Financial System in India: Assets, Institutions, Markets, and Regulation - Prof. Chandru, Study notes of Finance

Download Financial System in India: Assets, Institutions, Markets, and Regulation - Prof. Chandru and more Study notes Finance in PDF only on Docsity!

Principles & Practices ofPrinciples & Practices of

Banking Banking

Module A Module A

Indian Financial System Indian Financial System

K Chockalingam K Chockalingam

IIBF IIBF

Financial SystemFinancial System



An institutional framework existing in aAn institutional framework existing in a

country to enable financial transactions country to enable financial transactions



Three main partsThree main parts

 (^) Financial assets (loans, deposits, bonds, equities,Financial assets (loans, deposits, bonds, equities, etc.) etc.)  (^) Financial institutions (banks, mutual funds, insuranceFinancial institutions (banks, mutual funds, insurance companies, etc.) companies, etc.)  (^) Financial markets (money market, capital market,Financial markets (money market, capital market, forex market, etc.) forex market, etc.) 

Regulation is another aspect of theRegulation is another aspect of the

financial system (RBI, SEBI, IRDA, FMC) financial system (RBI, SEBI, IRDA, FMC)

Money Market InstrumentsMoney Market Instruments



Call money- money borrowed/lent for a day.Call money- money borrowed/lent for a day.

No collateral is required. No collateral is required.



Inter-bank term money- Borrowings amongInter-bank term money- Borrowings among

banks for a period of more than 7 days banks for a period of more than 7 days



Treasury Bills- short term instruments issuedTreasury Bills- short term instruments issued

by the Union Govt. to raise money. Issued at by the Union Govt. to raise money. Issued at

a discount to the face value a discount to the face value



Certificates of Deposit- Issued by banks toCertificates of Deposit- Issued by banks to

raise money. Minimum value is Rs. 1 lakh, raise money. Minimum value is Rs. 1 lakh,

tradable in the market tradable in the market



CDs can be issued by banks/FIsCDs can be issued by banks/FIs

Money Market InstrumentsMoney Market Instruments

 Commercial Paper (CPs) are issued byCommercial Paper (CPs) are issued by corporates to raise short term money corporates to raise short term money  Issued in multiple of Rs.25 lakhs, can beIssued in multiple of Rs.25 lakhs, can be issued by companies with a net worth of issued by companies with a net worth of at least Rs. 5 crores at least Rs. 5 crores  CP is an unsecured promissory noteCP is an unsecured promissory note privately placed with investors at a privately placed with investors at a discount rate to face value. The maturity discount rate to face value. The maturity of CP is between 3 and 6 months of CP is between 3 and 6 months

Financial MarketsFinancial Markets

Money Market- for short-term fundsMoney Market- for short-term funds (less than a year) (less than a year)  (^) Organized (Banks)Organized (Banks)  (^) Unorganized (money lenders, chit funds, etc.)Unorganized (money lenders, chit funds, etc.)

Capital Market- for long-term fundsCapital Market- for long-term funds  (^) Primary Issues MarketPrimary Issues Market  (^) Stock MarketStock Market  (^) Bond MarketBond Market

Organized Money MarketOrganized Money Market

 Call money marketCall money market  Bill MarketBill Market  (^) Treasury billsTreasury bills  (^) Commercial billsCommercial bills  Bank loans (short-term)Bank loans (short-term)  Organized money market comprisesOrganized money market comprises RBI, banks (commercial and co- RBI, banks (commercial and co- operative) operative)

Call money market (2)Call money market (2)

 Call loans are generally made on a clean basis-Call loans are generally made on a clean basis- i.e. no collateral is required i.e. no collateral is required  The main function of the call money market is toThe main function of the call money market is to redistribute the pool of day-to-day surplus funds redistribute the pool of day-to-day surplus funds of banks among other banks in temporary deficit of banks among other banks in temporary deficit of funds of funds  The call market helps banks earn interest and yetThe call market helps banks earn interest and yet improve their liquidity improve their liquidity  It is a highly competitive and sensitive marketIt is a highly competitive and sensitive market  It acts as a good indicator of the liquidity positionIt acts as a good indicator of the liquidity position

Bill MarketBill Market



Treasury Bill market- Also called the T-BillTreasury Bill market- Also called the T-Bill

market market

• (^) These bills are short-term liabilities (91-day, 182-These bills are short-term liabilities (91-day, 182- day, 364-day) of the Government of India day, 364-day) of the Government of India
• (^) It is an IOU of the government, a promise to pay theIt is an IOU of the government, a promise to pay the stated amount after expiry of the stated period from stated amount after expiry of the stated period from the date of issue the date of issue
• (^) They are issued at discount to the face value and atThey are issued at discount to the face value and at the end of maturity, the face value is paid the end of maturity, the face value is paid
• (^) The rate of discount and the corresponding issueThe rate of discount and the corresponding issue price are determined at each auction price are determined at each auction 

Commercial Bill market- Not as developed inCommercial Bill market- Not as developed in

India as the T-Bill market India as the T-Bill market

Indigenous bankersIndigenous bankers

 Individual bankers like Shroffs, Seths, Sahukars,Individual bankers like Shroffs, Seths, Sahukars, Mahajans, etc. Combine trading and other Mahajans, etc. Combine trading and other business with money lending. business with money lending.  Vary in size from petty lenders to substantialVary in size from petty lenders to substantial Shroffs Shroffs  Act as money changers and finance internal tradeAct as money changers and finance internal trade through hundis (internal bills of exchange) through hundis (internal bills of exchange)  Indigenous banking is usually family ownedIndigenous banking is usually family owned business employing own working capital business employing own working capital  At one point, it was estimated that IB met aboutAt one point, it was estimated that IB met about 90% of the financial requirements of rural India 90% of the financial requirements of rural India

RBI and indigenous bankersRBI and indigenous bankers (1) (1)  Methods employed by the indigenous bankers areMethods employed by the indigenous bankers are traditional with vernacular system of accounting. traditional with vernacular system of accounting.  RBI suggested that bankers give up their tradingRBI suggested that bankers give up their trading and commission business and switch over to the and commission business and switch over to the western system of accounting. western system of accounting.  It also suggested that these bankers shouldIt also suggested that these bankers should develop the deposit side of their business develop the deposit side of their business  Ambiguous character of the hundi should stopAmbiguous character of the hundi should stop  Some of them should play the role of discountSome of them should play the role of discount houses (buy and sell bills of exchange) houses (buy and sell bills of exchange)

Development OrientedDevelopment Oriented

Banking Banking

 Historically, close association between banks andHistorically, close association between banks and some traditional industries- cotton textiles in the some traditional industries- cotton textiles in the west, jute textiles in the east west, jute textiles in the east  Banking has not been mere acceptance ofBanking has not been mere acceptance of deposits and lending money to include deposits and lending money to include development banking development banking  Lead Bank Scheme-Lead Bank Scheme- opening bank offices in allopening bank offices in all important localities important localities  Providing credit for development of the districtProviding credit for development of the district  Mobilising savings in the district. ‘Service areaMobilising savings in the district. ‘Service area approach’ approach’

Progress of banking in IndiaProgress of banking in India (1) (1) 

Nationalisation of banks in 1969: 14 banksNationalisation of banks in 1969: 14 banks

were nationalised were nationalised



Branch expansion: Increased from 8260 inBranch expansion: Increased from 8260 in

1969 to 68500 in 2005 1969 to 68500 in 2005



Population served per branch has come downPopulation served per branch has come down

from 64000 to 15000 from 64000 to 15000



A rural branch office serves 15 to 25 villagesA rural branch office serves 15 to 25 villages

within a radius of 16 kms within a radius of 16 kms



Still only 32,180 villages out of 5 lakh haveStill only 32,180 villages out of 5 lakh have

been covered been covered

Progress of banking in IndiaProgress of banking in India (3) (3)  Diversification in banking: Banking hasDiversification in banking: Banking has moved from deposit and lending to moved from deposit and lending to  (^) Merchant banking and underwritingMerchant banking and underwriting  (^) Mutual fundsMutual funds  (^) Retail bankingRetail banking  (^) ATMsATMs  (^) Anywhere bankingAnywhere banking  (^) Internet bankingInternet banking  (^) Venture capital fundsVenture capital funds  (^) Factoring-Factoring-

Profitability ofProfitability of Banks(1)Banks(1)

Reforms has shifted the focus ofReforms has shifted the focus of banks from being development banks from being development oriented to being commercially viable oriented to being commercially viable

Prior to reforms, banks were notPrior to reforms, banks were not profitable and in fact made losses for profitable and in fact made losses for the following reasons: the following reasons:

Declining interest incomeDeclining interest income

Increasing cost of operationsIncreasing cost of operations