What is Financial Infrastructure ?

Financial infrastructure of India

Individual Industrial Trading companies and Government

All the institutions which promote savings amongst the public and transfer them to the actual investors The investors or borrowers are

Why Financial Infrastructure ?

Consider the Indian Scenario (numbers rounded off for convenience) GDP $800 billion Savings 29% of GDP ICOR 4 Investment 30% of GDP If we want to grow at 10% 2010 our GDP to be $1065bn Requires an investment of 265*4 = $1060bn Current savings pattern Household 22% 53% in non-financial assets 47% in financial assets Public sector Private sector 4.8% 2.2% With current level of mobilization of savings Domestic savings 274 + 186 = 460 External savings 75 + 75 =150 Deficit of $450b

Why Financial Infrastructure ?

Ways to finance this deficit
Increase savings rate Reduce ICOR Attract foreign direct and portfolio investments Channelize household savings into financial assets

Government does not have much control over the first two factors Growth can be achieved mostly through the last 2 ways
Stock markets help attract FDI & FII Banking system helps channelize household savings

This is why financial infrastructure is important in India

Source: Central Statistical Organization of http://www.migrationinformation.org/Feature/display.cfm?id=577

Overall Structure
Ministry Of Finance

National Housing Bank

IRDA

SIDBI

RBI

SEBI

NABARD

BANKS
Housing Pension Finance Insurance Funds Companies State Financial Institutions Banking & NBFCs Capital Markets Coop Banks & Regional rural Banks

Key events in the evolution of Banking in India

Phase 1 (1786 to 1969):
Indigenous banking (during independence) Family lending businesses Share greater than scheduled banks Nationalization (1969) Commercial banking system utilized to build private empires Small business units were neglected Agriculture credit was low 14 major banks with deposits > Rs 50cr Directed to lend fixed % of their deposits to priority sectors (Agriculture, Craftsmen, Cottage industries, Exporters) 6 more banks nationalized in 1980 Branch expansion
Year 1969 1991 2002 66240 32460 49 15000 60650 32750 54 14150 8260 1860 22 63800 Total Branches Rural Branches Rural branches as % of total Population per bank office

HISTORY AND PROGRESS OF BANKING IN INDIA

Growth was very slow Banks experienced periodic failures between 1913 to 1948 Approx. 1100 small banks in existence 1949 : Enactment of Banking Regulation Act- RBI, Central Banking Authority, to supervise banking in India. 1955 : Nationalization of State Bank of India. 1959 : Nationalization of SBI subsidiaries. 1961 : Insurance cover extended to deposits.

HISTORY AND PROGRESS OF BANKING IN INDIA

Structure of banking
Scheduled Banks

Scheduled Commercial Banks

Scheduled Cooperative Banks

Phase 2 (1969-1991): 1969: Nationalization of 14 major banks 1971 : Creation of credit guarantee corporation. 1975 : Creation of regional rural banks. 1980 : Nationalization of seven banks with deposits over 200 crore Phase 3 (Post 1991): 1991:Under the chairmanship of M Narasimham, a committee was set up by his name which worked for the liberalisation of banking practices.

Regional Rural Banks

Public Sector Banks

Private Sector Banks

Foreign Banks in India

Urban Cooperative Banks

State Cooperative Banks

Nationalized banks

SBI & associates

Old private banks

New private banks

Purpose Commercial Banks Regional Rural banks (196) Jointly held by Central Govt, State Govt and Sponsoring bank Bridge the credit gap in rural areas Check the outflow of rural deposits to urban areas The 20 banks which have been nationalized as of 1980 Private sector banks (30) IndusInd Bank first private bank to be setup Foreign banks in India (40) Permitted to set up local subsidiaries May not acquire Indian Banks Cooperative banks State Cooperative banks (16) Setup as market institutions do not cater to needs of poor A by the poor- for the poor arrangement Urban Cooperative banks (52) Setup as market institutions do not cater to needs of poor A by the poor- for the poor arrangement To give the govt more control on credit delivery Public sector Banks (27) Each one has a different business model To cater to increase in demand for retail and investment services

Sectors they cater

Example

Agriculture Retail traders Non-farm rual activities Self-help groups Priority sectors as mentioned during nationalization Each bank caters to different segments

Haryana State Cooperative Apex Bank Limited Syndicate Bank IOB Oriental Bank of Commerce SBI HDFC ING Vysya UTI ICICI Bank Urban population HSBC Standard Chartered Deutsche Bank

RBI
Established on April 1, 1935 Privately owned initially and taken over by the government in 1949

Farming Cattle Milk Hatchery Personal finance Self-employment Small scale units Home finance Consumer finance Personal finance

Punjab State Cooperative bank

SUCO Bank

Functions Monetary Authority Formulates, implements and monitors the monetary policy. Objective: maintaining price stability and ensuring adequate flow of credit to productive sectors. Regulator and supervisor of the financial system Prescribes broad parameters of banking operations within which the country's banking and financial system functions. Objective: maintain public confidence in the system, protect depositors' interest and provide cost-effective banking services to the public

Functions contd ..

Regulatory parameters

Manager of Foreign Exchange Manages the Foreign Exchange Management Act, 1999. Objective: to facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India. Issuer of currency Issues and exchanges or destroys currency and coins not fit for circulation. Objective: to give the public adequate quantity of supplies of currency notes and coins and in good quality. Developmental role Performs a wide range of promotional functions to support national objectives Related Functions Banker to the Government: performs merchant banking function for the central and the state governments; also acts as their banker. Banker to banks: maintains banking accounts of all scheduled banks

CRR SLR Bank rate Selective credit control Open market operations Repo Rates Reverse Repo Rates

Aspects of Regulation
Is 100 bps crr increase = 100 bps slr increase ?
In CRR, the money cannot be used by any investor in the economy In SLR, the credit giving capacity of the bank reduces but the money is still circulating in the economy and is available for investment (money multiplier reduces)

About current Inflation and CRR

RBI has used CRR as one of the tools to curb this How this works
An increase in CRR banks increase their lending rates to compensate for the decrease in profitability Borrowers have to pay more money now for their borrowings Lesser disposable income in the hands of people reduces demand for goods Decreased demand brings down prices reduces inflation

Capital markets

Capital Markets

A market where long term debt and equity securities are sold or traded Primary market Initial Public Offering Secondary market issued securities are traded Stock exchange provides a mechanism to trade securities in the secondary market First stock exchange in Asia BSE set up in 1875 NSE set up in 1993 to have a nation wide electronic exchange

Capital markets
Policy and Regulation SEBI, RBI Market Place NSE, BSE, Certain Regional Exchanges like DSE Players Brokers, Merchant Bankers, Depository Asset Classes Equities, Debt and Derivatives Rating Agencies ICRA, CRISIL, FITCH CARE

Capital markets evolution since 1992

Controller of Capital Issues (CCI) was abolished in 1992 and SEBI was set up to regulate the capital markets Free pricing of equities Introduction of book building mechanism, which leads to better price discovery of issues Dematerialisation of shares Demutualisation of stock exchanges Introduction of stock and index derivatives 2000,2001 Introduction of interest rate derivatives,2003 Allowing Indian companies to raise capital abroad by listing securities ADR, GDR

SEBI
Securities & Exchange Board of India
formed under the SEBI Act, 1992 as a step to strengthen the regulatory process for equity markets

SEBI
Legislative: Drafts the Rules Executive: Enforcement Judicial: Passes Rulings and Orders

Objectives: Protecting the interests of investors in securities Development of securities market Making rules & regulations for the securities market

Functions:
Regulator of Businesses in Stock Exchanges Review of- Market Operations Organizational Structure & Administrative Control of the Exchange Prohibiting fraudulent and unfair trade practices relating to securities markets. Promoting investor's education and training of intermediaries of securities markets.

 Prohibiting insider trading in securities, with the imposition of monetary penalties, on erring market intermediaries

Inability to use powers effectively

Could initiate prosecution proceedings on insider trading only in one case and seven cases on fraudulent and unfair practices Only in seven of the 181 cases, SEBI resorted to cancellation of registration during the last four years. Rarely has been the power to impose high penalties been exercised

Regulating substantial acquisition of shares and takeover of companies Calling for information from, carrying out inspection, conducting inquiries and audits of the stock exchanges and self regulatory organizations in the securities market

Money markets
Issue and trading of short term securities (not exceeding 1 yr) Instruments traded are T-Bills, Certificates of Deposits (CDs), Commercial Paper (CPs) and Bills of Exchange It also consists of inter-bank market: call money and notice money market In call market, money is lent for durations ranging from overnight to 14 days In notice market, money is lent for 14 days to a month

Corporate Bond markets

Primary market is essentially a private placement market Around 92% of the total funds mobilised were placed with private players Cost of issuance in term of listing, rating, disclosure makes public issue of bond expensive as compared to private placements

NBFIs
Non Banking Financial Institutions (NBFI) sector comprises
All India Financial Institutions (AIFIs)

Non Banking Financial Institutions

Created for long term financing with sectoral focus

Non-banking financial companies (NBFCs)

Private Sector institutions

Primary Dealers (PDs)

Primary and secondary Government Securities market

Institution
All Financial Institutions

Purpose
Large Public limited companies, Co-operative societies

Functions
-Issues bonds and debentures in open market -Guarantees Loans

Industrial Finance Corporation of India (IFCI) 1948

Other Financial Institutions

All India Financial Institutions

State Level Financial Institutions

State Finance Corporations (SFCs)

SFCs(18) SIDCs(28) ECGC (1987) DICGC (1987)

Small and Medium sized industries

-Sale and Issue of bonds and debentures - Guarantees Loans -Grant medium & long term loans -Provide Deferred credit, venture capital

Industrial Credit and Investment Corporation of India (ICICI) 1955

All India Development Banks

Investment Institutions

Refinance Institutions

Specialized Financial Institutions

Mission from World Bank for developing small and medium industries in the private sector Provide financial assistance to exporters and importers

IFCI (1948) ICICI (1955) IDBI (1964) IIBI(1964) IDBI (1990) LIC (1956) UTI (1964) GIC (1972) NHB (1980) NABARD (1982) EXIM Bank(1982) IVCF(1988) TFCI (1989) IDFL (1997)

Export-Import Bank of India (EXIM)

-Financing of Joint ventures in foreign countries -Loans to foreign companies & governments

Institution
Industrial Development Bank of India. 1964 -Large Financial resources to meet needs of rapid industrialization -To co-ordinate activities Small scale industries -Refinances loans -Extends seed capital -Direct, Indirect & Special Assistance - Foreign currency requirements

Purpose

Functions

Small Industries Development Bank of India (SDBI) Industrial Investment Bank of India (IIBI)

IRCI converted to IIBI IRCI : To look after sick units and provide assistance Pool savings of middle and lower income groups

-Principal All India credit and reconstruction agency

Insurance

Investment Institutions (LIC,GIC)

-Sell Units of the Trust & - Invest the proceeds in industrial and corporate securities

Insurance: History & Evolution

Insurance: History & Evolution

General Insurance Business Act 1972: Nationalized 100 odd GICs and merged to 4 companies
National Insurance New India Insurance Oriental Insurance United India Insurance

1818: Oriental Life Insurance Company by Europeans Discrimination in Pre-Independent era In 1870: Bombay Mutual Life Assurance Society covered Indian lives at normal rates 1912: Life Insurance Companies Act Insurance Act 1938 brought in strict state control In 1956: Life Insurance Industry Nationalized
A monopoly was created

Non-life Insurance or General Insurance business includes engineering, fire, marine, motor and miscellaneous

Structure
Why IRDA was set up?

Regulator: IRDA
To help economy meet its growing insurance needs Spark growth in rural areas To promote India as a regional reinsurance hub

IRDA Act 1999

Private players were allowed Maximum of 26% of foreign holding

1972-1999 : Non-life Insurance sector operated as state monopoly under GIC and its 4 subsidiaries 1956-1999: Life Insurance sector operated as monopoly Rates and terms established by Tariff Advisory Committee (TAC) The institution of Insurance Ombudsman 1998 Insurance Regulatory and Development Authority (IRDA) was set up in 1999

State owned insurers write the bulk of insurance business

Market Share for premiums: Life Market 2003-04

Company Private Sector 12.78 Public Sector 87.22 Company Market Share (%)

Post 1999
GIC- Reinsurer
Market Share for premiums: General Insurance 2003-04
Market Share (%)

Provides insurance to domestic companies Facilitates formation of market pools to further ensure that bulk of insurance premium remains in India

Private Sector 14.21 Public Sector 85.79

Source: An analysis of Evolution of Insurance in India by Tapen Sinha CRIS Discussion Paper Series 2005.III

Commercial Crop Coverage

Heavily reliant on Agriculture

2004, Farm Income Insurance Scheme (FIIS)

To protect farmers income against diseases, natural calamities, price fluctuations

Life Insurance in India (million US $) 1998 1999 2000 2001 2002 2003 5535.6 6436.3 7810.76 10649.33 12216.81 14938.63 %change 16.27 21.35 36.34 14.7 22.27

General Insurance in India (million US $) 1998 1999 2000 2001 2002 2003 2214.10 2314.44 2410.90 2609.08 2879.83 3484.58 % change 4.53 4.16 8.22 10.37 20.99

Source: An analysis of Evolution of Insurance in India by Tapen Sinha CRIS Discussion Paper Series 2005.III

Source: An analysis of Evolution of Insurance in India by Tapen Sinha CRIS Discussion Paper Series 2005.III