1. Management of financial services
INDIAN FINANCIAL SYSTEM
-1-

2. CHAPTER-1 INDIAN FINANCIAL SYSTEM
MEANING & DEFINITION OF FINANCIAL SYSTEM:
Definition
“In finance, the financial system is the system that allows the transfer of money between savers
and borrowers. It comprises a set of complex and closely interconnected financial institutions,
markets, instruments, services, practices, and transactions.”
-2-

3. According to Robinson, the primary function of the system is “To provide a link between
saving and investment for the creation of new wealth and to permit portfolio adjustment in
composition of existing wealth”
The word "system", in the term "financial system", implies a set of complex and closely
connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities
in the economy. The financial system is concerned about money, credit and finance-the three
terms are intimately related yet are somewhat different from each other. Indian financial system
consists of financial market, financial instruments and financial intermediation.
There are areas or people with surplus funds and there are those with a deficit. A financial
system or financial sector functions as an intermediary and facilitates the flow of funds from the
areas of surplus to the areas of deficit. A Financial System is a composition of various
institutions, markets, regulations and laws, practices, money manager, analysts, transactions and
claims and liabilities.
-3-

4. The economic development of a nation is reflected by the progress of the various economic units,
broadly classified into corporate sector, government and household sector. While performing
their activities these units will be placed in a surplus/deficit/balanced budgetary situations.
In finance, the financial system is the system that allows the transfer of money between savers
and borrowers it comprises a set of complex and closely interconnected financial institutions,
markets, instruments, services, practices, and transactions. Financial systems are crucial to the
allocation of resources in a modern economy. They channel household savings to the corporate
sector and allocate investment funds among firms. The functions are common to the financial
systems of most developed economies. Yet the form of these financial systems varies widely.
In finance, the financial system is the system that allows the transfer of money between savers
and borrowers it comprises a set of complex and closely interconnected financial institutions,
markets, instruments, services, practices, and transactions. Financial systems are crucial to the
allocation of resources in a modern economy. They channel household savings to the corporate
sector and allocate investment funds among firms. The functions are common to the financial
systems of most developed economies. Yet the form of these financial systems varies widely.
The financial system or the financial sector of any country consists of:-
(A) Specialized & non specialized financial institution.
(B) Organized &unorganized financial markets and,
(C) Financial instruments & services which facilitate transfer of funds.
Procedure & practices adopted in the markets, and financial inter relationships are also the parts
of the system. These parts are not always mutually exclusive. The word system in the term
financial system implies a set of complex and closely connected or inters mixed institution,
agent‟s practices, markets, transactions, claims, & liabilities in the economy. The financial
system is concerned about money, credit, & finance – the terms intimately related yet somewhat
different from each other. Money refers to the current medium of exchange or means of
payment. Credit or Loan is a sum of money to be returned normally with interest it refers to a
-4-

5. debt of economic unit. Finance is a monetary resources comprising debt & ownership fund of the
state, company or person.
DEFINITION
“In finance, the financial system is the system that allows the transfer of money between savers
and borrowers. It comprises a set of complex and closely interconnected financial institutions,
markets, instruments, services, practices, and transactions.”
Features of Financial System
 It provides an Ideal linkage between depositor‟s savers and investors Therefore it
encourages savings and investment.
 Financial system facilitates expansion of financial markets over a period of time.
 Financial system should promote deficient allocation of financial resources of
socially desirable and economically productive purpose.
 Financial system influence both quality and the pace of economic development.
Role of Financial System
The role of the financial system is to promote savings & investments in the economy. It has a
vital role to play in the productive process and in the mobilization of savings and their
distribution among the various productive activities. Savings are the excess of current
expenditure over income. The domestic savings has been categorized into three sectors,
household, government & private sectors.
The function of a financial system is to establish a bridge between the savers and investors. It
helps in mobilization of savings to materialize investment ideas into realities. It helps to increase
the output towards the existing production frontier. The growth of the banking habit helps to
activate saving and undertake fresh saving. The financial system encourages investment activity
by reducing the cost of finance risk. It helps to make investment decisions regarding projects by
sponsoring, encouraging, export project appraisal, feasibility studies, monitoring & execution of
the projects
-5-

6. COMPONENTS/ CONSTITUENTS OF INDIAN FINANCIAL SYSTEM
A. FORMAL FINANCIAL SYSTEM
1. Financial institutions/intermediaries
2. Financial Markets
3. Financial Instruments/Assets/Securities
4. Financial Services.
B. INFORMAL FINANCIAL SYSTEM: Like, Moneylenders, Local Bankers, Traders,
Landlords, and Pawn Broker etc.
1. FINANCIAL INSTITUTIONS
In financial economics, a financial institution is an institution that provides financial
services for its clients or members. Probably the most important financial service provided by
financial institutions is acting as financial intermediaries. Most financial institutions are
highly regulated by government
-6-

7. Financial institutions provide service as intermediaries of the capital and debt markets. They are
responsible for transferring funds from investors to companies in need of those funds. Financial
institutions facilitate the flow of money through the economy. To do so, savings a risk brought to
provide funds for loans. Such is the primary means for depository institutions to develop
revenue. Should the yield curve become inverse, firms in this arena will offer additional fee-
generating services including securities underwriting.
The financial institutions in India are divided in two categories. The first type refers to the
regulatory institutions and the second type refers to the intermediaries. The regulators are
assigned with the job of governing all the divisions of the Indian financial system. These
regulatory institutions are responsible for maintaining the transparency and the national interest
in the operations of the institutions under their supervision.
The regulatory bodies of the financial institutions in India are as follows:
 Reserve Bank of India (RBI)
 Securities and Exchange Board of India (SEBI)
 Central Board of Direct Taxes (CBDT)
 Central Board of Excise & Customs
Apart from the Regulatory bodies, there are the Intermediaries that include the banking and non-
banking financial institutions. Some of the specialized financial institutions in India are as
follows:
 Unit Trust of India (UTI)
 Securities Trading Corporation of India Ltd. (STCI)
 Industrial Development Bank of India (IDBI)
 Industrial Reconstruction Bank of India (IRBI), now (Industrial Investment Bank of
India)
 Export - Import Bank of India (EXIM Bank)
 Small Industries Development Bank of India (SIDBI)
 National Bank for Agriculture and Rural Development (NABARD)
 Life Insurance Corporation of India (LIC)
-7-

8. Intermediary Market Role
Stock Exchange Capital Market Secondary Market to securities
Corporate advisory services, Issue of
Investment Bankers Capital Market, Credit Market
securities
Subscribe to unsubscribed portion of
Underwriters Capital Market, Money Market
securities
Issue securities to the investors on behalf
Registrars, Depositories, Custodians Capital Market of the company and handle share transfer
activity
Primary Dealers Satellite Dealers Money Market Market making in government securities
Forex Dealers Forex Market Ensure exchange ink currencies
Thus, it can be concluded that a financial institution is that type of an institution, which
performs the collection of funds from private investors and public investors and utilizes those
funds in financial assets. The functions of financial institutions are not limited to a particular
country, instead they have also become popular in abroad due to the growing impact of
globalization.
2. FINANCIAL MARKETS
Financial Markets are an important component of financial system in an economy financial
system aims at establishing a regular, smooth, efficient and cost effective link between savers &
investors. Thus, it helps encouraging both saving and investment. All system facilitates
expansion of financial markets over space 8 times and promotes efficient allocation of financial
-8-

9. resources .For socially desirable and economically productive purposes. They influence both the
quality and the pace of economic development.
Various constituents of financial system are financial, institutions, financial services, financial
instruments and financial markets. These constituents of financial system are closely inter-mixed
and operate in conjunction with each other. For eg. Financial institutions operate in financial
markets generating, purchasing and selling financial instruments and rendering various financial
services in accordance with the practices and procedures established by law or tradition.
Financial markets are the centre or arrangements facilitating buying and selling of financial
claims, assets, services and the securities. Banking and non – banking financial institutions,
dealers, borrowers and lenders, investors and savers, and agents are the participants on demand
and supply side in these markets. Financial market may be specific place or location, e.g. stock
exchange or it may be just on over – the –phone market.
Financial markets in India are classified into four parts, viz.:-
 Money Market
 Capital Market
 Debt Market
 Forex Market
INTRODUCTION TO MONEY MARKET
Whenever a bear market comes along, investors realize that the stock market is a risky place for
their savings. It's a fact we tend to forget while enjoying the returns of a bull market!
Unfortunately, this is part of the risk-return tradeoff. To get higher returns, you have to take on a
higher level of risk. For many investors, a volatile market is too much to stomach - the money
market offers an alternative to this higher-risk investment.
The money market is better known as a place for large institutions and government to manage
their short-term cash needs. However, individual investors have access to the market through a
variety of different securities. In this tutorial, we'll cover various types of money market
securities and how they can work in your portfolio.
-9-

10. The money market is a subsection of the fixed income market. We generally think of the term
fixed income as being synonymous to bonds. In reality, a bond is just one type of fixed income
security. The difference between the money market and the bond market is that the money
market specializes in very short-term debt securities (debt that matures in less than one year).
Money market investments are also called cash investments because of their short maturities.
The easiest way for us to gain access to the money market is with money market mutual funds,
or sometimes through a money market bank account. These accounts and funds pool together the
assets of thousands of investors in order to buy the money market securities on their behalf.
However, some money market instruments, like Treasury bills, may be purchased directly.
Failing that, they can be acquired through other large financial institutions with direct access to
these markets.
MONEY MARKET INSTRUMENTS
The money market is a market for short-term financial assets that are close substitutes of money.
The most important feature of a money market instrument is that it is liquid and can be turned
over quickly at low cost and provides an opportunity for balancing the short-term surplus funds
of lenders and the requirements of borrowers. By convention, the term "Money Market" refers to
the market for short-term requirement and deployment of funds. Money market instruments are
those instruments, which have a maturity period of less than one year. The most active part of the
money market is the market for overnight call and term money between banks and institutions
and repo transactions. Call Money / Repo are very short-term Money Market products. There is a
wide range of participants (banks, primary dealers, financial institutions, mutual funds, trusts,
provident funds etc.) dealing in money market instruments. Money Market Instruments and the
participants of money market are regulated by RBI and SEBI.As a primary dealer SBI DFHI is
an active player in this market and widely deals in Short Term Money Market Instruments. T he
below mentioned instruments is normally termed as money market instruments:
 Call/ Notice Money
 Treasury Bill
 Inter-Bank Term Money
 Certificate of Deposit
- 10 -

11.  Commercial Paper
 Inter-Corporate Deposits
 Repo/Reverse Repo
Call /Notice-Money Market
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.
Treasury Bills:
The Treasury bills are short-term money market instrument that mature in a year or less than
that. The purchase price is less than the face value. At maturity the government pays
the Treasury bill holder the full face value. The Treasury Bills are marketable, affordable and
risk free. The only downside to T-bills is that you won't get a great return because Treasuries are
exceptionally safe.
Inter-Bank Term Money
Inter-bank market for deposits of maturity beyond 14 days is referred to as the term money
market. The entry restrictions are the same as those for Call/Notice Money except that, as per
existing regulations, the specified entities are not allowed to lend beyond 14 days.
Certificate of Deposit (CD)
The certificates of deposit are basically time deposits that are issued by
the commercial banks with maturity periods ranging from 3 months to five years. The return on
the certificate of deposit is higher than the Treasury Bills because it assumes a higher level of
risk.
Commercial Paper
- 11 -

12. Commercial Paper is short-term loan that is issued by a corporation use for financing accounts
receivable and inventories. The maturity period of Commercial Papers is a maximum of 9
months. They are very safe since the financial situation of the corporation can be anticipated over
a few months.
Inter-Corporate Deposits
Inter-corporate deposits are deposits made by one company with another company, and usually
carry a term of six months. The three types of inter-corporate deposits are: three month deposits,
six month deposits, and call deposits. The biggest advantage of inter-corporate deposits is that
the transaction is free from bureaucratic and legal hassles.
Repo/Reverse Repo
Repo is short for repurchase agreement. Those who deal in government securities use repos as a
form of overnight borrowing. They are usually very short-term, from overnight to 30 days or
more. The reverse repo is the complete opposite of a repo. In this case, a dealer buys government
securities from an investor and then sells them back at a later date for a higher price.
INTRODUCTION TO CAPITAL MARKET
Capital market is market for long term securities. It contains financial instruments of maturity
period exceeding one year. It involves in long term nature of transactions. It is a growing element
of the financial system in the India economy. It differs from the money market in terms of
maturity period & liquidity. It is the financial pillar of industrialized economy. The development
of a nation depends upon the functions & capabilities of the capital market. Capital market is the
market for long term sources of finance. It refers to meet the long term requirements of the
industry. Generally the business concerns need two kinds of finance:-
1. Short term funds for working capital requirements.
2. Long term funds for purchasing fixed assets.
Therefore the requirements of working capital of the industry are met by the money market. The
long term requirements of the funds to the corporate sector are supplied by the capital market. It
refers to the institutional arrangements which facilitate the lending & borrowing of long term
funds.
On the basis of financial instruments the capital markets are classifieds into
Two kinds:-
- 12 -

13. a) Equity market
b) Debt market
Recently there has been a substantial development of the India capital market. It comprises
various submarkets.
Equity market is more popular in India. It refers to the market for equity shares of existing &
new companies. Every company shall approach the market for raising of funds. The equity
market can be divided into two categories
(a) Primary market
(b) Secondary market.
PRIMARY MARKET
The primary market is that part of the capital markets that deals with the issue of
new securities. Companies, governments or public sector institutions can obtain funding through
the sale of a new stock or bond issue. This is typically done through a syndicate of securities
dealers. The process of selling new issues to investors is called underwriting. In the case of a
new stock issue, this sale is an initial public offering (IPO). Dealers earn a commission that is
built into the price of the security offering, though it can be found in the prospectus. Primary
markets create long term instruments through which corporate entities borrow from capital
market. A company can raise its capital through issue of share and debenture by means of:-
Public Issue:-
Public issue is the most popular method of raising capital and involves raising capital and fund
direct from the public.
Right Issue:-
Right issue is the method of raising additional finance from existing members by offering
securities to them on pro rata basis.
Bonus Issue:-
- 13 -

14. Some companies distribute profits to existing shareholders by way of fully paid up bonus share
in lieu of dividend. The shareholder does not have to any additional payment for these shares.
Private Placement:-
Private placement market financing is the direct sale by a public limited company or private
limited company of private as well as public sector of its securities to the intermediaries like
credit rating agencies and trustees and financial advisors such as merchant bankers.
SECONDARY MARKET
The secondary market is that segment of the capital market where the outstanding securities are
traded from the investors point of view the secondary market imparts liquidity to the long – term
securities held by them by providing an auction market for these securities. The secondary
market operates through the medium of stock exchange which regulates the trading activity in
this market and ensures a measure of safety and fair dealing to the investors. India has a long
tradition of trading in securities going back to nearly 200 years. The first India stock exchange
established at Mumbai in 1875 is the oldest exchange in Asia. The main objective was to protect
the character status and interest of the native share and stock broker.
The Indian stock markets can be divided into further categories depending on various aspects
like the mode of operation and the diversification in services. First of the two largest stock
exchanges in India can be divided on the basis of operation. While the Bombay stock exchange
or BSE is a conventional stock exchange with a trading floor and operating through mostly
offline trades, the National Stock Exchange or NSE is a completely online stock exchange and
the first of its kind in the country. The trading is carried out at the National Stock Exchange
through the electronic limit order book or the LOB. With the immense popularity of the process
and online trading facility other exchanges started to take up the online route including the BSE
where you can trade online as well. But the BSE is still having the offline trading facility that is
carried out at the trading floor of the exchange at its Dalal Street facility.
INTRODUCTION TO DEBT MARKET
- 14 -

15. Debt market refers to the financial market where investors buy and sell debt securities, mostly in
the form of bonds. These markets are important source of funds, especially in a developing
economy like India. India debt market is one of the largest in Asia. Like all other countries, debt
market in India is also considered a useful substitute to banking channels for finance. The fixed
return on the bond is often termed as the 'coupon rate' or the 'interest rate'.
The debt market often goes by other names, based on the types of debt instruments that are
traded. In the event that the market deals mainly with the trading of municipal and corporate
bond issues, the debt market may be known as a bond market. If mortgages and notes are the
main focus of the trading, the debt market may be known as a credit market. When fixed rates
are connected with the debt instruments, the market may be known as a fixed income market.
The instruments traded can be classified into the following segments based on the characteristics
of the identity of the issuer of these securities:
Market Segment Issuer Instruments
Government Central Government Zero Coupon Bonds, Coupon Bearing Bonds,
Securities Treasury Bills, STRIPS
State Governments Coupon Bearing Bonds.
Public Sector Government Agencies / Govt. Guaranteed Bonds, Debentures
Bonds Statutory Bodies
Public Sector Units PSU Bonds, Debentures, Commercial Paper
Private Sector Corporate Debentures, Bonds, Commercial Paper, Floating Rate
Bonds Bonds, Zero Coupon Bonds, Inter-Corporate Deposits
Banks Certificates of Deposits, Debentures, Bonds
Financial Institutions Certificates of Deposits, Bonds
INTRODUCTION TO FOREX MARKET
In India, foreign exchange has been given a statutory definition. Section 2 (b) of Foreign
Exchange Regulation Act, 1973 states:
- 15 -

16. „Foreign exchange‟ means foreign currency and includes:
“All deposits, credits and balances payable in any foreign currency and any drafts, traveler‟s
cheques, letters of credit and bills of exchange , expressed or drawn in Indian currency but
payable in any foreign currency.”
Particularly for foreign exchange market there is no market place called the foreign exchange
market. It is mechanism through which one country‟s currency can be exchange i.e. bought or
sold for the currency of another country. The foreign exchange market does not have any
geographic location. The market comprises of all foreign exchange traders who are connected to
each other throughout the world. They deal with each other through telephones, telexes and
electronic systems. With the help of Reuters Money 2000-2, it is possible to access any trader in
any corner of the world within a few seconds.
Participants
1. Customers
The customers who are engaged in foreign trade participate in foreign exchange markets
by availing of the services of banks.
2. Commercial banks
Commercial banks dealing with international transactions offer services for conversion of
one currency in to another.
3. Central Bank
In all countries central banks have been charged with the responsibility of maintaining
the external value of the domestic currency.
3. FINANCIAL INSTRUMENTS
Financial instrument is a claim against a person or an institution for payment, at a future date, of
a sum of money and/or a periodic payment in the form of interest or dividend. Financial
instrument can be classified according to Term and Type.
- 16 -

17. Under term wise it is classified by Short-term, Long-term and Medium term. While under type
wise it is classified as Primary security and Secondary security. Primary securities are termed as
direct security as they are directly issued by the ultimate borrowers of fund to the ultimate
savers. Primary security includes equity share, preference shares and debentures. Secondary
securities are referred to as indirect securities, as they are issued by the financial intermediaries
to the ultimate savers. It includes insurance policy, Mutual Fund Units, Term Deposits etc.
THE MAJOR TYPES OF FINANCIAL PRODUCTS ARE:
Shares:
These represent ownership of a company. While shares are initially issued by corporations to
finance their business needs, they are subsequently bought and sold by individuals in
the share market. They are associated with high risk and high returns. Returns on shares can be
in the form of dividend payouts by the company or profits on the sale of shares in the stock
market. Shares, stocks, equities and securities are words that are generally used interchangeably.
Bonds:
These are issued by companies to finance their business operations and by governments to fund
expenses like infrastructure and social programs. Bonds have a fixed interest rate, making the
risk associated with them lower than that with shares. The principal or face value of bonds is
recovered at the time of maturity.
Treasury Bills
These are instruments issued by the government for financing its short term needs. They are
issued at a discount to the face value. The profit earned by the investor is the difference between
the face or maturity value and the price at which the Treasury Bill was issued.
Options
Options are rights to buy and sell shares. An option holder does not actually purchase shares.
Instead, he purchases the rights on the shares.
Mutual Funds
These are professionally managed financial instruments that involve the diversification of
investment into a number of financial products, such as shares, bonds and government securities.
This helps to reduce an investor‟s risk exposure, while increasing the profit potential.
- 17 -

18. Credit Default Swaps (CDS)
Credit default swaps are highly leveraged contracts that are privately negotiated between two
parties. These swaps insure against losses on securities in case of a default. Since the government
does not regulate CDS related activities, there is no specific central reporting mechanism that
determines the value of these contracts.
Annuities
These are contracts between investors and insurance companies, wherein the latter makes
periodic payments in exchange for financial protection in the event of an unfortunate incident.
4. FINANCIAL SERVICES
Financial intermediaries provide key financial services such as merchant banking, leasing, hire
purchase, credit rating and so on. Financial services rendered by financial intermediaries bridge
the gap between lack of knowledge on part of investors and increasing sophistication of financial
instruments and markets.
Financial services encompass a variety of businesses that deal with money management. These
include many different kinds of organizations such as banks, investment companies, credit card
companies, insurance companies and even government programs. Financial services can also
refer to the services and products that money management organizations offer to the public.
Banks are one kind of financial services organizations. Banks generally function by providing a
sheltered and secure place for people to store their money. Usually, banks will invest their
clients' stored money for the bank's gain, while paying a small amount of interest to those who
keep their money in savings or checking accounts.
The Financial services were developed in order to meet the needs of individual as well as
companies. The financials of companies are expected to improve as a result of these financial
services in the form of lower debt equity ratio, improved liquidity and profitability ratios. The
financial service industry has been growing at a rate of 14% per annum.
Indian financial services industry was rather unexciting until the early seventies. The financial
services sector was started in mid seventies when a series of innovative services of which leasing
- 18 -

19. being the most notable. India has witnessed an explosive growth of leasing companies during the
early eighties.
(A)Banking and Financial Services:
Banking and financial services can also be further classified as:
1. Fee based financial services
 Financial management.
 Advisory services
 Custody services
 Credit card services
2. Securities-related financial services
 Securities lending services
 Mutual fund services
 Securities clearance
 Settlement services
 Under-writing services
(B)Insurance and insurance related services
Insurance services include the following:
Insurance brokerage
Specialty insurance products
Reinsurance
(C)Fee-based Financial Services
Financial services based on fees are as follows:
Issue management
- 19 -

20. Portfolio management
Loan based syndication
Mergers and acquisitions
CAPITAL MARKET SERVICES
The following are the financial services rendered by various intermediaries in relation to capital
market.
1. Issue management
Public issue management is the beginning of project financing activity. A company has to
appoint public issue managers who are normally merchant bankers. It is a marketing activity.
2. Merchant banking
A merchant banker is any person who is engaged in the business of issue management either by
making arrangements regarding selling, buying or subscribing to securities as manager,
consultant or advisor or vendoring corporate advisory services in relation to such issue
management
Services provided by Merchant Bankers
Underwriting of issues
Project finance
Private placements
ROLE/ FUNCTIONS OF FINANCIAL SYSTEM:
The role of the financial system is to promote savings & investments in the economy. It has a
vital role to play in the productive process and in the mobilization of savings and their
- 20 -

21. distribution among the various productive activities. Savings are the excess of current
expenditure over income. The domestic savings has been categorized into three sectors,
household, government & private sectors.
The function of a financial system is to establish a bridge between the savers and investors. It
helps in mobilization of savings to materialize investment ideas into realities. It helps to increase
the output towards the existing production frontier. The growth of the banking habit helps to
activate saving and undertake fresh saving. The financial system encourages investment activity
by reducing the cost of finance risk. It helps to make investment decisions regarding projects by
sponsoring, encouraging, export project appraisal, feasibility studies, monitoring & execution of
the projects.
A financial system performs the following functions:
1. It serves as a link between savers and investors. It helps in utilizing the mobilized savings
of scattered savers in more efficient and effective manner. It channelizes flow of saving
into productive investment.
2. It assists in the selection of the projects to be financed and also reviews the performance
of such projects periodically.
3. It provides payment mechanism for exchange of goods and services.
4. It provides a mechanism for the transfer of resources across geographic boundaries.
5. It provides a mechanism for managing and controlling the risk involved in mobilizing
savings and allocating credit.
6. It promotes the process of capital formation by bringing together the supply of saving and
the demand for investible funds.
7. It helps in lowering the cost of transaction and increase returns. Reduce cost motives
people to save more.
8. It provides you detailed information to the operators/ players in the market such as
individuals, business houses, Governments etc.
INDIAN FINANCIAL SYSTEM FROM 1950 TO 1980
Indian Financial System During this period evolved in response to the objective of planned
economic development. With the adoption of mixed economy as a pattern of industrial
- 21 -

22. development, a complimentary role was conceived for public and private sector. There was a
need to align financial system with government economic policies. At that time there was
government control over distribution of credit and finance. The main elements of financial
organization in planned economic development are as follows:-
1. Public ownership of financial institutions
The nationalization of RBI was in 1948, SBI was set up in 1956, LIC came in to existence in
1956 by merging 245 life insurance companies in 1969, 14 major private banks were brought
under the direct control of Government of India. In 1972, GIC was set up and in 1980; six more
commercial banks were brought under public ownership. Some institutions were also set up
during this period like development banks, term lending institutions, UTI was set up in public
sector in 1964, provident fund, pension fund was set up. In this way public sector occupied
commanding position in Indian Financial System.
2. Fortification of institutional structure
Financial institutions should stimulate / encourage capital formation in the economy. The
important feature of well developed financial system is strengthening of institutional structures.
Development banks was set up with this objective like industrial finance corporation of India
(IFCI) was set up in 1948, state financial corporation (SFCs) were set up in 1951, Industrial
credit and Investment corporation of India Ltd (ICICI)was set up in 1955. It was pioneer in many
respects like underwriting of issue of capital, channelization of foreign currency loans from
World Bank to private industry. In 1964, Industrial Development of India (IDBI).
3. Protection of investor
Lot many acts were passed during this period for protection of investors in financial markets.
The various acts Companies Act, 1956 ; Capital Issues Control Act, 1947 ; Securities Contract
Regulation Act, 1956 ; Monopolies and Restrictive Trade Practices Act, 1970 ; Foreign
Exchange Regulation Act, 1973 ; Securities & Exchange Board of India, 1988.
4. Participation in corporate management
- 22 -

23. As participation were made by large companies and financial instruments it leads to
accumulation of voting power in hands of institutional investors in several big companies
financial instruments particularly LIC and UTI were able to put considerable pressure on
management by virtual of their voting power. The Indian Financial System between 1951 and
mid80‟s was broad based number of institutions came up. The system was characterized by
diversifying organizations which used to perform number of functions. The Financial structure
with considerable strength and capability of supplying industrial capital to various enterprises
was gradually built up the whole financial system came under the ownership and control of
public authorities in this manner public sector occupy a commanding position in the industrial
enterprises. Such control was viewed as integral part of the strategy of planned economy
development.
INDIAN FINANCIAL SYSTEM POST 1990’S
The organizations of Indian Financial system witnessed transformation after launching of new
economic policy 1991. The development process shifted from controlled economy to free market
for these changes was made in the economic policy. The role of government in business was
reduced the measure trust of the government should be on development of infrastructure, public
welfare and equity. The capital market an important role in allocation of resources. The major
development during this phase is:-
1. Privatization of financial institutions
At this time many institutions were converted in to public company and numbers of private
players were allowed to enter in to various sectors:
a) Industrial Finance Corporation of India (IFCI): The pioneer development finance
institution was converted in to a public company.
b) Industrial Development Bank of India & Industrial Finance Corporation of India (IDBI &
IFCI): IDBI & IFCI ltd offers their equity capital to private investors.
c) Private Mutual Funds have been set up under the guidelines prescribed by SEBI.
d) Number of private banks and foreign banks came up under the RBI guidelines. Private
institution companies emerged and work under the guidelines of IRDA, 1999.
- 23 -

24. e) In this manner government monopoly over financial institutions has been dismantled in
phased manner. IT was done by converting public financial institutions in joint stock
companies and permitting to sell equity capital to the government.
2. Reorganization of institutional structure
The importance of development financial institutions decline with shift to capital market for
raising finance commercial banks were give more funds to investment in capital market for this.
SLR and CRR were produced; SLR earlier @ 38.5% was reduced to 25% and CRR which used
to be 25% is at present 5%. Permission was also given to banks to directly undertake leasing,
hire-purchase and factoring business. There was trust on development of primary market,
secondary market and money market.
3. Investor protection
SEBI is given power to regulate financial markets and the various intermediaries in the financial
markets.
REGULATORY FINANCIAL INSTITUTIONS
Regulatory institutions to be ensured that firms provide the goods and services promised and that
their behaviors, in general, conform to established standards In the county and or abroad.
These functions of the institutions are however not always neatly declined in practice. For
example, regulatory institutions may perform facilitator and / or promotional service to mitigate
any unintended negative consequences that their main activities may have for development of the
firms.
Financial intermediaries are heavily regulated in comparison to non-financial firms. Financial
intermediaries are subject to rules and regulations governing their business. They are also subject
to supervision and monitoring to ensure that rules and regulation are followed.
Following are the regulatory authorities which governs the working of financial intermediaries.
1. Securities and exchange board of India(SEBI)
2. The reserve bank of India(RBI)
3. Insurance regulatory and development authority(IRDA)
- 24 -

25. SECURITIES AND EXCHANGE BOARD OF INDIA [SEBI]
Securities and Exchange Board of India (SEBI) was first established in the year 1988 as a non-
statutory body for regulating the securities market. It became an autonomous body in 1992 and
more powers were given through an ordinance. Since then it regulates the market through its
independent powers.
 Established in the year 1988 and became an autonomous body in 1992
 Basic Functions
“…..to protect the interests of investors in securities and to promote the development of,
and to regulate the securities market and for matters connected therewith or incidental thereto”
THE BACKGROUND OF SEBI
Securities and Exchange Board of India, popularly called SEBI, is a quasi government body
that was initially formed in 1988 by an administrative order. The Indian capital market had
started developing very fast during the 1980s. The amount of capital raised by companies from
the primary market increased from a modest 200 crores in 1980 to a substantial 6500 crores in
1990. This implied a great exposure of public money, which also attracted a number of fly-by-
night operators. This necessitated a watchdog that could safeguard the interests of investors.
SEBI was provided a statutory status in the immediate aftermath of infamous securities scam
perpetrated by Harshad Mehta. The scam shook up the foundations of the Indian financial
framework. The stock market, which was making a frenzied climb upwards, collapsed on its
face. Thousands of crores of market equity was destroyed overnight and a number of financial
institutions and banks were forced to shut shop. That a single individual could twist and tweak
the system, with all is apparent loopholes, for earning tremendous profits became painfully
apparent to everyone.
A number of financial institutions and other market players were left high and dry after the scam,
but the biggest loser turned out to be the common investor. The economy had just started
opening up after the 1991 economic reforms, and the India market was just taking its first
- 25 -

26. tottering steps. At this stage, such a huge scam would not only have damaged the market, but
would have severely damaged investor confidence. In time, investors could have lost trust in the
system, thus adversely affecting the ability of companies to raise money in stock market. This, in
turn, would have severely restricted industrial growth at a time when the economy had started
improving.
The Securities and Exchange Board of India Act was passed in 1992, thus giving the regulatory
teeth to the body. SEBI was entrusted with the primary task of protecting the interests of the
investors. In addition, SEBI was also entrusted with the twin objectives of developing and
regulating the stock market. In this regard, SEBI has done a decent job, though admittedly, there
have been instances when the regulator has been caught napping! But overall, the lot of investors
has definitely improved due to the policies and steps taken by the regulator.
OFFICES AND ADMINISTRATION
SEBU has its head office located at Mumbai, the financial capital of India. In addition, SEBI has
four regional offices, located at New Delhi, Chennai, Kolkata and Ahmedabad. The regional
offices have jurisdiction over the companies and institutions located on their designated areas.
To manage its affairs, SEBI has a five member board, headed by a chairperson. Out of the five
members, one member each is taken from the Law and Finance ministries, one member is from
RBI, and the remaining two members can be eminent members of the industry.
ENTITY OF SEBI
It was registered with the common seal and with the power to acquire, hold and dispose any
property
Power to sue or to be sued in its own name
The Head office is situated in Mumbai; in addition the regional offices were established in the
following metropolitan cities viz Kolkata, Chennai and Delhi, to monitor and control the capital
market operations across the country
- 26 -

27. ROLE OF SEBI
SEBI has been entrusted with a wide ranging role to develop and regulate the financial markets.
The primary task of SEBI is to regulate the affairs of the stock markets. In this respect, SEBI has
introduced a number of notable reforms such as dematerialization of shares, online share trading,
approval for stock indices trading, derivatives trading. This has made the market broad based and
easily approachable by everyone. Over the years, SEBI has also evolved and enforced a code of
conduct for the banks, financial institutions, companies, mutual funds financial
intermediaries/brokers and portfolio managers. In addition, SEBI deals with following activities
related to financial markets -
1. Primary market issues
2. Secondary market issues
3. Mutual Funds
4. Takeovers and mergers & acquisition
5. Collective investment schemes
6. Share buy backs
7. Delisting of shares from Stock exchanges
SEBI is also entrusted with handling investor grievances and complaints related to any of the
abovementioned activities. SEBI also undertakes periodical investor education initiatives,
workshops and seminars to raise investment and financial awareness.
ORGANIZATIONAL GRID OF THE SEBI
1. Six members in the committee
2. Headed by the chairman
3. One member each from the ministries of Law and Finance
4. One member from the officials of Reserve Bank of India
5. Two nominees from the central government
6. It contains 4 different department viz primary department, issue management and
intermediaries department, secondary department and institutional investment
department.
- 27 -

28. SEBI in India's capital market:
SEBI from time to time have adopted many rules and regulations for enhancing the Indian
capital market. The recent initiatives undertaken are as follows:
Under this rule every brokers and sub brokers have to get registration with SEBI and any stock
exchange in India.
 For Underwriters: For working as an underwriter an asset limit of 20 lakhs has been
fixed.
 For Share Prices According to this law all Indian companies are free to determine their
respective share prices and premiums on the share prices.
 For Mutual Funds SEBI's introduction of SEBI (Mutual Funds) Regulation in 1993 is to
have direct control on all mutual funds of both public and private sector.
FUNCTIONS OF SEBI
(A) REGULATORY :
 Regulating the business in stock exchange any other securities market;
 Registering and regulating the working of stock brokers, sub-brokers, share transfer
agents, bankers to an issue, trustees of trust deeds, registrar to an issue, merchant bankers,
underwriters and so on;
 Registering and regulating the working of collective investment scheme including mutual
funds;
 Regulating the self- regulatory organizations;
 Prohibiting fraudulent and unfair trade practices relating to securities markets;
 Prohibiting inside trading in securities;
 Regulating substantial acquisition of shares and takeover of companies;
- 28 -

29.  Calling for formation from undertaking inspection, conducting inquiries and audits of the
stock exchange and intermediaries and self-regulatory organizations in the security
market;
 Levying fees or other charges for carrying out the purpose of this section.
(B) DEVELOPMENTAL :
 Promoting investors‟ education;
 Promoting self- regulating organizations;
 Training of intermediaries of security markets;
 Promotion of fair practices and code of conduct for all SROs;
 Conducting research and publishing information useful to all market participants.
OBJECTIVES OF SEBI
 To protect the interests of investors in securities
 To promote the development of Securities Market
 To regulate the securities market
 For matters connected therewith or incidental thereto
POWERS OF SEBI
The important powers of SEBI (Securities and Exchange Board of India) are:-
1. Powers relating to stock exchanges & intermediaries SEBI has wide powers regarding the
stock exchanges and intermediaries dealing in securities. It can ask information from the stock
exchanges and intermediaries regarding their business transactions for inspection or scrutiny and
other purpose
2. Power to impose monetary penalties SEBI has been empowered to impose monetary
penalties on capital market intermediaries and other participants for a range of violations. It can
even impose suspension of their registration for a short period.
- 29 -

30. 3. Power to initiate actions in functions assigned SEBI has a power to initiate actions in regard
to functions assigned. For example, it can issue guidelines to different intermediaries or can
introduce specific rules for the protection of interests of investors.
4. Power to regulate insider trading SEBI has power to regulate insider trading or can regulate
the functions of merchant bankers.
5. Powers under Securities Contracts Act For effective regulation of stock exchange, the
Ministry of Finance issued a Notification on 13 September, 1994 delegating several of its powers
under the Securities Contracts (Regulations) Act to SEBI.
SEBI is also empowered by the Finance Ministry to nominate three members on the Governing
Body of every stock exchange.
6. Power to regulate business of stock exchanges SEBI is also empowered to regulate the
business of stock exchanges, intermediaries associated with the securities market as well as
mutual funds, fraudulent and unfair trade practices relating to securities and regulation of
acquisition of shares and takeovers of companies.
- 30 -

31. RESERVE BANK OF INDIA [RBI]
The reserve bank of India is the central bank of country. It has been established by legislation in
1934 as body corporate under the Reserve Bank of India Act 1934. It has started functioning
from 1st April, 1935. The Reserve Bank was started as shareholder bank with a paid-up capital of
Rs 5 crores. Though originally privately owned, since nationalization in 1949, it is fully owned
by Government of India.
 Established on 1st April 1935
 Apex financial institution of the
country‟s financial system
 Entrusted with the task of control,
supervision, promotion, development
and planning
The reserve bank of India carries on its
operations according to provisions of the
reserve bank of India act, 1934. The act has
been amended from time to time.
STRUCTURE OF RBI
The organization of RBI can be divided into
three parts:
1) Central Board of Directors.
2) Local Boards
3) Offices of RBI
1. Central Board of Directors:
The organization and management of RBI is vested on the Central Board of Directors. It is
responsible for the management of RBI. Central Board of Directors consists of 20 members.
- 31 -

32. Central board is appointed by the central Government for the period of 4 years. It consists of
official directors and non-official directors.
It is constituted as follows.
 One Governor: It is the highest authority of RBI. He is appointed by the Government of
India for a term of 5 years. He can be re-appointed for another term.
 Four Deputy Governors: Four deputy Governors are nominated by Central Govt. for a
term of 5 years
 Fifteen Directors: Other fifteen members of the Central Board are appointed by the
Central Government. Out of these, four directors, one each from the four local Boards is
nominated by the Government separately by the Central Government.
Ten directors nominated by the Central Government are among the experts of commerce,
industries, finance, economics and cooperation. The finance secretary of the Government of
India is also nominated as Govt. officer in the board. Ten directors are nominated for a period of
4 years. The Governor acts as the Chief Executive officer and Chairman of the Central Board of
Directors. In his absence a deputy Governor nominated by the Governor, acts as the Chairman of
the Central Board. The deputy governors and government‟s officer nominee are not entitled to
vote at the meetings of the Board. The Governor and four deputy Governors are full time officers
of the Bank.
2. Local Boards:
There are 4 local boards, one each for the 4 regions of the country in Mumbai, Kolkata, Chennai,
and New Delhi. The membership of each local board consists of 5 members appointed by the
central Government for the period of 4 years. The functions of the local board is to advise the
central board on local matters; to represent territorial and economic interns of local cooperative
and indigenous banks‟ interest, and to perform such other functions as delegated by central board
from time to time
3. Offices of RBI:
The Head office of the bank is situated in Mumbai and the offices of local boards are situated in
Delhi, Kolkata and Chennai. In order to maintain the smooth working of banking system, RBI
has opened local offices or branches in Ahmedabad, Bangalore, Bhopal, Bhubaneswar,
Chandigarh, Guwahati, Hyderabad, Jaipur, Jammu, Kanpur, Nagpur, Patna, Thiruvananthpuram,
Kochi, Lucknow and Byculla (Mumbai). The RBI can open its offices with the permission of the
- 32 -

33. Government of India. In places where there are no offices of the bank, it is represented by the
state Bank of India and its associate banks as the agents of RBI.
OBJECTIVES OF THE RBI
 To Regulate the issue of Bank notes
 Keeping of reserves with a view to securing monetary stability in India
 To Operate the currency and credit system of the country for its advantage
 To secure monitory stability within country
 To Assist the planned process of development of the Indian economy
FEATURE OF RBI
1. RBI formulates implements and monitors the monetary policy
2. RBI maintains public confidence in the system, protect depositors interest and provide
cost-effective banking services to public
3. To facilitate external trade and payment and promote orderly development and
maintenance of foreign exchange market in India.
4. To give the public adequate quantity of supplies of currency notes and coins and good
quality.
FUNCTIONS OF THE RBI
 Issuing currency notes, i.e. to act as a currency or monitory authority of the country
 Maintaining price stability
 Ensuring adequate flow of credit to productive sectors to assist growth
 Serving as banker to the Government
 Acting as bankers‟ bank and supervisor
 Monetary regulation and management
 Exchange management and control
- 33 -

34.  Collection of data and their publication
 Miscellaneous developmental and promotional functions and activities
 Agricultural Finance
 Industrial Finance
 Export Finance
 Institutional promotion
- 34 -

35. INSURANCE REGULATORY AND DEVELOPMENT AUTHORITY (IRDA)
MISSION
To protect the interest of and secure fair treatment to policyholders;
To bring about speedy and orderly growth of the insurance industry (including annuity
and superannuation payments), for the benefit of the common man, and to provide long
term funds for accelerating growth of the economy;
To set, promote, monitor and enforce high standards of integrity, financial soundness, fair
dealing and competence of those it regulates;
To ensure speedy settlement of genuine claims, to prevent insurance frauds and other
malpractices and put in place effective grievance redressal machinery;
To promote fairness, transparency and orderly conduct in financial markets dealing with
insurance and build a reliable management information system to enforce high standards
of financial soundness amongst market players;
To take action where such standards are inadequate or ineffectively enforced;
To bring about optimum amount of self-regulation in day-to-day working of the industry
consistent with the requirements of prudential regulation.
VISION
Our goal is to have the IRDA recognized nationally by 2016 as a leader in agro-environmental
research, development and transfer activities. The IRDA distinguishes itself by its integrative
approach and by the dynamism of its partners. These factors allow it to anticipate problems and
develop innovative solutions that meet the needs of agricultural producers and society.
The Insurance Regulatory and Development Authority (IRDA) is a national agency of
the Government of India, based in Hyderabad. It was formed by an act of Indian Parliament
known as IRDA Act 1999, which was amended in 2002 to incorporate some emerging
requirements. Mission of IRDA as stated in the act is "to protect the interests of the
policyholders, to regulate, promote and ensure orderly growth of the insurance industry and for
matters connected therewith or incidental thereto."
- 35 -

36. In 2010, the Government of India ruled that the Unit Linked Insurance Plans (ULIPs) will be
governed by IRDA, and not the market regulator Securities and Exchange Board of India
ROLE OF IRDA
1. To (protect) the interest of and secure fair treatment to policyholders.
2. To bring about (speedy) and orderly growth of the insurance industry (including annuity and
superannuation payments), for the benefit of the common man, and to provide long term funds
for accelerating growth of the economy.
3. To set, promote, monitor and enforce high standards of (integrity), financial soundness, fair
dealing and competence of those it regulates.
4. To ensure that insurance customers receive precise, clear and correct (information) about
products and services and make them aware of their responsibilities and duties in this regard.
5. To ensure speedy settlement of genuine (claims), to prevent insurance frauds and other
malpractices and put in place effective grievance redressed machinery.
6. To promote fairness, (transparency) and orderly conduct in financial markets dealing with
insurance and build a reliable management information system to enforce high standards of
financial soundness amongst market players.
7. To take (action) where such standards are inadequate or ineffectively enforce d. 8. To bring
about optimum amount of (self-regulation)in day to day working of the industry consistent with
the requirements of prudential regulation.
DUTIES/POWER/FUNCTIONS OF IRDA
Section 14 of IRDA Act, 1999 lays down the duties, powers and functions of IRDA
(1) Subject to the provisions of this Act and any other law for the time being in force, the
Authority shall have the duty to regulate, promote and ensure orderly growth of the insurance
business and re-insurance business.
- 36 -

37. (2) Without prejudice to the generality of the provisions contained in sub-section (1)the powers
and functions of the Authority shall include,
a. Issue to the applicant a certificate of registration, renew, modify, withdraw,
suspend or cancel such registration;
b. protection of the interests of the policy holders in matters concerning assigning of
policy, nomination by policy holders, insurable interest, settlement of insurance
claim, surrender value of policy and other terms and conditions of contracts of
insurance;
c. Specifying requisite qualifications, code of conduct and practical training for
intermediary or insurance intermediaries and agents;
d. Specifying the code of conduct for surveyors and loss assessors;
e. Promoting efficiency in the conduct of insurance business;
f. Promoting and regulating professional organizations connected with the insurance
and re-insurance business;
g. Levying fees and other charges for carrying out the purposes of this Act
h. calling for information from, undertaking inspection of, conducting enquiries and
investigations including audit of the insurers, intermediaries, insurance
intermediaries and other organizations connected with the insurance business;
i. control and regulation of the rates, advantages, terms and conditions that may be
offered by insurers in respect of general insurance business not so controlled and
regulated by the Tariff Advisory Committee under section 64U of the Insurance
Act, 1938 (4 of 1938);
j. Specifying the form and manner in which books of account shall be maintained
and statement of accounts shall be rendered by insurers and other insurance
intermediaries;
k. Regulating investment of funds by insurance companies;
l. Regulating maintenance of margin of solvency;
m. Adjudication of disputes between insurers and intermediaries or insurance in term
diaries;
n. Supervising the functioning of the Tariff Advisory Committee;
- 37 -

38. o. Specifying the percentage of premium income of the insurer to finance scheme s
for promoting and regulating professional organizations referred to in clause (f);
p. Specifying the percentage of life insurance business and general insurance
business to be undertaken by the insurer in the rural or social sector; and
q. Exercising such other powers as may be prescribed
INSURANCE ADVISORY COMMITTEE
IRDA consists of a Chairman and four full time and four part time members. IRDA has
constituted the Insurance Advisory Committee and in consultation with this committee has
brought out 17 regulations. In addition, representatives of consumes, industry, insurance agents,
women‟s originations, and other interest groups are a part of this committee. It has also formed
a Consumer Advisory Committee and Surveyor and Loss Assessors Committee. It has a panel
of eligible chartered accountants to carry out investigation, inspection and so on
Chairman: HariNarayana is the current Chairman of IRDA.
The IRDA has issued 17 regulations in the areas of registration of insurers, their conduct of
business, solvency margins, and conduct if reinsurance business, licensing, and code of conduct
intermediaries. It follows the practice of prior consultation and discussion with the various
interest groups before issuing regulations and guidelines.
CHAIRMAN SELECTION PROCESS
Government of India has circulated to broad base IRDA chairman selection process. It is felt in
the market that placing of retired civil servants as IRDA Chairman has served the purpose of
administrative fiefdom of the regulator. Mostly, the regulator has become passive to market
realities and most of the original public policy intentions have been systematically replaced by
personal preferences. There seems to be no oversight of public policy erosions. Taking
advantage of the completion of term of current incumbent, there seem to be an attempt to
correct the future course but people do not perceive any outcome to result as the market does
not seem to throw up candidates of the stature of Howard Davies for Indian market. But a right
leadership is the solution to the requirement of this booming market.
- 38 -

39. IRDA REGULATES PRIVATE INSURANCE COMPANIES IN INDIA SUCH AS;
1. Royal Sundaram Alliance Insurance Company Limited
2. Reliance General Insurance Company Limited.
3. IFFCO Tokio General Insurance Co. Ltd
4. TATA AIG General Insurance Company Ltd.
5. Bajaj Allianz General Insurance Company Limited
6. ICICI Lombard General Insurance Company Limited.
7. Apollo DKV Insurance Company Limited
8. Future Generali India Insurance Company Limited
9. Universal Sompo General Insurance Company Ltd.
10. Cholamandalam General Insurance Company Ltd.
11. Export Credit Guarantee Corporation Ltd.
12. HDFC-Chubb General Insurance Co. Ltd.
13. Bharti Axa General Insurance Company Ltd.
14. Raheja QBE General Insurance Co. Ltd
15. Shriram General Insurance Co. Ltd.
- 39 -

40. Money market
TOPICS:-
Introduction of money market.
Functions of money market.
Money market instruments.
 Treasury bill
 Call notice money market
 Commercial paper
 Certificates of deposits
 Commercial bills
Collateralised borrowing and lending obligation.
Call/notice money market.
Money market intermediaries.
Money market mutual fund.
Link between the money market and the monetary policy in
India.
Tool for managing liquidity in the money market.
Money market derivatives.
Introduction of capital market.
Functions of capital market.
Primary capital and secondary capital market.
Brief history of the rise of equity trading in India.
Reforms in capital market.
- 40 -

41. THE MONEY MARKET
INTRODUCTION:-
The money market is a market for financial assets that are close substitutes for
money. It is the market for over night to short term funds and instruments having a
maturity period of one or less than one year. It is not a physical auction (like the
stock market) but an activity that is conducted over the telephone. The money
market constitutes a very important segment of the Indian financial system.
The features of the money market are as follows.
It is not a single market but a collection of markets for several instruments.
It is a wholesale market of a short-term debt instrument
Its principal features are honour where the creditworthiness of participant is
important.
The main players are: the reserve bank of India (RBI), the discount and
finance house of India (DFHI), mutual funds, banks, co-operative investors,
non-banking financial companies(NBFCs), state governments, provident
funds, primary dealers, the security trading corporation of India(STCI)
public sector undertakings (PSUs) and non residential Indians.
It is need based market wherein the demand and supply of money shape the
market.
Functions of money market
A money market is generally expected to perform broad functions.
Provide a balancing mechanism to even out the demand for and supply of
short term funds.
Provide a focal point for central bank intervention for influencing liquidity
and general level of interest rates in the economy.
Provide reasonable access to suppliers and users of short term funds to fulfil
their borrowings and investment requirements at an efficient market clearing
price.
Besides the above functions a well functioning money market facilitates the
development of a market for long term securities. The interest rates for
extremely short-term use of money serve as a benchmark for longer-term
financial instruments.
- 41 -

42. Benefits of an efficient money market
An efficient money market benefits a number of players. It provides a stable
source of funds to banks in addition to deposits, allowing alternatives
financing structures and completion.
It allows banks to manage risks arising from interest rate fluctuations and to
manage the maturity structure of their assets and liability.
A liquidity market provides an effective source of long-term finance to
borrowers.
Large borrowers can lower the cost of raising funds and manage short term
funding or surplus efficiency.
A liquid and vibrant money market is necessary for the development of a
capital market, foreign exchange market, and markets in derivatives
instruments.
The money market supports the long-term debt market by increasing the
liquidity of the securities.
The Indian money market
The average turn over of the money market in India is over 40,000crore rupees
daily. This is more than three percent let out of the system. This implies that 2% of
the annual GDP of India gets traded in the money market in just one day. Even
though, the money market is many times larger than the capital market.
Reforms in the money market:
- 42 -

43. New instruments
New participants
Changes in the operating procedure of monitoring policy.
Fine tuning of liquidity operations managements.
Technological infrastructure.
The money market centres:
There are market centres in India at Mumbai, Delhi, and Kolkata. Mumbai is the
only active money market centre in India with money flowing I from all parts of
the country getting transacted there.
- 43 -

44. MONEY MARKET INSTRUMENTS
The instruments traded in the Indian money market
are:
Treasury bills(T-bills)
Call/notice money market-call (over night) and short
notice (upto14 days)
Commercial papers(CPs)
Certificate of deposits(CDs)
Commercial bills(CBs)
Collateral borrowings and lending obligation (CBLO).
- 44 -

45. TREASURY BILLS
INTRODUCTION:-
Treasury Bills are short term money market instruments to finance the short term
requirements of the Government of India. These are discounted securities and thus
are issued at a discount to face value. The return to the investor is the difference
between the maturity value and issue price. This instruments is used by the
government it raise short-term funds to bridge seasonal or temporary gaps between
its receipts (revenue and capital) and expenditure.
FEATURES:-
They are negotiable securities.
They are highly liquid as they are of shorter tenure and there is a possibility
of inter-bank repos in them.
There is an absence of default risk.
They are not issued in the scrip form. The purchase and sales are affected
through the subsidiary general ledger (SGL) account.
At present there are 91 days, 182 days, and 364 day. 91 days T-bills are
auctioned by RBI every Friday and the 364-day T-bill every alternative
Wednesday i.e. the Wednesday preceding the reporting Friday.
T-bills are available for minimum amount of 25,000 and in multiplies
thereof.
TYPES OF TREASURY BILLS:-
ON TAP BILLS:
On tap bills as the name suggest caught be bought from the reserve bank at any
time at any interest yield of4.66%. They were discounted from April 1,1997, as
they had lost much of their relevance.
- 45 -

46. AD HOC BILLS:
Ad hoc bills were introduced in 1955. It was decided between the government and
RBI that the government could maintain cash of 50 crore with the reserve bank on
Friday and 4 crore of other days free of obligations to pay interest thereon and
when ever the balance fell below the minimum the government account would be
replenished by the ad hoc bill in favour of RBI.
AUCTIONED T-bills:
Auctioned T-bill the most active money market instrument, were first introduced in
april1992. The reserve bank receives bids in an auction from various participants
and issues the bills subject to some cut off limits.
BENEFITS OF INVESTMENT IN TREASURY BILLS
No tax deducted at source
Zero default risk being sovereign paper
Highly liquid money market instrument
Better returns especially in the short term
Transparency
Simplified settlement
High degree of tradability and active secondary market facilitates
meeting unplanned fund requirements.
- 46 -

47. PARTICIPANTS IN TRESURY BILLS
The reserve bank of India, banks, mutual funds, financial institutions, primary
dealers, provident funds, foreign banks, foreign institutional investor.
TYPES OF AUCTIONS
There are two types of auction for treasury bills:
Multiple Price Based or French Auction: Under this method, all
bids equal to or above the cut-off price are accepted. However, the bidder
has to obtain the treasury bills at the price quoted by him. This method is
followed in the case of 364days treasury bills and is valid only for
competitive bidders.
Uniform Price Based or Dutch auction: Under this system, all the
bids equal to or above the cut-off price are accepted at the cut- off level.
However, unlike the Multiple Price based method, the bidder obtains the
treasury bills at the cut-off price and not the price quoted by him. This
method is applicable in the case of 91 days treasury bills only.
- 47 -

48. COMMERCIAL PAPERS
INTRODUCTION:-
Commercial paper, or CP as it is popularly known, is in the nature of an unsecured
short term promissory note, transferable by endorsement and delivery. It is of fixed
maturity.
Corporate, primary dealers (PDs) and the all-India financial institutions (FIs) that
have been permitted to raise short-term resources under the umbrella limit fixed by
Reserve Bank of India are eligible to issue CP. The following are the eligibility
criteria, as per the extant guidelines:1] The company should have a minimum
tangible net worth of Rs. 40mn, as per the latest audited balancesheet.2] The
company should have been sanctioned working capital limits by banks/FIs and
should be classified as a 'Standard Asset' by the financing bank(s) / FIs.3] The
company should have minimum credit rating from an agency approved by RBI
Process for issuing CP
Once a company decides to issue CP for a specific amount, a resolution is required
to be passed by the Board of Directors approving the issue and authorising the
official(s) to execute the relevant documents, as per RBI norms. The CP issue is
required to be rated by an approved credit rating agency .The company selects the
Issuing and Paying Agent, which has to be a scheduled bank. The issuer should
disclose to its potential investors its financial position. The company may also
arrange for dealers for placement of CPs. The issue has to be completed within two
weeks of opening. CP may be issued on a single date or in parts on different dates
provided that in the latter case, each CP shall have the same maturity date.
- 48 -

49. COMMERCIAL BILLS
INTRODUCTION:-
The working capital requirement of business firms is provided by banks through
cash-credits / overdraft and purchase/discounting of commercial bills.
Commercial bill is a short term, negotiable, and self-liquidating instrument with
low risk. It enhances liability to make payment in a fixed date when goods are
bought on credit. According to the Indian Negotiable Instruments Act, 1881, bill or
exchange is a written instrument containing an unconditional order, signed by the
maker, directing to pay a certain amount of money only to a particular person, or to
the bearer of the instrument. Bills of exchange are negotiable instruments drawn by
the seller (drawer) on the buyer (drawee) or 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. The bank discounts this bill by keeping a
certain margin and credits the proceeds. Banks, when in need of money, can also
get such bills rediscounted by financial institutions such as LIC, UTI, GIC, ICICI
and IRBI. The maturity period of the bills varies from 30 days, 60 days or 90 days,
depending on the credit extended in the industry.
- 49 -

50. Types of Commercial Bills:
Commercial bill is an important tool finance credit sales. It may be a
demand bill or a usance bill. A demand bill is payable on demand, that is
immediately at sight or on presentation by the drawee. A usance bill is
payable after a specified time. If the seller wishes to give sometime for
payment, the bill would be payable at a future date. These bills can either be
clean bills or documentary bills. In a clean bill, documents are enclosed and
delivered against acceptance by drawee, after which it becomes clear. In the
case of a documentary bill, documents are delivered against payment
accepted by the drawee and documents of bill are filed by bankers till the
bill is paid.
Commercial bills can be inland bills or foreign bills. Inland bills must (1) be
drawn or made in India and must be payable in India: or (2) drawn upon any
person resident in India. Foreign bills, on the other hand, are (1) drawn
outside India and may be payable and by a party outside India, or may be
payable in India or drawn on a party in India or (2) it may be drawn in India
and made payable outside India. A related classification of bills is export
bills and import bills. While export bills are drawn by exporters in any
country outside India, import bills are drawn on importers in India by
exporters abroad.
The indigenous variety of bill of exchange for financing the movement of
agricultural produce, called a „hundi‟ has a long tradition of use in India. It is
vogue among indigenous bankers for raising money or remitting funds or to
finance inland trade. A hundi is an important instrument in India; so
indigenous bankers dominate the bill market. However, with reforms in the
financial system and lack of availability of funds from private sources, the
role of indigenous bankers is declining.
With a view to eliminating movement of papers and facilitating multiple
rediscounting, RBI introduced an innovation instruments known as
„Derivative Usance Promissory Notes,‟ backed by such eligible commercial
bills for required amounts and usance period (up to 90 days). Government
has exempted stamp duty on derivative usance promissory notes. This has
simplified and streamlined bill rediscounting by institutions and made the
commercial bill an active instrument in the secondary money market. This
instrument, being a negotiable instrument issued by banks, is a sound
- 50 -

51. investment for rediscounting institutions. Moreover rediscounting
institutions can further discount the bills anytime prior to the date of
maturity. Since some banks were using the facility of rediscounting
commercial bills and derivative usance promissory notes of as short a period
as one day, the Reserve Bank restricted such rediscounting to a minimum
period of 15 days. The eligibility criteria prescribed by the Reserve Bank for
rediscounting commercial bills are that the bill should arise out of a genuine
commercial transaction showing evidence of sale of goods and the maturity
date of the bill should to exceed 90 days from the date of rediscounting.
- 51 -

52. Features of Commercial Bills
Commercial bills can be traded by offering the bills for rediscounting. Banks
provide credit to their customers by discounting commercial bills. This
credit is repayable on maturity of the bill. In case of need for funds, and can
rediscount the bills in the money market and get ready money.
Commercial bills ensure improved quality of lending, liquidity and
efficiency in money management. It is fully secured for investment since it
is transferable by endorsement and delivery and it has high degree of
liquidity.
The bills market is highly developed in industrial countries but it is very
limited in India. Commercial bills rediscounted by commercial banks with
financial institutions amount to less than Rs 1,000 crore. In India, the bill
market did not develop due to (1) the cash credit system of credit delivery
where the onus of cash management rest with banks and (2) an absence of an
active secondary market.
Measures to Develop the Bills Market:
One of the objectives of the Reserve Bank in setting up the Discount and
finance House of India was to develop commercial bills market. The bank
sanctioned a refinance limit for the DFHI against collateral of treasury bills
and against the holdings of eligible commercial bills.
With a view to developing the bills market, the interest rate ceiling of 12.5
per cent on rediscounting of commercial bills was withdrawn from May 1,
1989.
To develop the bills market, the Securities and Exchange Board of India
(SEBI) allowed, in 1995-96, 14 mutual funds to participate as lenders in the
bills rediscounting market. During 1996-97, seven more mutual funds were
permitted to participate in this market as lenders while another four primary
dealers were allowed to participate as both lenders and borrowers.
- 52 -

53. In order to encourage the „bills‟ culture, the Reserve Bank advised banks in
October 1997 to ensure that at least 25 percent of inland credit purchases of
borrowers be through bills.
Size of the Commercial Bills market:
The size of the commercial market is reflected in the outstanding amount of
commercial bills discounted by banks with various financial institutions.
The share of bill finance in the total bank credit increased from 1993-94 to
1995-96 but declined subsequently. This reflects the underdevelopment state
of the bills market. The reasons for the underdevelopment are as follows:
The Reserve Bank made an attempt to promote the development of the bill
market by rediscounting facilities with it self till 1974. Then, in the
beginning of the 1980s, the availability of funds from the Reserve Bank
under the bill rediscounting scheme was put on a discretionary basis. It was
altogether stopped in 1981. The popularity of the bill of exchange as a credit
instrument depends upon the availability of acceptance sources of the central
bank as it is the ultimate source of cash in times of a shortage of funds.
However, it is not so in India. The Reserve Bank set up the DFHI to deal in
this instrument and extends refinance facility to it. Even then, the business in
commercial bills has declined drastically as DFHI concentrates more on
other money market instruments such as call money and treasury bills.
It is mostly foreign trade that is financed through the bills market. The size
of this market is small because the share of foreign trade in national income
is small. Moreover, export and import bills are still drawn in foreign
currency which has restricted their scope of negotiation.
A large part of the bills discounted by banks are not genuine. They are bills
created by converting the cash-credit/overdraft accounts of their customers.
- 53 -

54. The system of cash-credit and overdraft from banks is cheaper and more
convenient than bill financing as the procedures for discounting and
rediscounting are complex and time consuming.
This market was highly misused in the early 1990s by banks and finance
companies which refinanced it at times when it could to be refinanced. This
led to channelling of money into undesirable use
- 54 -

55. CERTIFICATE OF DEPOSITE
INTRODUCTION:-
Certificates of deposit are unsecured, negotiable, short term instrument in bearer
form, issued by commercial banks and development financial institutes.
Certificates of deposits were introduced in 1989. Only scheduled commercial
banks excluding regional rural banks and local area banks were allowed to issue
them initially. Financial institutions were permitted to issue certificates of deposit
within the umbrella limit fixed by the reserve bank in 1992.
GUIDELINES FOR ISSUE OF CERTIFICATE OF DEPOSITE
Eligibility:-
CDs can be issued by scheduled commercial banks and excluding regional rural
banks. Local area banks (2) and select all India financial institution that have been
permitted by RBI.
Aggregate amount:-
Should not exceed 100% of its net owned funds.
Minimum size of issue and denomination:-
Minimum amount of CDs should be 1 lacks i.e. the minimum deposit that can be
accepted from a single subscriber should not be less than 1 lacks.
Who can subscribe:-
CDs can be issued to entities like individuals, corporations, companies, trusts,
funds, and association.
- 55 -

56. Maturity:-
Not less than 7 days and not more than 1 year. and not exceeding 3 years from the
date of issue.
- 56 -

57. COMPARISION OF CERTIFICATE OF
DEPOSITE AND COMMERCIAL PAPERS
CDs and commercial papers are both forms of money market instruments and are
issued in the money markets by organizations that wish to raise funds, and are
traded by investors who wish to profit from the interest rate fluctuations.
However, there are many differences between these two forms of instruments,
since
CDs commercial papers
CDs are issued as a proof of an Commercial papers are issued to an
investment of funds in the bank by a investor as a proof of purchase of the
depositor while issuer‟s debt (purchasing debt means
providing funds like a bank gives out a
loan).
While a CD is usually for a longer term. A promissory note is for a shorter period
The issuance of a CD, owing to this The issuance of commercial papers
difference in maturity, entails higher entails lower responsibility of the
responsibility on the issuer‟s part issuer‟s part.
- 57 -

58. COLLATERALISED BORROWING AND
LENDING OBLIGATION
The clearing corporation of India limited (CCIL) launched a new product-
collateralised borrowing and lending obligation (CBLO) on January 20 2003. To
provide liquidity to non bank entities. Hit by restrictions on access to call money
market. The minimum order lot for auction market is fixed rs.50,000 and in
multiples of 500000 thereof.
The minimum order for normal market is fixed at 500000 and in multiples of
500000 there of. The reserve bank has prescribed the mode of operation in the
CBLO segment. In the auction market, on the platform provided by CCIL the
borrowers will submit their offers and the lenders will give their bids. Specifying
the discount rate and maturity period.
- 58 -

59. CALL/NOTICE MONEY MARKET
INTRODUCTION:-
The call/notice/term money market is a market for trading very short term liquid
financial assets that are readily convertible into cash at low cost. The money
market primarily facilitates lending and borrowing of funds between banks and
entities like Primary Dealers. An institution which has surplus funds may lend
them on an uncollateralized basis to an institution which is short of funds. The
period of lending may be for a period of 1 day which is known as call money and
between 2 days and 14 days which is known as notice money. Term money refers
to borrowing/lending of funds for a period exceeding 14 days. The interest rates on
such funds depend on the surplus funds available with lenders and the demands for
the same which remains volatile.
This market is governed by the Reserve Bank of India which issues guidelines for
the various participants in the call/notice money market. The entities permitted to
participate both as lender and borrower in the call/notice money market are
Scheduled Commercial Banks (excluding RRBs), Co-operative Banks other than
Land Development Banks
Scheduled commercial banks are permitted to borrow to the extent of 125% of
their capital funds in the call/notice money market, however their fortnightly
average borrowing outstanding should not exceed more than 100% of their capital
funds (Tier I and Tier II capital). At the same time SCBs can lend to the extent of
50% of their capital funds on any day, during a fortnight but average fortnightly
outstanding lending should not exceed 25% of their total funds
Co-operative Banks are permitted to borrow up to 2% of their aggregate deposits
as end of March of the previous financial year in the call/notice money market
Primary Dealers can borrow on average in a reporting fortnight up to 200% of the
total net owned funds (NOF) as at end-March of the previous financial year and
lend on average in a reporting
- 59 -

60. The average daily turnover in the call money market is around Rs. 12,000-13,000
cr every day and trading occurs between 9.30 am to 5.00 pm on Monday to Friday.
The trades are conducted both on telephone as well as on the NDS Call system,
which is an electronic screen based system set up by the RBI for negotiating
money market deals between entities permitted to operate in the money market.
The settlement of money market deals is by electronic funds transfer on the Real
Time Gross Settlement (RTGS) system operated by the RBI. The repayment of the
borrowed money also takes place through the RTGS system on the due date of
repayment.
Participants in the call money market:-
Participants in the call money market are scheduled commercial banks, non-
scheduled commercial banks, foreign banks, state, district and urban, cooperative
banks, Discount and Finance House of India (DFHI) and Securities Trading
Corporation of India (STCI). The DFHI and STCI borrow as well as lend, like
banks and primary dealers, in the call market. At one time, only a few large banks.
Over time, however, the market has expanded and now small banks and non-
scheduled banks also participate in this market. However, now their participation
as borrowers has increased for meeting CRR requirements.
Difficulties in tapping deposits through branch expansion, and an increase in the
cost of servicing (FCNR) deposits have also compelled foreign banks to borrow in
the call money market.
Among the large commercial banks, the SBI kept away from the call market till
1970 after which it has been regularly participating in this market. Because of its
large size and formidable cash position, its participation made the market more
active. The SBI group is a major lender but a small borrower in the call market.
- 60 -

61. Call rate:-
The interest rate on a type of short-term loan that banks gives to brokers who in
turn lend the money to investors to fund margin accounts. For both brokers and
investors, this type of loan does not have a set repayment schedule and must be
repaid on demand.
MIBOR:-
The Committee for the Development of the Debt Market that had studied and
recommended the modalities for the development for a benchmark rate for the call
money market. Accordingly, NSE had developed and launched the NSE Mumbai
Inter-bank Bid Rate (MIBID) and NSE Mumbai Inter-bank Offer Rate (MIBOR)
for the overnight money market on June 15, 1998.
Call rate volatility:-
In India money and credit situation is subject to seasonal fluctuation every year. A
decrease in call money requirement is greater in the slack season (mid April to mid
October) than in a buy session (mid October to mid April).
- 61 -

62. Factors influencing call money market rate:-
The National Stock Exchange (NSE) developed and launched the NSE Mumbai
Inter bank Bid the (MIBID) and NSE Mumbai Inter-bank Offer Rate (MIBOR) or
the overnight money markets on June 15, 1998, NSE MIBID/ MIBOR are based on
rates pooled by NSE from a representative panel of 31 banks/institutions/primary
dealers. Currently, quotes are polled and processed daily by the exchange at 9:40
(IST) for the overnight rate and at 11:30 (IST) for the 14 day, 1 month, and 24
month rates. The rates pooled are then processed using the boost trap method to
arrive at an efficient estimate of the references rates. This rate is used as a
benchmark rate or majority of the deals stuck for floating rate debentures and term
deposits. Benchmark is rate at which money is raised in financial markets. These
rates are used in hedging strategies as reference points in forwards and swaps.
Reuters MIBOR (Mumbai Inter-bank Overnight Average) is arrived at by
obtaining weighted average of call money transactions of 22 banks and other
players.
MIBOR is a better official benchmark rate for interest rate swaps (IRs) and
forward rate agreements (FRAs). MIBOR is transparent, market determined and
mutually acceptable to counterparties as reference.
Call Rates Volatility:
In India, money and credit situation is subject to seasonal fluctuation every year.
The volume of call money transactions and the amount as well as call rate levels
characterize seasonal fluctuation/volatility. A decrease in the call/notice money
requirements is greater in the slack season (mid-April to mid-October) than in the
buy season (mid-October to mid-April).
Liquidity conditions:
Liquidity conditions are governed by factors on both the demand and supply side
of money. Liquidity conditions are governed by deposit mobilization, capital flows
and reserve requirements on the supply side, and tax outflows, government
borrowings programs, non-food credit off take and seasonal fluctuations on the
demand side. When easy liquidity conditions prevail, call rates move around the
- 62 -

63. Reserve Bank‟s repo rate. During times of tight liquidity, call rates tend to move
up towards the bank rate.
Reserve requirement prescriptions and
stipulations regarding average reserve
maintenance:
A cut in CRR reduces call rates while an increase in CRR increases call rates.
Moreover, banks do not plan the demand for funds to meet their reserve
requirements which increase call rate volatility.
Till April 1997, inter-bank transactions were included in the reserve calculation.
This led to a halt in money market activity every second Friday (reserve
calculation day) when banks tried to reduce their reserve requirements by
eliminating inter-bank borrowing. Due to this, the overnight call rates fell to zero
per cent very second Friday. This inhibited the development of liquid money
market yield curve beyond 13 days.
Structural factors:
Structural factors refer to government legislation, conditions of the stock markets
and so on which affect the volatility of the call money rate.
Investment policy of non-bank participants in the call market who are the major
lenders of funds in the call market: money market is asymmetrical in the sense
there are few lenders and chronic borrowers. This asymmetry leads to fluctuations
in the call money market rate.
Liquidity changes and gaps in the foreign exchange
market:
Call rates increase during volatile forex market conditions. This increase is a result
of monetary measures for tightening liquidity conditions and short position taken
by market agents in domestic currency against long positions in US dollars in
anticipation of higher profits through depreciation of the rupee. Banks fund foreign
currency positions by withdrawing from the inter bank call money market which
leads to a hike in the call money rates.
- 63 -