Indian Financial System

(Role of Banks in the Financial System)

Banking

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 in India has evolved through four distinct phases: Foundation phase

Expansion phase
Consolidation phase Reforms phase

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 the way 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

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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Visible results of Reform process

Capital adequacy ratio Asset quality

Return on assets
Business per employee Recapitalization of banks by government.

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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 and consumption 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, insurance companies, etc.) Financial markets (money market, capital market, forex market, etc.)

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

Financial assets/instruments

Enable channelising funds from surplus units to deficit units There are instruments for savers such as deposits, equities, mutual fund units, etc. There are instruments for borrowers such as loans, overdrafts, etc. Like businesses, governments too raise funds through issuing of bonds, Treasury bills, etc. Instruments like PPF, KVP, etc. are available to savers who wish to lend money to the government

Financial Markets
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

Capital market

Money Market

Financial Market

Security Market

Foreign Exchange Market

Participants in the Financial Market

Commercial Banks

Individuals

Corporate
Government

Mutual Funds
Primary dealers

Regulators
Financial Institutions*

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 like banks

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Intermediation
The process of mobilizing the savings of the community and deploying the same to deficit sectors is called intermediation. Organizations which does the Financial intermediaries Banks are financial intermediaries Now the concept of financial disintermediation also is prevalent
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job are called as

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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
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Call money market

It is an integral part of the Indian money market where day-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 it exceeds 1 day but is less than 15 days it is called notice money. Money lent for more than 15 days is term money

The borrowing is exclusively limited to banks, who are temporarily 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 of funds.
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 call money market only on the lenders side These were phased out and call money market is now a pure inter-bank market (since August 2005)

Commercial Papers

Short-term borrowings by corporate, financial institutions, from the money market Can be issued in the physical form (Usance Promissory Note) or Demat form. Introduced in 1990 When issued in physical form are negotiable by endorsement and delivery and hence, highly flexible Issued subject to minimum of Rs. 5 lacs and in the multiple of 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 primary issues 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 InstitutionsRisk Capital &Technology Finance Corporation Ltd (RCTC), ICICI Venture Limited, Tourism Finance Corporation 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, development banking is project-oriented.
.
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while

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 by other CRAs.
The issuers shall ensure at the time of issuance of the CP that the rating so obtained 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 single

investor 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 from

an 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/investors

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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 Rate
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Reverse Repo transaction

Security Cash

Reserve Bank of India

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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 Facility
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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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Marginal Standing Facility

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 and Time Liabilities".

The rate of interest on the amount accessed from this facility will be 100 basis points (i.e. 1%) above the repo rate

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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 and State 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 10

per 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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Thank you very much

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