented to the Court. 7. Revival of registration The Authority has a discretion, where the registration of an insurer has been cancelled, to revive the registration, if the insurer within six months from the date on which t he cancellation took effect: • makes the deposits, or • complies with the provisions as to t he excess of the value of his assets over the amount of his liabilities, or • has his standing contract restored, or • has the application accepted, or • satisfies the Authority that no claim upon him remains unpaid, or • has complied with any requirements of the Insurance Act or the IRDA Act, or any rule or regulation, or any order made there under or any direct ion issued under these Acts, or • That he has ceased to carry on any business other than insurance business or any prescribed business.

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