The term financial system includes a complex of institutions and mechanisms which affect the generation of savings and their transfer to those who will invest.
Ideal linkage between depositors and investors Facilitates expansion of financial markets Promotes efficient allocation of financial resources for socially desirable and economically productive purposes Influences both the quality and the pace of economic development
Financial Institutions Funds Deposits/ shares Commercial banks Insurance Cos Mutual Funds Provident Funds Non Banking Financial Cos Funds Loans
Demanders of funds Individuals Businesses Governments Financial Markets Money Market Capital Market
Funds
Funds Securities
Securities
Financial institutions / intermediaries like banks, insurance org., mutual funds and so on which collect capital from savers and distribute them to entrepreneurs/ productive enterprises.
2. Financial markets comprising of capital /securities market , the money market and the foreign exchange market
The main function of financial systems is the collection of savings and their distribution for industrial investment, thereby stimulating capital formation and to that extent accelerating the process of economic growth
FINANCIAL INTERMEDIARIES
FINANCIAL MARKETS
FINANCIAL INTERMEDIARIES
BANKS
NBFCs
MUTUAL FUNDS
INSURANCE COS
1. 2. 3. 4. 5. 6. 7. 8. 9.
Leasing Companies Hire purchase/Consumer Finance Cos Housing Finance Cos Venture Capital Funds Merchant Banking Organisations Credit Rating Agencies Factoring and Forfeiting organisations Stock Broking Firms Depositories
FINANCIAL INTERMEDIARIES
Their relevance to the flow of savings is derived from what is called the TRANSMUTATION EFFECT. Transmutation refers to the ability of the financial intermediaries to convert contracts with a given set of characteristics into contracts with different features.
FINANCIAL INTERMEDIARIES
The services that tailor financial assets to the desires of savers- investors are: 1. Convenience
2. 3.
Lower Risk
Expert management
Benefits of trained, experienced and specialised mgt along with continuous supervision Lower cost
4.
Economies of scale
Commercial Banks
Traditional practice Short term funds for working capital needs Emerging needs of economic and financial system Term lending particularly in infrastructure sector Capital market Retail finance such as housing finance, consumer finance etc Enlarged their geographical and functional coverage in terms of rural/ agriculture and other priority sector financing like exports, small enterprises etc.
NBFC
Provide a variety of fund/asset based and non fund based /advisory services Types of services Leasing Companies Hire purchase/Consumer Finance Cos Housing Finance Cos Venture Capital Funds Merchant Banking Organisations Credit Rating Agencies Factoring and Forfeiting organisations Stock Broking Firms Depositories
Mutual Funds
Pools the savings of relatively small investors and invest in a well diversified portfolio of sound invt. A mutual fund is set up in the form of a trust which has
1. 2. 3. 4.
Insurance Organisations
Protection against risk Contractual Nature contributes to mobilisation of funds as it tends to commit the policyholder Desire to save due to
1. 2. 3.
Emergency fund to guard his family Build a potential family estate Accumulation of fund for retirement
FINANCIAL MARKETS
Money Market
FINANCIAL MARKETS
A link between the savers and investors both individual as well as institutions
FINANCIAL MARKETS
Based on the nature of the funds which are stock in trade, the financial markets are classified into
Money Market
Dealing in monetary assets of short term nature ie namely working capital finance Major participants are
1. 2.
Money Market
The broad objectives are 1. Equilibrium for balancing out short term surpluses and deficiencies 2. Focal point for intervention by RBI for influencing liquidity 3. A reasonable access to the users of short term funds at reasonable cost Egs- Commercial paper market, Treasury bills market, Certificate of deposit market etc Negotiated dealing system (NDS) is an electronic platform for facilitating dealing in Govt. Securities and Money Market Instruments
Capital Market
Capital Market
1.
2. Secondary Stock Market /Exchange (SE) Market for old/existing securities Three Vital functions
1. 2. 3.
Nexus between savings and investments Liquidity to investors Continuous price formation
Primary /Direct
Indirect
Derivatives
Debentures
Forward Futures
Options
1. Mutual Fund Units 1. Convertible debenture 2. Security Receipts 2. Non convertible deb 3. Pass Through 3. Secured Premium Notes Certificates 4. Warrants
Direct / Primary
1.
2.
3.
Ordinary / equity shares Preference Shares Debentures/ bonds including innovative debt instruments
Participating Debentures Convertible Debentures with options Third party convertible debentures Convertible debentures redeemable at premium Debt Equity swaps Zero coupon convertible notes Zero interest fully convertible debentures Warrants either with equity or debentures Fully convertible debentures with interest (Optional)
Indirect Securities
Derivatives/Derivative instrument
Used to partially/ fully transfer price risks by locking in asset prices. Derivative is a product whose value is derived from the value of one/more basic variables called base( underlying asset/index/reference rate) in a contractual manner
Derivatives/Derivative instrument
An agreement to exchange an asset, for cash, at a predetermined future date specified today Not typically tradeable and has to be settled by delivery of asset They are transferable specific delivery forward contracts. They are agreement between two counterparties to fix the terms of an exchange/lock in price today of an exchange that will take place between them at some fixed future date.
Options Options are contracts that give the holder the right (but not the obligation) to buy (call option) or sell (put option) securities at a pre determined price (strike /exercise price) within /at the end of a specified period (expiration period)
Features Closed circle character of industrial entrepreneurship A semi organised and narrow industrial securities market Devoid of issuing institutions Virtual absence of participation of intermediary financial institutions in the long term financing of the industry
Nationalisation of the RBI in 1948 Setting up of SBI in 1956 by taking over Imperial Bank of India 245 Life insurance cos were nationalised and merged with LIC 14 Major Banks were nationalised in 1969 GIC in 1972 6 more banks were nationalised in 1980 DFIs / term lending institutions were set up UTI was created The entire instutional structure was owned and controlled by Government.
Pioneer in many aspects like underwriting of shares, channelisation of foreign currency loans from World Bank to private industry etc
Industrial Development Bank of India (IDBI) in 1964 as a subsidiary of RBI and was delinked in 1976 Small Industrial Development Bank of India as a subsidiary of IDBI LIC in 1956 UTI in 1964
Diversification in forms of financing of commercial banks such as Term Lending, underwriting of new issues. Enlargement of functional coverage
Protection to investors
Enactment of 1. Companies Act of 1956 2. Capital Issues (control) Act, 1947 3. Securities Contracts (Regulation) Act, 1956 4. Monopolies and Restrictive Trade Practices Act, 1970 5. Foreign Exchange Regulation Act (FERA), 1973
Re organisation of Structure
DFIs PFIs
Banks
NBFCs
Mutual funds
Primary
Conversion of Industrial Finance Corporation of India in to a public company. (IFCI Ltd.) IDBI and IFCI offered equity to public investors Pvt. mutual funds set up Pvt. Banks have come up With the enactment of IRDA, 1999 pvt. Insurance Cos set up by both domestic and foreign promoters Establishment of Pension Fund Regulation and Development Authority, pvt. Entities are posed to enter this field.
Development/Public Financial Institutions 1. Greater reliance of industry on capital market. 2. Giving core working capital to industry in addition to traditional loan 3.Growing focus on non fund based financial activities like merchant banking etc 4. Pattern of financing changed 5. Change in the nature of institutions sponsored from TCO, MDI to CRISIL, CARE,ICRA 6. Extension of internationally accepted accounting std has improved the bottomline 7. With conversion of ICICI Ltd and IDBI into banks, DFIs and PFIs have disappeared.
Commercial Banks
Geographically wide and functionally diverse banking system But gross profits progressively declined
Internal Factors Couldnt cope with Interest on SLR load of servicing more very low branches Credit to priority sector Diluted the quality of resulted in deterioration in manpower quality and growth of over dues Accounting practices not Political and adm. in conformity with interference international stds. Escalation in interest cost Lack of autonomy
NBFCs
2.
3.
4.
5.
Chapter III B of the RBI Act amended in 1998 RBI Acceptance of Deposits Regulations, 1998 NBFCs Prudential Norms (RBI) Directions, 1998 NBFCs Auditor Reports (RBI) Directions , 1998 RBI has set up Department of Non Banking Supervision which undertakes both on site and off site surveillance over the institutions
A remarkable development post 1991 Vehicle for institutionalisation of security invts for the relatively small investors Domestic mutual funds sponsored by UTI, bank subsidiaries, insurance organisations, private sector with foreign collaboration and foreign institutional investors/ merchant banks Several off shore/overseas/country funds sponsored by Indian Financial institutions as well as Foreign institutional investors A variety of schemes focusing on income
Mutual Funds
Capital/Securities Market
Dormant till mid 1980s After that it has emerged as the most important mechanism for allocating resources
Shown by rapid expansion in quantum of funds raised the number of investors in primary market Increase in number of stock exchanges and listed securities Speedy rise in market capitalisation and volume of trade Entry of FIIs and mutual funds
Capital Market
Primary Market
Secondary Market
Primary Market
New Issue Market One component of the organisation, namely, the market intermediaries comprise of
Specialist merchant banks/ lead manager Underwriters Bankers to an issue Registrars to an issue Share transfer agents Porfolio managers Brokers, FIIs etc
Secondary Market
A few stock exchanges , dominated by Bombay Stock Exchange provided the trading platforms for secondary market transactions NSE introduced Screen based trading in 1992 The Depositories Act, 1996- Central Depository services Ltd(CDSL) and National Securities Depository Ltd.(NSDL) were set up Successful dematerialisation of shares upto 99 percent of total market capitalisation
Shortening of settlement cycle from 14 days to T+2 Introduction of securities related derivatives FIIs have been allowed to invest in India
Money Market
Sophisticated and articulate money market has emerged Emergence of specialised institutions Primary Dealers and money market mutual funds Consists of inter related sub markets
Call/notice mkt, Commercial bills mkt, T-bills mkt, Commercial paper mkt, Certificates of deposits market and Repo market
The Capital Issues (Control) Act was repealed in 1992 The office of the Controller of Capital Issues was abolished SEBI was set up in 1988
Mandate of SEBI
1.
2.
3.
Protect the interest of the investors in securities Promote the development of the securities market Regulate the securities market
The SEBI Act Securities Contract s(Regulation) Act Depositories Act The delegated powers under the Companies Act
The SEBI regulates and supervises the securities markets through 1. regulation 2. guidelines and schemes
OBJECTIVES
To protect the interest of investors so that there is a steady flow of savings into the capital market To regulate the securities market and ensure fair practices by the issue of securities so that they can raise resources at minimum cost
FINANCIAL MARKET
FINANCIAL MARKET
Capital Market
Money Market
Capital Market
1 2 3 4
New Issue Market Types of security New Nature of Financing Organisation Functions Direct No geographical existence Specialist institutional triple services Origination Underwriting Distribution
Stock Exchange Existing/ old Indirect Physical existence Nexus between savings and investments Market place Continuous price formation
Stock exchange Listing Stock Exchange exercise considerable control over new issues Economic Interdependence Has two dimensions
Behaviour of Stock Exchange has significant bearing on the level of activity in the NIM Prices of new issues are influenced by the price movements on the stock market
2.
3.
Nexus between Savings and Investments Market Place Continuous price formation
Savings of the community are mobilised and channelled by stock exchanges for investment into those sectors and units which are favoured by the community Stock Exchanges render this service thru new issues and sale of existing securities Ensures that the various listing rules are complied with Members of stock exchange help by acting as
As brokers try to procure invts from all over the country As underwriters
Market Place
Provide market place for purchase and sale of shares thereby ensuring transferability
Large number of buyers and sellers has the effect of bringing about changes in the levels of security prices in small graduations Ever changing demand and supply conditions result in continuous revision of assets Stock exchanges act as a barometer of the state of health of the nations economy , by constantly measuring its progress or otherwise
Transfer of resources from sav ers to entrepreneurs Is a complex set of institutions thru which funds can be obtained directly or indirectly by those who require the, from investors have savings The Securities issued by the company for the first time either after the incorporation or conversion from Private to Public companies are designated as initial issues, while those issued by cos which already have stock exchange quotation either public issue or by rights to existing shareholders, are referred to as old
Two types of issues are excluded from the category of new issues
Bonus issues Exchange issues by which shares are exchanged for securities in another co.
Origination
Refers to the work of investigation as analysis and processing of new proposals Are performed by specialist agencies which act as the sponsors of issues A careful study of technical, economic , financial and legal aspects of the issuing companies In this process, the sponsoring institutions render some services of an advisory nature which go to improve quality of capital issues
Services include
Determination of the class of security to be issued and prices of the issues in the light of market conditions The timing and magnitude of issue Methods of floatation Technique of selling etc
Underwriting
A form of guarantee that issues would be sold by eliminating the risk arising from uncertainty of public response
Distribution
Issue Mechanism
Public issue through prospectus Tender / Book building Offer for sale Placement Rights issue
Issuing companies offer directly to the public Issues are underwritten Minimum contents of a issue are prescribed by the Companies Act, 1956.