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INTRODUCTION

The term financial intermediary may refer to an institution, firm orindividual who performs intermediation between two or more parties in afinancial context. Typically the first party is a provider of a product or serviceand the second party is a consumer or customer.

Financial intermediaries are banking and non-banking institutions whichtransfer funds from economic agents with surplus funds (surplus units) toeconomic agents (deficit units) that would like to utilize those funds. FIs arebasically two types: Bank Financial Intermediaries, BFIs (Central banks andCommercial banks) and Non-Bank Financial Intermediaries, NBFIs(insurance companies, mutual trust funds, investment companies, pensions funds, discount houses etc)

Financial intermediaries can be:

Banks; Building Societies; Credit Unions; Financial adviser or broker; Insurance Companies; Life Insurance Companies; Mutual Funds; or Pension Funds.

The borrower who borrows money from the FinancialIntermediaries/Institutions pays higher amount of interest than that receivedby the actual lender and the difference between the Interest paid and Interestearned is the Financial Intermediaries/Institutions profit.

Financial Intermediaries are broadly classified into two major categories:

1) Fee-based or Advisory Financial Intermediaries2) Asset Based Financial Intermediaries.

Fee Based/Advisory Financial Intermediaries: These FinancialIntermediaries/ Institutions offer advisory financial services and charge a feeaccordingly for the services rendered.

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Their services include:

i. Issue Managementii. Underwriting

iii. Portfolio Managementiv. Corporate Counselingv. Stock Broking

vi. Syndicated Creditvii. Arranging Foreign Collaboration Services

viii. Mergers and Acquisitionsix. Debenture Trusteeshipx. Capital Restructuring

ASSET-BASED Financial Intermediaries: These Financial

Intermediaries/Institutions finance the specific requirements of their clientele.The required infra-structure, in the form of required asset or finance isprovided for rent or interest respectively. Such companies earn their incomesfrom the interest spread, namely the difference between interest paid andinterest earned.

The financial institutions may be regulated by various regulatory authorities,or may be required to disclose the qualifications of the person to potentialclients. In addition, regulatory authorities may impose specific standards of conduct requirements on financial intermediaries when providing services toinvestors.

Financial Instruments

1. Money Market Instruments

The principal money market instruments are:

i. US Treasury Billsii. Negotiable Bank Certificates of Deposit

iii. Commercial Paperiv. Bankers Acceptances

All of these money market instruments are, by definition, short-term debtinstruments, with maturities less than one year.

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US Treasury Bills:

Issued by the US Government. Currently issued with maturities of 1, 3, and 6 months. Pay a fixed amount at maturity. Make no regular interest payments, but sell at a discount.

Example: A Treasury bill that pays off $1000 at maturity 6 months from nowsells for $950 today. The $50 difference between the purchase price and theamount paid at maturity is the interest on the loan.

Are the safest of all money market instruments, since it is very unlikely thatthe US Government will go bankrupt?

Negotiable Certificates of Deposit (CDs):

Issued by banks. Make regular interest payments until maturity. At maturity, return the original purchase price. Large CDs, with value over $100,000, trade on a secondary market. Negotiable means that the CD trades on a secondary market.

Commercial Paper:

Short-term debt issued by corporations.. Make no interest payments, but sell at a discount. Trade on a secondary market.

Bankers Acceptances:

Bank draft (like a check) issued by a firm and payable at some futuredate.

Stamped accepted by the firms bank, which then guarantees that itwill be paid.

Often arise in the process of international trade. Make no interest payments, but sell at a discount. Trade on a secondary market.

2. Capital Market Instruments

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i. Corporate Stocksii. Residential, Commercial, and Farm Mortgages

iii. Corporate Bondsiv. US Government Securities (Intermediate and Long-Term)v. State and Local Government (Municipal) Bonds

vi. US Government Agency Bondsvii. Bank Commercial and Consumer Loans

All of these capital market instruments are, by definition, intermediate-termdebt instruments, long-term debt instruments, or equities.

Corporate Stocks:

Equity claims to the income and assets of corporations.

Mortgages (Residential, Commercial and Farm):

Loans to individuals and firms used to purchase land, houses, and otherstructures.

The land or structure then serves as collateral. The mortgage market is the biggest debt market in the US.

Corporate Bonds: Intermediate and long-term debt issued by corporations. Usually make regular interest payments twice per year. Return a fixed amount (face value) at maturity.

US Government Securities: Treasury Notes = currently issued with maturities of 2, 5, and 10 years;

hence intermediate-term debt. Treasury Bonds = Before October 2001, issued with maturity of 30

years; hence long-term debt. In October 2001, the US Treasury stopped issuing 30-year bonds,

making the 10-year US Treasury note the US Government security with the longest

maturity. Make regular interest payments twice per year and return a fixed

amount at maturity.

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State and Local Government (Municipal) Bonds:

Intermediate and long-term debt issued by state and local governments. Interest payments are exempt from federal income taxes, making

municipal bonds especially attractive to some investors.

US Government Agency Bonds:

Somewhat like a combination between US Treasury bonds and notesand corporate bonds, but issued by US Government agencies(government-sponsored corporations).

Examples: Federal National Mortgage Association (FNMA, FannieMae) and Federal Home Loan Mortgage Corporation (FHLMC,Freddie Mac) sell bonds and use the proceeds to buy mortgages.Student Loan Marketing Association (SLMA, Sallie Mae) sells bondsand uses the proceeds to buy student loans.

Commercial and Consumer Loans:

Loans, originally made by banks, to businesses and households. Secondary markets for these loans are only now just developing.

ROLE OF FINANCIAL INTERMEDIARIES

We have now considered a wide variety of financial instruments thatarise through the process of direct finance, in which the lender sellssecurities directly to the borrower.

Why does some borrowing and lending take place, instead, throughindirect finance that is, with the help of a financial intermediary?

Financial intermediaries play a number of special roles, and help solve anumber of special problems, in the process of indirect finance.

i. Transaction Costs and Economies Transaction costs = the time and money spent in carrying out financial

transactions. Financial intermediaries help reduce transaction costs by taking

advantage of economies of scale. Example: a bank can use the same loan contract again and again,

thereby reducing the Costs of making each individual loan.ii. Risk Sharing and Diversification

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Risk = uncertainty about the returns investors will receive on anyparticular asset.

By purchasing a large number of different assets issued by a wide rangeof borrowers, financial intermediaries use diversification to help withrisk sharing.

Example: by lending to a large number of different businesses, a bankmight see a few of its loans go bad; but most of the loans will be repaid,making the overall return less risky.

Here, again, the bank is taking advantage of economies of scale, since itwould be difficult for a smaller investor to make a large number of loans.

iii. Adverse Selection and Moral Hazard Financial intermediaries also use their expertise to screen out bad credit

risks and monitor borrowers.

They thereby help solve two problems related to imperfect informationin financial markets.

Adverse Selection = refers to the problem that arises before a loan ismade because borrowers who are bad credit risks tend to be those whomost actively seek out loans.

Financial intermediaries can help solve this problem by gatheringinformation about potential borrowers and screening out bad creditrisks.

Moral Hazard = refers to the problem that arises after a loan is madebecause borrowers may use their funds irresponsibly

Financial intermediaries can help solve this problem by monitoringborrowers activities.

TYPES OF FINANCIAL INTERMEDIARIES

The main types of financial intermediaries are listed

1. Depository Institutions (Banks):Depository institutions as a group:

Accept (issue) deposits, which then become their liabilities. Make loans, which then become their assets.

i. Commercial Banks Sources of funds (liabilities): issue deposits Checking deposits = provide check-writing privileges. Savings deposits = do not provide check-writing privileges, but allow

funds to be withdrawn at any time.

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Time deposits = require that funds be deposited for a fixed period of time, with penalty for early withdrawal.

Uses of funds (assets): make commercial, consumer, and mortgageloans, buy US Government and municipal bonds.

ii. Savings and Loan Associations Sources of funds: issue deposits. Uses of funds: make loans, mainly mortgage loans.

iii. Mutual Savings Banks Like S&Ls, but structured as mutuals, meaning that the depositors

own the bank. Sources of funds: issue deposits. Uses of funds: make loans, mainly mortgage loans.

iv. Credit Unions Set up to serve small groups: union members, employees of a particular

firm, etc. Sources of funds: issue deposits Uses of funds: make loans, mainly consumer loans. Collectively, savings and loan associations, mutual savings banks, and

credit unions are called thrift institutions. The distinctions between commercial banks and thrift institutions are

mainly historical and have blurred over the years. Example: before 1980, thrift institutions were not permitted to issue

checking deposits. S&Ls and mutual savings banks were not allowed tomake consumer loans, and credit unions were not allowed to makemortgage loans.2. Contractual Savings Institutions

Contractual savings institutions as a group:

Acquire funds at periodic, or regular, intervals on a contractual basis.

i. Life Insurance Companies Sources of funds: collect premiums from policies. Uses of funds: buy corporate bonds and mortgages, some stocks.

ii. Fire and Casualty Insurance Companies Sources of funds: collect premiums from policies. Uses of funds: buy US Government and municipal bonds, corporate

stocks and bonds.iii. Pension Funds

Sources of funds: collect contributions from employers and employees. Uses of funds: buy corporate stocks and bonds.

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3. Investment Intermediariesi. Finance Companies

Sources of funds: sell commercial paper, stocks, and bonds. Uses of funds: make consumer and business loans. Example: Ford Motor Credit sells commercial paper and bonds and

uses the proceeds to make loans to people who buy Ford cars andtrucks.

ii. Mutual Funds Mutual funds allow individual investors to pool their resources and

thereby hold a more diversified portfolio of assets with lowertransaction costs.

Sources of funds: sells shares to individuals. Uses of funds: buy stocks and bonds.

iii. Money Market Mutual Funds Sources of funds: sell shares to individuals. Uses of funds: buy money market instruments. Shareholders can often write checks against the value of their

shareholdings.

WHAT DOES FLOATING INTEREST RATE MEAN?

An interest rate that is allowed to move up and down with the rest of themarket or along with an index. This contrasts with a fixed interest rate, inwhich the interest rate of a debt obligation stays constant for the duration of the agreement. A floating interest rate can also be referred to as a variableinterest rate because it can vary over the duration of the debt obligation.

London Inter-Bank Offer Rate (LIBOR)

London Inter-Bank Offer Rate. The interest rate that the banks charge eachother for loans (usually in Eurodollars) . This rate is applicable to the short-term international interbank market, and applies to very large loans

borrowed for anywhere from one day to five years. This market allows bankswith liquidity requirements to borrow quickly from other banks withsurpluses, enabling banks to avoid holding excessively large amounts of theirasset base as liquid assets. The LIBOR is officially fixed once a day by a smallgroup of large London banks, but the rate changes throughout the day.

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The LIBOR is the world's most widely used benchmark for short-terminterest rates. It's important because it is the rate at which theworld's most preferred borrowers are able to borrow money. It is also the rateupon which rates for less preferred borrowers are based. For example, amultinational corporation with a very good credit rating may be able toborrow money for one year at LIBOR plus four or five points.

Countries that rely on the LIBOR for a reference rate include the UnitedStates, Canada, Switzerland and the U.K.

An interest rate at which banks can borrow funds, in marketable size, fromother banks in the London interbank market. The LIBOR is fixed on a dailybasis by the British Bankers' Association. The LIBOR is derived from afiltered average of the world's most creditworthy banks' interbank depositrates for larger loans with maturities between overnight and one full year.

LIBOR is the interest rate that banks charge each other for one-month, three-month, six-month and one-year loans. LIBOR is an acronym for London Inter

Bank Offered Rate. This rate is that which is charged by London banks, andis then published and used as the benchmark for bank rates all over theworld.

LIBOR is also used to guide banks in setting rates for adjustable-rate loans,including interest-only mortgages and credit card debt. Lenders typically adda point or two to create a profit.

Mumbai Interbank Offered Rate (MIBOR)

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The interest rate at which banks can borrow funds, in marketable size, fromother banks in the Indian interbank market. The Mumbai Interbank OfferedRate (MIBOR) is calculated everyday by the National Stock Exchange of India (NSEIL) as a weighted average of lending rates of a group of banks, onfunds lent to first-class borrowers

The MIBOR was launched on June 15, 1998 by the Committee for theDevelopment of the Debt Market, as an overnight rate. The NSEIL launchedthe 14-day MIBOR on November 10, 1998, and the one month and threemonth MIBORs on December 1, 1998. Since the launch, MIBOR rates havebeen used as benchmark rates for the majority of money market deals madein India.

An overnight lending rate calculated daily by the National Stock Exchange of India. This rate is given to first class borrowers and lending institutions, andis based on an average of lending rates offered by major banks throughoutIndia. Since its launch on June 15th 1998, this benchmark has been used todetermine rates on nearly all money market deals made in India.

Mumbai Interbank Bid Rate (MIBID)

The interest rate that a bank participating in the Indian interbank marketwould be willing to pay to attract a deposit from another participant bank.The MIBID is calculated everyday by the National Stock Exchange of India(NSEIL) as a weighted average of interest rates of a group of banks, on fundsdeposited by first-class depositors.

This would be the interest rate that one participating bank would pay anotherto attract the deposit of funds. The MIBID rate would be lower than the

interest rate offered to those wanting to borrow funds, known as MumbaiInterbank Offered Rate (MIBOR). This is to provide the bank a profit fromthe spread of interest earned and paid.

Reserve Bank of India

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The central bank of the country is the Reserve Bank of India (RBI). It wasestablished in April 1935 with a share capital of Rs. 5 crores on the basis of the recommendations of the Hilton Young Commission. The share capital wasdivided into shares of Rs. 100 each fully paid which was entirely owned byprivate shareholders in the begining. The Government held shares of nominalvalue of Rs. 2, 20,000.

Reserve Bank of India was nationalized in the year 1949. The generalsuperintendence and direction of the Bank is entrusted to Central Board of Directors of 20 members, the Governor and four Deputy Governors, oneGovernment official from the Ministry of Finance, ten nominated Directors bythe Government to give representation to important elements in the economiclife of the country, and four nominated Directors by the Central Governmentto represent the four local Boards with the headquarters at Mumbai, Kolkata,

Chennai and New Delhi. Local Boards consist of five members each CentralGovernment appointed for a term of four years to represent territorial andeconomic interests and the interests of co-operative and indigenous banks.

The Bank was constituted for the need of following:

To regulate the issue of banknotes To maintain reserves with a view to securing monetary stability and To operate the credit and currency system of the country to its

advantage.

Functions of Reserve Bank of India

The Reserve Bank of India Act of 1934 entrust all the important functions of acentral bank the Reserve Bank of India.

Bank of Issue

Under Section 22 of the Reserve Bank of India Act, the Bank has the sole rightto issue bank notes of all denominations. The distribution of one rupee notesand coins and small coins all over the country is undertaken by the ReserveBank as agent of the Government. The Reserve Bank has a separate IssueDepartment which is entrusted with the issue of currency notes. The assetsand liabilities of the Issue Department are kept separate from those of theBanking Department. Originally, the assets of the Issue Department were to

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consist of not less than two-fifths of gold coin, gold bullion or sterlingsecurities provided the amount of gold was not less than Rs. 40 crores invalue. The remaining three-fifths of the assets might be held in rupee coins,Government of India rupee securities, eligible bills of exchange and

promissory notes payable in India. Due to the exigencies of the Second WorldWar and the post-was period, these provisions were considerably modified.Since 1957, the Reserve Bank of India is required to maintain gold andforeign exchange reserves of Ra. 200 crores, of which at least Rs. 115 croresshould be in gold. The system as it exists today is known as the minimumreserve system.

Banker to Government

The second important function of the Reserve Bank of India is to act asGovernment banker, agent and adviser. The Reserve Bank is agent of CentralGovernment and of all State Governments in India excepting that of Jammuand Kashmir. The Reserve Bank has the obligation to transact Governmentbusiness, via. to keep the cash balances as deposits free of interest, to receiveand to make payments on behalf of the Government and to carry out theirexchange remittances and other banking operations. The Reserve Bank of India helps the Government - both the Union and the States to float new loans

and to manage public debt. The Bank makes ways and means advances to theGovernments for 90 days. It makes loans and advances to the States and localauthorities. It acts as adviser to the Government on all monetary and bankingmatters.

Bankers' Bank and Lender of the Last Resort

The Reserve Bank of India acts as the bankers' bank. According to theprovisions of the Banking Companies Act of 1949, every scheduled bank was

required to maintain with the Reserve Bank a cash balance equivalent to 5%of its demand liabilites and 2 per cent of its time liabilities in India. By anamendment of 1962, the distinction between demand and time liabilities wasabolished and banks have been asked to keep cash reserves equal to 3 per centof their aggregate deposit liabilities. The minimum cash requirements can bechanged by the Reserve Bank of India.

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The scheduled banks can borrow from the Reserve Bank of India on the basisof eligible securities or get financial accommodation in times of need orstringency by rediscounting bills of exchange. Since commercial banks can

always expect the Reserve Bank of India to come to their help in times of banking crisis the Reserve Bank becomes not only the banker's bank but alsothe lender of the last resort.

Controller of Credit

The Reserve Bank of India is the controller of credit i.e. it has the power toinfluence the volume of credit created by banks in India. It can do so through

changing the Bank rate or through open market operations. According to theBanking Regulation Act of 1949, the Reserve Bank of India can ask anyparticular bank or the whole banking system not to lend to particular groupsor persons on the basis of certain types of securities. Since 1956, selectivecontrols of credit are increasingly being used by the Reserve Bank.

The Reserve Bank of India is armed with many more powers to control theIndian money market. Every bank has to get a licence from the Reserve Bankof India to do banking business within India, the licence can be cancelled bythe Reserve Bank of certain stipulated conditions are not fulfilled. Every bankwill have to get the permission of the Reserve Bank before it can open a newbranch. Each scheduled bank must send a weekly return to the Reserve Bankshowing, in detail, its assets and liabilities. This power of the Bank to call forinformation is also intended to give it effective control of the credit system.The Reserve Bank has also the power to inspect the accounts of anycommercial bank.

As supereme banking authority in the country, the Reserve Bank of India,therefore, has the following powers:

It holds the cash reserves of all the scheduled banks. It controls the credit operations of banks through quantitative and

qualitative controls.

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It controls the banking system through the system of licensing,inspection and calling for information.

It acts as the lender of the last resort by providing rediscount facilitiesto scheduled banks.

Custodian of Foreign Reserves

The Reserve Bank of India has the responsibility to maintain the official rateof exchange. According to the Reserve Bank of India Act of 1934, the Bankwas required to buy and sell at fixed rates any amount of sterling in lots of notless than Rs. 10,000. The rate of exchange fixed was Re. 1 = sh. 6d. Since 1935the Bank was able to maintain the exchange rate fixed at lsh.6d. though therewere periods of extreme pressure in favour of or against

the rupee. After India became a member of the International Monetary Fundin 1946, the Reserve Bank has the responsibility of maintaining fixedexchange rates with all other member countries of the I.M.F.

Besides maintaining the rate of exchange of the rupee, the Reserve Bank hasto act as the custodian of India's reserve of international currencies. The vaststerling balances were acquired and managed by the Bank. Further, the RBI

has the responsibility of administering the exchange controls of the country.Supervisory functions

In addition to its traditional central banking functions, the Reserve bank hascertain non-monetary functions of the nature of supervision of banks andpromotion of sound banking in India. The Reserve Bank Act, 1934, and theBanking Regulation Act, 1949 have given the RBI wide powers of supervisionand control over commercial and co-operative banks, relating to licensing andestablishments, branch expansion, liquidity of their assets, management andmethods of working, amalgamation, reconstruction, and liquidation. The RBIis authorised to carry out periodical inspections of the banks and to call forreturns and necessary information from them. The nationalisation of 14major Indian scheduled banks in July 1969 has imposed new responsibilitieson the RBI for directing the growth of banking and credit policies towards

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more rapid development of the economy and realisation of certain desiredsocial objectives. The supervisory functions of the RBI have helped a greatdeal in improving the standard of banking in India to develop on sound linesand to improve the methods of their operation.

Promotional functions

With economic growth assuming a new urgency since Independence, therange of the Reserve Bank's functions has steadily widened. The Bank nowperforms a varietyof developmental and promotional functions, which, at onetime, were regarded as outside the normal scope of central banking. TheReserve Bank was asked to promote banking habit, extend banking facilitiesto rural and semi-urban areas, and establish and promote new specialisedfinancing agencies. Accordingly, the Reserve Bank has helped in the setting upof the IFCI and the SFC; it set up the Deposit Insurance Corporation in 1962,the Unit Trust of India in 1964, the Industrial Development Bank of India alsoin 1964, the Agricultural Refinance Corporation of India in 1963 and theIndustrial Reconstruction Corporation of India in 1972. These institutionswere set up directly or indirectly by the Reserve Bank to promote saving habitand to mobilise savings, and to provide industrial finance as well asagricultural finance. As far back as 1935, the Reserve Bank of India set up the

Agricultural Credit Department to provide agricultural credit. But only since1951 the Bank's role in this field has become extremely important. The Bankhas developed the co-operative credit movement to encourage saving, toeliminate moneylenders from the villages and to route its short term credit toagriculture. The RBI has set up the Agricultural Refinance and DevelopmentCorporation to provide long-term finance to farmers.

Classification of RBIs functions

The monetary functions also known as the central banking functions of theRBI are related to control and regulation of money and credit, i.e., issue of currency, control of bank credit, control of foreign exchange operations,banker to the Government and to the money market. Monetary functions of the RBI are significant as they control and regulate the volume of money andcredit in the country.

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Equally important, however, are the non-monetary functions of the RBI in thecontext of India's economic backwardness. The supervisory function of theRBI may be regarded as a non-monetary function (though many consider thisa monetary function). The promotion of sound banking in India is an

important goal of the RBI, the RBI has been given wide and drastic powers,under the Banking Regulation Act of 1949 - these powers relate to licencing of banks, branch expansion, liquidity of their assets, management and methodsof working, inspection, amalgamation, reconstruction and liquidation. Underthe RBI's supervision and inspection, the working of banks has greatlyimproved. Commercial banks have developed into financially andoperationally sound and viable units. The RBI's powers of supervision havenow been extended to non-banking financial intermediaries. Since

independence, particularly after its nationalisation 1949, the RBI has followedthe promotional functions vigorously and has been responsible for strongfinancial support to industrial and agricultural development in the country.

Fiscal Policy:

Fiscal policy is an additional method to determine public revenue and publicexpenditure. In the recent years importance of fiscal policy has increased dueto economic fluctuations. Fiscal policy is an important instrument in themodern time. According to Arther Simithies fiscal policy is a policy underwhich government uses its expenditure and revenue programme to producedesirable effects and avoid undesirable effects on the national income,production and employment.

Objectives of fiscal policy:

The objectives of fiscal policy may be regarded as follows;

1. To achieve desirable price level:

The stability of general prices is necessary for economic stability. Themaintenance of a desirable price level has good effects on production,employment and national income. Fiscal policy should be used to remove;fluctuations in price level so that ideal level is maintained.

2. To Achieve desirable consumption level:

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A desirable consumption level is important for political, social and economicconsideration. Consumption can be affected by expenditure and tax policies of the government. Fiscal policy should be used to increase welfare of theeconomy through consumption level.

3. To Achieve desirable employment level:

The efficient employment level is most important in determining the livingstandardof the people. It is necessary for political stability and formaximization ofproduction. Fiscal policy should achieve this level.

4. To achieve desirable income distribution:

The distribution of income determines the type of economic activities theamount of savings. In this way, it is related to prices, consumption andemployment. Income distribution should be equal to the most possible degree.Fiscal policy can achieve equality in distribution of income.

5. Increase in capital formation:

In under-developed countries deficiency of capital is the main reason forunder-development. Large amounts are required for industry and economicdevelopment. Fiscal policy can divert resources and increase capital.

6. Degree of inflation:In under-developed countries, a degree of inflation is required for economicdevelopment. After a limit, inflationary be used to get rid of this situation.

Instruments of Fiscal Policy:

1. Public expenditure

2. Taxes3. Public debts

The above mentioned instruments are used by the public authorities to

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achieve desirable level of production, consumption and National Income.During inflationary trend more and more taxes are levied on the community.In this way, purchasing power of the people can be decreased and desirableprice level is achieved. During inflation public expenditure is decreased sothat all in production may decrease high prices and increase the value of money. During deflationary period taxes are reduced and public expenditureis increased. In this way incentives to invest are increased and national incomebegins to rise. For economic development public debts are necessary. In underdeveloped countries, due to insufficient resources economic development isnot possible. Public loans are drawn internally and externally.

The above mentioned methods are called budgetary policy of the government.This policy can increase national income, production level and maintain full

employment level.

Definition of Fiscal Policy

Fiscal Policy is the main part of Economic Policy and Fiscal Policy's first wordFiscal is taken from French word Fisc it mean s treasure of Govt. So we candefine fiscal policy as the revenue and expenditure policy of Govt. of India .Itis 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 welfareprojects are completed under this policy

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. Withthis policy, all work is done govt. planning and proper use of fund fordevelopment functions. If govt. does not make fiscal policy, then it mayhappen that revenue may be misused without targeted expenditure of govt.

2. Employment:-

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Getting the full employment is also objective of fiscal policy. Govt. can takemuch action for increase employment. Government can fix certain amountwhich can be utilized for creation of new employment for unemployedpeoples.

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 otherare earning less than Rs. 100 per day. By making a good fiscal policy, govt.can reduce this difference. If government 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 fiscalpolicy different minister's accountability can be checked. I was seeing theEpisode of Chanakya on YouTube in which I found that in old time fiscalpolicy was made and treasury officer and even prime minister are alsoresponsible for any shortage of government fund.

Commercial Banks

An institution which accepts deposits, makes business loans, and offers relatedservices. Commercial banks also allow for a variety of deposit accounts, suchas checking, savings, and time deposit. These institutions are run to make aprofit and owned by a group of individuals, yet some may be members of theFederal Reserve System. While commercial banks offer services toindividuals, they are primarily concerned with receiving deposits and lendingto businesses.

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Scheduled Commercial Banks In India

The commercial banking structure in India consists of:

Scheduled Commercial Banks in India Unscheduled Banks in India

Scheduled Banks in India constitute those banks which have been included inthe Second Schedule of Reserve Bank of India(RBI) Act, 1934. RBI in turnincludes only those banks in this schedule which satisfy the criteria laid downvide section 42 (6) (a) of the Act.

As on 30th June, 1999, there were 300 scheduled banks in India having a total

network of 64,918 branches. The scheduled commercial banks in Indiacomprise of State bank of India and its associates (8), nationalized banks (19),foreign banks (45), private sector banks (32), co-operative banks and regionalrural banks.

"Scheduled banks in India" means the State Bank of India constituted underthe State Bank of India Act, 1955 (23 of 1955), a subsidiary bank as defined inthe State Bank of India (Subsidiary Banks) Act, 1959 (38 of 1959), acorresponding new bank constituted under section 3 of the BankingCompanies (Acquisition and Transfer of Undertakings) Act, 1970 (5 of 1970),or under section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 (40 of 1980), or any other bank being a bankincluded in the Second Schedule to the Reserve Bank of India Act, 1934 (2 of 1934), but does not include a co-operative bank".

"Non-scheduled bank in India" means a banking company as defined inclause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949), which

is not a scheduled bank".

The following are the Scheduled Banks in India (Public Sector):

State Bank of India State Bank of Bikaner and Jaipur State Bank of Hyderabad

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State Bank of Indore State Bank of Mysore State Bank of Saurashtra State Bank of Travancore Andhra Bank Allahabad Bank Bank of Baroda Bank of India Bank of Maharashtra Canara Bank Central Bank of India Corporation Bank Dena Bank Indian Overseas Bank Indian Bank Oriental Bank of Commerce Punjab National Bank Punjab and Sind Bank Syndicate Bank Union Bank of India United Bank of India UCO Bank Vijaya Bank

The following are the Scheduled Banks in India (Private Sector):

ING Vysya Bank Ltd Axis Bank Ltd Indusind Bank Ltd ICICI Bank Ltd South Indian Bank HDFC Bank Ltd

Centurion Bank Ltd Bank of Punjab Ltd IDBI Bank Ltd Jammu & Kashmir Bank Ltd.

The following are the Scheduled Foreign Banks in India:

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American Express Bank Ltd. ANZ Gridlays Bank Plc. Bank of America NT & SA Bank of Tokyo Ltd. Banquc Nationale de Paris Barclays Bank Plc Citi Bank N.C. Deutsche Bank A.G. Hongkong and Shanghai Banking Corporation Standard Chartered Bank. The Chase Manhattan Bank Ltd. Dresdner Bank AG.

MEANING AND FUNCTIONS OF COMMERCIAL BANK

Meaning of commercial banks

A banking company is one which transacts the business of banking whichmeans the accepting for the purpose of lending all investments, of deposits of money form the public, repayuable on demand or otherwise andwithdrawable by cheque, draft or otherwise.

There are two essential functions that a financial institution must perform tobecome a bank. These are

a) Accepting of the chequable deposit form the public

b) LendingMain features:

1. It accepts deposits from the public. These deposits can be withdrawn bycheque and are repayable on demand.

2. A commercial bank uses the deposited money for lending and forinvestment in securities.

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3. It is a commercial institution , whose aim is to earn profit4. It is a unique financial institution, that creates demand deposits which

serves as the medium of exchange.5. Money created by commercial banks is known as deposit money.

Functions of commercial Banks

Various functions of commercial banks can be divided into three maingroups;

i. Primary functionsii. Agency functionsiii. General utility functions

PRIMARY FUNCTIONS - There are two main primary functions of thecommercial banks which are discussed below :

1. Accepting deposits The primary function of commercial bank is toaccept deposits form every class and from every source. To attractsavings the bank accepts mainly three types of deposits. They arenamely demand deposits, saving deposits, fixed deposit.

Demand deposit ( also known as current deposit) are those deposits whichcan be withdrawn by the depositor at any time by means of cheque. Nointerest is paid on such deposits. Rather, the depositor have to paysomething to the bank for the services rendered by the businessmen andindustrialists. It is also called current account.

Saving deposits These are those deposits on the withdrawal of whichbank places certain restrictions. Cheque facility is provided to the

depositors. Saving deposits accounts are generally held by households whohave idle or surplus money for short period.

Fixed deposit These are those deposits which can be withdrawn only afterthe expiry of the certain fixed time period. These deposits carry high rateof interest. The longer the period, higher will be the rate of interest.

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Distingusish between demand deposit and fixed deposit

Demand deposit Fixed deposit

1. Demand deposit can bewithdrawn by the depositor atanytime without notice.

These deposit can be withdrawnonly afgter the expiry of thecertain fixed time period.

2.They are chequable i.e., demanddeposits are withdrawablethrough cheques

They are not chequable.

3.No interest is paid on thesedeposits. Rather depositors haveto pay something to the bank forits services.

These deposits carry high rate of ihterest.

4. These deposits constitute of apart of money supply

They fall under sthe categoryu of near money assests.

Advancing of loans

Commercial banks give loans and advances to businessmen, farmers,consumers and employers against approved securities. Approved securitiesrefer to gold, silver, vullion, govt. securities, easily savable stock and sharesand marketable goods. The bank advances following types of loans-

a. Cash credit Under this the borrower is allowed to withdraw upto a certain amount on a given security which comprise mainlystocks of goods and B/R from others., But interest is charged on

the amount actually withdrawn.b. Overdraft It is a most common way of lending. Under it, theborrower is allowed to overdraw hios current a/c balance.Overdraft is a temporary facility.

c. Short term loans Under it loans of a fixed amount aresanctioned. The sanctioned amount is credited in the debtors a/c.

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Bank charges interest on the whole amount form the day it wassanctioned.

The difference between a loan and an overdraft is that, while in case of loan,the borrower pays interest on the amount outstanding against his a/c. But is

the case of an overdraft, the customer pays interest on the deal balancestanding against his a/c further. Loans are given against security, whileoverdrafts are made without securities. From the borrowers point of view,overdraft is preferable thorough a loan because, in case of loan, he will haveto pay interest on the full amount of loan sanctioned whether he uses it fullyor not. But in the case of overdraft, he has the facility of borrowing only asmuch as he requires.

d. Discounting of trhe bill of exchangeThis is another popular type of lending by the commercial banks.Through this method, the holder of the bills of exchange (writtenduring trade transactions) can get it discounted by the banks. Thebanks after demanding the comm. pays the value of the bills to theholder. When the bills of exchange mature, the bank gets its paymentfrom the party which had accepted the bill.

e. Money at callSuch loans are very short period loans and can be called back by the

bank at a very short notice of say one day to 14 days. These loans aregenerally made by one bank to another bank or financial institutions.

THE BANK BALANCE SHEET

To understand how a bank operates, we first examine a commercial bank'sbalance sheet, where: Total Assets = Debt + Equity (or TA = Total Liabilities+ Capital)

BANK LIABILITIES = Sources of Bank Funds:

1. Checkable Deposits - (10%)

a. Demand deposits (non-interest-bearing checking)

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b. NOW accounts - interest-bearing checking

c. Money market deposit accounts (MMDAs) - money market mutual funds.

Checkable deposits are payable on demand, you can write a check for anyamount, including your entire balance. Checkable deposits are lowest costsource of funds for a bank, sometimes 0 (demand deposits), because peoplelike the liquidity of checking accounts and will forego interest for convenienceof checks.

2. Nontransaction Deposits (59%) are the Primary source of bank funds

a. Savings accounts (passbook savings)

b. Small-denomination Time Deposits (CDs, certificate of deposits), fixedmaturity from several months to 10 years, less than $100,000. Higher interestrates than passbook savings, penalties for early withdrawal, less liquid, morecostly for the bank.

c. Large-denomination Time Deposits, over $100,000, bought by corporations,money market funds and other banks. Liquid, negotiable, marketable, can beresold in secondary market before they mature, like a corporate bond or T-

bond. Alternative to commercial paper and T-bills.3. Borrowings (23%) of bank funds:

a. from other banks - Fed Funds Market - to meet reserve requirements

b. from FRS - discount rate - to meet reserve requirements

c. from parent companies - bank holding companies

d. from corporations and from foreign banks - negotiable CDs and Eurodollardeposits

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3. Bank capital (8%), equity from issuing new stock or capital from retainedearnings. Bank capital is also a cushion against a drop in the value of itsassets, to protect against insolvency, bankruptcy.

NOTE: Banks are usually highly leveraged - 92% D/A ratio, very thinlycapitalized.

BANK ASSETS = Uses of Bank Funds:

A bank uses its deposits to acquire income-earning assets, to make profits, byearning more interest on assets than they pay out on liabilities.

1. Reserves (1%): Deposits kept on account at the Fed (all banks have anaccount at the Fed) + Vault cash on hand at bank, stored in the vaultovernight.

Some reserves are required by FRS, as a percentage of deposits. Reserverequirements - percentage a bank is required to hold as a percent of certaindeposits. Notice that reserves (R) are only about 1.6% of Deposits (D),checking and saving deposits, (1 / 63). Banks also hold excess reserves, inaddition to required reserves for increased liquidity, to meet demand for cash

withdrawals and check clearing.2. Securities (22%): Banks also hold securities like Tbills and muni bonds andGNMA bonds, etc. Commercial banks are not allowed to own stock, mustonly own government debt instruments.

3. Loans (72%): Most bank profits come from Loans. Loans make up 72% of bank assets:a. Commercial loans to businesses

b. real estate loans (mortgages, home improvement loans, etc.)

c. consumer loans (credit card, automobiles)

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d. interbank loans, Federal Funds market

e. other loans

Loans are less liquid than other assets (e.g. securities, T-Bills, etc.) because theassets tied up for the length of the loan, 30 years in the case of a typicalmortgage. Loans are also more risky, higher default risk than securities.Because loans are more risky and less liquid, they earn more interest forbanks.

4. Other Assets (5%): Property, plant and equipment. Buildings, officeequipment, computer systems, etc.

BASIC OPERATION OF A BANK:

GENERAL PRINCIPLES OF BANK MANAGEMENT

We now look at bank management, how it manages assets (loans) andliabilities (deposits) to maximize profits.

1. Liquidity Management - maintaining enough liquid assets to meetobligations to depositors (for cash withdrawals) and to FRS.

2. Asset Management - managing assets (loan portfolio) to achieve

diversification and minimize default risk/credit risk and interest rate risk. 3. Liability Management - acquire/attract funds (deposits) at lowest possiblecost.

4. Capital Adequacy Management - maintaining the appropriate net worth tomeet federal regulations and prevent bank failure.

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1. LIQUIDITY MANAGEMENT- Management of bank reserves. Twoconcerns: 1) excess reserves and 2) insufficient reserves.

Bank is holding non interest-bearing assets, reserves pay 0 interest. Loansgenerate interest income ( example: credit cards @ 20%). Opp cost of excessreserves is the lost/foregone interest income. Banks therefore want tominimize excess reserves. However, if a bank has deficient reserves, therecould possibly be a costly readjustment process. Banks want to hold theoptimal amount of excess reserves, but the optimal amount is NOT zero.

Example: see page 220. Assume reserve requirement is 10%, banks are

required to hold minimum reserves equal to 10% of checking and savingsdeposits.

Scenario #1: Bank initially has excess reserves. Required reserves: $10m.Actual reserves: $20m. Excess reserves in the amount of $10m.

Assume a deposit outflow of $10m. People move to Florida for the winter andwithdraw $10m from Bank One. Or Stock market boom and people transfermoney from checking to mutual funds. Or there is a natural disaster (flood,earthquake, hurricane) and there is a large deposit outflow. Bank can handle

the $10m deposit outflow and still meet the 10% reserve requirement withouthaving to make any other changes in its balance sheet.

ASSET MANAGEMENT

Banks want to manage their assets (loans) to maximize profits by:

1. Assess creditworthiness of loan customers, avoid costly defaults. Banks areusually conservative - defaults are less than 1% of bank loans. Optimalnumber of loan defaults is not zero. Why?

2. Purchase securities, subject to banking regulations. Usually restricted totreasury securities and muni bonds.

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3. Diversify assets. Short and long term securities. Diversity loan portfolio -commercial, auto, student, mortgage, credit card, etc. Undiversified loanportfolios are exposed to risk. Example: too many real estate or farm loans inone area is risky.

4. Manage assets to ensure liquidity, holding sufficient liquid assets like T-Bills in case of large deposit outflows, loss of reserves. T-Bills are so safe andliquid that they are considered "secondary reserves." Bank has to balanceliquidity (holding reserves and T-Bills) against increased earnings from lessliquid assets (holding loans).

LIABILITY MANAGEMENT

Banks used to rely on demand deposits (no interest) for their main source of funds - 60%, in 1960s. Before 1980, banks were not allowed to pay interest onchecking, so there was no competition for demand deposits. Also, the fedfunds market was not developed, so inter-bank borrowing was rare, to meetreserve requirements. Therefore, banks used to focus on asset management(optimal loan portfolio), because liabilities (demand deposits) were stable andnon-competitive.

Starting in the 1960s, fed funds market developed, so banks had access to anew source of funds: other banks. Also, banks began to issue negotiable CDs,

which allowed banks access to another source of funds besides deposits.Banks now placed greater emphasis on liability management, due to increasedflexibility for attracting sources of funds. They no longer needed to relyexclusively on checking deposits. They now set goals for asset (growth) andthen acquired funds (issuing liabilities) as they needed for new loans.

Economic Reforms of the Banking Sector In India

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Indian banking sector has undergone major changes and reforms duringeconomic reforms. Though it was a part of overall economic reforms, it haschanged the very functioning of Indian banks. This reform have not onlyinfluenced the productivity and efficiency of many of the Indian Banks, buthas left everlasting footprints on the working of the banking sector in India.

Let us get acquainted with some of the important reforms in the bankingsector in India.

1. Reduced CRR and SLR : The Cash Reserve Ratio (CRR) and StatutoryLiquidity Ratio (SLR) are gradually reduced during the economic reformsperiod in India. By Law in India the CRR remains between 3-15% of theNet Demand and Time Liabilities. It is reduced from the earlier high level of 15% plus incremental CRR of 10% to current 4% level. Similarly, the SLRIs also reduced from early 38.5% to current minimum of 25% level. Thishas left more loanable funds with commercial banks, solving the liquidityproblem.

2. Deregulation of Interest Rate: During the economic reforms period, interestrates of commercial banks were deregulated. Banks now enjoy freedom of fixing the lower and upper limit of interest on deposits. Interest rate slabs

are reduced from Rs.20 Lakhs to just Rs. 2 Lakhs. Interest rates on the bankloans above Rs.2 lakhs are full decontrolled. These measures have resultedin more freedom to commercial banks in interest rate regime.

3. Fixing prudential Norms: In order to induce professionalism in itsoperations, the RBI fixed prudential norms for commercial banks. Itincludes recognition of income sources. Classification of assets, provisionsfor bad debts, maintaining international standards in accounting practices,etc. It helped banks in reducing and restructuring Non-performing assets(NPAs).

4. Introduction of CRAR: Capital to Risk Weighted Asset Ratio (CRAR) wasintroduced in 1992. It resulted in an improvement in the capital position of commercial banks, all most all the banks in India has reached the CapitalAdequacy Ratio (CAR) above the statutory level of 9%.

5. Operational Autonomy: During the reforms period commercial banksenjoyed the operational freedom. If a bank satisfies the CAR then it gets

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freedom in opening new branches, upgrading the extension counters, closingdown existing branches and they get liberal lending norms.

6. Banking Diversification: The Indian banking sector was well diversified,during the economic reforms period. Many of the banks have stared newservices and new products. Some of them have established subsidiaries inmerchant banking, mutual funds, insurance, venture capital, etc which hasled to diversified sources of income of them.

7. New Generation Banks: During the reforms period many new generationbanks have successfully emerged on the financial horizon. Banks such asICICI Bank, HDFC Bank, UTI Bank have given a big challenge to thepublic sector banks leading to a greater degree of competition.

8. Improved Profitability and Efficiency: During the reform period, theproductivity and efficiency of many commercial banks has improved. It hashappened due to the reduced Non-performing loans, increased use of

technology, more computerization and some other relevant measuresadopted by the government.

These are some of the import reforms regarding the banking sector in India.

With these reforms, Indian banks especially the public sector banks haveproved that they are no longer inefficient compared with their foreigncounterparts as far as productivity is concerned.

Financial and Banking Sector ReformsThe last decade witnessed the maturity of India's financial markets. Since1991, every governments of India took major steps in reforming the financialsector of the country. The important achievements in the following fields isdiscussed under separate heads:

Financial markets Regulators The banking system Non-banking finance companies The capital market Mutual funds

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Overall approach to reforms Deregulation of banking system Capital market developments Consolidation imperative

Now let us discuss each segment separately.

The banking system

Almost 80% of the businesses are still controlled by Public Sector Banks(PSBs). PSBs are still dominating the commercial banking system. Shares of the leading PSBs are already listed on the stock exchanges.

The RBI has given licenses to new private sector banks as part of theliberalization process. The RBI has also been granting licenses to industrialhouses. Many banks are successfully running in the retail and consumersegments but are yet to deliver services to industrial finance, retail trade,small business and agricultural finance.

The PSBs will play an important role in the industry due to its number of branches and foreign banks facing the constraint of limited number of branches. Hence, in order to achieve an efficient banking system, the onus ison the Government to encourage the PSBs to be run on professional lines.

Development finance institutions

FIs's access to SLR funds reduced. Now they have to approach the capitalmarket for debt and equity funds.

Convertibility clause no longer obligatory for assistance to corporatesanctioned by term-lending institutions.

Capital adequacy norms extended to financial institutions.

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DFIs such as IDBI and ICICI have entered other segments of financialservices such as commercial banking, asset management and insurancethrough separate ventures. The move to universal banking has started.

Non-banking finance companies

In the case of new NBFCs seeking registration with the RBI, the requirementof minimum net owned funds, has been raised to Rs.2 crores.

Until recently, the money market in India was narrow and circumscribed bytight regulations over interest rates and participants. The secondary marketwas underdeveloped and lacked liquidity. Several measures have beeninitiated and include new money market instruments, strengthening of existing instruments and setting up of the Discount and Finance House of India (DFHI).

The RBI conducts its sales of dated securities and treasury bills through itsopen market operations (OMO) window. Primary dealers bid for thesesecurities and also trade in them. The DFHI is the principal agency fordeveloping a secondary market for money market instruments andGovernment of India treasury bills. The RBI has introduced a liquidityadjustment facility (LAF) in which liquidity is injected through reverse repoauctions and liquidity is sucked out through repo auctions.

On account of the substantial issue of government debt, the gilt- edged marketoccupies an important position in the financial set- up. The Securities Trading

Corporation of India (STCI), which started operations in June 1994 has amandate to develop the secondary market in government securities.

Long-term debt market: The development of a long-term debt market iscrucial to the financing of infrastructure. After bringing some order to theequity market, the SEBI has now decided to concentrate on the development

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of the debt market. Stamp duty is being withdrawn at the time of dematerialization of debt instruments in order to encourage paperlesstrading.

The capital market

The number of shareholders in India is estimated at 25 million. However, onlyan estimated two lakh persons actively trade in stocks. There has been adramatic improvement in the country's stock market trading infrastructureduring the last few years. Expectations are that India will be an attractiveemerging market with tremendous potential. Unfortunately, during recenttimes the stock markets have been constrained by some unsavory

developments, which has led to retail investors deserting the stock markets.

Mutual funds

The mutual funds industry is now regulated under the SEBI (Mutual Funds)Regulations, 1996 and amendments thereto. With the issuance of SEBIguidelines, the industry had a framework for the establishment of many moreplayers, both Indian and foreign players.

The Unit Trust of India remains easily the biggest mutual fund controlling acorpus of nearly Rs.70, 000 crores, but its share is going down. The biggestshock to the mutual fund industry during recent times was the insecuritygenerated in the minds of investors regarding the US 64 schemes. With thegrowth in the securities markets and tax advantages granted for investment inmutual fund units, mutual funds started becoming popular.

The foreign owned AMCs are the ones which are now setting the pace for theindustry. They are introducing new products, setting new standards of customer service, improving disclosure standards and experimenting withnew types of distribution.

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The insurance industry is the latest to be thrown open to competition from theprivate sector including foreign players. Foreign companies can only enter

joint ventures with Indian companies, with participation restricted to 26 percent of equity. It is too early to conclude whether the erstwhile public sectormonopolies will successfully be able to face up to the competition posed by thenew players, but it can be expected that the customer will gain from improvedservice.

The new players will need to bring in innovative products as well as freshideas on marketing and distribution, in order to improve the low per capitainsurance coverage. Good regulation will, of course, be essential.

Overall approach to reforms

The last ten years have seen major improvements in the working of variousfinancial market participants. The government and the regulatory authoritieshave followed a step-by-step approach, not a big bang one. The entry of foreign players has assisted in the introduction of international practices andsystems. Technology developments have improved customer service. Somegaps however remain (for example: lack of an inter-bank interest ratebenchmark, an active corporate debt market and a developed derivativesmarket). On the whole, the cumulative effect of the developments since 1991has been quite encouraging. An indication of the strength of the reformedIndian financial system can be seen from the way India was not affected bythe Southeast Asian crisis.

However, financial liberalization alone will not ensure stable economicgrowth. Some tough decisions still need to be taken. Without fiscal control,financial stability cannot be ensured. The fate of the Fiscal Responsibility Billremains unknown and high fiscal deficits continue. In the case of financial

institutions, the political and legal structures have to ensure that borrowersrepay on time the loans they have taken. The phenomenon of richindustrialists and bankrupt companies continues. Further, frauds cannot betotally prevented, even with the best of regulation. However, punishment hasto follow crime, which is often not the case in India.

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Deregulation of banking system

Prudential norms were introduced for income recognition, asset classification,provisioning for delinquent loans and for capital adequacy. In order to reachthe stipulated capital adequacy norms, substantial capital were provided bythe Government to PSBs.

Government pre-emption of banks' resources through statutory liquidity ratio(SLR) and cash reserve ratio (CRR) brought down in steps. Interest rates onthe deposits and lending sides almost entirely were deregulated.

New private sector banks allowed to promote and encourage competition.PSBs were encouraged to approach the public for raising resources. Recoveryof debts due to banks and the Financial Institutions Act, 1993 was passed, andspecial recovery tribunals set up to facilitate quicker recovery of loan arrears.

Bank lending norms liberalized and a loan system to ensure better controlover credit introduced. Banks asked to set up asset liability management(ALM) systems. RBI guidelines issued for risk management systems in banksencompassing credit, market and operational risks.

A credit information bureau being established to identify bad risks. Derivativeproducts such as forward rate agreements (FRAs) and interest rate swaps(IRSs) introduced.

Capital market developments

The Capital Issues (Control) Act, 1947, repealed, office of the Controller of Capital Issues were abolished and the initial share pricing were decontrolled.SEBI, the capital market regulator was established in 1992.

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Foreign institutional investors (FIIs) were allowed to invest in Indian capitalmarkets after registration with the SEBI. Indian companies were permitted toaccess international capital markets through euro issues.

The National Stock Exchange (NSE), with nationwide stock trading andelectronic display, clearing and settlement facilities was established. Severallocal stock exchanges changed over from floor based trading to screen basedtrading.

Private mutual funds permitted

The Depositories Act had given a legal framework for the establishment of depositories to record ownership deals in book entry form. Dematerializationof stocks encouraged paperless trading. Companies were required to discloseall material facts and specific risk factors associated with their projects whilemaking public issues.

To reduce the cost of issue, underwriting by the issuer were made optional,subject to conditions. The practice of making preferential allotment of sharesat prices unrelated to the prevailing market prices stopped and freshguidelines were issued by SEBI.

SEBI reconstituted governing boards of the stock exchanges, introducedcapital adequacy norms for brokers, and made rules for making client orbroker relationship more transparent which included separation of client andbroker accounts.

Buy back of shares allowed

The SEBI started insisting on greater corporate disclosures. Steps were takento improve corporate governance based on the report of a committee.

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SEBI issued detailed employee stock option scheme and employee stockpurchase scheme for listed companies.

Standard denomination for equity shares of Rs. 10 and Rs. 100 wereabolished. Companies given the freedom to issue dematerialized shares in anydenomination.

Derivatives trading starts with index options and futures. A system of rollingsettlements introduced. SEBI empowered to register and regulate venturecapital funds.

The SEBI (Credit Rating Agencies) Regulations, 1999 issued for regulatingnew credit rating agencies as well as introducing a code of conduct for allcredit rating agencies operating in India.

Consolidation imperative

Another aspect of the financial sector reforms in India is the consolidation of existing institutions which is especially applicable to the commercial banks. InIndia the banks are in huge quantity. First, there is no need for 27 PSBs withbranches all over India. A number of them can be merged. The merger of Punjab National Bank and New Bank of India was a difficult one, but thesituation is different now. No one expected so many employees to takevoluntary retirement from PSBs, which at one time were much sought after

jobs. Private sector banks will be self consolidated while co-operative andrural banks will be encouraged for consolidation, and anyway play only a

niche role.

In the case of insurance, the Life Insurance Corporation of India is abehemoth, while the four public sector general insurance companies willprobably move towards consolidation with a bit of nudging. The UTI is yetagain a big institution, even though facing difficult times, and most other

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public sector players are already exiting the mutual fund business. There area number of small mutual fund players in the private sector, but the businessbeing comparatively new for the private players, it will take some time.

We finally come to convergence in the financial sector, the new buzzwordinternationally. Hi-tech and the need to meet increasing consumer needs isencouraging convergence, even though it has not always been a success tilldate. In India organizations such as IDBI, ICICI, HDFC and SBI are alreadytrying to offer various services to the customer under one umbrella. Thisphenomenon is expected to grow rapidly in the coming years. Where mergersmay not be possible, alliances between organizations may be effective. Variousforms of bancassurance are being introduced, with the RBI having alreadycome out with detailed guidelines for entry of banks into insurance. The LIC

has bought into Corporation Bank in order to spread its insurancedistribution network. Both banks and insurance companies have startedentering the asset management business, as there is a great deal of synergyamong these businesses. The pensions market is expected to open up freshopportunities for insurance companies and mutual funds.

It is not possible to play the role of the Oracle of Delphi when a vast nationlike India is involved. However, a few trends are evident, and the comingdecade should be as interesting as the last one.

E banking

Internet banking (or E-banking) means any user with a personal computerand a browser can get connected to his bank -s website to perform any of thevirtual banking functions. In internet banking system the bank has acentralized database that is web-enabled. All the services that the bank has

permitted on the internet are displayed in menu. Any service can be selectedand further interaction is dictated by the nature of service. The traditionalbranch model of bank is now giving place to an alternative delivery channelswith ATM network. Once the branch offices of bank are interconnectedthrough terrestrial or satellite links, there would be no physical identity forany branch. It would a borderless entity permitting anytime, anywhere andanyhow banking.

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The network which connects the various locations and gives connectivity tothe central office within the organization is called intranet. These networksare limited to organizations for which they are set up. SWIFT is a liveexample of intranet application.

Internet banking in India

The Reserve Bank of India constituted a working group on Internet Banking.The group divided the internet banking products in India into 3 types basedon the levels of access granted. They are:i) Information Only System: General purpose information like interest rates,branch location, bank products and their features, loan and depositcalculations are provided in the banks website. There exist facilities fordownloading various types of application forms. The communication is

normally done through e-mail. There is no interaction between the customerand bank's application system. No identification of the customer is done. Inthis system, there is no possibility of any unauthorized person getting intoproduction systems of the bank through internet.ii) Electronic Information Transfer System: The system provides customer-specific information in the form of account balances, transaction details, andstatement of accounts. The information is still largely of the 'read only'format. Identification and authentication of the customer is throughpassword. The information is fetched from the bank's application systemeither in batch mode or off-line. The application systems cannot directlyaccess through the internet.iii) Fully Electronic Transactional System: This system allows bi-directionalcapabilities. Transactions can be submitted by the customer for online update.This system requires high degree of security and control. In this environment,web server and application systems are linked over secure infrastructure. Itcomprises technology covering computerization, networking and security,inter-bank payment gateway and legal infrastructure.

Automated Teller Machine (ATM):

ATM is designed to perform the most important function of bank. It isoperated by plastic card with its special features. The plastic card is replacingcheque, personal attendance of the customer, banking hours restrictions andpaper based verification. There are debit cards. ATMs used as spring boardfor Electronic Fund Transfer. ATM itself can provide information aboutcustomers account and also receive instructions from customers - ATM

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cardholders. An ATM is an Electronic Fund Transfer terminal capable of handling cash deposits, transfer between accounts, balance enquiries, cashwithdrawals and pay bills. It may be on-line or 0ff-line. The on-line ATNenables the customer to avail banking facilities from anywhere. In off-line thefacilities are confined to that particular ATM assigned. Any customerpossessing ATM card issued by the Shared Payment Network System can goto any ATM linked to Shared Payment Networks and perform histransactions.

Credit Cards/Debit Cards:

The Credit Card holder is empowered to spend wherever and whenever hewants with his Credit Card within the limits fixed by his bank. Credit Card isa post paid card. Debit Card, on the other hand, is a prepaid card with some

stored value. Every time a person uses this card, the Internet Banking housegets money transferred to its account from the bank of the buyer. The buyersaccount is debited with the exact amount of purchases. An individual has toopen an account with the issuing bank which gives debit card with a PersonalIdentification Number (PIN). When he makes a purchase, he enters his PINon shops PIN pad. When the card is slurped through the electronic terminal,it dials the acquiring bank system - either Master Card or VISA that validatesthe PIN and finds out from the issuing bank whether to accept or decline thetransactions. The customer can never overspend because the system rejectsany transaction which exceeds the balance in his account. The bank neverfaces a default because the amount spent is debited immediately from thecustomers account.

Smart Card:

Banks are adding chips to their current magnetic stripe cards toenhance security and offer new service, called Smart Cards. Smart Cardsallow thousands of times of information storable on magnetic stripe cards.In addition, these cards are highly secure, more reliable and perform multiple

functions. They hold a large amount of personal information, from medicaland health history to personal banking and personal preferences.

You can avail the following services through E-Banking.

Bill payment service

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You can facilitate payment of electricity and telephone bills, mobile phone,

credit card and insurance premium bills as each bank has tie-ups with variousutility companies, service providers and insurance companies, across thecountry. To pay your bills, all you need to do is complete a simple one-timeregistration for each biller. You can also set up standing instructions online topay your recurring bills, automatically. Generally, the bank does not chargecustomers for online bill payment.

Fund transfer

You can transfer any amount from one account to another of the same orany another bank. Customers can send money anywhere in India. Once youlogin to your account, you need to mention the payees's account number, his

bank and the branch. The transfer will take place in a day or so, whereas in atraditional method, it takes about three working days. ICICI Bank says thatonline bill payment service and fund transfer facility have been their mostpopular online services.Credit card customers

With Internet banking, customers can not only pay their credit card billsonline but also get a loan on their cards. If you lose your credit card, you canreport lost card online.Railway pass

This is something that would interest all the aam janta. Indian Railways hastied up with ICICI bank and you can now make your railway pass for localtrains online. The pass will be delivered to you at your doorstep. But thefacility is limited to Mumbai, Thane, Nashik, Surat and Pune.

Investing through Internet banking

You can now open an FD online through funds transfer. Now investors with

interlinked demat account and bank account can easily trade in the stockmarket and the amount will be automatically debited from their respectivebank accounts and the shares will be credited in their demat account.Moreover, some banks even give you the facility to purchase mutualfunds directly from the online banking system.

Nowadays, most leading banks offer both online banking and demat account.

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However if you have your demat account with independent share brokers,then you need to sign a special form, which will link your two accounts.

Recharging your prepaid phone

Now just top-up your prepaid mobile cards by logging in to Internet banking.By just selecting your operator's name, entering your mobile number and theamount for recharge, your phone is again back in action within few minutes.

Shopping

With a range of all kind of products, you can shop online and the payment isalso made conveniently through your account. You can also buy railway andair tickets through Internet banking.

Advantage of Internet banking

As per the Internet and Mobile Association of India's report on onlinebanking 2006, "There are many advantages of online banking. It isconvenient, it isn't bound by operational timings, there are no geographicalbarriers and the services can be offered at a miniscule cost."

Through Internet banking, you can check your transactions at any time of the day, and as man