FINANCIAL INSTITUTIONS

Financial Institutions

A financial institution is an institution

that provides financial services for its
clients or members.

Act as financial intermediaries.

 OBJECTIVE OF FINANCIAL
INSTITUTIONS
To transform financial assets acquired through the market
and constitute them into a different, and more widely
preferable, type of asset-which becomes their liability. This is
the function performed by financial intermediaries, the most
important type of financial institution.

To exchange financial assets on behalf of customers.

To exchange of financial assets for their own accounts.

To assist in the creation of financial assets for their

customers, and then selling those financial assets to other
market participants.

To provide investment advice to other market participants.

To manage the portfolios of other market participants.

Examples of financial
institutions
Banks
Stock Brokerage Firms
Non Banking Financial Institutions
Building Societies
Asset Management Firms
Credit Unions
Insurance Companies
FUNCTIONS OF FINANCIAL
INSTITUTIONS
Financial institutions offer various types of transformation services :

Liability-Asset transformation - They issue claims to their

customers that have characteristics different from those of their own
assets. For example, banks accept deposits as liability and convert
them into assets such as loans.
Size- transformation They choose and manage portfolios whose
risk and return they alter by applying resources to acquire better
information and to reduce or overcome transaction costs. They
provide large volumes of finance on the basis of small deposits or
unit capital.
Risktransformation - They distribute risk through diversification
and thereby reduce it for savers as in the case of mutual funds.
Maturity transformation They offer savers alternate forms of
deposits according to their liquidity preferences, and provide
borrowers with loans of requisite maturities.
Classification
Financial
Institutions

Intermediaries Regulators

Banking

Non-banking
IMPORTANCE OF
FINANCIAL INSTITUTIONS
Financial intermediaries convert the money
given by savers to investment by borrowers,
such as banks, UTI, NBFIs, etc.
Non-intermediaries give loans but do not
collect deposits or funds from savers.
Regulators watch the markets, players and
modes of transactions.
Regulators design the market system,
create and enforce regulations and rules for
the market.
FINANCIAL
INTERMEDIARIES
Financial intermediaries are a special group of
financial institutions that obtain funds by issuing claims to
market participants and use these funds to purchase financial
assets. Intermediaries transform funds they acquire into
assets that are more attractive to the public. By doing so,
financial intermediaries do one or more of the following:

Provide maturity intermediation

Provide risk reduction via diversification at lower cost
Reduce the cost of contracting and information processing
Provide a payments mechanism.
What is a Bank ?

A bank as an institution which accepts

deposits from the public and in turn
advances loans by creating credit. It is
different from other financial
institutions in that they cannot create
credit though they may be accepting
deposits and making advances.
Functions of Banks

Primary Functions
Acceptance of deposits
Lending money
Making investments
Borrowing money
Functions of Banks

Agency Functions
Collection and payment of cheques
Collection and payment of bills
Remittance of funds
Collections of government taxes
Undertaking administration of estates
as executors and trustees
Functions of Banks

General Utility Functions

Issues of guarantees, letters of credit,
cheques, credit and debit cards
Dealing with bullion, foreign exchange,
merchant banking, safe custody of
articles, etc,
OVERVIEW OF IMPORTANT
FINANCIAL INSTITUTIONS
There are various kinds of financial institutions
performing their role in financial intermediation and
infrastructural development, differing on the basis of
their inception and operations. Broadly, the existing
financial institutions may be classified as
(a) All India institutions like Industrial Development
Bank of India (lDBI), Industrial Finance Corporation
of India (IFCI) etc.,
(b) Regional/State level institutions like the State
Financial Corporation (SFC)
(c) Other Institutions like DICGC etc.
Industrial Finance Corporation
of India

The Industrial Finance Corporation of India (IFCI) ,

the first All-India term-lending institution was set up
in 1948 with the primary objective of providing
medium and long-term credit to industry.

It is headquartered in New Delhi.

The sources of funds for IFCI are Paid-up capital,

reserves, repayment of loans, market borrowings,
loans from the Government of India, advances from
the Industrial Development Bank of India and
foreign lines of credit from KfW (West Germany),
BFCE (France), ODA(UK) and others.
IFCI -Functions
Functions :
The main functions of IFCI are
To provide various kinds of financial services to the industries.
Primarily, its services focus on project finance as it provides
assistance to all viable industrial projects above Rs.50m.
IFCI provides assistance industrial concerns for their new
projects, expansion, diversification and modernization
schemes.
Loans are generally extended for a period of 5-7 years with a
moratorium of 2-3 years. Loans are extended both in rupee
and foreign currency.
Loans are provided after a detailed project appraisal.

Future :
In order to tap on the other financial services that offer greater
scope for the corporation, IFCI is diversifying into bill
discounting, trade bills important financing and working capital
financing.
Industrial Credit and
Investment Corporation of India

The Industrial and Investment Corporation of India (ICICI) was

founded in 1955.

It is owned and financed mainly by the private sector.

It is headquartered in Bombay.

It provides assistance to units in the private sector, particularly

to meet their foreign exchange requirements.

The resources of ICICI consist of Paid-up capital, reserves,

repayment of loans, market borrowings, loans from the
Government of India, advances from the Industrial
Development Bank of India, market borrowings and foreign
lines of credit from World Bank, USAID, KFW, UK
government and others.
Industrial Development Bank of
India

The Industrial Development Bank of India (IDBI) was

established in 1964 as a subsidiary of the Reserve Bank of
India.

Industrial Development Bank of India (IDBI) is the largest

financial institution in India, with assets at the end of 1999
approximating to Rs.600 billion.

It is headquartered in Bombay.

This apex financial institution in India, is also the 10th largest

development bank in the world.

The resources of IDBI consist of Paid-up capital, reserves,

repayment of loans, market borrowings both within and
outside the country, temporary credit from the Reserve Bank
of India, foreign lines of credit from the World Bank, ADB and
others.
Role of IDBI
Planning, promoting and developing industries to fill
the gaps in the industrial sector.
Co-coordinating the working of institutions engaged
in such activities and assisting in their development.
Providing technical and administrative assistance
for promotion, management or expansion of
industry.
Undertaking market and investment research and
techno-economic studies to contribute to the
development of industry.
 IDBI - Operations
IDBI initially provided long-term assistance to industries such as textiles,
fertilizers, chemicals products and machinery. The assistance was mainly in
the form of long-term loans or in the form of project lending.

In 1964, IDBI also began a role in assisting the State Finance Corporations
(SFCs) of various states.

By 1965, IDBI entered into rediscounting of -machinery bills to promote the

sale of indigenous machinery on deferred payment basis.

Subsequently, IDBI entered into finanancing exports on a different payment

basis, till the time Export- Import (Exim) Bank of India was formed in 1982.

In 1986, IDBI created a Small Industries Development Fund (SIDF) to provide

a special focus to the needs of the small scale sector. This fund is intended to
provide financial inputs catered to the specific needs of the small scale sector.

Through the late 80s and the early 90s IDBI played a significant role in the
development of financial markets - it played a major role in setting up of the
Stock Holding Corporation of India Limited (SHCIL)
Non Banking Financial
Institutions [NBFC]

NBFCs help to bridge the credit gaps

in several sectors which traditional
institution are unable to fulfill.
NBFCs are more flexible in their
operations and quick in decision-
making.
Activities of NBFCs

Fund-Based Activities Fee-Based Activities

1. Equipment leasing 1. Issue Management
2. Hire Purchase 2. Portfolio Management
3. Bill discounting 3. Corporate Counseling
4. Loan and Investment
5. Venture Capital 4. Project Counseling
6. House Finance 5. Arranging Foreign Collaboration
7. Factoring 6. Advising on acquisitions
&mergers
8. Equity Participant 7. Advising on Capital restructuring
9. Short-term loans
10. Inter-Corporate Loans
Life Insurance Corporation of
India

The Life Insurance Corporation of India (LIC) came into being in 1955
after the nationalization and merger of about 250 independent life
insurance societies.

It is headquartered in Bombay.

The primary activity of LIC is to carry on life insurance business, but it

has gradually developed into an important all-india financial institution
which provides substantial support to industry.

It works in close liaison with the other all-india financial institutions in

providing finance directly and in helping industrial concerns by its
underwriting support.

Thanks to its massive resources, LIC is one of the two largest

institutional investors in the country. By law it is required to invest 25
percent of its funds in government securities and a further 25 percent
in approved securities.
General Insurance Corporation

The General Insurance Corporation (GIC) was

founded when the management of general
insurances business in india was taken over by the
government in 1971 and subsequently nationalized
in 1973.

It is headquartered in Bombay.

In addition to investing in socially-oriented sectors,

where the bulk of its inevitable resources are
required to be Invested, GIC provides substantial
assistance to industrial projects by way of term
loans, subscription to equity capital and debentures,
and underwriting of securities.
Unit Trust of India

The Unit Trust of India (UTI) was set up in 1964 with the
principal objective of mobilizing public savings and channeling
them into productive corporate investments.

UTI raises its resources primarily through the sale small

denomination units.

UTI subscribes to industrial securities and also purchases

outstanding securities in the secondary market, in its
investment activity.

UTI is naturally governed by considerations of yield and

security as it has an obligation to earn a responsible rate of
return for its unit holders in its various schemes, without
exposing them to undue risks. UTI has emerged as one of the
two largest institutional investors in India.
State Financial Corporations

The State Financial Corporation (SFC), set up

under the State Financial Corporations Act, 1951,
render assistance to medium and small scale
industries to their respective states.

Their shareholders are the respective state

governments, IDBI, insurance companies, credit
cooperatives, and private shareholders.

The financial resources of SFCs consist of Paid-up

capital, reserves, market borrowings, refinance from
IDBI and borrowings from the Reserve Bank of
India and the Government of India.
State Industrial and
Development Corporations

The state Industrial and Development Corporations (SIDCs), were

set up by the state Governments during the 1960s to serve as
catalytic agents in the industrialization process of their respective
states.

Presently almost every state has an SIDC which is fully owned by the
respective state government. In addition to providing term finance to
industry, SIDCs perform a variety of other functions.

In particular, their role in sponsoring joint sector projects with the

participation of private entrepreneurs need to be emphasized.

The major resources of the SIDCs are

Paid-up capital reserves

Market borrowings
Loans from the government.
In addition, SIDCs get funds from IDBI under its refinancing scheme.
Direct Financial Assistance

Financial institutions provide direct financial

assistance in the following ways:

Rupee term loans

Foreign Currency term loans
Subscription to equity shares
Seed capital Money used for the initial
investment in a project or start-up company,for
proof of concept or market research or product
development. Also called as seed money or seed
financing.
Indirect Financial
Assistance

Besides providing direct financial

assistance, financial institutions extend help
to industrial units in obtaining finance/credit
through the following ways:
Deferred Payment guarantee - A deferred
payment guarantee is a contract under which a bank promises
to pay the supplier the price of machinery supplied by him on
deferred terms, in agreed installments with stipulated interest
in the respective due dates, in case of default in payment
there of by the buyer.
Guarantee for foreign currency loans
Underwriting
Advantages of financial
institutions

Reduction of information and transaction

costs
Grant long-term loans
Provide liquid claims and pool risks.
Financial intermediaries economize costs of
borrowers and lenders.
Banks are set up to mobilize savings of
many small depositors, which are insured.
 Investment strategy
Nature of Liabilities of financial institutions
The nature of their
Liability type Amount of Timing of
liabilities determines cash outlay cash outlay
the investment strategy
Type I Known Known
pursued by all financial
institutions. The
liabilities of all financial Type II Known Uncertain
institution will generally
fall into one of the four
Type III Uncertain Known
types shown in the
adjacent Table :
Type IV Uncertain Uncertain
Conclusion

Thus, it can be concluded that a financial

institution is that type of an institution, which
performs the collection of funds from private
investors and public investors and utilizes
those funds in financial assets. The
functions of financial institutions are not
limited to a particular country, instead they
have also become popular in abroad due to
the growing impact of globalization.