The Reserve Bank of India (RBI) is the central bank of India that monitors and implements monetary policy. It acts as a banker to the government and other banks, manages government securities, controls money supply and credit in the economy, regulates foreign exchange, and publishes important economic data. RBI also plays a promotional role in developing the banking and financial system.

3. FINANCIAL MARKET
• A financial market is a market in which people and entities can trade financial
securities, commodities, and other items of value at low transaction costs
and at prices that reflect supply and demand. Securities include stocks and
bonds, and commodities include precious metals or agricultural goods .
• Financial markets facilitate:
• The raising of capital (in the capital markets)
• The transfer of risk (in the derivatives markets)
• Price discovery
• Global transactions with integration of financial markets
• The transfer of liquidity (in the money markets)
• International trade (in the currency markets)

4. Types of financial markets
• Capital markets which consist of:
– Stock markets, which provide financing through the issuance of shares
or common stock, and enable the subsequent trading thereof.
– Bond markets, which provide financing through the issuance of bonds,
and enable the subsequent trading thereof.
• Commodity markets, which facilitate the trading of commodities.
• Money markets, which provide short term debt financing and
investment.
• Derivatives markets, which provide instruments for the
management of financial risk.
• Futures markets, which provide standardized forward contracts for
trading products at some future date; see also forward market.
• Insurance markets, which facilitate the redistribution of various
risks.
• Foreign exchange markets, which facilitate the trading of foreign
exchange.

5. CONSTITUENTS OF A FINANCIAL SYSTEM

6. FINANCIAL INSTRUMENTS
Money Market Instruments
• The money market can be defined as a market for short-
term money and financial assets that are near substitutes
for money. The term short-term means generally a period
up to one year and near substitutes to money is used to
denote any financial asset which can be quickly converted
into money with minimum transaction cost.
Some of the important money market instruments are
briefly discussed below;
1. Call/Notice Money
2. Treasury Bills
3. Term Money
4. Certificate of Deposit
5. Commercial Papers

7. 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.

8. Treasury Bills.
• Treasury Bills are short term (up to one year)
borrowing instruments of the union government.
It is an IOU of the Government. It is a promise by
the Government to pay a stated sum after expiry
of the stated period from the date of issue
(14/91/182/364 days i.e. less than one year).
They are issued at a discount to the face value,
and on maturity the face value is paid to the
holder. The rate of discount and the
corresponding issue price are determined at each
auction.

9. • 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.

10. • Certificates of Deposit (CDs) is a negotiable money market instrument
and issued in dematerialized form or as a Usance Promissory Note,
for funds deposited at a bank or other eligible financial institution for
a specified time period. Guidelines for issue of CDs are presently
governed by various directives issued by the Reserve Bank of India, as
amended from time to time.
• CDs can be issued by
• (i) scheduled commercial banks excluding Regional Rural Banks (RRBs)
and Local Area Banks (LABs); and
• (ii) select all-India Financial Institutions that have been permitted by
RBI to raise short-term resources within the umbrella limit fixed by
RBI. Banks have the freedom to issue CDs depending on their
requirements. An FI may issue CDs within the overall umbrella limit
fixed by RBI, i.e., issue of CD together with other instruments viz.,
term money, term deposits, commercial papers and inter corporate
deposits should not exceed 100 per cent of its net owned funds, as
per the latest audited balance sheet.

11. • CP is a note in evidence of the debt obligation of the issuer.
On issuing commercial paper the debt obligation is
transformed into an instrument. CP is thus an unsecured
promissory note privately placed with investors at a
discount rate to face value determined by market forces.
CP is freely negotiable by endorsement and delivery.
• A company shall be eligible to issue CP provided -
(a) the tangible net worth of the company, as per the
latest audited balance sheet, is not less than Rs. 4 crore;
(b) the working capital (fund-based) limit of the
company from the banking system is not less than Rs.4
crore and (c) the borrowal account of the company is
classified as a Standard Asset by the financing bank/s.
• The minimum maturity period of CP is 7 days. The
minimum credit rating shall be P-2 of CRISIL or such
equivalent rating by other agencies.

12. • The capital market generally consists of the following long term period i.e.,
more than one year period, financial instruments;
In the equity segment:
• Equity shares &preference shares: Equity shares are those shares which are ordinary in the
course of company's business. They are also called as ordinary shares.
• Convertible preference shares,
• non-convertible preference shares etc
and in the debt segment
• debentures,
• zero coupon bonds,
• deep discount bonds etc.

13. • Hybrid instruments have both the features of
equity and debenture. This kind of
instruments is called as hybrid instruments.
Examples are convertible debentures,
warrants etc.

14. Reserve Bank of India (RBI) is the central bank of
India. It monitors, formulates and implements
India’s monetary policy. Established in the year
1935, RBI was nationalized in the year 1949.
Owned fully by the Government of India,
Reserve Bank has 22 regional offices in various
state capitals of India with its headquarters
located in Mumbai. It has a majority stake in the
State Bank of India.

16. Banker to the Government -
RBI acts as banker, both to the central government and state governments. It
manages all the banking transactions of the government involving the receipt and
payment of money. In addition, RBI remits exchange and performs other banking
operations.
RBI provides short-term credit to the central government.
RBI also manages all new issues of government loans, servicing the government debt
outstanding, and nurturing the market for governments securities.
Managing Government Securities -
Various financial institutions such as commercial banks are required by law to invest
specified minimum proportions of their total assets/liabilities in government
securities. RBI administers these investments of institutions.
The other responsibilities of RBI regarding these securities are to ensure -
Smooth functioning of the market
Readily available to potential buyers
Easily available in large numbers
Undisturbed maturity-structure of interest rates because of excess or deficit
supply
Not subject to quick and huge fluctuations
Reasonable liquidity of investments
Good reception of the new issues of government loans.

17. Banker to Other Banks
The role of RBI as a banker to other banks is as follows:
Holds some of the cash reserves of banks
Lends funds for short period
Provides centralized clearing and quick remittance facilities
RBI has the authority to statutorily ensure that the scheduled commercial banks deposit a stipulated
ratio of their total net liabilities. This ratio is known as cash reserve ratio [CRR]. However, banks can
use these deposits to meet their temporary requirements for interbank clearing as the maintenance of
CRR is calculated based on the average balance over a period.
Controller of Money Supply and Credit -
In a planned economy, the central bank plays an important role in controlling the paper currency
system and inflationary tendency. RBI has to regulate the claims of competing banks on money
supply and credit. RBI also needs to meet the credit requirements of the rest of the banking system.
RBI needs to ensure promotion of maximum output, and maintain price stability and a high rate of
economic growth. To perform these functions effectively, RBI uses several control instruments such
as -
Open Market Operations
Changes in statutory reserve requirements for banks
Lending policies towards banks
Control over interest rate structure
Statutory liquidity ration of banks.

18. Exchange Manager and Controller -
RBI manages exchange control, and represents India as a member of the
international Monetary Fund [IMF]. Exchange control was first imposed on India
in September 1939 when World War II started and continues till date. Exchange
control was imposed on both receipts and payments of foreign exchange.
Publisher of Monetary Data and Other Data -
RBI maintains and provides all essential banking and other economic data,
formulating and critically evaluating the economic policies in India. In order to
perform this function, RBI collects, collates and publishes data regularly. Users
can avail this data in the weekly statements, the RBI monthly bulletin, annual
report on currency and finance, and other periodic publications.
Promotional Role of RBI -
Promotion of commercial banking
Promotion of cooperative banking
Promotion of industrial finance
Promotion of export finance
Promotion of credit to weaker sections
Promotion of credit guarantees
Promotion of differential rate of interest scheme
Promotion of credit to priority sections including rural & agricultural sector.

19. MONETARY POLICY
Monetary policy is the process by which monetary authority of a country, generally a
central bank controls the supply of money in the economy by exercising its control over
interest rates in order to maintain price stability and achieve high economic growth. In
india, the central monetary authority is the reserve bank of india (rbi). Is so designed as to
maintain the price stability in the economy.
Monetary operations involve monetary techniques which operate on monetary
magnitudes such as money supply, interest rates and availability of credit aimed to
maintain price stability, stable exchange rate, healthy balance of payment, financial
stability, economic growth.
RBI, the apex institute of India which monitors and regulates the monetary policy of the
country stabilizes the price by controlling inflation. RBI takes into account the following
monetary policies:
Open market operations
Cash reserve ratio
Statutory liquidity ratio
Bank rate policy
Credit ceiling

20. Open Market Operations
An open market operation is an instrument of monetary policy which involves buying or
selling of government securities from or to the public and banks. This mechanism influences
the reserve position of the banks, yield on government securities and cost of bank credit. The
RBI sells government securities to contract the flow of credit and buys government securities
to increase credit flow. Open market operation makes bank rate policy effective and maintains
stability in government securities market.
Cash Reserve Ratio
Cash Reserve Ratio is a certain percentage of bank deposits which banks are required to keep
with RBI in the form of reserves or balances .Higher the CRR with the RBI lower will be the
liquidity in the system and vice-versa.RBI is empowered to vary CRR between 15 percent and
3 percent. But as per the suggestion by the Narshimam committee Report the CRR was
reduced from 15% in the 1990 to 5 percent in 2002. As of 30th Jan 2013, the CRR is 4.0
percent.
Statutory Liquidity Ratio
Statutory Liquidity Ratio Every financial institution has to maintain a certain quantity of liquid
assets with the RBI for time and demand liabilities. These assets can be cash, precious metals,
approved securities like bonds etc. The ratio of the liquid assets to time and demand liabilities
is termed as the Statutory liquidity ratio. There was a reduction of SLR from 38.5% to 25%
because of the suggestion by Narshimam Committee. The current SLR is 23%.

21. Bank Rate Policy
Bank rate is the rate of interest charged by the RBI for providing funds or loans to the
banking system. This banking system involves commercial and co-operative banks,
Industrial Development Bank of India, IFC, EXIM Bank, and other approved
financial institutes. Funds are provided either through lending directly or
rediscounting or buying money market instruments like commercial bills and treasury
bills. Increase in Bank Rate increases the cost of borrowing by commercial banks
which results into the reduction in credit volume to the banks and hence declines the
supply of money. Increase in the bank rate is the symbol of tightening of RBI
monetary policy. Bank rate is also known as Discount rate. The current Bank rate is
8.75%
Credit Ceiling
In this operation RBI issues prior information or direction that loans to the
commercial banks will be given up to a certain limit. In this case commercial bank
will be tight in advancing loans to the public. They will allocate loans to limited
sectors. Few example of ceiling are agriculture sector advances, priority sector
lending.

22. Fiscal Policy
The fiscal policy is concerned with the raising of government revenue and
incurring of government expenditure. To generate revenue and to incur
expenditure, the government frames a policy called budgetary policy or fiscal
policy. So, the fiscal policy is concerned with government expenditure and
government revenue.
It is prime duty of Government to make fiscal policy . By making this policy ,
Govt. collects money from his different resources and utilize it in different
expenditure . Thus fiscal policy is related to development policy . All welfare
projects are completed under this policy

23. Objectives of Fiscal Policy
There are following objectives of fiscal policy :-
1. Development of Country :-
For development of Country , every country has to make fiscal policy . With this policy , all
work work is done govt. planning and proper use of fund for development functions . If govt.
does not make fiscal policy , then it may happen that revenue may be misused
without targeted expenditure of govt.
2. Employment :-
• Getting the full employment is also objective of fiscal policy . Govt. can take many action for
increase employment. Government can fix certain amount which can be utilized for creation of
new employment for unemployed peoples .
3. Inequality :-
• In developing country like India , we can see the difference one basis of earning . 10% of
people are earning more than Rs. 100000 per day and other are earning less than Rs .100 per
day . By making a good fiscal policy , govt. can reduce this difference . If govt. makes it as his
target .
4. Fixation of Govt. Responsibility :-
• It is the duty of Govt. to effective use of resources and by making of fiscal policy different
minister's accountability can be checked .

24. Techniques of Fiscal Policy
1. Taxation Policy
Taxation policy is relating to new amendments in direct tax and indirect tax . Govt. of India
passes finance bill every year . In this policy govt. determines the rate of taxes . Govt. can
increase or decrease these tax rates and amend previous rules of taxation .Govt.'s earning's
main source is taxation . But more tax on public will adverse effect on the development of
economy.
→ If Govt. will increase taxes , more burden will be on the public and it will reduce
production and purchasing power of public .
→ If Govt. will decrease taxes , then public's purchasing power will increase and it will
increase the inflation.
Govt. analyzes both the situation and will make his taxation policy more progressive .
2. Govt. Expenditure Policy
There are large number of public expenditure like opening of govt schools , colleges and
universities , making of bridges , roads and new railway tracks . In all above projects govt has
paid large amount for purchasing and paying wages and salaries all these expenditure are paid
after making govt. expenditure policy . Govt. can increase or decrease the amount of public
expenditure by changing govt. budget . So , govt. expenditure is technique of fiscal policy by
using this , govt. use his fund first on very necessary sector and other will be done after this .

25. 3. Deficit Financing Policy
If Govt.'s expenditures are more than his revenue , then govt. should have to collect this
amount . This amount is deficit and it can be fulfilled by issuing new currency by
central bank of country . But , it will reduce the purchasing power of currency . More
new currency will increase inflation and after inflation value of currency will decrease .
So, deficit financing is very serious issue in the front of govt. Govt. should use it , if
there is no other source of govt. earning .
4. Public Debt Policy
If Govt. thinks that deficit financing is not sufficient for fulfilling the public expenditure
or if govt. does not use deficit financing , then govt. can take loan from world bank , or
take loan from public by issuing govt. securities and bonds . But it will also increase the
cost of debt in the form of interest which govt. has to pay on the amount of loan . So,
govt. has to make solid budget for this and after this amount is fixed which is taken as
debt. This policy can also use as the technique of fiscal policy for increase the treasure
of govt.

26. OVERVIEW OF FOREIGN EXCHANGE MARKET
What is Foreign Exchange?
Foreign exchange consists of trading one type of currency for another. Unlike other
financial markets, the FX market has no physical location and no central exchange. It
operates "over the counter" through a global network of banks, corporations and individuals
trading one currency for another. The FX market is the world's largest financial market,
operating 24 hours a day with enormous amounts of money traded on a daily basis.
'Foreign Exchange Market'
The market in which participants are able to buy, sell, exchange and speculate on
currencies. Foreign exchange markets are made up of banks, commercial companies,
central banks, investment management firms, hedge funds, and retail forex brokers and
investors. The forex market is considered to be the largest financial market in the world.
A Short History of the Foreign Exchange Trading Market
Foreign exchange markets originally developed to facilitate cross border trade conducted
in different currencies by governments, companies and individuals. While these markets
primarily existed to provide for the international movement of money and capital, even
the earliest markets had speculators.
Today, an enormous proportion of FX market activity is being driven by speculation,
arbitrage and professional dealing, in which currencies are traded like any other
commodity.

27. Advantages of Forex markets:
1. Minimal or no commissions - There are no clearing fees, no exchange fees,
no government fees and no brokerage fees.
2. Easy access – if you compare the money you need on the market in
comparison with the amount needed for entering the stock, options or futures
market, it’s a huge difference. The amount of capital is very low and it allows
numerous types of people to easily enter the foreign exchange market.
3. No middlemen – spot currency trading is decentralized and eliminates
middlemen, allowing you to trade directly.
4. Time and location flexibility – the market is open 24 hours each day, so you
don’t have to match your schedule with the one of the market. It doesn’t
require a full-time engagement and you can choose the hours that suit your
best.
6. Low transaction costs – the transaction cost, determined by the
bid/ask spread, is usually less than 0.1%, and it can go even lower in the case
of large dealers.
7. A high liquidity market – the market is huge, so is extremely liquid. Around 4
trillion dollars are exchanged every day, according to the latest figures
released by the Bank of International Settlements (BIS). That becomes an
advantage, as you don’t have to struggle so much until you will find someone
who wants to buy your currency or sell you one

28. DIFFERENT TYPES OF TRANSACTIONS IN THE FOREIGN EXCHANGE MARKET
Spot Market:
The term spot exchange refers to the class of foreign exchange transaction which
requires the immediate delivery or exchange of currencies on the spot. In practice the
settlement takes place within two days in most markets. The rate of exchange
effective for the spot transaction is known as the spot rate and the market for such
transactions is known as the spot market.
Forward Market:
The forward transactions is an agreement between two parties, requiring the delivery
at some specified future date of a specified amount of foreign currency by one of the
parties, against payment in domestic currency be the other party, at the price agreed
upon in the contract. The rate of exchange applicable to the forward contract is called
the forward exchange rate and the market for forward transactions is known as the
forward market.
Futures
While a focus contract is similar to a forward contract, there are several differences
between them. While a forward contract is tailor made for the client be his
international bank, a future contract has standardized features the contract size and
maturity dates are standardized. Futures cab traded only on an organized exchange
and they are traded competitively.

29. Options
While the forward or futures contract protects the purchaser of the contract fro m the
adverse exchange rate movements, it eliminates the possibility of gaining a windfall
profit from favorable exchange rate movement. An option is a contract or financial
instrument that gives holder the right, but not the obligation, to sell or buy a given
quantity of an asset as a specified price at a specified future date. An option to buy the
underlying asset is known as a call option and an option to sell the underlying asset is
known as a put option.

30. OVERVIEW OF FINANCAL SERVICES
Brief Overview
Indian financial markets, broadly comprising of segments like asset
management, banking, insurance, foreign direct investments (FDI) and
foreign institutional investors (FII), effectively promote the savings of
the economy by directing them towards suitable investment options.
The Indian financial sector is well developed, competitive and
integrated to face all traumas (like the recent financial turmoil).
World Economic Forum’s latest report ‘Financial Development Report
2012’ has named India as the world's top-ranked country in terms of life
insurance density. Life insurance density is the ratio of direct domestic
premiums for life insurance to per capita gross domestic product (GDP)
of a country. India has been ranked 40th in terms of overall financial
development of a country, but is much ahead of larger economies like
the US, UK, Japan and China for life insurance density.

31. Scope of Financial Services Services
•Financial services cover a wide range Financial services cover a wide range of
activities. They can be broadly of activities. They can be broadly classified into two,
namely :classified into two, namely :
•i Traditional. Activities.
•ii. Modern activities.
Traditional Activities
• Traditionally, the financial Traditionally, the financial intermediaries have been
rendering intermediaries have been rendering a wide range of services a wide range
of services encompassing both capital and encompassing both capital and money
market activities. They can be money market activities. They can be grouped under
two heads, viz. grouped under two heads, viz.
A. Fund based activities and
B. Non-fund based activities.

32. Fund based activities :
The traditional services which come under fund based activities are the under fund based
activities are the following:-
•i. Underwriting or investment in shares, debentures, bonds, etc. of new issues (primary
market activities)
ii. Dealing in secondary market activities.
iii. Participating in money market instruments like commercial papers, certificate of
deposits, treasury bills, discounting of bills etc
iv. Involving in equipment leasing, hire purchase, venture capital,
v. Dealing in foreign exchange market activities.

33. Non fund based activities.
Financial intermediaries provide services on the basis of non-fund activities also. This can
be called 'fee based' activity. Today customers, whether individual or corporate,
customers, are not satisfied with mere provisions of are not satisfied with mere
provisions of finance. They expect more from financial services companies. Hence a wide
variety of services, are being provided under this head. services, are being provided
under this head. They include : They include :
1.Managing the capital issue — i.e. management of pre-issue and post-issue activities
relating to the capital issue in activities relating to the capital issue in accordance with the
SEBI guidelines and thus enabling the promoters to market their issue. enabling the
promoters to market their issue.•ii. Making arrangements for the placement
2. Making arrangements for the placement of capital and debt instruments with of capital
and debt instruments with investment institutions.
3. Arrangement of funds from financial institutions for the clients' project cost or his
working capital requirements
4.Assisting in the process of getting all Government and other clearances.

34. Modern Activities
•Beside the above traditional services, the financial intermediaries render
innumerable services in recent times. Most of them are in the nature of non-fund
based activity.
In view of the importance, these activities have been brief under the head 'New
financial in brief under the head 'New financial products and services'.
However, some of the modern services provided by them are given in brief
here under.
1.Rendering project advisory services right from the right from the preparation
of the project report till the raising of funds for starting the project with
necessary Government approvals.
2.Planning for M&A and assisting for smooth carry out.
3.Guiding corporate customers in capital restructuring.
4. Acting as trustees to the debenture holders.
5.Recommending suitable changes in the management structure and
management style with a to achieving better results.

35. UNIT- 2
MANAGEMENT OF COMMERCIAL BANKS