indian financial system – an overview

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Indian Financial System

-An Overview

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Indian Financial System – An Overview

FUNCTIONS• Collection of SAVINGS & Distribution for INDUSTRIAL INVESTMENT.

• Stimulating CAPITAL FORMATION & ACCELERATING THE ECONNOMIC GROWTH

STRUCTURES1. Regulatory Bodies (RBI/SEBI/IRDA/PFRDA)

2. Financial Intermediotories

3. Financial Markets

4. Financial Assets / Instruments

PHASES* Upto 1951 Pvt. Sector

* 1951 to 1990 Public Sector

* Early Ninties Privatisation

* Present Status Globalisation

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Process of Capital Formation

Involves three distinct, although inter-related activities.

(i) Savings: The ability by which resources are set aside and becomeavailable for other purpose.

(ii) Finance: The activity by which claims to resources are eitherassembled from those released by domestic savings, obtainedfrom abroad, or specially created usually as bankdeposits or notes and then placed in the hands of the investor.

(iii) Investments: The activity by which resources are actuallycommitted to production.

The financial system is a link between the savers (savings – surpluseconomic units) and the investors (savings – deficit economicunits). It is made up of all those channels through which savingsbecome available for investment.

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• Orderly mechanism & structure in economy.

• Mobilises the monetary resources/capital from

surplus sectors.

• Distributes resources to needy sectors.

• Transformation of savings into investment &

consumption.

• Financial Markets – Places where the

above activities take place.


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Indian Financial System – An OverviewORGANISATION Financial System consists of

What they do Who They Are

Financial Intermediaries (a) Collect Savings (b) Issue claim against themselves Banks, NBFC,

(c) Use Funds, thus raised, to purchase MF insurance

ownership or debt-claims organisations etc.

Notes: Characteristics of claims issued against

self & debt-claims are absolutely different.

(ii) Financial Markets (a) Not a Source of funds Call Market

(b) Act as a facilitating organisation and link T-Bill Market

saver & investor CP-Market

(c) Based on nature of work they are classified Report Market

as (1) Money Market (2) Capital/Security Stock Exchange

Markets.

(iii) Financial Asset/Instrument/ (a) Financial Product – innovation Shares, Debt

Security (b) Three broad categories Instruments

(1) Direct/Primary e.g. Share, Debt., Debentures etc. Pref. Share etc.

(2) Indirect MF, Security Receipts,

Securitized Debt Investment.

(3) Derivatives Forward, Future, Options.

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Pre 19511. Control of Money Lenders

2. No Laws / Total Private Sector

3. No Regulatory Bodies

4. Hardly any industrialization

5. Banks – Traditional lenders for Trade and that too short term

6. Main concentration on Traditional Agriculture

7. Narrow industrial securities market (i.e. Gold/Bullion/Metal but largely linked to London Market)

8. Absence of intermediatory institutions in long-term financing of industry

9. Industry had limited access to outside saving/resources

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1951 to 1990

Moneylenders ruled till 1951. No worth-while Banks at that time.

Industries depended upon their own money. 1951 onwards 5 years

PLAN commenced.

PVT. SECTORS TO PUBLIC SECTOR – MIXED ECONOMY

1st 5 year PLAN in 1951 – Planned Economic Process. As part of

Alignment of Financial Systems – Priorities were laid down by Govt. –

Policies.

MAIN Elements of Financial Organisations

i. Public ownership of Financial Institution

ii. Strengthening of Institutional Structure

iii. Protection to Investors

iv. Participation in Corporate Management

v. Organisational Deficiencies.

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Nationalisation

RBI 1948

SBI 1956 (take-over of Imperial Bank of India)

LIC 1956 (Merges of over 250 Life Insurance Companies)

Banks 1969 (14 major banks with Deposits of over Rs. 50

Crs.nationalised)

1980 (6 more Banks)

Insurance 1972 (General Insurance Corp. GIC by New India,

Oriental, united and National

i. Public ownership of Financial Institutionii. Strengthening of Institutional Structure


iv. Participation of Corporate Management



1951-1990

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i. Pu blic ownership of Financial Institutionii. Strengthening of Institutional Structure



v. Organisational Deficiencies.Development

• Directing the Capital in confirmity with Planning priorities

• Encouragement to new entrepreneurs and small set-ups

• Development of Backward Region

• IFCI (1948) (Industrial Finance Corporation of India)

• State Finance Corporation (1951) Purely Mortgage institution

• IDBI (1964) As subsidiary of RBI to provide Project / Term Finance

• ICICI (1966) Channellising of Foreign Currency Loan from World Bankto Pvt. Sector and underwriting of Capital issues.

• SIDC’s & State Industrial Investment Corporation (SIIC) State LevelCorporations for SME sector

• UTI (1964) to enable small investors to share Industrial Growth

• Industrial Reconstruction Corporation of India (IRCI) (1971) to takecare of rehabilitation of sick-mills promoted by IDBI, Banks & LIC. IRCIname changed to Industrial Investment Bank of India (IIBI) in 1997.


1951-1990

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• NCC (1968) National Credit Council to assess the demand of Credit & determine priorities for grant of Loans, advances, investment & requirements of priority sector (presently 40%)

• Credit Guarantee Scheme (1960) for SSI Finance upto 75% of defaulted amount or guarantee amount whichever is lower with ceiling of Rs. 7.5 Lacs for W/Cap & Rs. 2.5 Lacs for T/L per borrower.

i. Pu blic ownership of Financial Institution

ii. Strengthening of Institutional Structureiii. Protection to Investors



• Agriculture Finance Corp. (AFC) for financing agriculture projects and help Banks. Lead Districts (580) Service Area Approach. Scrapped in 2006.

• ARC (1963) Agriculture Refinance Corp. for refinance of medium & long term loans.

• Export Credit Guarantee Corporation ECGC (1964) FOR Export Performance


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Commercial Banks

• Continued old way of Deposit – Banking & short term credit to trade

• Selective Credit Control (Control through quantum, rate of interest margin etc).

• Extensive Branch Expansion. (4000 in 1969 now over 5,00,000)

• Refinance Facility to share risk & also cost of Banks’ funds (Nationalisation. Objectives of Madame Indira Gandhi)

Better needs of Economic development

Create job opportunities

Fulfilment of Plan objectives

Servicing maximum population by Branch expansion

Setting up Committees. Tandon (1974) to regulate Bank Credit & follow-up

Bank Credit to Priority Sector. (substantial increase)

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LIC

Mobilised massive long term funds & single largest organisation with large long term savings. Dominant role in underwriting issues and direct push of industrial activities.

LIC helped in price stabilization during downswing (e.g. mid 2008 when market faced crisis due to turmoil in global finance market).

Premium Amount (Rs. in Crs.) Rs. 87108 Crs.*

Life Insurance Policies Nos. 5.09 Crs.

Nos. of Agents/Selling fore 10,00,000+

Rent Income Rs. 7000 Crs. p.a.

* The largest Pvt. Sector ICICI prudential is Rs. 6813 Crs. (less than 10%)


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PROTECTION TO INVESTORS

• Building up confidence of investors shattered due to distrust in Pvt. Ltd.

• Redesigning Legal & Administrative set up of Companies.

* Ban on Forward Trading

* Abolition of Managing Agency System

STEPS TAKEN (LEGAL/ADMINISRTATIVE)

• Companies Act 1956 to regulate Companies, Capital Structure.

• Capital Issues (Control) Act, 1947 implemented through CCI in MOF to

regulate Capital Issues & Foreign Investment (repealled in 1992)

• Securities Contract (Regulation) Act, 1956 enforced through Directorate of

Stock Exchange under MOF to regulate Capital Market.

• MRTPA (1970) to avoid (a) concentration of economic power and

(b) Control monopolistic and restrictive trade practices.

• FERA (1973) to regulate foreign investment & foreign business.



iii. Protection to Investorsiv. Participation of Corporate Management


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Participation of Corporate Management

• By Financial Institutions (IDBI, IFCI, ICICI, IRBI, SFC,

SIIC etc.

• By LIC

• By GIC

• Through conversion of Loans into Equity.

(NOMINEE DIRECTORS – enjoy protection)

Indian Financial System – An Overviewi. Pu blic ownership of Financial Institution



iv. Participation of Corporate Managementv. Organisational Deficiencies.

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Organisational Deficiencies

(i) Institutional Structure

* Banks, LIC, UTI, Collected Savings directly from investors

* DFI/PFI like IDBI, IFCI, ICICI, SFCs etc. got funds from sponsers like RBI/GOVT.

* Term Finance moved to Big Industries

(ii) Distributive Mechanism

FIs were incapable of handling growing needs of industries

(iii) Form of Financing

* Term Loan (Debt) was main part of financial structure with little part of equity Capital

* Sometimes Institution became more sympathetic & permitted more than desired finance in case of strain / default.

* Position of IFCI, IDBI, ICICI, & most of the SFCs became precarious.






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Small & New Enterprises

* System was unable to meet the financial requirements.

* Very costly to raise funds from the market.

New Issues Marketing / Management

Absence of right – type Merchant Banking Institutions.






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POST 1990s

IMPORTANT DEVELOPMENTS

Development Financial Institutions : (DFIs)

• Started providing Working Capital also

• Set up CREDIT RATING AGENCIES

CRISIL(IPO IN 1993-94; standard & poor acquires 9.68% in 1996-97 S & P acquires shares / holding upto 58.46%)

ICRA Set up in 1991 by leading FIs/Banks/Fin. Ser. Cos. And Moody’s CARE Set-up by IFCI/Banks.

FITCH a 100% subsidiary of FITCH Group.

• Privatisation of DFI

Reduction in Govt. holding & Public Participation e.g. IFCI Ltd., IDBI Ltd., ICICI Ltd.

• Conversion into Banking / Merger into Banking Companies IDBI Bank & ICICI Bank

• Issuance of Bond by DFIs without Govt.’s Guarantees to mobiliseresources.

• Reduction in holding of Govt. in Banks, i.e. Public Participation / Listing

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POST 1990

INDUSTRIES

• Rise & Growth of Service Sector industries.

• Reliance & Dependance on technology.

• E-mail & mobile made sea-change in communication, data collection etc.

• Computerisation – a catch phrase and inevitable need of an hour.

• Dependent on Capital Market rather than only Debts dependancy.

• Scalability of operations through globally competitive size.

• Broad basing of Board.

• Professional Management.

NBFC

• NBFC under RBI governance to finance retail assets and mobilisesmall/medium sized savings.

• Very large NBFCs are emerging (Shri Ram Transport Finance, Birla, Tata Finance, Sundaram Finance, Reliance Finance, DLF, Religare etc.

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POST 1990Commercial Bank

• Govt. holding reduced even by upto 40%

• Setting up of Universal Banks (from CASA to Corp. Finance)

• One-stop Banking.

• Capital Adequacy. (Basel II accepted) 9%

• Assets classification (Regular, Problem, Anxiety, Causing, Non-Performing) and Provisioning norms identified/reviewed & revised.

• NPA classification – substandard, Doubtful & Loss Assets.

• Focus on Non-Fund Business like L/C, Guarantees, Acceptance, FOREX etc.

• Promoting Signature-based and consultancy services like Project Counselling, Merchant Banking, New Issues Management, Capital Market related activities, Merger & Acquisitions, debt syndication, trusteeship of debts, sponsoring Mutual Funds, Wealth Management, Sales & Services of insurance (both life & non-life) products etc.

• New Private Sector Banks (AXIS, YES, HDFC, KOTAK MAHINDRA etc.)

• CAMELS’ Rating (C-Capital Adequacy, A-Asset Quality, M-Management, E-Earning, L-Liquidity, & S-Systems & controls).

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Mutual Funds Bifurcation of UTI and UTI (AMC) put under SEBI.

• Banks, Broking Houses, Finance Companies Insurance Companies, Pvt. Sector in Foreign collaboration, FII and Merchant Banks set up Mutual Funds with a varieties of schemes.

• Helps small investors in big way

• Backbone of Capital Markets

Mutual Funds,

• AIG, Baroda Pioneer, Birla Sunlife, Canara Robeco, DBS Chola, Edelweiss, Fidelity, Fortis, Franklin, HSBC, HDFC, ICICI Prudential, IDFC, ING, JM, Kotak, LIC, Magnum, Mirae, Morgan, Quantum, Reliance, Religare, Sahara, Sundaram BNP, Tata Tourus, UTI etc.

• Mutual Funds Investment Schemes (over 1000 in Nos.)

Equity Balanced Funds

Equity Diversified Hybrid – Equity Oriented

Equity Index Hybrid – Debt Oriented

Equity Tax Planning Hybrid – Asset Allocation

Equity Banking Hybrid Arbitrage

Equity FMCG Bond Funds

Equity Pharma Debt Medium Term/Short Term

Equity Technology Debt Medium Term/Short Term Institutional

Equity Speciality Hybrid Monthly Income

Cash Funds Gilt Medium & Long Term

Debt Liquid Plus


POST 1990

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Securities/Capital Market

Primary Market

- Phenominal increase in number of investors.

- New intermediatories i.e. Merchant Bankers, Lead Manager & Book-Builders, Underwriters, Bankers to Issue, Registrar to Issue, Share Transfer Agents, Portfolio Managers, Depositories, FIIs, Custodians, Rating Agencies, etc. are playing important role.

- FIIs are allowed to invest & participate in public issues of Debt & Equities within sectoral limits fixed by the Govt.

Indian Financial System – An

Overview

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Secondary Market

- Over 90% Securities Dematerialised.

- Depository Act 1996; 2 Depositories NSDC & CDSL.

- Settlement Cycle reduced from 15 days to T + 2.

- Clearing & Settlement by Clearing Corp.

- Securities related derivatives introduced.

- Future, Option, Arbitrage, Hedging permitted.


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Money Market

- Primary Dealers

- Money Market Mutual Funds came up

- Call/Notice Market

- Treasury Bills Market

- Commercial Paper Market (CP)

- Certificate of Deposit Market (CD)

- Repo Market

- FOREX Market

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POST 1990

Organisational Structure• Boards of PSU Banks reorganised.

• Regulation / guidelines for Statutory Auditors.

• Most of the Banks entrusted Business Plan / Restructure of Organisations to Globally acclaimed Consultants like KPMG, PWC, E & Y etc.

CAPITAL MARKET• NSE set up as FIRST automated Exchange.(turnover now is Rs. 65000 Crs. p.d.)

Total 2500 + V-SATs in 191 cities; 1242 Members (1096 Corporates)

• Depositories Promoters’ Participants Centers No. of Clients

NSDL IDBI, UTI, NSE, SBI etc. 282 1015 1 Cr.

CDSL BSE, HDFC, SBI, BOI, BOB etc. 483 6469 60.37 Lacs

• Custodian

* Stock Holding Corp. of India.

• OTC

• Regional Stock Exchanges

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GLOBAL FINANCIAL SYSTEMS

IBRD (World Bank) Long-Term Capital Assistance

IFCI To finance PRIVATE enterprises in the form of loans & equity

IDA Affiliate of World Bank Soft – Loan window of the Bank. Mainly for

developing & under-developed nations. Re-payment period upto 50

years Govt. & Private, both, eligible.

MIGA Multilateral Investment Guarantee Agency – an affiliate of World Bank

(1988) Provides guarantee for investment in needy countries.

ABD Under the aegis of ECAFE (Economic Commission for Asia & Far East)

(1966) promote investment in Asia & Far East and also finance priority area.

Also co-ordinates with U.N. agencies.

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Indian Financial System – An OverviewGLOBAL FINANCIAL SYSTEMS

International Financial Markets

MONEY STOCK BOND LOAN

Main Players

Commercial Banks

Corporations

Non Bank Financial Institutions.

Central Bank and other Govt. Agencies.

Venture Funds/PE Funds

Hedge Funds

University Funds

Trusts & Foundations and charitable Societies

Endowments.

HNI.

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Global Financial System – An Overview

Functions of Financial Market• Price Discovery

• Liquidity

• Cost of Transactions (saver search & information costs)

• Transfer of savings from one sector to other

• Reflects as Barometer for economic growth

Financial Assets

• Treasury Bonds

• Debt Bonus

• Equity (with/without Voting Rights)

• Commercial Paper/Debentures etc.

• Euro & Petro Bonds.

• Gold/Silver

• Deep Discount Bond/Coss Border Bonds /instruments.

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GLOBAL FINANCIAL SYSTEMS

July 1944 Briton Woods Conference

UNO GATT (now WTO) IMF

To Settle To regulate global To promote international monetary co-

Political trade & services. operation, exchange stability and to

disputes/ address to temporary liquidity problems

Conflicts. of members.

Bilateral

dialogues.

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STRUCTURE OF FINANCIAL MARKETS IN INDIA

Financial Markets in India

Debt Market

Primary /

Secondary

Forex

Market

Capital Market

Primary /

Secondary &

Depository

Insurance

Life/General

Banks (including

RRBs, co-op etc)

Mutual Funds,

Venture Funds,

Investment

Bonds

RBI RBI SEBI IRDA RBI RBI/SEBI

REGULATORY AUTHORITY

indian financial system – an overview

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