INDIAN FINANCIAL

SYSTEM
-DEEPAK BANSAL
UNIT-1
OVERVIEW OF INDIAN FINANCIAL SYSTEM
AGENDA
Role of Financial Markets in capital formation
and economic development.
Commercial Banks and industrial fnance-
evolving role.
Reserve Bank of India as a regulator of Banking
systems and its other functions.
Securities & Exchange Board of India as a
regulator of Indian capital market
FINANCIAL SYSTEM AND ECONOMIC
DEVELOPMENT
The growth of output in any economy depends on the
increase in the proportion of savings/investment to a
nations output of goods and services.
The fnancial system and fnancial institutions help
in the diversion of rising current income into
savings/investments.
The fnancial system is possibly the most important
institutional and functional vehicle for economic
transformation. Finance is a bridge between the
present and the future and whether it be the
mobilisation of savings or their efcient, efective and
equitable allocation for investment, it is the success
with which the fnancial system performs its
functions that sets the pace for the achievement of
broader national objectives.
SIGNIFICANCE & DEFINITION
The term fnancial system is a set of inter-related
activities/services working together to achieve
some predetermined purpose or goal. It includes
diferent markets, the institutions, instruments,
services and mechanisms which infuence the
generation of savings, investment capital
formation and growth.
Van Horne defned the fnancial system as the
purpose of fnancial markets to allocate savings
efciently in an economy to ultimate users either
for investment in real assets or for consumption.
According to Robinson, the primary function of
the system is "to provide a link between savings
and investment for the creation of new wealth
and to permit portfolio adjustment in the
composition of the existing wealth.
From the above defnitions, it may be said that
the primary function of the fnancial system is
the mobilisation of savings, their distribution for
industrial investment and stimulating capital
formation to accelerate the process of economic
growth.
TYPES OF MARKET
Well-developed fnancial markets are required for
creating a balanced fnancial system in which
both fnancial markets and fnancial institutions
play important roles.
The primary function of the fnancial markets is
to facilitate the transfer of funds from surplus
sectors (lenders) to defcit sectors (borrowers).
Normally households have excess of funds or
savings which they lend to borrowers in the
corporate and public sectors, whose requirement
of funds exceed their savings.
A fnancial Market consists of investors or
buyers, sellers, dealers and brokers and does not
refer to a physical location.
The participants in the market are linked by
formal trading rules and communication
networks for originating and trading fnancial
securities.
The primary market in which the public issue of
securities is made through a prospectus is a
retail market and there is no physical location.
The investors are reached by direct mailing or
invitation to bid within a price band.
On the other hand, the secondary market or stock
exchange where existing securities are traded, is
an auction market and may have a physical
location such as the rotunda of the Bombay Stock
Exchange or the trading foor of Delhi,
Ahmadabad and other exchanges where the
exchange members meet to trade securities face-
to-face.
MONEY MARKET
The money or credit market is the centre for
dealings in monetary assets of short-term nature
generally below one year.
The instruments are call money/notice money,
term money, treasury bills, commercial paper,
certifcates of deposits, participation certifcates
and forward rate agreements/interest rate swaps.
Themoney market has organised and
unorganised components.
The organised credit market is dominated by
commercial banks.
The other major players are the Reserve bank of
India, Life Insurance corporation, General
Insurance corporation, Unit Trust of India,
Securities Trading corporation of India Ltd. And
Discount and fnance house of India.
Unorganised Market consists of indigenous
bankers and money lenders.
There is no clear demarcation between short-
term and long-term fnance in as much as there
is nothing on a hundi to indicate accommodation.
Hundi is the indigenous bill of exchange.
Hundis are usually accommodation bills.
CAPITAL MARKET
The capital market consists of primary and
secondary markets.
The primary market deals with the issue of new
instruments by corporate sector such as equity
shares, preference shares and debentures.
The secondary market consists of 24 stock
exchanges, (out of which 5 has been de-
recognized) including the national stock
exchange, the over the counter exchange of India
and interconnected stock exchange of India Ltd.
Where existing instruments including negotiable
debts are traded.
Capital formation occurs in the primary market
while the secondary market provides a
continuous market for the securities already
issued to be bought and sold in volume with little
variation in the current market price.
The major player in the primary market are the
merchant banker, mutual funds, fnancial
institutions, foreign institutional investors and
the anchor of the market, the individual investor.
In the secondary market, the stockbrokers who
are members of the stock exchanges, the mutual
funds, fnancial institutions, foreign institutional
investors and individual investors.
FOREIGN EXCHANGE MARKET
The foreign exchange market encompasses all
transactions involving the exchange of diferent
monetary units for each other.
Every sovereign nation has its own currency. The
monetary unit of a country can be exchanged with
any other currency of any other country in the foreign
exchange market.
The foreign exchange market is not a physical place.
It is a network of banks dealers and brokers who are
dispersed throughout the leading fnancial sectors of
the world.
It acts as an intermediary for individual buyers and
sellers. The foreign exchange market links fnancial
activities in diferent currencies.
FEM in India comprises of authorized dealers
consisting mainly of commercial banks,
customers and Reserve Bank of India.
There are seven major centres in Mumbai, Delhi,
Calcutta, Chennai, Bangalore, Kochi and
Ahmadabad with Mumbai accounting for the
major portion of the transactions.
The Foreign Exchange Dealers Association of
India(FEDAI) plays an important role by laying
down the rules for commission and other charges.
FOREIGN EXCHANGE RATES
The foreign exchange rates govern the rate at
which one currency can be exchanged for
another.
An exchange rate may be defned as the amount
of currency that one requires to buy one unit of
another currency or is the amount of a currency
one receives when selling one unit of another
currency.
RESERVE BANK OF INDIA
The Reserve Bank of India as the central bank of
the country, is at the head of this group.
Commercial banks themselves may be divided
into two groups, the scheduled and the non
scheduled.
Thecommercial banking system may be
distinguished into:
A. Public Sector Banks
B. Priate Sector Banks
A. Public Sector Banks
i) State Bank of India
ii) Associate Bank
iii) 14 Nationalized Banks (1969)
iv) 6 Nationalized Banks (1980)
v) Regional Rural Banks
B. Private Sector Banks
Other Private Banks;
ii) New sophisticated Private Banks;
iii) Cooperative Banks included in the second
schedule;
iv) Foreign banks in India, representative ofces,
and
v) One non-scheduled banks
RBI
The Reserve Bank of India (RBI) is the apex
fnancial institution of the countrys fnancial
system entrusted with the task of control,
supervision,promotion,developmentand
planning.
RBI is the queen bee of the Indian fnancial
system which infuences the commercial banks'
management in more than one way.
RBI performs the four basic functions of
management, viz., planning, organising, directing
and controlling in laying a strong foundation for
the functioning of commercial bank
F!NCTI"NS
Issuing currency notes, to act as a currency
authority.
Banker, Agent and Financial Advisor to the State
Banker to the Banks
Custodian of Foreign Exchange Reserves
Lender of the Last Resort
Banks of Central Clearance, Settlement and
Transfer
Controller of Credit
Supervisory Functions
COMMERCIAL BANKS
In India there are 88 commercial banks which
account for about 82 %of the total assets of the
fnancial sector, over 2000 cooperative banks
accounting for about 5% and 133 regional Rural
Banks, which account for about 3% of the total
assets of the fnancial sector.
Commercial banks are business enterprises
which deal in fnances, fnancial instruments and
provide various fnancial services for a price
known as interest, discount, commission, fee etc.
According to the Banking Regulation Act, 1949,
Banking means, accepting, deposit of money
from the public, for the purpose of lending or
investment.
These deposits may be repayable on demand or
otherwise and may be withdrawn by cheque,
draft, order or otherwise.
Accepting deposits and lending these resources to
business houses and individuals are the main
function of commercial banks.
Commercial banks also involve into various
fnancial services.
FUNCTIONS OF COMMERCIAL BANKS
Accepting deposits
Loans and advances
Agency functions
Dealings in foreign exchange
Credit creation
Popularising cheque system
Transfer of funds
Other functions
Function under innovative banking
Insurance business
SECURITY & EXCHANGE BOARD OF INDIA
The SEBI Act was passed on 4th April, 1992
which empowered SEBI to regulate entire gamut
of activities in primary and secondary market.
SEBIexercises control over new issues
registrationandregulationofmarket
intermediaries, regulation of mutual funds,
regulating listing of securities, imposing a code of
conduct on merchant bankers, underwriter,
brokers.
SEBI protects the interests of investors in
securities and promote the development and
regulation of the securities market.
The Board consists of a chairman, two members
from the Government of India, ministries of Law
and Finance, one member from the RBI and two
other members.
The SEBI prohibits unfair trade practices and
insider trading, regulation of take-overs etc.
FUNCTIONS OF SEBI
Regulating the business in stock exchanges and
any other securities market.
Registering and regulating the working of stock
brokers, sub-brokers, share transfer agents,
bankers to an issue, merchant bankers,
underwriters, portfolio managers, investment
advisers and such other intermediaries who may
be associated with securities markets in any
manner.
Registering and regulatingthe working of
collective investment schemes including mutual
fund.
Promotingandregulatingself-regulatory
organisation.
Prohibiting fraudulent and unfair trade practices
relating to securities market.
Promoting investors education and training of
intermediaries of securities market.
Prohibiting insider trading in securities.
Levying fees or other charges for carrying out the
above purposes and
Conducting research for the above purposes.
UNIT- II
FINANCIAL MARKET
Agenda
Money Market: Organisation, Constituents and
Instruments
Capital Market: New Issue Market & Stock
Exchanges-Diferences&Similarities,
Functions, Methods of New Issues, Regulatory
framework.
MONEY MARKET
Money Market is a very important segment of the
Indian fnancial system.
MoneyMarket is basically over-the-phone
market. The transactions are conducted through
oral communications.
It is the market for dealing in monetary assets of
short-term nature. Short-term funds up to one
year.
Moneymarketinstrumentshavethe
characteristics of liquidity, minimum transaction
cost and no loss in value.
Money market provides access to providers and
users of short term funds to fulfll their
borrowings and investment requirements.
The Money Market is the major mechanism
through which the Reserve Bank infuences
liquidity and the general level of interest rates.
There are a large number of participants in the
money market: Commercial Banks, Mutual
funds,investmentinstitutions,fnancial
institutions and fnally the Reserve Bank of
India.
The money market can obtain funds from the
central bank either by borrowing or through sale
of securities.
ORGANISATION OF MONEY MARKET
Organised
Reserve Bank of India
# Public Sector Banks
# Private Sector Banks-
#
Non-Scheduled Banks
Scheduled Banks-
Foreign Banks
Indian Banks
# Development Banks and other Financial Institutions
like LIC, UTI, IFC, IDBI etc.
# DFHI Ltd.
Unorganised
#
#
#
#
#
#
Indigenous bankers
Money Lenders
Traders
Commission Agents
Chit Funds
Nidhis
MONEY MARKET INSTRUMENTS
Money at call and short notice (Call Loans)
Treasury Bills
Bills Rediscounting Scheme (BRS)
Certifcates of Deposits (CDs)
Commercial Papers (CPs)
Repurchase Options
Inter-Bank Participation Certifcates on a risk
sharing basis or without risk sharing basis
Options
Swaps
CAPITAL MARKET
Ne$ Issue Market
New Issues Market comprises all people,
institutions, methods, services and practices
involved in raising fresh capital for both new and
existing companies. This Market is also called
Primary Market. PM deals in only new securities
which acquire form for the frst time, i.e. which
were not available previously.
On the other hand, secondary market or stock
market or stock exchange deal in existing
securities, i.e. securities which have already been
issued by companies and are listed with the stock
exchanges.
FUNCTIONS OF NIM
Facilitates transfer of resources from savers to
entrepreneurs establishing new companies.
Helps raising resources for expansion and/or
diversifcation of activities of existing companies
Helps selling existing enterprises to the public as
going concerns through conversion of existing
proprietorship/partnership/privatelimited
concerns into public limited companies.
PLAYERS IN THE NEW ISSUE MARKET
Merchant Bankers
Registrars
Collecting and co-ordinating Bankers
Underwriters
Brokers, Agents
Printers
Advertising Agencies
Mailing Agencies
SEBI
DIFFERENCES BETWEEN NIM AND STOCK
EXCHANGES
NIM
1. Market for new securities
2. No fxed geographical location
Stock E%c&an'es
1. Market for existing securities
2. Located at a fxed place
3. Results in raising fresh3. Facilitates transfer of
resources for the corporate sector securities from one corporate
investor to another.
4. All companies enter NIM
4. Securities of only listed
companies can be traded at stock
exchanges
5. Has a defnite administrative
set-up and a tangible form.
6. Subjected to control both from
within and outside.
5. No tangible form or
administrative set-up
6. Subjected to outside control by
SEBI, Stock Exchanges and the
companies Act.
SIMILARITIES BETWEEN NIM & STOCK
EXCHANGES
Securities traded at stock exchanges are those
which have frst been issued by the companies.
Whileissuing prospectus, the companies
stipulate in the prospectus that application has
been made or will be made in due course for
listing of shares with the stock exchange.
Stockexchange exercise control over the
organisation of new issues as a precondition for
listing of shares.
Stockexchanges provide liquidity to the
securities which have passed through NIM.
METHODS OF NEW ISSUES
Public issue through prospectus
Through ofer for sale
Through placement of securities- private
placement and stock exchange placing
Rights issue
Issue of Bonus shares
Book-building
Stock option or Employees Stock Option Scheme
UNIT-III
BANKING INSTITUTIONS
Agenda
Commercial Banks
Co-operative Banks
COMMERCIAL BANKS
Commercial Banks are business enterprises
which deal in fnances, fnancial instruments and
provide various fnancial services for a price
known as interest, discount, commission, fee etc.
According to the Banking Regulation Act, 1949,
banking means, Accepting deposits of money
from the public, for the purpose of lending or
investment.
These deposit may be repayable on demand or
otherwise and may be withdrawn by cheques,
draft, order or otherwise.
Accepting deposits and lending these resources to
business houses and individuals are the main
function of commercial banks.
FUNCTIONS OF COMMERCIAL BANKS
Accepting Deposits
Demand deposits or current accounts
Savings deposits
Time deposits or fxed deposits
Loans and Advances
Cash Credits
Overdrafts
Discounting of bills
Short-term,Medium-term or Long-term
loans
Agency function
Dealings in foreign exchange
Credit Creation
Popularising Cheque System
Transfer of funds
Other functions
Insurance Business
SOURCES & APPLICATION OF FUNDS
Sources
Paid-up Capital
Reserves and Surpluses
Deposits
Application
Buildings, furniture, ofce equipment etc. for
conducting business
Money at call and short notice
Bills discounted and purchased
Treasury bills etc.
ASSET STRUCTURE OF COMMERCIAL
BANKS
Cash Balances
Money at call and short notice
Short-term Bills
Loans and advances
Investments
NON-PERFORMING ASSETS
A non-performing Asset in India represents an
advance that has not been serviced as a result of
past dues accumulating for 90 days and over.
NPAs consist of assets under three categories:-
Sub-standard
Doubtful and
Loss
A non-performing asset is an advance where:
Interest and/or installment of principal remain
overdue for a period of more than 90 days in
respect of term loan.
The account remains our of order for a period of
more than 90 days in respect of an
overdraft/cash credit.
The bill remains overdue for a period of more
than 90 days in case of the bills purchased and
discounted.
Interest and/or installment of principal remain
overdue for two harvest seasons but for a period
of not exceeding 180 days in the case of an
advance granted for agricultural purposes.
And amount to be received for a period of more
than 90 days in respect of other accounts.
BANK RATE, LENDING RATES AND
CREDIT-OFF TAKE
Bank rate is the rate of interest at which Reserve
Bank of India lends money to banks.
Its is the rate at which the central bank
rediscounts certain defned bills and other
eligible papers.
Prime Lending rate is the rate of interest at
which banks lend to the borrowers with highest
credit-worthiness.
Credit-of take occurs when the demand for
money at lower rate (bank rate and various
interest rate) is promoted.
REPO AND REVERSE REPO RATE
Repo rate is the rate at which banks borrow
short-term funds from RBI.
Reverse repo rate is the rate at which banks park
their short-term surplus funds in the RBI.
Commercial Banks
Scheduled Banks
(i) Public Sector (28)
(ii) Private Sector (60)
(iii) Regional Rural (231)
non-scheduled banks
(i) Local Area Banks
SBI Group (8)
Nationalised Bank(19)
Indian (29)
Foreign (31)
ORGANISATIONAL STRUCTURE OF CO-
OPERATIVE CREDIT INSTITUTIONS
Urban Co-operative Banks
Rural Co-operative Credit Institutions
#
Short Term Credit
State Co-operative Banks
District/Central Banks
Primary Agricultural Credit Societies
#
Long Term Credit
State Co-operative Agricultural & Rural
Development Banks
Primary Co-operative Agricultural & Rural
Development Banks
CO-OPERATIVE BANKS
Co-operative Banks undertake the business of
banking both in urban and rural areas on the
principle of co-operation.
They have served a useful role in spreading the
banking habit throughout the country.
The co-operative banks have been set up under
the various Co-operative Societies Acts enacted
by the State Governments.
The State Governments regulate/monitor these
banks.
Certain provisions of the Banking Regulation Act
1949 were made applicable to co-operative banks
as well.
The State Co-operative Banks and Urban Co-
operative Banks are eligible to be granted the
status of scheduled banks by the Reserve Bank of
India.
All Co-operative banks are eligible for being
registered as insured banks.
URBAN CO-OPERATIVE BANKS
These banks are required to obtain a license from
the Reserve Bank of India under section 22 of the
Banking Regulation Act, 1949.
Recently the Reserve Bank of India has revised
the licensing policy of new banks.
According the this, a new bank should have share
capital of Rs. 4 Crore and membership of at least
3000 if the population is over 10 lakhs.
A share capital of Rs. 2 Crore and membership of
at least 2000 are required for population of 5 to
10 lakhs.
Share capital of Rs. 1 Crore and membership of
at least 1500 are required for population of 1 to 5
lakhs.
Share capital of Rs. 25 lakhs and membership of
at least 500 for population of less than 1 lakh.
The new bank should have at least 2 directors
with suitable banking experience or relevant
professional qualifcations.
An urban co-operative bank is allowed to become
a schedule bank if its net demand and time
liabilities are at least Rs. 100 Crore and its
overall functioning in terms of select parameters
is satisfactory.
All categories of scheduled banks including co-
operative banks are now subject to the same cash
reserve requirement as applicable to Scheduled
Commercial Banks.
STATE CO-OPERATIVE BANKS
These are the important banks in the feld of
short-term co-operative credit in rural areas.
The scheduled co-operative banks are eligible for
loans and advances from RBI and have to make
cash reserve ratio with the RBI.
The non-scheduled state co-operative banks have
to comply with the requirement of making
deposit with RBI.
State co-operative banks are also required to seek
licence from RBI for carrying on of Banking
business under section 22 of the Banking
Regulation Act, 1949.
State Co-operative banks are eligible for
obtaining credit from NABARD on the basis of
short-term and medium-term credit granted by
them.
Stateco-operative banks grant loans and
advances to the central/district co-operative
banks.
UNIT-IV
NON-BANKING FINANCIAL INTERMEDIARIES
Agenda
Investment Policy and performance appraisal of
Unit Trust of India and other mutual funds
Non-Banking Financial Companies
Insurance Companies
NON-BANKING FINANCIAL COMPANIES
Non-banking Financial Institutions carry out
fnancing activities but their resources are not
directly obtained from the savers as debt.
Instead, these Institutions mobilize the public
savings for rendering other fnancial services
including investment. All such Institutions are
fnancial intermediaries and when they lend,
they are known as Non-Banking Financial
Intermediaries(NBFIs)orInvestment
Institutions.
The principal business of NBFCs is to accept
deposits under various schemes or arrangements
like regulated deposits and exempted deposits
and to lend in various ways.
NBFCs except HFCs are regulated by the RBI.
HFCs are regulated by NHB.
NBFCs were allowed to enter into credit card
business on their own or in association with
another NBFC or a scheduled commercial bank.
Loan Companies
Investment Companies
Hire-purchase Finance
Housing fnance
Lease Finance
Mutual Beneft Financial Companies
Residuary Non-Banking Companies
Merchant Banks
Venture Capital Funds
Factors
Apart from these NBFIs, another part of Indian
fnancial system consists of a large number of
privately owned, decentralised, and relatively
small-sized fnancial intermediaries. Most work
in diferent, miniscule niches and make the
market more broad-based and competitive. While
some of them restrict themselves to fund-based
business, many others provide fnancial services
of various types. The entities of the former type
are termed as "non-bank fnancial companies
(NBFCs)". The latter type are called "non-bank
fnancial services companies (NBFCs)".
Non-bank fnancial intermediaries (NBFIs)
comprise a mixed bag of institutions, ranging
from leasing, factoring, and venture capital
companies to various types of contractual savings
and institutional investors (pension funds,
insurance companies, and mutual funds). The
common characteristic of these institutions is
that they mobilize savings and facilitate the
fnancing of diferent activities, but they do not
accept deposits from the public. NBFIs play an
important dual role in the fnancial system.
MUTUAL FUNDS
Mutual Funds are fnancial intermediaries which
collect the savings of investors and invest them
in a large and well diversifed portfolio of
securities such as money market instruments,
corporate and Government bonds and equity
shares of joint stock companies.
A Mutual Fund is a pool of mix funds invested by
diferent investors, who have no contact with
each other.
Mutual funds helps the investors who generally
dont have adequate time, knowledge, experience
and resources for directly accessing the capital
market.
The frst mutual fund was the Unit Trust of India
in 1964 under an act of Parliament.
During the years 1987-1992, seven new mutual
funds were established in the public sector.
In 1993, the Government changed its policy to
allow the entry of private corporate and foreign
institutional investor into the mutual fund
segment.
There are two types of Mutual Funds :
Open-ended funds
# Closed-ended funds
#
ORGANIZATION
The Sponsor
The Board of Trustee or Trust Company
The Asset Management Company
The Custodian
The Unit-holders
INVESTMENT POLICY & PERFORMANCE
APPRAISAL OF UTI
The MFs invest their resources in diferent type
of fnancial assets subject to the guidelines form
the government and the SEBI.
The government directs that investment by the
UTI in anyone company should not exceed fve
percent of its total investible fund, or 10 percent
of the value of the outstanding securities of that
company, whichever is lower.
It is further laid down that UTI should not invest
more than 5 percent of its funds in the initial
issues of any new industrial concern.
The objective of government regulations are to
minimize risk and avoid concentration of
investments in a few large companies.
In view of the requirement of safe provision of a
stable, regular and growing income to its unit-
holders, the portfolio of its assets has to be
composed of fxed-income securities and ordinary
shares.
The SEBI requires other mutual funds to invest
not more than 5 percent of the outstanding
equity capital of any company.
DETERMINANTS OF MUTUAL FUND
PERFORMANCE
Factors afecting expected returns include asset
allocation and systematic risk, while transaction
costs include explicit and implicit ones, which can
be measured by expense ratios, age of the funds,
fund fees, management structure, management
tenure, macro economics variables like infation,
growth rate of GDP, development of capital
market, and size of funds respectively.
In order to judge the performance of MF schemes
in an objective manner and ofer investors an
easy way to identify funds that have performed
better in relation to their peer, a number of.
Entities are evaluating and ranking their
performance.
Themostpopularofthemare
rankings/evaluations by CRISIL, Value Research
India and Credence Analytics.
INSURANCE COMPANIES
TheInsurancecompaniesarefnancial
intermediaries as they collect and invest large
amounts of premiums.
They ofer protection to the investors, provide
means for accumulating savings and channelise
funds to the government and other sectors.
The insurance industry has both economic and
social purpose. It provides social security and
promotes individual welfare.
The actual premium of insurance companies
comprises the pure premium and administrative
as well as marketing cost.
The pure premium is the present value of the
expected cost of an insurance claim.
Since there is a lag between payment of
premiums and payment of claims, there is
generation of investible funds known as
insurance reserves.
Insurance companies may be organised as either
corporations or mutual associations.
There are various parts of insurance industry:
life insurance, health insurance, general
insurance, etc.
INSURANCE INDUSTRY IN INDIA
Public Sector
Life LIC, Post Ofce Insurance
# General GIC and its four subsidiaries
#
Private Sector
Life
# General
#
INVESTMENT PATTERN AND POLICY
The pattern of investment of LIC funds has been
governed by the provisions of the Insurance Act
1938.
Till very recently, it had to invest at least 50
percent of its controlled funds in government and
other approved securities, 15 percent in other
investments which included loans to state
government for housing and water supply
schemes, municipal securities not included in
category one, government guaranteed loans to
municipal committees and co-operative sugar
factories, and upto 35 percent in approved ..
investments which included shares and
debentures of public and private limited
companies, of co-operative societies, immovable
property, loans to its policy-holders and fxed
deposits with scheduled banks and co-operative
societies.
UNIT-V
DEVELOPMENT, MERCHANT & INVESTMENT
BANKING
Agenda
Development Banking
Merchant Banking
Investment Banking
DEVELOPMENT BANKING
Development Banking is the fnancing of projects
assessed on the basis of their viability to generate
cash fows to meet the interest and repayment
obligation.
They have an in-built promotional aspect because
projects have to fall within the overall national
industrial priorities, located preferably in
backward areas and promoted by entrepreneurs.
Development banking is diferent: Loans are
made not to those who have accumulated wealth
in the past but to those who show promise to
become wealthy in the future. Normal banking
looks for safety in assets accumulated from the
past;indevelopmentbanking,possible
accumulation of assets in the future is the true
collateral. Thus, while in normal banking, the
collateral is real and tangible, in development
banking, the collateral is a dream; it is
intangible. In normal banking, an interest
default of more than 90 days becomes a non-
performing asset. In the case of development,
growth is rarely smooth; development happens in
fts and starts; cash fows are subject to wild
fuctuations and become negative at times.
development banks need to have a longer
perspective than three months; they should show
patience for years. Normal banks can aford to be
myopic; development banks should take the long
view. For development banks, it is the trend line
and not the current surplus that is important. As
one development banker blithely explained:
"When I see any risk, I take my money and run
away." But that is not development banking;
development banks take risks that ordinary
banks will not.
MERCHANT BANKING
Merchant banking activity was formally initiated
into the Indian Capital markets when Grindlays
bank in 1967 received the license from Reserve
Bank of India in 1967.
Apart from meeting specially, the needs of small
scale units, it provided management consultancy
services to large and medium sized companies.
Following Grindlays Bank, Citibank set up its
merchant banking division in 1970. The division
took up the task of assisting new entrepreneurs
and existing units in the evaluation of new
projects and raising funds through borrowing and
equity issues.
Merchant Bankers are permitted to carry on activities
of primary dealers in government securities.
On the recommendations of Banking Commission in
1972, Indian banks should ofer merchant banking
services as part of the multiple services they could
provide their clients.
State Bank of India started the merchant Banking
division in 1972. In the initial years the SBIs
objective was to render corporate advice and
assistance to small and medium entrepreneurs.
The commercial banks that followed SBI were Central
Bank of India, Bank of India and syndicate Bank in
1977; Bank of Baroda, Standard Chartered Bank and
Mercantile Bank in 1978 and United Bank of India,
United Commercial Bank, PNB, Canara Bank and
IOB in late 1970s and early 1980s.
Among the development banks ICICI started
merchant banking activities in 1973, followed by
IFCI(1986) and IDBI (1991).
The notifcation of the Ministry of Finance defnes a
merchant banker as, any person who is engaged in
the business of issue management either by making
arrangementsregardingselling,buyingor
subscribing to securities as manager, consultant,
advisor or rendering corporate advisory service in
relation to such issue management.
Merchant bankers have to be organized as body
corporates. They are governed by the merchant
bankers rules issued by the Ministry of Finance and
merchant bankers regulations issued by SEBI.
SERVICES RENDERED BY MERCHANT
BANKS
Organizing and extending fnance for investment
in projects,
Assistance in fnancial management,
Acceptance of house business,
Raising Eurodollar loans and issue of foreign
currency bonds,
Financing local authorities
Financingexport of capital goods, ships,
hydropower installation, railways.
Financingofhire-purchasetransactions,
equipment leasing, mergers and take-overs
Valuation of Assets,
Investmentmanagement and promotion of
investment trusts.
All merchant banks dont ofer all these services.
Diferentmerchant bankers specialize in
diferent services.
Merchant banking is a skill based activity and
involves servicing of any fnancial need of the
client.
Merchant banking activities are regulated by (1)
Guidelines of SEBI and Ministry of Finance, (2)
Companies act 1956 (3) Listing guidelines of
Stock Exchanges and (4) Securities Contracts
(Regulation) Act 1956.
INVESTMENT BANKING
UNIT-VI
FDI AND ISSUES RELATED THEREIN
Agenda
Foreign Investment and its regulation
Accessing International Capital Market
FOREIGN DIRECT INVESTMENT