Indian Financial System - TSM

7/27/2019 Indian Financial System - TSM

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Indian Financial System

(Role of Banks in the Financial System)

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Accepting, for the purpose of lending or investment of

deposits of money from the public, repayable on

demand or otherwise and Withdrawable by cheques,

draft, order or otherwise.

Banking Regulation Act : u/s 5 (b)

Banking


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Banking in India has evolved through four distinct

phases:

Foundation phase

Expansion phase

Consolidation phase

Reforms phase


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Foundation phase can be considered to cover 1950s

and 1960s till the nationalization of banks in 1969.

The focus during this period was to lay the foundation

for a sound banking system in the country. A major

development was transformation of Imperial Bank of

India into State Bank of India in 1955 and

nationalization of 14 major private banks during

1969. :


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Expansion phase had begun in mid-60s but gained

momentum after nationalization of banks and continued till

1984.

A determined effort was made to make banking facilities

available to the masses.

Branch network of the banks was widened at a very fast pace

covering the rural and semi-urban population, which had no

access to banking hitherto.


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Consolidation phase: The phase started in 1985 when a

series of policy initiatives were taken by RBI which saw

marked slowdown in the branch expansion. Attention was

paid to improve house-keeping, customer service, credit

management, staff productivity and profitability of banks.

Measures were also taken to reduce the structural

constraints that obstructed the growth of money market.


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Reforms phase :

The macro-economic crisis faced by the country in 1991 paved theway for extensive financial sector reforms which brought

deregulation of interest rates, more competition, technological

changes, prudential guidelines on asset classification and income

recognition, capital adequacy, autonomy packages. The

Narasimham Committee report suggested wide ranging reforms

for the banking sector in 1992 to introduce internationally

accepted banking practices. The amendment of Banking

Regulation Act in 1993 saw the entry of new private sector banks.

:


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Areas of Impact of reform measures


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Dismantling the barriers and opening the system to competition

by adopting measures promoting healthy competition

Deregulation of Interest rates

Restrictions on directed lending

Prudential Regulation Policies

Transparency in disclosures

Merger of Banks

CRR/SLR reduction


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Capital adequacy ratio

Asset quality

Return on assets

Business per employee

Recapitalization of banks by government.

Visible results of Reform process


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Financial System

A structure available in the economy to mobilize

resources from the surplus sectors of the

economy and deploy the same to the deficit

sectors.

Transformation of savings in to Investment andconsumption is the function of a financial system

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Financial System An institutional framework existing in a country

to enable financial transactions

Three main parts Financial assets (loans, deposits, bonds, equities, etc.)

Financial institutions (banks, mutual funds, insurancecompanies, etc.)

Financial markets (money market, capital market, forexmarket, etc.)

Regulation is another aspect of the financialsystem (RBI, SEBI, IRDA )


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Financial assets/instruments Enable channelising funds from surplus units to

deficit units

There are instruments for savers such asdeposits, equities, mutual fund units, etc.

There are instruments for borrowers such asloans, overdrafts, etc.

Like businesses, governments too raise fundsthrough issuing of bonds, Treasury bills, etc.

Instruments like PPF, KVP, etc. are available tosavers who wish to lend money to the

government


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Financial Markets

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A financial market is a mechanism that allows

people to easily buy & sell (trade) financial

securities ( such as stocks & bonds ),

commodities ( such as precious metals or

agricultural goods


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Types of Financial Market

Financial Market

Capitalmarket

MoneyMarket

SecurityMarket

ForeignExchange

Market


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Participants in the Financial Market

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Individuals

Corporate

Government

Regulators

Financial

Institutions*

Commercial Banks

Mutual Funds

Primary dealers

Non banking financial

companies

FI


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In the financial markets, there is a flow of funds

from (funds-surplus units) known as investors to

another group (funds-deficit units) which require

funds.

However, often these groups do not have direct link.

The link is provided by market intermediaries such

as brokers, mutual funds, financial institutions likebanks


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IntermediationThe process of mobilizing the savings of the

community and deploying the same to deficit sectors

is called intermediation.

Organizations which does the job are called as

Financial intermediaries

Banks are financial intermediaries

Now the concept of financial disintermediation also is

prevalent

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Financial Markets

a)Money Market

b)Securities Market

c)Forex Market

d)Capital Market

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Money Market

As per RBI definitions A market for short terms financial assets

that are close substitute for money, facilitates the exchange of

money in primary and secondary market..

The money market is a mechanism that deals with the lending and

borrowing of short term funds (less than one year).

A segment of the financial market in which financial instruments

with high liquidity and very short maturities are traded.


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Banks borrow in the money market to:

Fill the gaps or temporary mismatch of funds

To meet the CRR and SLR mandatory requirements

as stipulated by the central bank.

To meet sudden demand for funds arising out of

large outflows (like advance tax payments)


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Money Market Instruments

Call Money

Treasury Bill

Certificate of Deposits

Commercial Paper

Repo & Reverse Repo

Marginal standing facility 23


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Call money market

It is an integral part of the Indian money market whereday-to-day surplus funds (mostly of banks) are traded.

The loans are of short-term duration (1 to 14 days).

Money lent for one day is called call money; if itexceeds 1 day but is less than 15 days it is callednoticemoney.

Money lent for more than 15 days is termmoney

The borrowing is exclusively limited to banks, who aretemporarily short of funds.


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Call loans are generally made on a clean basis- i.e.

no collateral is required.

The main function of the call money market is to

redistribute the pool of day-to-day surplus funds of

banks among other banks in temporary deficit offunds.

The call market helps banks economize their cash

and yet improve their liquidity.

It is a highly competitive and sensitive market

It acts as a good indicator of the liquidity position


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Call Money Market Participants

Those who can both borrow and lend in the market RBI (through LAF), banks and primary dealers.

Once upon a time, select financial institutions viz.,IDBI, UTI, Mutual funds were allowed in the callmoney market only on the lenders side

These were phased out and call money market is

now a pure inter-bank market (since August 2005)


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Commercial Papers

Short-term borrowings by corporate, financial institutions,from the money market

Can be issued in the physical form (Usance PromissoryNote) or Demat form.

Introduced in 1990

When issued in physical form are negotiable byendorsement and delivery and hence, highly flexible

Issued subject to minimum of Rs. 5 lacs and in the multipleof Rs. 5 lacs after that

Maturity is 7 days to 1 year Unsecured and backed by credit rating of the issuing

company

Issued at discount to the face value

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Corporate, PDs and all-India financial institutions

(FIs) that have been permitted to raise short-term

resources under the umbrella limit fixed by the

Reserve Bank of India (RBI) are eligible to issue CP.


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Primary Dealers & Satellite Dealers

Primary Dealers can be referred to as Merchant

Bankers to Government of India, comprising the

first tier of the government securities market.

Primary Dealers can also be referred to as

Merchant Bankers to Government of India, as

they are only allowed to underwrite primaryissues of government securities other than RBI

who have since shed this role.


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The role of Primary Dealers is to;

1) Provide underwriting services

2) offer firm buy sell quotes for T-Bills & dated

securities

3) Development of Secondary Debt Market


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All India Financial Institutions

All India Development Banks- IDBI,IFCI,ICICI Limited,

SIDBI,IIBI

Specialized Financial Institutions-

Risk Capital &Technology Finance Corporation Ltd

(RCTC), ICICI Venture Limited, Tourism FinanceCorporation of India Ltd. (TFCI

Investment Institutions- LIC,GIC,UTI


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Commercial Banking is primarily concerned with short

term lending for financing working capital requirements

of a concern.

Development banking, on the other hand is concerned

with lending funds for medium to long-term for financing

of investments in fixed assets of the company.

Commercial Banking is security-oriented, while

development banking is project-oriented.

.


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An FI may issue CPs within the overall umbrella

limit fixed by RBI i.e., issue of CPs together with

other instruments viz., term money, term deposits,

CDs and inter corporate deposits should not

exceed 100% of its net owned funds, as per the

latest audited balance sheet.


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Eligibility Norms:

( a) the tangible net worth of the company, as per the

latest audited balance sheet, is not less than Rs.4 crore;

(b) the company has been sanctioned working capital

limit by bank/s or FIs; and

(c) the borrowal account of the company is classified as

a Standard Asset by the financing bank/institution.


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The minimum credit rating shall be P-2

of CRISIL or such equivalent rating byother CRAs.

The issuers shall ensure at the time of

issuance of the CP that the rating soobtained is current and has not fallen

due for review.


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CP can be issued for maturities between a minimum of

7 days and a maximum of up to one year from the date

of issue. The maturity date of the CP should not go

beyond the date up to which the credit rating of the

issuer is valid.

CP can be issued in denominations of Rs.5 lakh or

multiples thereof. Amount invested by a singleinvestor should not be less than Rs.5 lakh (face value).


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CP can be issued as a "stand alone"

product. The aggregate amount of CP froman issuer shall be within the limit as

approved by its Board of Directors or the

quantum indicated by the CRA for the

specified rating,


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Only a scheduled bank can act as an IPA for

issuance of CP.

CP may be issued to and held by individuals,

banking companies, other corporate bodies

(registered or incorporated in India) and

unincorporated bodies, Non-Resident Indians

and Foreign Institutional Investors (FIIs).

However, investment by FIIs would be within

the limits set for them by Securities and

Exchange Board of India (SEBI).


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Certificates of Deposit

CDs are short-term borrowings in the form of UPN issued by all

scheduled banks and are freely transferable by endorsement and

delivery. It is a negotiable instrument.

Maturity of not less than 7 days and maximum up to a year. FIs are

allowed to issue CDs for a period between 1 year and up to 3 years

Subject to payment of stamp duty under the Indian Stamp Act,

1899

Issued to individuals, corporations, trusts, funds and associations

They are issued at a discount rate freely determined by the

market/investors39


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Repo & Reverse Repo

Repo is a collateralized lending i.e. the banks which

borrow money from Reserve Bank to meet short

term needs have to sell securities, usually bonds, to

Reserve Bank with an agreement to repurchase the

same at a predetermined rate and date.

Interest Rate Charged by RBI to commercial Banks

for such transactions is called as Repo Rate40


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Reserve Bank of

India

Cash

Security

Reverse Repo transaction

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In a reverse repo, Reserve Bank absorbs money

from banks by giving securities. The interest paid

by Reserve Bank in this case is called reverse repo

rate.

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Borrower of funds is called as seller of repo and

lender of funds is called as buyer of repo.

When the term of the loan is for one day, it is

known as an overnight repo and if it is for more

than one day it is called a term repo.

When the transaction is between a commercial

Bank and RBI, such repo transactions are called

Liquidity Adjustment Facility44


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Reserve bank controls repo rates and reverse repo rates as

a measure of controlling liquidity and inflation.

For commercial banks, the major source of short term

funding is Reserve Bank. Banks go short of money, when

there is a high demand for loans and the cash in hand at

the banks is low.

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Policy rates as on date

Present Repo rate : 8.00

Present Reverse Repo Rate:7.00%

Bank rate:9.00%

Marginal Standing Facility Rate :9.00

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Reserve Ratios

Cash Reserve Ratio : 4.75%

Statutory Reserve Ratio : 24.00%


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Under this scheme, Banks will be able to borrow

up to 2% (earlier it was 1%, increased to 2% wef

17/04/2012) of their respective Net Demand andTime Liabilities".

The rate of interest on the amount accessed from

this facility will be 100 basis points (i.e.

1%) above the repo rate

Marginal Standing Facility


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Marginal Standing Facility

All Scheduled Commercial Banks having Current Account and

SGL Account with Reserve Bank, Mumbai will be eligible to

participate in the MSF Scheme.

Under the facility, the eligible entities can avail overnight, up to

Two per cent of their respective Net Demand and Time Liabilities

(NDTL) outstanding at the end of the second preceding fortnight.

But for the intervening holidays, the MSF facility will be for one

day except on Fridays when the facility will be for three days or

more, maturing on the following working day.


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MSF will be undertaken in all SLR-eligible transferable

Government of India (GoI) dated Securities/Treasury Bills andState Development Loans (SDL).

A margin of five per cent will be applied in respect of GoI dated

securities and Treasury Bills. In respect of SDLs, a margin of 10per cent will be applied. Thus, the amount of securities offered on

acceptance of a request for Rs.100 will be Rs.105 (face value) of

GoI dated securities and Treasury Bills or Rs.110 (face value) of

SDLs.

Such facility can be availed against the securities already lodged

with RBI for the SLR requirement.


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Indian Financial System - TSM

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