financial system.ppt

7/30/2019 Financial System.ppt

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Financial System


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The term Financial Environment refers to the financial sector orfinancial system of a country. It comprises various financialinstitutions, instruments, policies and services concerning thefinancial sector.

Meaning of Financial System The financial system of a country means a set of financial

arrangements by which the savings in the economy are

mobilized for investment in productive assets.

The financial system deals with all types of finance, agricultural,industrial, developmental and governmental finance.

The suppliers and users of funds are a part of the financialsystem.

Thus, the financial system is concerned with borrowing andlending of funds or the demand and supply of funds of allindividuals, institutions, companies and the Government.


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Constituents of the Financial System

1. Financial Markets: Provide facilities for raising long term and short term funds.

2. Financial Institutions: Serve as intermediaries between borrowers and lendersof funds.

3. Financial Instruments: Are used to raise funds in the financial markets

4. Financial Services: Services offered by various financial institutions.

Financial Markets:

Financial Markets refer to the market for borrowing and lending of funds. They

provide facilities for buying and selling of financial claims.

Capital Market: A capital market may be defined as the market for borrowing andlending of long term funds. It is concerned with the raising of capital for thepurpose of investment. Capital market is a market where securities issued byfirms (ie shares, bonds and debentures) can be bought and sold freely.

The demand for capital comes from business firms, agriculture andGovernment while the supply of capital is provided by individual savers,corporate savings, specialized financial institutions.


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Capital Markets (contd)The capital market is classified into:

Primary Market: The primary market or the new issues market refers to the

raising of new capital by the issue of new shares, debentures and bonds. By prospectus: It is an invitation to the general public for subscribing to the

capital.

By offer for sale: This method is almost similar to the prospectus method exceptwith a difference that shares are taken up by a third party in bulk. Later astatement like prospectus is issued for sale to the public. Thus the company hasalready received the money and any premium from the public goes to the thirdparty.

By private placing: Shares are sold to individuals or institutions directly by makinga private appeal to them.

By offering rights issue: Under a rights issue, the shareholders have the right to acertain number of shares in proportion to the shares held by them.

Secondary Market: The secondary market or the stock exchange is themarket for old or already issued securities. It comprises of the stock market

in which industrial securities are bought and sold.

The capital market serves a very useful purpose by pooling the capitalresources of the country and making them available to the enterprisinginvestors.

Well developed capital markets augment resources by attracting and

lending funds on a global scale.


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Money Markets Money market refers to the market for lending and borrowing of

short term funds. It is the market in which the short term

surplus investible funds of banks and other financialinstitutions are demanded by borrowers. A well organized moneymarket is the basis of an effective monetary policy.

The money market consists of the Organised and UnorganisedSector. The rates of interest differ between the two markets.

Organised Sector: Comprises the Reserve Bank of India,public and private sector banks, foreign banks, financecorporations, mutual funds etc. This consists of the submarketsuch as the commercial bill market and the interbank call moneymarket. The RBI is the Apex organization in the Indian money

market The Unorganised Sector consist of indigenous bankers and

money lenders who pursue the banking business on traditionallines and non banking financial companies such as chit funds,nidhis and finance companies. The unorganized sector is by andlarge outside the control of the Central Bank and is characterizedby lack of uniformity and formality in their business dealings.


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Functions of Money Market

By providing various kinds of credit instruments suitable andattractive for different sections, a money market augments thesupply of funds

Efficient working of a money market helps to minimize thestringencies in the money market due to the seasonal variations

in the flow of and demand for funds. A money market by augmenting the supply of funds and making

them readily available to the legitimate borrowers, helps in makingfunds available at cheaper rates.

A well organised money market, through quick transfer of funds,helps to avoid regional imbalances in availability of funds and

enhances the liquidity available. A money market by providing profitable investment opportunities for

short term surplus funds, helps to enhance the profit of FIs


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Constituents of the Indian Money Market

Call money Market: The call money market consists of overnight

and money at short notice for period upto 14 days. It is meant tobalance the short term needs of banks, most important of thesebeing to meet the CRR requirements. This is the most sensitive partof the financial system and any change in flow of funds is clearlyreflected in it. There is currently no ceiling on the call money rate.

Treasury Bill market : This market deals in treasury bills and inIndia are short term liability of the Central Government. These billsare issued to meet deficits which a Government faces due to itsexcess of expenditure over revenue. Treasury bills arepromissory notes issued by the Central Government to raiseshort term funds to bridge short term mismatches between

receipts and expenditures. The treasury bill market in India isquite underdeveloped and RBI is the major holder of these bills as itis under an obligation to purchase all treasury bills being offered bythe Government. RBI is also required to rediscount treasury bills thatare presented to it by banks and others.


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Repo Market: Repo market helps in collateralised short termborrowing and lending through sale / purchase operations in debtinstruments. Under a repo transaction, securities are sold by theirholder to an investor with an agreement to repurchase at apredetermined rate and date. Under reverse repo transaction,securities are purchased with a simultaneous commitment to resell

at a predetermined interest and rate. Repos help to maintain liquidityconditions in the short term.

Certificate of Deposit market: A certificate of deposit is acertificate issued by a bank to depositors of funds that remain ondeposit at the bank for a specified time period between fifteen days

to one year. They are similar to traditional term deposits but arenegotiable and tradeable in the short term money market. CDs areissued at discount to face value and the discount rate is marketdetermined. They are freely transferable by endorsement anddelivery, however as banks pay a high interest rate on CDs, holdersof CDs prefer to hold them till maturity.



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Commercial Bill market: In this market trade bills or commercialbills are handled. Commercial bill is a bill drawn by one merchantfirm on the other. Legitimate purpose of a commercial bill is toreimburse the seller while the buyer delays the payment. These billscan be rediscounted.

Commercial Paper: Commercial paper is a short term instrument of

raising funds by corporates and Institutional investors. It is essentially asort of unsecured promissory note sold by the investor. The maturity ofthe instrument is flexible and borrowers and lenders adopt a maturity toa CP as per their needs. Highly rated corporates which can obtainfunds at a cost lower than the cost of borrowing from banks aregenerally keen on issuing CPs. CP can be issued for maturitiesbetween a minimum of 15 days and a maximum up to one year from

the date of issue. CP will be issued at a discount to face value as maybe determined by the issuer

Money market mutual funds: Banks, public and private financialinstitutions can set up MMMFs and can issue untis to corporateenterprises and others. Resources mobilised by MMMFs can be

invested in call money market, CDs, CPs, commercial bill etc.TheMMFS have been brought under the purview of SEBI.


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Money Market Reforms

RBI deregulated money market interest rates in 1989 tomake interest rates flexible and lend transparency totransaction. Earlier the call money was subject to interestrate ceiling of 10%, rediscounting of commercial bills12.54% etc.

Over the past fifteen years four major money marketinstruments have been introduced 182 days treasurybills, 364 days treasury bills, CDs and CPs.

Introducing money market mutual funds in 1991 whichprovide an additional short term avenue to investors and

bring money market instruments within the reach ofindividuals


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Developing call money market: Earlier only UTI and LIC were

allowed to operate as lenders in the call money market. As ofnow, broadly speaking banks are operating as lenders andborrowers while a number of non bank financial institutions andmutual funds are operating only as lenders.

Setting the Discount and Finance House of India (DFHI): TheDFHI was set up in 1988 and its major function is to bring into the

fold of the Indian money market the financial system comprisingof scheduled commercial banks, foreign and co-operative banksso that their short term surpluses and deficits are equilibrated atmarket related prices.

Sector specific refinance facilities: Refinance is used by centralbanks to meet liquidity shortage in the system, to control

monetary and credit conditions and direct credit to selectivesectors. Currently there are two refinance schemes exportcredit refinance and general refinance. With the emergence ofthe bank rate as the signaling rate of monetary policy stance, theRBIs policy has been to keep the refinance rate linked to thebank rate.

Money Market Reforms (contd)


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Foreign Exchange Market: In this market foreigncurrency is made available. It comprises of the RBI,authorized dealers in foreign currency, money changers,foreign banks, exporters and importers. The Indian forexmarket has grown in depth in the 1990s.

Government Securities Market: Government requiresconsiderable amount of funds to invest in economic andsocial projects. The market in which Government

securities are purchased and sold is known as theGovernment securities market.

Treasury bills are issued for raising short term fundswhile bonds are issued for long term funds. Market forGovernment and semi government securities is known

as the Gilt edged market. Gilt edged market is relatively risk free and returns are

guaranteed, RBI plays a dominant role and its position isthat of a monopolist. Government securities are the mostliquid debt instruments.


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Financial Market

Capital MarketMoney

Market

Foreign

Exchange

Market

Government

Securities

Market

Primary Market

Secondary Market

Organised Market

Unorganised MarketRBI

Authorised Dealers

Importers and Exporters

Foreign Banks

Money Changers

Bonds

Treasury Bills


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Financial Instruments:Primary or Direct Securities: These are financial claims

against real sector units. They are created by real sector units asultimate borrowers for raising funds. Eg: Equities, bills ofexchange, bonds etc.

Secondary or Indirect Securities: These are financialclaims issued by financial institutions for raising funds from thepublic. Eg: Currency, bank deposits, insurance policies,government securities etc. Bank drafts, cheques, dividendwarrants, treasury bills, railway receipts, promissory notes, creditand debit cards, letters of credit, travelers cheques etc. are also

examples of financial instruments. Some of these instrumentsare described below

Promissory Note: An instrument in writing containing anunconditional promise signed by the maker to pay a certain sum

of money to the bearer of the instrument.


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Bill of exchange: An instrument in writing

containing an unconditional order signed by themaker, directing the certain person to pay certain

some of money to the bearer of the instrument

Commercial Paper Credit Card

Cheque

Travellers Cheque: A cheque issued to thetraveling public by a bank for a fixed amount withoutrequiring any letter of identification.


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Financial Services:Some of the prominent types of financial services are:

Mutual Funds A mutual fund is a fund established in the form of a trust by a sponsor to raise

money by the trustees through the sale of units to the public under one or moreschemes for investing in securities in accordance with the regulations.

A mutual fund raises funds from the investors by offering various types of unitschemes and invests the mobilized funds in eligible instruments and securities.In a mutual fund the legal relationship between the investor and the mutual fund

is that of a trustee and beneficiary while in the case of a bank it is of a creditorand debtor.

Mutual Funds offer both open ended and close ended schemes.

Mutual funds offer the follow. benefits:

Diversification of risks

Liquidity

Professional management

Convenience

Tax Benefits: Tax benefits are available under the Income Tax Act, Wealth TaxAct etc.


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Financial Services:Venture Capital Funds: Venture capital funds provide commercial support to new ideas and for

the introduction and adoption of new technologies.

Banks and financial institutions require a sizable equity contributionfrom the promoter of a project.

However technocrats and scientists who want to become entrepreneurscannot afford to provide such capital. It is the venture capital funds

which provide them the equity capital for such projects. However one must bear in mind that there is a high degree of risk

involved. In India, the VC funds are regulated under the SEBIRegulations, 1996.

Merchant Banking:

A financial institution that specializes in providing various financialservices such as accepting bills arising out of trade, underwriting newissues and providing advice on mergers, acquisitions etc. Law nowrequires that all public issues are managed by merchant bankers whofunction as Lead Managers. They help the company in carrying outfunctions relating to new issues such as determination of securities tobe issued, drafting of prospectus, application forms, allotment letter,

appointment of registrars etc.


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Financial Services:Factoring:

Factoring is a continual financial arrangement under which afinancial institution undertakes the credit and collection functions forits client, purchases his receivables as they arise, maintains thesales ledger, and attends to other functions such as accountsreceivables. Factoring is of recent origin in India. Eg: CanbankFactors Ltd. Etc.

A financial institution (factor) buys the accounts receivable of acompany (Client) and pays up to 80%(rarely up to 90%) of theamount immediately on agreement. Factoring company pays theremaining amount (Balance 20%-finance cost-operating cost) to theclient when the customer pays the debt

Leasing: Leasing means an agreement between the leasing company (called

lessor) and the user (called lessee), under which the formerundertakes to buy the capital equipment for use by the latter. Thelessor remains the owner of the asset during the specified period .The lessee has to pay the rentals to the lessor.


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Financial Services:

Credit Rating:

Credit rating by a competent and authorized agency provides abirds view of the financial strength of the company and its securities

Such an agency makes a systematic analysis of the strengths and

weaknesses of a company and its securities before assigning arating to it.

This means a codified rating assigned to an issue of securities by anauthorized credit rating agency.

Financial Institutions like IDBI, ICICI, UTI and commercial bankshave established credit rating agencies.

Credit Rating and Information Services of India Ltd (CRISIL),Investment Information and Credit Rating Agency of India Ltd(ICRA) and Credit Analysis and Research Ltd. (CARE) areprominent credit rating agencies in India.


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Financial InstitutionsThe financial institutions maybe classified as:Banking Institutions:

A bank is an institution which deals in money and credit. It accepts depositsfrom the public and lends to the borrowers. The Banking Regulation Act. 1949defines banking as the accepting, for the purpose of lending or investment, ofdeposits of money from the public, repayable on demand or otherwise andwithdrawable by cheque, draft, order or otherwise.

Central Bank The Reserve Bank of India is the central bank of the country. Itsupervises and regulates the entire banking system.

Commercial Banks: They perform the usual banking functions of mobilizingdeposits and providing credit. Cooperative Banks: They are organized on the principles of cooperation to

encourage thrift and savings amongst members. They are usually formed by lowand middle income groups in urban and rural areas.

Agricultural Banks: They provide financial assistance to farmers. Generally,loans are provided against mortgage of agricultural land. Regional Rural Banks

were set up to provide credit and deposit facilities to farmers, agricultural laborand small entrepreneurs in rural areas.

Merchant Banks: These banks manage and underwrite new issues ofsecurities. They undertake credit syndication, advise companies on fund raisingand other financial matters etc.

Indigenous Banks: In rural and semi urban areas, moneylenders carry onbanking business in a traditional manner and usually charge a high interest rate.


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Non Banking Institutions/ NonBanking Finance Companies:

The NBFC raise deposits from the public by offeringattractive interest rates and other incentives andthereafter advance loans to small scale industries,traders and semi employed persons. NBFCs

generally provide unsecured loans and therebycharge high interest rates. Besides giving loans,they run chit funds, purchase and discount hundiesand undertake other financial activities like hire-purchase and leasing.

NBFCs are financial intermediaries engagedprimarily in the business of accepting public depositsand making loans and advances. They cannotaccept demand deposits.


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Non Banking Institutions/ NonBanking Finance Companies

Merits: Relatively lower degree of regulation

Simplified and speedy sanction and disbursement procedures.

Orientation towards customers

Attractive interest rates on deposits Flexibility and timeliness in meeting the credit needs of customers.

Wide rage of financial services.

Demerits:

Risks are faced due to: Bulk of their loans are unsecured and are given to risky enterprises.

The loans though given for short periods are often renewed.

The same firm may borrow from more than one finance company

The deposits made by the public with the NBFC are not protected by theDeposit Insurance Corporation.


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Types of NBFC

Loan Companies: Lend money to companies and individuals. Eg:Housing finance companies

Investment Companies: These companies mobilize savings and investthem in industrial securities. They provide the benefits of diversificationof risk and a steady return to investors. Eg: UTI, LIC

Leasing Companies: They provide loans to small firms and individualswho want to buy new machines and equipment.

Chit Funds: Under this scheme the promoter collects subscriptions atspecified time periods from enrolled members and the amount so

collected if handed over to a member on rotation.

Housing Finance Companies: HUDCO is a national level institutionwhich gives loans to individuals and societies for building houses andflats


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Objectives of FinancialInstitutions1. To promote and develop new industries so as to fill gaps in

the industrial structure of the country.2. To meet the growing needs of industries for long term

finance

3. To help promotion of new enterprises by identifying andformulating new projects, training and developing

entrepreneurs, streamlining the management of assistedindustrial units.

4. To provide merchant banking facilities.

5. To mobilize public savings and accelerate the rate of capitalformation

6. To ensure balanced regional development

7. To develop a strong and healthy capital market

8. To assist in the modernization, expansion and diversificationof existing industries.

9. To encourage the growth of small scale industries and newand technical entrepreneurs.

10. To optimize the use of scarce resources.


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Industrial Finance Corporation ofIndiaThe IFCI was established on July 1, 1948. It was jointly owned by the GOI,

the RBI and the financial institutions. In 1993, IFCI was converted into a

Public Limited Company to enable it reshape its business strategieswith greater authority, tap the capital market for funds, expand its equitybase and provide better customer services.

Objective:

Making medium and long term credit available to industrial concerns.

Assisting industrial concerns which have planned schemes formanufacture of or modernization and expansion of a plant.

Provide project finance, merchant banking, equipment leasing etc. andpromotional services.

To give priority to development of backward areas, new entrepreneursand technocrats, indigenous technology, ancillary industries etc.

Provide financial assistance to public companies and cooperativesectors engaged in manufacturing, mining, shipping, hotel business etc.


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Industrial Finance Corporation ofIndiaFunctions, Scope:

Granting loans and advance to or subscribing to debentures ofindustrial concerns.

Guaranteeing loans raised by industrial concerns from the capitalmarket.

Providing guarantees for deferred payments for import of capital foods

manufactured in India. Guaranteeing with the approval of the GOI, loans raised from or credit

arrangements made by industrial concerns with any bank or financialinstitution outside India.

Underwriting the issue of shares and debentures by industrial concerns.

Subscribing directly to the shares and debentures of industrialconcerns.

Providing financial assistance on concessional terms for setting upindustrial projects in backward areas.

Providing guidance in project planning and implementation throughspecialized agencies like Technical Consultancy Organisation.

The financial assistance is available for setting up new projects and forthe expansion, diversification and modernization of existing units.


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Industrial Finance Corporation ofIndiaBefore sanctioning assistance, IFCI evaluates the proposal in terms of:

Importance of the industry in the national economy

Feasibility and cost of the project Competence of the management

Nature of the security offered

Adequacy of supply of technical personnel and raw materials

The countrys requirements of the product manufactured and its quantity.

IFCI has been criticized for the following reasons: Assistance sanctioned for new projects has been only about 20% of the

total assistance

Equity finance has been very little as compared to debt finance

Adequate focus has not been laid on backward regions and small scalesector.

Percentage share of infrastructure projects in the total loans outstandingis about 13%

There has been a sharp fall in the assistance provided in foreigncurrency.

Income of IFCI has fallen sharply

Non performing assets of IFCI are very high of the total net assets. Itscapital adequacy ratio has fallen to less than one percent.


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Industrial Credit and InvestmentCorporation of India (ICICI Bank)

Was established in 1955 as a public limited company in the private sector.ICICI set up the ICICI Bank in 2002. The ICICI Ltd was later mergedwith its subsidiary the ICICI Bank ltd. ICICI Bank is now the secondlargest commercial bank in India and the largest bank in the privatesector. It has assumed the role of a universal bank.

Objectives:

Main aim was to promote industrial development in the private sector byproviding financial, technical, administrative and other services

To assist in the promotion, expansion and modernization of industrialenterprises in the private sector

To encourage and promote the participation of private capital, bothIndian and foreign

To stimulate the growth of private ownership of industrial investmentsand expansion of investment markets.


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Industrial Credit and InvestmentCorporation of India (ICICI Bank)Functions: ICICI provides assistance in the following ways

Granting medium and long term rupee loans to industrial concerns

Advancing loans in foreign countries towards the cost of imported capitalequipment.

Providing guarantees to the loans raised by companies in the open market

Sponsoring and underwriting new issues of industrial securities.

Subscribing directly to shares and debentures of companies

Making funds available for reinvestment by revolving investments as rapidly asprudent

Providing technical and managerial know how to industries.

Encouraging the participation of private capital in industrial concerns

Assisting industrial concerns in obtaining technical and administrative servicesfrom internal and external sources

ICICI has played a vital role in the development of industries in the private sectorand in strengthening the capital market in the country. It has become the largestsupplier of foreign currency to private sector industries. It has also played aleading role in the areas of venture capital. ICICI Bank Ltd. is listed on the NewYork Stock Exchange. It launched infinity the first internet banking service inIndia.


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Industrial Development Bankof India It started operations in 1964. IDBI represents an attempt to combine in

a single institution the requirements of an expanding economy andneed for a coordinated approach to industrial financing. In 1994 theBank was permitted to issue equity shares in the capital market.Majority of its shares are still owned by the Government.

Objectives:

To co-ordinate, regulate and supervise the activities of all financialinstitutions providing long term finance to industry.

To enlarge the usefulness of these institutions by supplementing theirresources and by widening the scope of their assistance

Provide direct finance to industry to bridge the gap between demandand supply of long term and medium term finance to industrial concerns

in both the public and private sectors Locate and fill up gaps in the industrial structure of the country

Adopt and enforce a system of priorities so as to diversify and speed upthe process of industrial growth


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Industrial Development Bankof IndiaFunctions:

Subscribe to the shares and bonds of financial institutions Refinancing term loans and export credits extended by other financial

institutions

Granting loans and advances directly to industrial concerns

Guaranteeing deferred payments due from and loans raised byindustrial concerns

Subscribing to and underwriting shares and debentures of industrialconcerns

Accepting, discounting and rediscounting commercial bills orpromissory notes of industrial concerns

Financing turnkey projects by Indians outside India

Planning, promoting and developing industries to fill gaps in the

industrial structure of the country. Providing technical and managerial assistance for promotion and

expansion of industrial undertakings

Coordinating and regulating the activities of other financial institutions.

On 30.12.2003, IDBI was converted into a banking company and IDBI

Bank Ltd and IDBI were merged together.


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Small Industries DevelopmentBank of India (SIDBI)Set up in 1990as a wholly owned subsidiary of IDBI. SIDBI took over the

outstanding portfolio of IDBI related to the small scale sector worth Rs.4000 crores.

Objective: It was envisaged as the principal financial institution for the promotion,

financing and development of the industry in the small scale sector andto coordinate the functions of other institutions engaged in similar

activities.Functions: Refinancing loans and advances extended by primary lending

institutions to small scale industrial units

Discounting and rediscounting bills in the small scale sector

Extending need capital /soft loan assistance under the National Equity

Fund, Mahila Vikas Nidhi etc. Granting direct assistance and refinance for financing exports of

products manufactured in the small scale sector

Providing financial support to NSIC (National Small IndustriesCorporation) for providing leasing, and marketing support

Providing services like leasing, factoring to industrial concerns in the

small scale sector

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