Indian Financial System

- An Overview

Reference: Indian Financial System. M. Y. Khan 1

Web site of RBI/SEBI
 Introduction
Finance may be defined as the art and
service of managing money.
Two major areas of finance:
1. Financial management
2. Financial services
Financial services is concerned with the
design and delivery of advice and financial
products to individuals and businesses.
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 Indian Financial System – An Overview

FUNCTIONS
• Collection of SAVINGS & Distribution for INDUSTRIAL INVESTMENT.
• Stimulating CAPITAL FORMATION & ACCELERATING THE ECONNOMIC
GROWTH

STRUCTURES
1. Regulatory Bodies (RBI/SEBI/IRDA/PFRDA)
2. Financial Intermediotories
3. Financial Markets
4. Financial Assets / Instruments

PHASES
* Up to 1951 Pvt. Sector
* 1951 to 1990 Public Sector
* Early Nineties Privatization
* Present Status Globalization

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 Indian Financial System – An Overview
Process of Capital Formation
Involves three distinct, although inter-related activities.

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

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

(iii) Investments: The activity by which resources are actually committed to

production.

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

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 Indian Financial System – An Overview

• 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 Overview
ORGANISATION Financial System consists of

What they do Who They Are

Financial Intermediotories (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. 6
 Indian Financial System – An Overview

Pre 1951
1. 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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Indian Financial System – An Overview

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 laid down by Govt. – Policies.
MAIN Elements of Fin. 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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 Indian Financial System – An Overview
1951-1990
i. Pu blic ownership of Financial Institution
ii. Strengthening of Institutional Structure
iii. Protection to Investors
iv. Participation of Corporate Management
v. Organisational Deficiencies.

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

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Indian Financial System – An Overview
1951-1990
i. Pu blic ownership of Financial Institution
ii. Strengthening of Institutional Structure
iii. Protection to Investors
iv. Participation of Corporate Management
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)
• 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
Bank to Pvt. Sector and underwriting of Capital issues.
• SIDC’s & SIIC State Level Corporations for SME sector
• UTI (1964) to enable small investors to share Industrial Growth
• IRCI (1971) to take care of rehabilitation of sick-mills promoted by
IDBI, Banks & LIC-Name changed to IIBI in 1997.
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 Indian Financial System – An Overview
i. Pu blic ownership of Financial Institution

ii. Strengthening of Institutional Structure

iii. Protection to Investors
iv. Participation of Corporate Management
v. Organisational Deficiencies.

• 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.
• 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.
• ECGC (1964) FOR Export Performance

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 Indian Financial System – An Overview
i. Pu blic ownership of Financial Institution
ii. Strengthening of Institutional Structure
iii. Protection to Investors
iv. Participation of Corporate Management
v. Organisational Deficiencies.

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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 Indian Financial System – An Overview
i. Pu blic ownership of Financial Institution
ii. Strengthening of Institutional Structure
iii. Protection to Investors
iv. Participation of Corporate Management
v. Organisational Deficiencies.

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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 Indian Financial System – An Overview
i. Pu blic ownership of Financial Institution
ii. Strengthening of Institutional Structure
iii. Protection to Investors
iv. Participation of Corporate Management
v. Organisational Deficiencies.

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.

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 Indian Financial System – An Overview
i. Pu blic ownership of Financial Institution
ii. Strengthening of Institutional Structure
iii. Protection to Investors
iv. Participation of Corporate Management
v. Organisational Deficiencies.

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)

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 Indian Financial System – An Overview
i. Pu blic ownership of Financial Institution
ii. Strengthening of Institutional Structure
iii. Protection to Investors
iv. Participation of Corporate Management
v. Organisational Deficiencies.

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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 Indian Financial System – An Overview
i. Pu blic ownership of Financial Institution
ii. Strengthening of Institutional Structure
iii. Protection to Investors
iv. Participation of Corporate Management
v. Organisational Deficiencies.

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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 Indian Financial System – An Overview
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 mobilise
resources.
• Reduction in holding of Govt. in Banks, i.e. Public Participation / Listing

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 Indian Financial System – An Overview
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 mobilise
small/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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 Indian Financial System – An Overview
POST 1990
Commercial 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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 Indian Financial System – An Overview
POST 1990
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
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 Indian Financial System – An
Overview
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.

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 Indian Financial System – An Overview

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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 Indian Financial System – An Overview
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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 Indian Financial System – An Overview
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
NSSDL 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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 Indian Financial System – An Overview
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 Overview
GLOBAL 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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 Indian Financial System – An Overview
STRUCTURE OF FINANCIAL MARKETS IN INDIA

Financial Markets in India

Debt Market Forex Capital Market Insurance Banks (including Mutual Funds,
Primary / Market Primary / Life/General RRBs, co-op etc) Venture Funds,
Secondary Secondary & Investment
Depository Bonds

RBI RBI SEBI IRDA RBI RBI/SEBI

REGULATORY AUTHORITY

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