MA 0036

Financial System and Commercial Banking

Q1. Explain about various regulatory institutions. Ans: 1. Reserve Bank of India : Reserve Bank of India is the apex monetary Institution of India. It is also called as the central bank of the country. The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934. The Central Office of the Reserve Bank was initially established in Calcutta but was permanently moved to Mumbai in 1937. The Central Office is where the Governor sits and where policies are formulated. Though originally privately owned, since nationalization in 1949, the Reserve Bank is fully owned by the Government of India. 2. Securities and Exchange Board of India : SEBI Act, 1992 : 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.

3. Insurance Regulatory and Development Authority : The Insurance Regulatory and Development Authority (IRDA) is a national agency of the Government of India and is based in Hyderabad (Andhra Pradesh). 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." (B) Part of the Ministries of the Government of India : 4. Forward Market Commission India (FMC) : Forward Markets Commission (FMC) headquartered at Mumbai, is a regulatory authority which is overseen by the Ministry of Consumer Affairs, Food and Public Distribution, Govt. of India. It is a statutory body set up

in 1953 under the Forward Contracts (Regulation) Act, 1952 This Commission allows commodity trading in 22 exchanges in India, out of which three are national level. 5. PFRDA under the Finance Ministry : Pension Fund Regulatory and Development Aulthority : PFRDA was established by Government of India on 23rd August, 2003. The Government has, through an executive order dated 10th October 2003, mandated PFRDA to act as a regulator for the pension sector. The mandate of PFRDA is development and regulation of pension sector in India.

Q2. Explain hybrid instruments. Ans:

HYBRID INSTRUMENT is a package containing two or more different kinds of risk management instruments that are usually interactive. The term hybrid instrument is not precisely defined. Generally, it is used to refer to financial instruments that blend characteristics of debt and equity markets. Convertible bonds are an example. They are debt instruments that have an imbedded option allowing the holder to exchange them for shares of the issuing corporation's stock. For this reason, their market prices tend to be influenced by both interest rates as well as the issuer's stock price. Hybrid instruments - essentially bonds with an equity component - are found in a multitude of guises. This generic heading encompasses a seemingly endless array of finance instruments, including convertible bonds, mandatory convertibles, reverse convertibles, preferred shares, ELKS, DECS and LYONs, Within each one of these instruments are found a wide range of variations and features. These include reset, negative pledge, screw and forced conversion clauses, as well as step up coupons, call schedules, call options with soft and hard protection, etc. The range of possibilities can seem bewildering, but it is this very flexibility which proves a huge attraction for investors, issuers and financial institutions. On the sell side companies issue these securities and corporate service departments advise on the type of options to include in them. On the buy side, investment managers seek to build portfolios with limited risk exposure using these securities and hedge funds utilize arbitrage opportunities between the convertible bond and the common share. Hybrid instruments, or convertibles, have a fascinating history. Originally created in 1881, by 1929 they made up 40% of debt issuance but during the Second World War they all but disappeared from the scene. Today - perhaps thanks to the risks of the well-publicized financial collapses seen over recent years - they have made a remarkable comeback and

currently command a market of US$350 billion. Their low historical volatility and high historical returns when compared to alternative investments are a huge attraction to many investors. The secret of the success of hybrids lies in their inherent flexibility.

Q3. . What role does the RBI play in ensuring that the guidelines as per the RBI Act 1934 and Banking Regulation Act 1949 are adhered to by banks? Ans: The Reserve Bank of India was established on 1.4.1935, in accordance with the provisions of the RBI Act, 1934. The Banks main functions are: (i) operating monetary policy with the aim of maintaining economic and financial stability and ensuring adequate financial resources for development purposes; (ii) meeting the currency requirement of the public; (iii) promotion of an efficient financial system; (iv) foreign exchange reserve management; (v) the conduct of banking and financial operations of the government. Since the onset of the process economic reforms, including the on-going liberalization and globalization of the economy, the role of the RBI as the Regulator of the financial sector has grown and diversified. What control is to the command economy, regulation is to the market economy. Therefore, an important dimension of this Committees enquiry relates to the regulatory role of the RBI in the context of the Stock market Scam and Matters Relating thereto. Reserve Bank of India is regulator for all the banks in the country and as a regulator, apart from commercial banks, also supervises Co-operative banks, Non Banking Finance Companies, Financial Institutions etc. Thus the entire institutional function of providing finance comes under the regulatory oversight of the RBI. A. COMMERCIAL BANKS The Banking Regulation Act 1949 vests requisite powers with the RBI for supervising the working of the commercial banks. Till 1993, regulatory as well as supervisory functions over commercial banks were performed by the Department of Banking Operations and Development(DBOD). Subsequently, a new Department of Banking Supervision (DBS) was set up to take over from DBOD supervisory functions relating to the commercial banks. In order to have integrated supervision over all credit institutions i.e. banks, development

financial institutions and non-banking finance companies, a high powered Board of Financial Supervision (BFS), comprising the Governor of RBI as Chairman, one of the Deputy Governors as Vice-Chairman and four Directors of the Central Board of RBI as members, was set up in November 1994 under the aegis of the RBI. For focussed attention in the area of supervision over non-banking finance companies, the Department of Supervision was further sub-divided in August 1997 into the Department of Non-Banking Supervision (DNBS).

Q4. What is financial inclusion? Ans: The Reserve Bank of India (RBI) set up the Khan Commission in 2004 to look into financial inclusion and the recommendations of the commission were incorporated into the mid-term review of the policy (200506). In the report RBI exhorted the banks with a view to achieving greater financial inclusion to make available a basic "no-frills" banking account. In India, financial inclusion first featured in 2005, when it was introduced by K.C. Chakraborthy, the chairman of Indian Bank. Mangalam became the first village in India where all households were provided banking facilities. Norms were relaxed for people intending to open accounts with annual deposits of less than Rs. 50,000. Opening of no-frills accounts: Basic banking no-frills account is with nil or very low minimum balance as well as charges that make such accounts accessible to vast sections of the population. Relaxation on know-your-customer (KYC) norms:KYC requirements for opening bank accounts were relaxed for small accounts in August 2005, thereby simplifying procedures by stipulating that introduction by an account holder who has been subjected to the full KYC drill would suffice for opening such accounts. Engaging business correspondents (BCs):In January 2006, RBI permitted banks to engage business facilitators (BFs) and BCs as intermediaries for providing financial and banking services. The BC model allows banks to provide doorstep delivery of services, especially cash in-cash out transactions, thus addressing the last-mile problem. Use of technology:Recognizing that technology has the potential to address the issues of outreach and credit delivery in rural and remote areas in a viable manner,banks have been advised to make effective use of information and communications technology (ICT), to provide doorstep banking services through the BC model where the accounts can be operated by even illiterate customers by using biometrics, thus ensuring the security of transactions and enhancing confidence in the banking system. Adoption of EBT: Banks have been advised to implement EBT by leveraging ICT-based banking through BCs to transfer social benefits electronically to the bank account of the

beneficiary and deliver government benefits to the doorstep of the beneficiary, thus reducing dependence on cash and lowering transaction costs. GCC:With a view to helping the poor and the disadvantaged with access to easy credit, banks have been asked to consider introduction of a general purpose credit card facility up to `25,000 at their rural and semi-urban branches. Simplified branch authorization:To address the issue of uneven spread of bank branches, in December 2009, domestic scheduled commercial banks were permitted to freely open branches in tier III to tier VI centres with a population of less than 50,000 under general permission, subject to reporting. Opening of branches in unbanked rural centres: To further step up the opening of branches in rural areas so as to improve banking penetration and financial inclusion rapidly, the need for the opening of more bricks and mortar branches, besides the use of BCs, was felt.

Q5. Explain the measures to improve customer service. Ans: 1. Stay in contact with customers on a regular basis. Offer them a free e-zine subscription. Ask customers if they want to be updated by e-mail when you make changes to your Web site. After every sale, follow-up with the customer to see if they are satisfied with their purchase. 2. Create a customer focus group. Invite ten to twenty of your most loyal customers to meet regularly. They will give you ideas and input on how to improve your customer service. You could pay them, take them out to dinner or give them free products. 3. Make it easy for your customers to navigate on your web site. Have a "FAQ" page on your Web site to explain anything that might confuse your customers. Ask them to fill out an electronic survey to find out how make your web site more customer friendly. 4. Resolve your customers complaints quickly and successfully. Answer all e-mail and phone calls within an hour. If possible, you the owner of the business, personally take care of the problem. This will show your customers you really care about them. 5. Make it easy for your customers to contact you. Offer as many contact methods as possible. Allow customers to contact you by e-mail. Hyperlink your e-mail address so customers won't have to type it. Offer toll free numbers for phone and fax contacts.

6. Make sure employees know and use your customer service policy. Give your employees bonuses or incentives to practice excellent customer service. Tell employees to be flexible with each individual customer, each one has different concerns, needs and wants. 7. Give your customers more than they expect. Send thank you gifts to lifetime customers. E-mail them online greeting cards on holidays or birthdays. Award bonuses to your customers who make a big purchase. 8.Always be polite to your customers. Use the words your welcome, please, and thank you. Be polite to your customers even if they are being irate with you. Always apologize to your customers should you make a mistake. Admit your mistakes quickly and make it up to them in a big way. 9. Reward customers a point for every one dollar they spend. Let's say customers can get a free computer for 300 points. That means customers will spend $300 dollars on your products and services to get enough points to get the free computer. 10. Build strong relationships with your customers. Invite them to company meetings, luncheons, workshops or seminars. Create special events for your customers like parties, barbecue's, dances etc. This will make them feel important when you include them in regular business operations and special events. Author Dan Brown has been active in internet marketing for the past 4 years. Dan currently is working with The Paid Surveys Report, introducing a very successful paid surveys database.

Q6. Explain perspectives in relation to banking regulation. Ans: Recently, the theory of banking regulation has undergone important changes. This has been the consequence of a number of compounding effects that have been occurring in the financial sector. First among these is on-going financial innovation, which has caused a virtual revolution in both financial instruments and markets. As a result, the markets and institutions that must be regulated have changed substantially over time. At the same time, regulation has evolved, as the regulators have learned the lessons from the recent spat of banking crises. As a consequence of these experiences, regulation has become more sophisticated, with the introduction of capital requirements and more complex restrictions on operating procedures. At the same time, a second force of change has emerged in academic circles where a new paradigm central to our understanding of both financial markets and the regulation of these markets has been developing. Asymmetric information

theory, a setting in which economic agents are presumed to operate in a world of incomplete and, at times biased, information, has developed. In our view, this framework is perfect to adapt to the issues central to the theory of banking. The insights that this theory offers have had a profound effect on our view of regulation. In this chapter we review the impact of imperfect information on our understanding of why financial markets exist, how they operate, and how best to regulate them. In the first part of this chapter (section 2) we start by identifying the market failures that are specific to the banking industry. Namely, we will consider, first, the types of imperfections characteristic of financial markets, then turn to the justification of financial intermediaries, so as to provide a better understanding of what are the main market failures in the financial industry. This will allows us to draw a coherent view of the role of regulation in the financial intermediation industry. The benefits from constructing this overall perspective will be derived from showing how apparently disconnected regulatory measures, such as capital requirements, law and finance or the Glass- Steagall Act are interwoven. The second part of this chapter (section 3) considers the design of regulation as well as its impact, and reviews the working of the main regulatory instruments, as well as the effects they had on the banks behavior.