INTRODUCTION TO

INDIAN FINANCIAL SYSTEM

Management Of Financial
Services(MFS)
 INTRODUCTIOJN TO INDIAN
FINANCIAL SYSTEM

POINTS TO BE COVERED
• Meaning
• Types of financial system
• Components
• Functions
• Key elements of good financial system
 Meaning/Components of
financial system
It is Set of sub system:
i. Financial institution
ii. Financial markets
iii. Financial instruments
iv. Financial services
facilitates transfer of
funds
 Types of financial system
• Formal

• Informal
COMPONENTS OF FINANCIAL
SYSTEM
 FINANCIAL MARKETS
It is link between saver and investor.
Types
1.Money market
2.Capital market
 Primary market
 Secondary market
 Financial Instruments
• Equity
• Debenture
• Preference shares
• MFs
• Insurance policies
 Financial Services
• Credit Rating
• Factoring
• Leasing
• Hire purchase
• Underwriting
 Evolution of Indian Financial
System
3 Phases:
i. Upto 1951
ii.1951 to Mid Eighties
iii.Post Nineties
 UPTO 1951
• Initiation of eco. Dev.
• Semi-organised,narrow security
market
• Absence of participation by FIs in
financing industry
• Low industrial growth,less
investment opportunity
 1951 TO MID EIGHTIES
• Planned economic dev initiated- 5
year plans started
 Public/Govt ownership of FI
Nationalisation of RBI,SBI,LIC
 Fortification of Institutional structure
DFIs were established
diversification of forms of financing
enlargement of fin. coverage
 1951 TO MID EIGHTIES
 Protection to investors
CO’s Act,1956
Cap.issue Act,1947(now SEBI)
MRTP Act,1970
FERA,1973
 Participation of FIs in corporate
mgmt.
through shareholding in Pvt. Cos
 POST NINETIES
New economic policy in 1991
 Privatisation of FIs
Pvt.MFs were allowed
DFIs converted into Public co
IRDA was set up-foreign insurance cos
allowed to enter
Pvt sector banks emerged
 POST NINETIES
 Reorganisation of Institutional Structure
• FIs started providing service in addition to
financing

• Changes in banking industry

branch expansion in rural and semi-urban area
growth in deposits,priority sector lending
 Evolution-POST NINETIES
• Narsimham committee(1991)
framework regarding SLR, Int. rate,
CAR(9%)
foreign bank entry, branch licensing
 Investor Protection
SEBI got statutory status to :
monitor cap. Mkt.,regulate cap. Mkt.,

protect investor interest.

RBI AND FINANCIAL SYSTEM
1. Financing Function
liquidity mgmt.,
issue currency,
banker to govt.
2. Regulatory Function
protect depositor’s interest,
maintain public confidence in system
regulate banks thro Banking
Regulation Act,1949
 CONT…
3. Promotional/Dev. Function
Encourage to set up DFIs
encourage banks to open branches in
rural,less developed areas
made priority sector lending compulsory for
public & pvt sector banks
encourage agriculture finance,micro-credit
CAPITAL MARKET

Management Of Financial
Services(MFS)
 Capital Market
 A market for long term funds

 Aids economic growth through capital

formation by:
 Issue of primary securities
 Issue of secondary securities
 Secondary market transactions
 Functions of a Capital
Market
 Mobilise savings
 Provide risk capital
 Provide liquidity
 Lower costs
 Disseminate information
 Enable valuation of assets
 Provide operational efficiency
 Develop integration among markets and
segments
 Channelise funds to productive sectors
 Primary Market
 A market for new issues
 Leads to capital formation
 Nature of fund raising
 Domestic
• equity and debt issues
 External
• GDRs, ADRs and ECBs
• FDI, FII and NRI deposits
 FDI and FII
• FDI

Foreign direct investment is investment of

foreign assets into domestic structures,
equipment, and organizations. It does not
include foreign investment into the stock
market.
 Cont..
The FDIs may acquire 10% or more of the voting
power of an enterprise in an economy through
any of the following methods:
• by incorporating a wholly owned subsidiary or
company.
• by acquiring shares in an associated enterprise
• through a merger or an acquisition of an
unrelated enterprise
• participating in an equity JV with another investor
or enterprise
 Cont…
• FII
- It refers to outside companies investing in
the financial markets of India.
- FIIs must register with the Securities and
Exchange Board of India to participate in
the market.
- One of the major market regulations
pertaining to FIIs involves placing limits on
FII ownership in Indian companies
 History of the Indian Capital
Market
Under British rule – Not organised and developed
Post independence – Small size and supervised by
CCI
In 1950s – Rampant speculation; Government enacted
Securities Contract (Regulations) Act and Companies Act,
1956;Development of Financial Institutions.
In 1960s – Ban on badla, UTI set up in 1964
 Cont…
In 1970s – Badla resumed; circulation of the
Dividend Restriction Ordinance – slump in BSE
sensex; FERA issues revive stock markets
In 1980s – Small investor participation;
Introduction of PSU bonds; popularity of
convertible debentures.
In 1990s – Capital Issues (Control) Act
repealed. Emergence of SEBI; Free pricing;
entry of new players and new trading
mechanism; Capital market scams.
 Capital Market Scams
 The 1991-92 Securities Scam (Harshad
Mehta Scam) Misuse of public sector banks,
mutual funds, bank receipts, and SGL
ledger accounts; a bank scam, repos banned
 The 2001 Ketan Parekh Scam

Misuse of pay orders, private sector banks

and cooperative banks; a securities scam;
badla banned.
 Reforms in the Capital Market
 Specialised Regulator
 Emergence of specialised intermediaries
 Entry to FIIs
 Pricing of securities through book building
 Access to international markets
 Emphasis on corporate governance
 Screen-based trading system
 Cont…

 Rolling settlement
 Dematerialisation of securities
 Derivatives trading
 Comprehensive risk management
systems
 MONEY MARKET

Management Of financial
Services(MFS)
 Introduction
- Market for short term funds having
maturity
< 1year
- No physical location
- Main players are RBI,mutual
funds,banks,NBFCs,primary
dealers,corporate investors
 Functions
• mechanism to even out demand &
supply of short term funds
• focal point for central bank intervention
for influencing liquidity and int. rate
• provide access to suppliers and users of
short-term funds to fulfill their borrowing
and invt.
requirements.
 Money Market Instruments
1. TREASURY BILLS(T-BILLS)
2. COMMERCIAL PAPERS(CPs)
3. COMMERCIAL BILLS(CBs)
4. CERTIFICATE OF DEPOSITS(CDs)
5. CALL/NOTICE MONEY MARKET
 TREASURY BILLS(T-BILLS)
 Meaning
 Features
negotiable instrument
highly liquid
absence of default risk
low transaction cost,assured
yield,eligible for inclusion in SLR
 Cont…
 TYPES
• Ad-hoc T-bills
• Auctioned T-bills
 Participants
RBI, banks, mutual funds, primary
dealers, corporates,
Sale of T-bills (done thro
Auctions)
Multiple-price Auction
Uniform-price Auction
 COMMERCIAL PAPERS(CPs)
 An unsecured short-term promissory note issued
at a discount
 Issuers
 Creditworthy corporates
 primary dealers
 All India financial institutions
 Largest issuers of CPs–Leasing and Finance
companies
 Usually privately placed with investors
 Attracts stamp duty
 Underwriting not mandatory
 Process for Issuing CP

 A resolution to be passed by the Board of

Directors
 CP issue to be rated

 Select an Issuing and Paying Agent for

verification of documents

 Arrange for dealers for placement of CP

Report to the RBI regarding the issue
Guidelines Relating to CPs
 Corporates, primary dealers and all India
financial institutions eligible to issue a
CP
 Minimum credit rating P2 of Crisil
 Maturity period of minimum of 7 days and
maximum up to one year from the date
of issue
 Minimum of Rs 5 lakh and multiples
 To be issued in demat form
 COMMERCIAL BILL
• A short-term, negotiable and self
liquidating instrument with low risk.
• Types
 Demand bill
 Usance bill
 Clean bill
 Documentary bill
 Inland bill
 Foreign bill Hundi
 Derivative Usance Promissory Note
CERTIFICATES OF DEPOSITS
A short- term tradable time deposit issued by
commercial banks and financial institutions.
 Issued at a discount to face value.
 Minimum amount Rs 1 lakh and in multiples
thereof
 Maturity period
7 days to one year for banks
1 to 3 years for FIs
 No lock-in period
 Cont…
 Transferable by endorsement
 Banks to maintain appropriate reserve
requirement on issue of CDs.
 Issued in demat form
 Key investors--Mutual Funds
 CALL/NOTICE MONEY
MARKET
 Banks borrow/lend money for a period
ranging between 1 and 14 days.
 No collateral security required
 Highly liquid, risky, and volatile market
 Banks trade money to adhere to CRR
requirement
Factors Influencing Call Rate
Volatility
 Liquidity conditions

 Reserve requirement prescriptions

 Structural factors

 Liquidity changes and gaps in the foreign

exchange market
 Collateralised Borrowing and
Lending Obligations (CBLO)
MEANING: IT IS
• An obligation by the borrower to return
the money borrowed, at a specified future
date;
• An authority to the lender to receive
money lent, at a specified future date with
an option/privilege to transfer the authority
to another person for value received;
• An underlying charge on securities held
in custody (with CCIL) for the amount
borrowed/lent.
•
 CONT…
Launched by CCIL
 To provide liquidity to non-bank
entities
 No lock-in period
 Original tenure varies between one
day and one year
 Trading volumes have grown
 Money Market Intermediaries
 DFHI AND MMMs
 The Discount and Finance House of
India--set up in 1988 by RBI.
 Role is to stimulate activity in money
market.
 DFHI is an recognised primary dealer.
 Money Market Mutual Funds: Introduced
in April 1991. Mobilize savings from small
investors.
 Invest in money market instruments
 Link Between Money Market and
Monetary Policy in India
 Objectives of the monetary policy
 Price stability
 Growth
 Instruments used to influence monetary
conditions
 Direct instruments such as reserve
requirements,limits on refinance,
administrative interest rates, restrictions on
credit
 Indirect instruments such as open market
operation and repos
 Tools of Managing Liquidity in the
Money Market
 Reserve requirements: CRR & SL
 Interest rates
 Prime lending rate
 Bank rate
 Refinance from RBI
 Liquidity Adjustment Facility: operates through
repo and reverse repo auctions; coupled with
OMOs and MSS provides RBI greater flexibility
in managing liquidity
 Market stabilisation scheme (MSS): deals with
enduring capital inflows without affecting short-
term liquidity management role of LAF.
 CONT…
• Types of Repos: Interbank repos,
RBI repos: Reverse Repo (Borrowing of
overnight funds by RBI)- rate 6% and
Repo (Lending to banks)- rate 7%
(Short-term rates)

 Refinance from RBI