indian finsncial system
TRANSCRIPT
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Management of financial services
INDIAN FINANCIAL SYSTEM
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CHAPTER-1 INDIAN FINANCIAL SYSTEM
MEANING & DEFINITION OF FINANCIAL SYSTEM:
Definition
“In finance, the financial system is the system that allows the transfer of money between savers
and borrowers. It comprises a set of complex and closely interconnected financial institutions,
markets, instruments, services, practices, and transactions.”
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According to Robinson, the primary function of the system is “To provide a link between
saving and investment for the creation of new wealth and to permit portfolio adjustment in
composition of existing wealth”
The word "system", in the term "financial system", implies a set of complex and closely
connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities
in the economy. The financial system is concerned about money, credit and finance-the three
terms are intimately related yet are somewhat different from each other. Indian financial system
consists of financial market, financial instruments and financial intermediation.
There are areas or people with surplus funds and there are those with a deficit. A financial
system or financial sector functions as an intermediary and facilitates the flow of funds from the
areas of surplus to the areas of deficit. A Financial System is a composition of various
institutions, markets, regulations and laws, practices, money manager, analysts, transactions and
claims and liabilities.
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The economic development of a nation is reflected by the progress of the various economic units,
broadly classified into corporate sector, government and household sector. While performing
their activities these units will be placed in a surplus/deficit/balanced budgetary situations.
In finance, the financial system is the system that allows the transfer of money between savers
and borrowers it comprises a set of complex and closely interconnected financial institutions,
markets, instruments, services, practices, and transactions. Financial systems are crucial to the
allocation of resources in a modern economy. They channel household savings to the corporate
sector and allocate investment funds among firms. The functions are common to the financial
systems of most developed economies. Yet the form of these financial systems varies widely.
In finance, the financial system is the system that allows the transfer of money between savers
and borrowers it comprises a set of complex and closely interconnected financial institutions,
markets, instruments, services, practices, and transactions. Financial systems are crucial to the
allocation of resources in a modern economy. They channel household savings to the corporate
sector and allocate investment funds among firms. The functions are common to the financial
systems of most developed economies. Yet the form of these financial systems varies widely.
The financial system or the financial sector of any country consists of:-
(A) Specialized & non specialized financial institution.
(B) Organized &unorganized financial markets and,
(C) Financial instruments & services which facilitate transfer of funds.
Procedure & practices adopted in the markets, and financial inter relationships are also the parts
of the system. These parts are not always mutually exclusive. The word system in the term
financial system implies a set of complex and closely connected or inters mixed institution,
agent‟s practices, markets, transactions, claims, & liabilities in the economy. The financial
system is concerned about money, credit, & finance – the terms intimately related yet somewhat
different from each other. Money refers to the current medium of exchange or means of
payment. Credit or Loan is a sum of money to be returned normally with interest it refers to a
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debt of economic unit. Finance is a monetary resources comprising debt & ownership fund of the
state, company or person.
DEFINITION
“In finance, the financial system is the system that allows the transfer of money between savers
and borrowers. It comprises a set of complex and closely interconnected financial institutions,
markets, instruments, services, practices, and transactions.”
Features of Financial System
It provides an Ideal linkage between depositor‟s savers and investors Therefore it
encourages savings and investment.
Financial system facilitates expansion of financial markets over a period of time.
Financial system should promote deficient allocation of financial resources of
socially desirable and economically productive purpose.
Financial system influence both quality and the pace of economic development.
Role of Financial System
The role of the financial system is to promote savings & investments in the economy. It has a
vital role to play in the productive process and in the mobilization of savings and their
distribution among the various productive activities. Savings are the excess of current
expenditure over income. The domestic savings has been categorized into three sectors,
household, government & private sectors.
The function of a financial system is to establish a bridge between the savers and investors. It
helps in mobilization of savings to materialize investment ideas into realities. It helps to increase
the output towards the existing production frontier. The growth of the banking habit helps to
activate saving and undertake fresh saving. The financial system encourages investment activity
by reducing the cost of finance risk. It helps to make investment decisions regarding projects by
sponsoring, encouraging, export project appraisal, feasibility studies, monitoring & execution of
the projects
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COMPONENTS/ CONSTITUENTS OF INDIAN FINANCIAL SYSTEM
A. FORMAL FINANCIAL SYSTEM
1. Financial institutions/intermediaries
2. Financial Markets
3. Financial Instruments/Assets/Securities
4. Financial Services.
B. INFORMAL FINANCIAL SYSTEM: Like, Moneylenders, Local Bankers, Traders,
Landlords, and Pawn Broker etc.
1. FINANCIAL INSTITUTIONS
In financial economics, a financial institution is an institution that provides financial
services for its clients or members. Probably the most important financial service provided by
financial institutions is acting as financial intermediaries. Most financial institutions are
highly regulated by government
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Financial institutions provide service as intermediaries of the capital and debt markets. They are
responsible for transferring funds from investors to companies in need of those funds. Financial
institutions facilitate the flow of money through the economy. To do so, savings a risk brought to
provide funds for loans. Such is the primary means for depository institutions to develop
revenue. Should the yield curve become inverse, firms in this arena will offer additional fee-
generating services including securities underwriting.
The financial institutions in India are divided in two categories. The first type refers to the
regulatory institutions and the second type refers to the intermediaries. The regulators are
assigned with the job of governing all the divisions of the Indian financial system. These
regulatory institutions are responsible for maintaining the transparency and the national interest
in the operations of the institutions under their supervision.
The regulatory bodies of the financial institutions in India are as follows:
Reserve Bank of India (RBI)
Securities and Exchange Board of India (SEBI)
Central Board of Direct Taxes (CBDT)
Central Board of Excise & Customs
Apart from the Regulatory bodies, there are the Intermediaries that include the banking and non-
banking financial institutions. Some of the specialized financial institutions in India are as
follows:
Unit Trust of India (UTI)
Securities Trading Corporation of India Ltd. (STCI)
Industrial Development Bank of India (IDBI)
Industrial Reconstruction Bank of India (IRBI), now (Industrial Investment Bank of
India)
Export - Import Bank of India (EXIM Bank)
Small Industries Development Bank of India (SIDBI)
National Bank for Agriculture and Rural Development (NABARD)
Life Insurance Corporation of India (LIC)
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Intermediary Market Role
Stock Exchange Capital Market Secondary Market to securities
Investment Bankers Capital Market, Credit Market Corporate advisory services, Issue of
securities
Underwriters Capital Market, Money Market Subscribe to unsubscribed portion of
securities
Registrars, Depositories, Custodians Capital Market
Issue securities to the investors on behalf
of the company and handle share transfer
activity
Primary Dealers Satellite Dealers Money Market Market making in government securities
Forex Dealers Forex Market Ensure exchange ink currencies
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.
2. FINANCIAL MARKETS
Financial Markets are an important component of financial system in an economy financial
system aims at establishing a regular, smooth, efficient and cost effective link between savers &
investors. Thus, it helps encouraging both saving and investment. All system facilitates
expansion of financial markets over space 8 times and promotes efficient allocation of financial
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resources .For socially desirable and economically productive purposes. They influence both the
quality and the pace of economic development.
Various constituents of financial system are financial, institutions, financial services, financial
instruments and financial markets. These constituents of financial system are closely inter-mixed
and operate in conjunction with each other. For eg. Financial institutions operate in financial
markets generating, purchasing and selling financial instruments and rendering various financial
services in accordance with the practices and procedures established by law or tradition.
Financial markets are the centre or arrangements facilitating buying and selling of financial
claims, assets, services and the securities. Banking and non – banking financial institutions,
dealers, borrowers and lenders, investors and savers, and agents are the participants on demand
and supply side in these markets. Financial market may be specific place or location, e.g. stock
exchange or it may be just on over – the –phone market.
Financial markets in India are classified into four parts, viz.:-
Money Market
Capital Market
Debt Market
Forex Market
INTRODUCTION TO MONEY MARKET
Whenever a bear market comes along, investors realize that the stock market is a risky place for
their savings. It's a fact we tend to forget while enjoying the returns of a bull market!
Unfortunately, this is part of the risk-return tradeoff. To get higher returns, you have to take on a
higher level of risk. For many investors, a volatile market is too much to stomach - the money
market offers an alternative to this higher-risk investment.
The money market is better known as a place for large institutions and government to manage
their short-term cash needs. However, individual investors have access to the market through a
variety of different securities. In this tutorial, we'll cover various types of money market
securities and how they can work in your portfolio.
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The money market is a subsection of the fixed income market. We generally think of the term
fixed income as being synonymous to bonds. In reality, a bond is just one type of fixed income
security. The difference between the money market and the bond market is that the money
market specializes in very short-term debt securities (debt that matures in less than one year).
Money market investments are also called cash investments because of their short maturities.
The easiest way for us to gain access to the money market is with money market mutual funds,
or sometimes through a money market bank account. These accounts and funds pool together the
assets of thousands of investors in order to buy the money market securities on their behalf.
However, some money market instruments, like Treasury bills, may be purchased directly.
Failing that, they can be acquired through other large financial institutions with direct access to
these markets.
MONEY MARKET INSTRUMENTS
The money market is a market for short-term financial assets that are close substitutes of money.
The most important feature of a money market instrument is that it is liquid and can be turned
over quickly at low cost and provides an opportunity for balancing the short-term surplus funds
of lenders and the requirements of borrowers. By convention, the term "Money Market" refers to
the market for short-term requirement and deployment of funds. Money market instruments are
those instruments, which have a maturity period of less than one year. The most active part of the
money market is the market for overnight call and term money between banks and institutions
and repo transactions. Call Money / Repo are very short-term Money Market products. There is a
wide range of participants (banks, primary dealers, financial institutions, mutual funds, trusts,
provident funds etc.) dealing in money market instruments. Money Market Instruments and the
participants of money market are regulated by RBI and SEBI.As a primary dealer SBI DFHI is
an active player in this market and widely deals in Short Term Money Market Instruments. T he
below mentioned instruments is normally termed as money market instruments:
Call/ Notice Money
Treasury Bill
Inter-Bank Term Money
Certificate of Deposit
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Commercial Paper
Inter-Corporate Deposits
Repo/Reverse Repo
Call /Notice-Money Market
Call/Notice money is the money borrowed or lent on demand for a very short period. When
money is borrowed or lent for a day, it is known as Call (Overnight) Money. Intervening
holidays and/or Sunday are excluded for this purpose. Thus money, borrowed on a day and
repaid on the next working day, (irrespective of the number of intervening holidays) is "Call
Money". When money is borrowed or lent for more than a day and up to 14 days, it is "Notice
Money". No collateral security is required to cover these transactions.
Treasury Bills:
The Treasury bills are short-term money market instrument that mature in a year or less than
that. The purchase price is less than the face value. At maturity the government pays
the Treasury bill holder the full face value. The Treasury Bills are marketable, affordable and
risk free. The only downside to T-bills is that you won't get a great return because Treasuries are
exceptionally safe.
Inter-Bank Term Money
Inter-bank market for deposits of maturity beyond 14 days is referred to as the term money
market. The entry restrictions are the same as those for Call/Notice Money except that, as per
existing regulations, the specified entities are not allowed to lend beyond 14 days.
Certificate of Deposit (CD)
The certificates of deposit are basically time deposits that are issued by
the commercial banks with maturity periods ranging from 3 months to five years. The return on
the certificate of deposit is higher than the Treasury Bills because it assumes a higher level of
risk.
Commercial Paper
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Commercial Paper is short-term loan that is issued by a corporation use for financing accounts
receivable and inventories. The maturity period of Commercial Papers is a maximum of 9
months. They are very safe since the financial situation of the corporation can be anticipated over
a few months.
Inter-Corporate Deposits
Inter-corporate deposits are deposits made by one company with another company, and usually
carry a term of six months. The three types of inter-corporate deposits are: three month deposits,
six month deposits, and call deposits. The biggest advantage of inter-corporate deposits is that
the transaction is free from bureaucratic and legal hassles.
Repo/Reverse Repo
Repo is short for repurchase agreement. Those who deal in government securities use repos as a
form of overnight borrowing. They are usually very short-term, from overnight to 30 days or
more. The reverse repo is the complete opposite of a repo. In this case, a dealer buys government
securities from an investor and then sells them back at a later date for a higher price.
INTRODUCTION TO CAPITAL MARKET
Capital market is market for long term securities. It contains financial instruments of maturity
period exceeding one year. It involves in long term nature of transactions. It is a growing element
of the financial system in the India economy. It differs from the money market in terms of
maturity period & liquidity. It is the financial pillar of industrialized economy. The development
of a nation depends upon the functions & capabilities of the capital market. Capital market is the
market for long term sources of finance. It refers to meet the long term requirements of the
industry. Generally the business concerns need two kinds of finance:-
1. Short term funds for working capital requirements.
2. Long term funds for purchasing fixed assets.
Therefore the requirements of working capital of the industry are met by the money market. The
long term requirements of the funds to the corporate sector are supplied by the capital market. It
refers to the institutional arrangements which facilitate the lending & borrowing of long term
funds.
On the basis of financial instruments the capital markets are classifieds into
Two kinds:-
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a) Equity market
b) Debt market
Recently there has been a substantial development of the India capital market. It comprises
various submarkets.
Equity market is more popular in India. It refers to the market for equity shares of existing &
new companies. Every company shall approach the market for raising of funds. The equity
market can be divided into two categories
(a) Primary market
(b) Secondary market.
PRIMARY MARKET
The primary market is that part of the capital markets that deals with the issue of
new securities. Companies, governments or public sector institutions can obtain funding through
the sale of a new stock or bond issue. This is typically done through a syndicate of securities
dealers. The process of selling new issues to investors is called underwriting. In the case of a
new stock issue, this sale is an initial public offering (IPO). Dealers earn a commission that is
built into the price of the security offering, though it can be found in the prospectus. Primary
markets create long term instruments through which corporate entities borrow from capital
market. A company can raise its capital through issue of share and debenture by means of:-
Public Issue:-
Public issue is the most popular method of raising capital and involves raising capital and fund
direct from the public.
Right Issue:-
Right issue is the method of raising additional finance from existing members by offering
securities to them on pro rata basis.
Bonus Issue:-
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Some companies distribute profits to existing shareholders by way of fully paid up bonus share
in lieu of dividend. The shareholder does not have to any additional payment for these shares.
Private Placement:-
Private placement market financing is the direct sale by a public limited company or private
limited company of private as well as public sector of its securities to the intermediaries like
credit rating agencies and trustees and financial advisors such as merchant bankers.
SECONDARY MARKET
The secondary market is that segment of the capital market where the outstanding securities are
traded from the investors point of view the secondary market imparts liquidity to the long – term
securities held by them by providing an auction market for these securities. The secondary
market operates through the medium of stock exchange which regulates the trading activity in
this market and ensures a measure of safety and fair dealing to the investors. India has a long
tradition of trading in securities going back to nearly 200 years. The first India stock exchange
established at Mumbai in 1875 is the oldest exchange in Asia. The main objective was to protect
the character status and interest of the native share and stock broker.
The Indian stock markets can be divided into further categories depending on various aspects
like the mode of operation and the diversification in services. First of the two largest stock
exchanges in India can be divided on the basis of operation. While the Bombay stock exchange
or BSE is a conventional stock exchange with a trading floor and operating through mostly
offline trades, the National Stock Exchange or NSE is a completely online stock exchange and
the first of its kind in the country. The trading is carried out at the National Stock Exchange
through the electronic limit order book or the LOB. With the immense popularity of the process
and online trading facility other exchanges started to take up the online route including the BSE
where you can trade online as well. But the BSE is still having the offline trading facility that is
carried out at the trading floor of the exchange at its Dalal Street facility.
INTRODUCTION TO DEBT MARKET
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Debt market refers to the financial market where investors buy and sell debt securities, mostly in
the form of bonds. These markets are important source of funds, especially in a developing
economy like India. India debt market is one of the largest in Asia. Like all other countries, debt
market in India is also considered a useful substitute to banking channels for finance. The fixed
return on the bond is often termed as the 'coupon rate' or the 'interest rate'.
The debt market often goes by other names, based on the types of debt instruments that are
traded. In the event that the market deals mainly with the trading of municipal and corporate
bond issues, the debt market may be known as a bond market. If mortgages and notes are the
main focus of the trading, the debt market may be known as a credit market. When fixed rates
are connected with the debt instruments, the market may be known as a fixed income market.
The instruments traded can be classified into the following segments based on the characteristics
of the identity of the issuer of these securities:
Market Segment Issuer Instruments
Government
Securities
Central Government Zero Coupon Bonds, Coupon Bearing Bonds,
Treasury Bills, STRIPS
State Governments Coupon Bearing Bonds.
Public Sector
Bonds
Government Agencies /
Statutory Bodies
Govt. Guaranteed Bonds, Debentures
Public Sector Units PSU Bonds, Debentures, Commercial Paper
Private Sector
Bonds
Corporate Debentures, Bonds, Commercial Paper, Floating Rate
Bonds, Zero Coupon Bonds, Inter-Corporate Deposits
Banks Certificates of Deposits, Debentures, Bonds
Financial Institutions Certificates of Deposits, Bonds
INTRODUCTION TO FOREX MARKET
In India, foreign exchange has been given a statutory definition. Section 2 (b) of Foreign
Exchange Regulation Act, 1973 states:
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„Foreign exchange‟ means foreign currency and includes:
“All deposits, credits and balances payable in any foreign currency and any drafts, traveler‟s
cheques, letters of credit and bills of exchange , expressed or drawn in Indian currency but
payable in any foreign currency.”
Particularly for foreign exchange market there is no market place called the foreign exchange
market. It is mechanism through which one country‟s currency can be exchange i.e. bought or
sold for the currency of another country. The foreign exchange market does not have any
geographic location. The market comprises of all foreign exchange traders who are connected to
each other throughout the world. They deal with each other through telephones, telexes and
electronic systems. With the help of Reuters Money 2000-2, it is possible to access any trader in
any corner of the world within a few seconds.
Participants
1. Customers
The customers who are engaged in foreign trade participate in foreign exchange markets
by availing of the services of banks.
2. Commercial banks
Commercial banks dealing with international transactions offer services for conversion of
one currency in to another.
3. Central Bank
In all countries central banks have been charged with the responsibility of maintaining
the external value of the domestic currency.
3. FINANCIAL INSTRUMENTS
Financial instrument is a claim against a person or an institution for payment, at a future date, of
a sum of money and/or a periodic payment in the form of interest or dividend. Financial
instrument can be classified according to Term and Type.
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Under term wise it is classified by Short-term, Long-term and Medium term. While under type
wise it is classified as Primary security and Secondary security. Primary securities are termed as
direct security as they are directly issued by the ultimate borrowers of fund to the ultimate
savers. Primary security includes equity share, preference shares and debentures. Secondary
securities are referred to as indirect securities, as they are issued by the financial intermediaries
to the ultimate savers. It includes insurance policy, Mutual Fund Units, Term Deposits etc.
THE MAJOR TYPES OF FINANCIAL PRODUCTS ARE:
Shares:
These represent ownership of a company. While shares are initially issued by corporations to
finance their business needs, they are subsequently bought and sold by individuals in
the share market. They are associated with high risk and high returns. Returns on shares can be
in the form of dividend payouts by the company or profits on the sale of shares in the stock
market. Shares, stocks, equities and securities are words that are generally used interchangeably.
Bonds:
These are issued by companies to finance their business operations and by governments to fund
expenses like infrastructure and social programs. Bonds have a fixed interest rate, making the
risk associated with them lower than that with shares. The principal or face value of bonds is
recovered at the time of maturity.
Treasury Bills
These are instruments issued by the government for financing its short term needs. They are
issued at a discount to the face value. The profit earned by the investor is the difference between
the face or maturity value and the price at which the Treasury Bill was issued.
Options
Options are rights to buy and sell shares. An option holder does not actually purchase shares.
Instead, he purchases the rights on the shares.
Mutual Funds
These are professionally managed financial instruments that involve the diversification of
investment into a number of financial products, such as shares, bonds and government securities.
This helps to reduce an investor‟s risk exposure, while increasing the profit potential.
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Credit Default Swaps (CDS)
Credit default swaps are highly leveraged contracts that are privately negotiated between two
parties. These swaps insure against losses on securities in case of a default. Since the government
does not regulate CDS related activities, there is no specific central reporting mechanism that
determines the value of these contracts.
Annuities
These are contracts between investors and insurance companies, wherein the latter makes
periodic payments in exchange for financial protection in the event of an unfortunate incident.
4. FINANCIAL SERVICES
Financial intermediaries provide key financial services such as merchant banking, leasing, hire
purchase, credit rating and so on. Financial services rendered by financial intermediaries bridge
the gap between lack of knowledge on part of investors and increasing sophistication of financial
instruments and markets.
Financial services encompass a variety of businesses that deal with money management. These
include many different kinds of organizations such as banks, investment companies, credit card
companies, insurance companies and even government programs. Financial services can also
refer to the services and products that money management organizations offer to the public.
Banks are one kind of financial services organizations. Banks generally function by providing a
sheltered and secure place for people to store their money. Usually, banks will invest their
clients' stored money for the bank's gain, while paying a small amount of interest to those who
keep their money in savings or checking accounts.
The Financial services were developed in order to meet the needs of individual as well as
companies. The financials of companies are expected to improve as a result of these financial
services in the form of lower debt equity ratio, improved liquidity and profitability ratios. The
financial service industry has been growing at a rate of 14% per annum.
Indian financial services industry was rather unexciting until the early seventies. The financial
services sector was started in mid seventies when a series of innovative services of which leasing
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being the most notable. India has witnessed an explosive growth of leasing companies during the
early eighties.
(A)Banking and Financial Services:
Banking and financial services can also be further classified as:
1. Fee based financial services
Financial management.
Advisory services
Custody services
Credit card services
2. Securities-related financial services
Securities lending services
Mutual fund services
Securities clearance
Settlement services
Under-writing services
(B)Insurance and insurance related services
Insurance services include the following:
Insurance brokerage
Specialty insurance products
Reinsurance
(C)Fee-based Financial Services
Financial services based on fees are as follows:
Issue management
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Portfolio management
Loan based syndication
Mergers and acquisitions
CAPITAL MARKET SERVICES
The following are the financial services rendered by various intermediaries in relation to capital
market.
1. Issue management
Public issue management is the beginning of project financing activity. A company has to
appoint public issue managers who are normally merchant bankers. It is a marketing activity.
2. Merchant banking
A merchant banker is any person who is engaged in the business of issue management either by
making arrangements regarding selling, buying or subscribing to securities as manager,
consultant or advisor or vendoring corporate advisory services in relation to such issue
management
Services provided by Merchant Bankers
Underwriting of issues
Project finance
Private placements
ROLE/ FUNCTIONS OF FINANCIAL SYSTEM:
The role of the financial system is to promote savings & investments in the economy. It has a
vital role to play in the productive process and in the mobilization of savings and their
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distribution among the various productive activities. Savings are the excess of current
expenditure over income. The domestic savings has been categorized into three sectors,
household, government & private sectors.
The function of a financial system is to establish a bridge between the savers and investors. It
helps in mobilization of savings to materialize investment ideas into realities. It helps to increase
the output towards the existing production frontier. The growth of the banking habit helps to
activate saving and undertake fresh saving. The financial system encourages investment activity
by reducing the cost of finance risk. It helps to make investment decisions regarding projects by
sponsoring, encouraging, export project appraisal, feasibility studies, monitoring & execution of
the projects.
A financial system performs the following functions:
1. It serves as a link between savers and investors. It helps in utilizing the mobilized savings
of scattered savers in more efficient and effective manner. It channelizes flow of saving
into productive investment.
2. It assists in the selection of the projects to be financed and also reviews the performance
of such projects periodically.
3. It provides payment mechanism for exchange of goods and services.
4. It provides a mechanism for the transfer of resources across geographic boundaries.
5. It provides a mechanism for managing and controlling the risk involved in mobilizing
savings and allocating credit.
6. It promotes the process of capital formation by bringing together the supply of saving and
the demand for investible funds.
7. It helps in lowering the cost of transaction and increase returns. Reduce cost motives
people to save more.
8. It provides you detailed information to the operators/ players in the market such as
individuals, business houses, Governments etc.
INDIAN FINANCIAL SYSTEM FROM 1950 TO 1980
Indian Financial System During this period evolved in response to the objective of planned
economic development. With the adoption of mixed economy as a pattern of industrial
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development, a complimentary role was conceived for public and private sector. There was a
need to align financial system with government economic policies. At that time there was
government control over distribution of credit and finance. The main elements of financial
organization in planned economic development are as follows:-
1. Public ownership of financial institutions
The nationalization of RBI was in 1948, SBI was set up in 1956, LIC came in to existence in
1956 by merging 245 life insurance companies in 1969, 14 major private banks were brought
under the direct control of Government of India. In 1972, GIC was set up and in 1980; six more
commercial banks were brought under public ownership. Some institutions were also set up
during this period like development banks, term lending institutions, UTI was set up in public
sector in 1964, provident fund, pension fund was set up. In this way public sector occupied
commanding position in Indian Financial System.
2. Fortification of institutional structure
Financial institutions should stimulate / encourage capital formation in the economy. The
important feature of well developed financial system is strengthening of institutional structures.
Development banks was set up with this objective like industrial finance corporation of India
(IFCI) was set up in 1948, state financial corporation (SFCs) were set up in 1951, Industrial
credit and Investment corporation of India Ltd (ICICI)was set up in 1955. It was pioneer in many
respects like underwriting of issue of capital, channelization of foreign currency loans from
World Bank to private industry. In 1964, Industrial Development of India (IDBI).
3. Protection of investor
Lot many acts were passed during this period for protection of investors in financial markets.
The various acts Companies Act, 1956 ; Capital Issues Control Act, 1947 ; Securities Contract
Regulation Act, 1956 ; Monopolies and Restrictive Trade Practices Act, 1970 ; Foreign
Exchange Regulation Act, 1973 ; Securities & Exchange Board of India, 1988.
4. Participation in corporate management
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As participation were made by large companies and financial instruments it leads to
accumulation of voting power in hands of institutional investors in several big companies
financial instruments particularly LIC and UTI were able to put considerable pressure on
management by virtual of their voting power. The Indian Financial System between 1951 and
mid80‟s was broad based number of institutions came up. The system was characterized by
diversifying organizations which used to perform number of functions. The Financial structure
with considerable strength and capability of supplying industrial capital to various enterprises
was gradually built up the whole financial system came under the ownership and control of
public authorities in this manner public sector occupy a commanding position in the industrial
enterprises. Such control was viewed as integral part of the strategy of planned economy
development.
INDIAN FINANCIAL SYSTEM POST 1990’S
The organizations of Indian Financial system witnessed transformation after launching of new
economic policy 1991. The development process shifted from controlled economy to free market
for these changes was made in the economic policy. The role of government in business was
reduced the measure trust of the government should be on development of infrastructure, public
welfare and equity. The capital market an important role in allocation of resources. The major
development during this phase is:-
1. Privatization of financial institutions
At this time many institutions were converted in to public company and numbers of private
players were allowed to enter in to various sectors:
a) Industrial Finance Corporation of India (IFCI): The pioneer development finance
institution was converted in to a public company.
b) Industrial Development Bank of India & Industrial Finance Corporation of India (IDBI &
IFCI): IDBI & IFCI ltd offers their equity capital to private investors.
c) Private Mutual Funds have been set up under the guidelines prescribed by SEBI.
d) Number of private banks and foreign banks came up under the RBI guidelines. Private
institution companies emerged and work under the guidelines of IRDA, 1999.
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e) In this manner government monopoly over financial institutions has been dismantled in
phased manner. IT was done by converting public financial institutions in joint stock
companies and permitting to sell equity capital to the government.
2. Reorganization of institutional structure
The importance of development financial institutions decline with shift to capital market for
raising finance commercial banks were give more funds to investment in capital market for this.
SLR and CRR were produced; SLR earlier @ 38.5% was reduced to 25% and CRR which used
to be 25% is at present 5%. Permission was also given to banks to directly undertake leasing,
hire-purchase and factoring business. There was trust on development of primary market,
secondary market and money market.
3. Investor protection
SEBI is given power to regulate financial markets and the various intermediaries in the financial
markets.
REGULATORY FINANCIAL INSTITUTIONS
Regulatory institutions to be ensured that firms provide the goods and services promised and that
their behaviors, in general, conform to established standards In the county and or abroad.
These functions of the institutions are however not always neatly declined in practice. For
example, regulatory institutions may perform facilitator and / or promotional service to mitigate
any unintended negative consequences that their main activities may have for development of the
firms.
Financial intermediaries are heavily regulated in comparison to non-financial firms. Financial
intermediaries are subject to rules and regulations governing their business. They are also subject
to supervision and monitoring to ensure that rules and regulation are followed.
Following are the regulatory authorities which governs the working of financial intermediaries.
1. Securities and exchange board of India(SEBI)
2. The reserve bank of India(RBI)
3. Insurance regulatory and development authority(IRDA)
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SECURITIES AND EXCHANGE BOARD OF INDIA [SEBI]
Securities and Exchange Board of India (SEBI) was first established in the year 1988 as a non-
statutory body for regulating the securities market. It became an autonomous body in 1992 and
more powers were given through an ordinance. Since then it regulates the market through its
independent powers.
Established in the year 1988 and became an autonomous body in 1992
Basic Functions
“…..to protect the interests of investors in securities and to promote the development of,
and to regulate the securities market and for matters connected therewith or incidental thereto”
THE BACKGROUND OF SEBI
Securities and Exchange Board of India, popularly called SEBI, is a quasi government body
that was initially formed in 1988 by an administrative order. The Indian capital market had
started developing very fast during the 1980s. The amount of capital raised by companies from
the primary market increased from a modest 200 crores in 1980 to a substantial 6500 crores in
1990. This implied a great exposure of public money, which also attracted a number of fly-by-
night operators. This necessitated a watchdog that could safeguard the interests of investors.
SEBI was provided a statutory status in the immediate aftermath of infamous securities scam
perpetrated by Harshad Mehta. The scam shook up the foundations of the Indian financial
framework. The stock market, which was making a frenzied climb upwards, collapsed on its
face. Thousands of crores of market equity was destroyed overnight and a number of financial
institutions and banks were forced to shut shop. That a single individual could twist and tweak
the system, with all is apparent loopholes, for earning tremendous profits became painfully
apparent to everyone.
A number of financial institutions and other market players were left high and dry after the scam,
but the biggest loser turned out to be the common investor. The economy had just started
opening up after the 1991 economic reforms, and the India market was just taking its first
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tottering steps. At this stage, such a huge scam would not only have damaged the market, but
would have severely damaged investor confidence. In time, investors could have lost trust in the
system, thus adversely affecting the ability of companies to raise money in stock market. This, in
turn, would have severely restricted industrial growth at a time when the economy had started
improving.
The Securities and Exchange Board of India Act was passed in 1992, thus giving the regulatory
teeth to the body. SEBI was entrusted with the primary task of protecting the interests of the
investors. In addition, SEBI was also entrusted with the twin objectives of developing and
regulating the stock market. In this regard, SEBI has done a decent job, though admittedly, there
have been instances when the regulator has been caught napping! But overall, the lot of investors
has definitely improved due to the policies and steps taken by the regulator.
OFFICES AND ADMINISTRATION
SEBU has its head office located at Mumbai, the financial capital of India. In addition, SEBI has
four regional offices, located at New Delhi, Chennai, Kolkata and Ahmedabad. The regional
offices have jurisdiction over the companies and institutions located on their designated areas.
To manage its affairs, SEBI has a five member board, headed by a chairperson. Out of the five
members, one member each is taken from the Law and Finance ministries, one member is from
RBI, and the remaining two members can be eminent members of the industry.
ENTITY OF SEBI
It was registered with the common seal and with the power to acquire, hold and dispose any
property
Power to sue or to be sued in its own name
The Head office is situated in Mumbai; in addition the regional offices were established in the
following metropolitan cities viz Kolkata, Chennai and Delhi, to monitor and control the capital
market operations across the country
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ROLE OF SEBI
SEBI has been entrusted with a wide ranging role to develop and regulate the financial markets.
The primary task of SEBI is to regulate the affairs of the stock markets. In this respect, SEBI has
introduced a number of notable reforms such as dematerialization of shares, online share trading,
approval for stock indices trading, derivatives trading. This has made the market broad based and
easily approachable by everyone. Over the years, SEBI has also evolved and enforced a code of
conduct for the banks, financial institutions, companies, mutual funds financial
intermediaries/brokers and portfolio managers. In addition, SEBI deals with following activities
related to financial markets -
1. Primary market issues
2. Secondary market issues
3. Mutual Funds
4. Takeovers and mergers & acquisition
5. Collective investment schemes
6. Share buy backs
7. Delisting of shares from Stock exchanges
SEBI is also entrusted with handling investor grievances and complaints related to any of the
abovementioned activities. SEBI also undertakes periodical investor education initiatives,
workshops and seminars to raise investment and financial awareness.
ORGANIZATIONAL GRID OF THE SEBI
1. Six members in the committee
2. Headed by the chairman
3. One member each from the ministries of Law and Finance
4. One member from the officials of Reserve Bank of India
5. Two nominees from the central government
6. It contains 4 different department viz primary department, issue management and
intermediaries department, secondary department and institutional investment
department.
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SEBI in India's capital market:
SEBI from time to time have adopted many rules and regulations for enhancing the Indian
capital market. The recent initiatives undertaken are as follows:
Under this rule every brokers and sub brokers have to get registration with SEBI and any stock
exchange in India.
For Underwriters: For working as an underwriter an asset limit of 20 lakhs has been
fixed.
For Share Prices According to this law all Indian companies are free to determine their
respective share prices and premiums on the share prices.
For Mutual Funds SEBI's introduction of SEBI (Mutual Funds) Regulation in 1993 is to
have direct control on all mutual funds of both public and private sector.
FUNCTIONS OF SEBI
(A) REGULATORY :
Regulating the business in stock exchange any other securities market;
Registering and regulating the working of stock brokers, sub-brokers, share transfer
agents, bankers to an issue, trustees of trust deeds, registrar to an issue, merchant bankers,
underwriters and so on;
Registering and regulating the working of collective investment scheme including mutual
funds;
Regulating the self- regulatory organizations;
Prohibiting fraudulent and unfair trade practices relating to securities markets;
Prohibiting inside trading in securities;
Regulating substantial acquisition of shares and takeover of companies;
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Calling for formation from undertaking inspection, conducting inquiries and audits of the
stock exchange and intermediaries and self-regulatory organizations in the security
market;
Levying fees or other charges for carrying out the purpose of this section.
(B) DEVELOPMENTAL :
Promoting investors‟ education;
Promoting self- regulating organizations;
Training of intermediaries of security markets;
Promotion of fair practices and code of conduct for all SROs;
Conducting research and publishing information useful to all market participants.
OBJECTIVES OF SEBI
To protect the interests of investors in securities
To promote the development of Securities Market
To regulate the securities market
For matters connected therewith or incidental thereto
POWERS OF SEBI
The important powers of SEBI (Securities and Exchange Board of India) are:-
1. Powers relating to stock exchanges & intermediaries SEBI has wide powers regarding the
stock exchanges and intermediaries dealing in securities. It can ask information from the stock
exchanges and intermediaries regarding their business transactions for inspection or scrutiny and
other purpose
2. Power to impose monetary penalties SEBI has been empowered to impose monetary
penalties on capital market intermediaries and other participants for a range of violations. It can
even impose suspension of their registration for a short period.
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3. Power to initiate actions in functions assigned SEBI has a power to initiate actions in regard
to functions assigned. For example, it can issue guidelines to different intermediaries or can
introduce specific rules for the protection of interests of investors.
4. Power to regulate insider trading SEBI has power to regulate insider trading or can regulate
the functions of merchant bankers.
5. Powers under Securities Contracts Act For effective regulation of stock exchange, the
Ministry of Finance issued a Notification on 13 September, 1994 delegating several of its powers
under the Securities Contracts (Regulations) Act to SEBI.
SEBI is also empowered by the Finance Ministry to nominate three members on the Governing
Body of every stock exchange.
6. Power to regulate business of stock exchanges SEBI is also empowered to regulate the
business of stock exchanges, intermediaries associated with the securities market as well as
mutual funds, fraudulent and unfair trade practices relating to securities and regulation of
acquisition of shares and takeovers of companies.
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RESERVE BANK OF INDIA [RBI]
The reserve bank of India is the central bank of country. It has been established by legislation in
1934 as body corporate under the Reserve Bank of India Act 1934. It has started functioning
from 1st April, 1935. The Reserve Bank was started as shareholder bank with a paid-up capital of
Rs 5 crores. Though originally privately owned, since nationalization in 1949, it is fully owned
by Government of India.
Established on 1st April 1935
Apex financial institution of the
country‟s financial system
Entrusted with the task of control,
supervision, promotion, development
and planning
The reserve bank of India carries on its
operations according to provisions of the
reserve bank of India act, 1934. The act has
been amended from time to time.
STRUCTURE OF RBI
The organization of RBI can be divided into
three parts:
1) Central Board of Directors.
2) Local Boards
3) Offices of RBI
1. Central Board of Directors:
The organization and management of RBI is vested on the Central Board of Directors. It is
responsible for the management of RBI. Central Board of Directors consists of 20 members.
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Central board is appointed by the central Government for the period of 4 years. It consists of
official directors and non-official directors.
It is constituted as follows.
One Governor: It is the highest authority of RBI. He is appointed by the Government of
India for a term of 5 years. He can be re-appointed for another term.
Four Deputy Governors: Four deputy Governors are nominated by Central Govt. for a
term of 5 years
Fifteen Directors: Other fifteen members of the Central Board are appointed by the
Central Government. Out of these, four directors, one each from the four local Boards is
nominated by the Government separately by the Central Government.
Ten directors nominated by the Central Government are among the experts of commerce,
industries, finance, economics and cooperation. The finance secretary of the Government of
India is also nominated as Govt. officer in the board. Ten directors are nominated for a period of
4 years. The Governor acts as the Chief Executive officer and Chairman of the Central Board of
Directors. In his absence a deputy Governor nominated by the Governor, acts as the Chairman of
the Central Board. The deputy governors and government‟s officer nominee are not entitled to
vote at the meetings of the Board. The Governor and four deputy Governors are full time officers
of the Bank.
2. Local Boards:
There are 4 local boards, one each for the 4 regions of the country in Mumbai, Kolkata, Chennai,
and New Delhi. The membership of each local board consists of 5 members appointed by the
central Government for the period of 4 years. The functions of the local board is to advise the
central board on local matters; to represent territorial and economic interns of local cooperative
and indigenous banks‟ interest, and to perform such other functions as delegated by central board
from time to time
3. Offices of RBI:
The Head office of the bank is situated in Mumbai and the offices of local boards are situated in
Delhi, Kolkata and Chennai. In order to maintain the smooth working of banking system, RBI
has opened local offices or branches in Ahmedabad, Bangalore, Bhopal, Bhubaneswar,
Chandigarh, Guwahati, Hyderabad, Jaipur, Jammu, Kanpur, Nagpur, Patna, Thiruvananthpuram,
Kochi, Lucknow and Byculla (Mumbai). The RBI can open its offices with the permission of the
- 33 -
Government of India. In places where there are no offices of the bank, it is represented by the
state Bank of India and its associate banks as the agents of RBI.
OBJECTIVES OF THE RBI
To Regulate the issue of Bank notes
Keeping of reserves with a view to securing monetary stability in India
To Operate the currency and credit system of the country for its advantage
To secure monitory stability within country
To Assist the planned process of development of the Indian economy
FEATURE OF RBI
1. RBI formulates implements and monitors the monetary policy
2. RBI maintains public confidence in the system, protect depositors interest and provide
cost-effective banking services to public
3. To facilitate external trade and payment and promote orderly development and
maintenance of foreign exchange market in India.
4. To give the public adequate quantity of supplies of currency notes and coins and good
quality.
FUNCTIONS OF THE RBI
Issuing currency notes, i.e. to act as a currency or monitory authority of the country
Maintaining price stability
Ensuring adequate flow of credit to productive sectors to assist growth
Serving as banker to the Government
Acting as bankers‟ bank and supervisor
Monetary regulation and management
Exchange management and control
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Collection of data and their publication
Miscellaneous developmental and promotional functions and activities
Agricultural Finance
Industrial Finance
Export Finance
Institutional promotion
- 35 -
INSURANCE REGULATORY AND DEVELOPMENT AUTHORITY (IRDA)
MISSION
To protect the interest of and secure fair treatment to policyholders;
To bring about speedy and orderly growth of the insurance industry (including annuity
and superannuation payments), for the benefit of the common man, and to provide long
term funds for accelerating growth of the economy;
To set, promote, monitor and enforce high standards of integrity, financial soundness, fair
dealing and competence of those it regulates;
To ensure speedy settlement of genuine claims, to prevent insurance frauds and other
malpractices and put in place effective grievance redressal machinery;
To promote fairness, transparency and orderly conduct in financial markets dealing with
insurance and build a reliable management information system to enforce high standards
of financial soundness amongst market players;
To take action where such standards are inadequate or ineffectively enforced;
To bring about optimum amount of self-regulation in day-to-day working of the industry
consistent with the requirements of prudential regulation.
VISION
Our goal is to have the IRDA recognized nationally by 2016 as a leader in agro-environmental
research, development and transfer activities. The IRDA distinguishes itself by its integrative
approach and by the dynamism of its partners. These factors allow it to anticipate problems and
develop innovative solutions that meet the needs of agricultural producers and society.
The Insurance Regulatory and Development Authority (IRDA) is a national agency of
the Government of India, based in Hyderabad. It was formed by an act of Indian Parliament
known as IRDA Act 1999, which was amended in 2002 to incorporate some emerging
requirements. Mission of IRDA as stated in the act is "to protect the interests of the
policyholders, to regulate, promote and ensure orderly growth of the insurance industry and for
matters connected therewith or incidental thereto."
- 36 -
In 2010, the Government of India ruled that the Unit Linked Insurance Plans (ULIPs) will be
governed by IRDA, and not the market regulator Securities and Exchange Board of India
ROLE OF IRDA
1. To (protect) the interest of and secure fair treatment to policyholders.
2. To bring about (speedy) and orderly growth of the insurance industry (including annuity and
superannuation payments), for the benefit of the common man, and to provide long term funds
for accelerating growth of the economy.
3. To set, promote, monitor and enforce high standards of (integrity), financial soundness, fair
dealing and competence of those it regulates.
4. To ensure that insurance customers receive precise, clear and correct (information) about
products and services and make them aware of their responsibilities and duties in this regard.
5. To ensure speedy settlement of genuine (claims), to prevent insurance frauds and other
malpractices and put in place effective grievance redressed machinery.
6. To promote fairness, (transparency) and orderly conduct in financial markets dealing with
insurance and build a reliable management information system to enforce high standards of
financial soundness amongst market players.
7. To take (action) where such standards are inadequate or ineffectively enforce d. 8. To bring
about optimum amount of (self-regulation)in day to day working of the industry consistent with
the requirements of prudential regulation.
DUTIES/POWER/FUNCTIONS OF IRDA
Section 14 of IRDA Act, 1999 lays down the duties, powers and functions of IRDA
(1) Subject to the provisions of this Act and any other law for the time being in force, the
Authority shall have the duty to regulate, promote and ensure orderly growth of the insurance
business and re-insurance business.
- 37 -
(2) Without prejudice to the generality of the provisions contained in sub-section (1)the powers
and functions of the Authority shall include,
a. Issue to the applicant a certificate of registration, renew, modify, withdraw,
suspend or cancel such registration;
b. protection of the interests of the policy holders in matters concerning assigning of
policy, nomination by policy holders, insurable interest, settlement of insurance
claim, surrender value of policy and other terms and conditions of contracts of
insurance;
c. Specifying requisite qualifications, code of conduct and practical training for
intermediary or insurance intermediaries and agents;
d. Specifying the code of conduct for surveyors and loss assessors;
e. Promoting efficiency in the conduct of insurance business;
f. Promoting and regulating professional organizations connected with the insurance
and re-insurance business;
g. Levying fees and other charges for carrying out the purposes of this Act
h. calling for information from, undertaking inspection of, conducting enquiries and
investigations including audit of the insurers, intermediaries, insurance
intermediaries and other organizations connected with the insurance business;
i. control and regulation of the rates, advantages, terms and conditions that may be
offered by insurers in respect of general insurance business not so controlled and
regulated by the Tariff Advisory Committee under section 64U of the Insurance
Act, 1938 (4 of 1938);
j. Specifying the form and manner in which books of account shall be maintained
and statement of accounts shall be rendered by insurers and other insurance
intermediaries;
k. Regulating investment of funds by insurance companies;
l. Regulating maintenance of margin of solvency;
m. Adjudication of disputes between insurers and intermediaries or insurance in term
diaries;
n. Supervising the functioning of the Tariff Advisory Committee;
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o. Specifying the percentage of premium income of the insurer to finance scheme s
for promoting and regulating professional organizations referred to in clause (f);
p. Specifying the percentage of life insurance business and general insurance
business to be undertaken by the insurer in the rural or social sector; and
q. Exercising such other powers as may be prescribed
INSURANCE ADVISORY COMMITTEE
IRDA consists of a Chairman and four full time and four part time members. IRDA has
constituted the Insurance Advisory Committee and in consultation with this committee has
brought out 17 regulations. In addition, representatives of consumes, industry, insurance agents,
women‟s originations, and other interest groups are a part of this committee. It has also formed
a Consumer Advisory Committee and Surveyor and Loss Assessors Committee. It has a panel
of eligible chartered accountants to carry out investigation, inspection and so on
Chairman: HariNarayana is the current Chairman of IRDA.
The IRDA has issued 17 regulations in the areas of registration of insurers, their conduct of
business, solvency margins, and conduct if reinsurance business, licensing, and code of conduct
intermediaries. It follows the practice of prior consultation and discussion with the various
interest groups before issuing regulations and guidelines.
CHAIRMAN SELECTION PROCESS
Government of India has circulated to broad base IRDA chairman selection process. It is felt in
the market that placing of retired civil servants as IRDA Chairman has served the purpose of
administrative fiefdom of the regulator. Mostly, the regulator has become passive to market
realities and most of the original public policy intentions have been systematically replaced by
personal preferences. There seems to be no oversight of public policy erosions. Taking
advantage of the completion of term of current incumbent, there seem to be an attempt to
correct the future course but people do not perceive any outcome to result as the market does
not seem to throw up candidates of the stature of Howard Davies for Indian market. But a right
leadership is the solution to the requirement of this booming market.
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IRDA REGULATES PRIVATE INSURANCE COMPANIES IN INDIA SUCH AS;
1. Royal Sundaram Alliance Insurance Company Limited
2. Reliance General Insurance Company Limited.
3. IFFCO Tokio General Insurance Co. Ltd
4. TATA AIG General Insurance Company Ltd.
5. Bajaj Allianz General Insurance Company Limited
6. ICICI Lombard General Insurance Company Limited.
7. Apollo DKV Insurance Company Limited
8. Future Generali India Insurance Company Limited
9. Universal Sompo General Insurance Company Ltd.
10. Cholamandalam General Insurance Company Ltd.
11. Export Credit Guarantee Corporation Ltd.
12. HDFC-Chubb General Insurance Co. Ltd.
13. Bharti Axa General Insurance Company Ltd.
14. Raheja QBE General Insurance Co. Ltd
15. Shriram General Insurance Co. Ltd.
- 40 -
Money market
TOPICS:-
Introduction of money market.
Functions of money market.
Money market instruments.
Treasury bill
Call notice money market
Commercial paper
Certificates of deposits
Commercial bills
Collateralised borrowing and lending obligation.
Call/notice money market.
Money market intermediaries.
Money market mutual fund.
Link between the money market and the monetary policy in
India.
Tool for managing liquidity in the money market.
Money market derivatives.
Introduction of capital market.
Functions of capital market.
Primary capital and secondary capital market.
Brief history of the rise of equity trading in India.
Reforms in capital market.
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THE MONEY MARKET
INTRODUCTION:-
The money market is a market for financial assets that are close substitutes for
money. It is the market for over night to short term funds and instruments having a
maturity period of one or less than one year. It is not a physical auction (like the
stock market) but an activity that is conducted over the telephone. The money
market constitutes a very important segment of the Indian financial system.
The features of the money market are as follows.
It is not a single market but a collection of markets for several instruments.
It is a wholesale market of a short-term debt instrument
Its principal features are honour where the creditworthiness of participant is
important.
The main players are: the reserve bank of India (RBI), the discount and
finance house of India (DFHI), mutual funds, banks, co-operative investors,
non-banking financial companies(NBFCs), state governments, provident
funds, primary dealers, the security trading corporation of India(STCI)
public sector undertakings (PSUs) and non residential Indians.
It is need based market wherein the demand and supply of money shape the
market.
Functions of money market
A money market is generally expected to perform broad functions.
Provide a balancing mechanism to even out the demand for and supply of
short term funds.
Provide a focal point for central bank intervention for influencing liquidity
and general level of interest rates in the economy.
Provide reasonable access to suppliers and users of short term funds to fulfil
their borrowings and investment requirements at an efficient market clearing
price.
Besides the above functions a well functioning money market facilitates the
development of a market for long term securities. The interest rates for
extremely short-term use of money serve as a benchmark for longer-term
financial instruments.
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Benefits of an efficient money market
An efficient money market benefits a number of players. It provides a stable
source of funds to banks in addition to deposits, allowing alternatives
financing structures and completion.
It allows banks to manage risks arising from interest rate fluctuations and to
manage the maturity structure of their assets and liability.
A liquidity market provides an effective source of long-term finance to
borrowers.
Large borrowers can lower the cost of raising funds and manage short term
funding or surplus efficiency.
A liquid and vibrant money market is necessary for the development of a
capital market, foreign exchange market, and markets in derivatives
instruments.
The money market supports the long-term debt market by increasing the
liquidity of the securities.
The Indian money market
The average turn over of the money market in India is over 40,000crore rupees
daily. This is more than three percent let out of the system. This implies that 2% of
the annual GDP of India gets traded in the money market in just one day. Even
though, the money market is many times larger than the capital market.
Reforms in the money market:
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New instruments
New participants
Changes in the operating procedure of monitoring policy.
Fine tuning of liquidity operations managements.
Technological infrastructure.
The money market centres:
There are market centres in India at Mumbai, Delhi, and Kolkata. Mumbai is the
only active money market centre in India with money flowing I from all parts of
the country getting transacted there.
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MONEY MARKET INSTRUMENTS
The instruments traded in the Indian money market
are:
Treasury bills(T-bills)
Call/notice money market-call (over night) and short
notice (upto14 days)
Commercial papers(CPs)
Certificate of deposits(CDs)
Commercial bills(CBs)
Collateral borrowings and lending obligation (CBLO).
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TREASURY BILLS
INTRODUCTION:-
Treasury Bills are short term money market instruments to finance the short term
requirements of the Government of India. These are discounted securities and thus
are issued at a discount to face value. The return to the investor is the difference
between the maturity value and issue price. This instruments is used by the
government it raise short-term funds to bridge seasonal or temporary gaps between
its receipts (revenue and capital) and expenditure.
FEATURES:-
They are negotiable securities.
They are highly liquid as they are of shorter tenure and there is a possibility
of inter-bank repos in them.
There is an absence of default risk.
They are not issued in the scrip form. The purchase and sales are affected
through the subsidiary general ledger (SGL) account.
At present there are 91 days, 182 days, and 364 day. 91 days T-bills are
auctioned by RBI every Friday and the 364-day T-bill every alternative
Wednesday i.e. the Wednesday preceding the reporting Friday.
T-bills are available for minimum amount of 25,000 and in multiplies
thereof.
TYPES OF TREASURY BILLS:-
ON TAP BILLS:
On tap bills as the name suggest caught be bought from the reserve bank at any
time at any interest yield of4.66%. They were discounted from April 1,1997, as
they had lost much of their relevance.
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AD HOC BILLS:
Ad hoc bills were introduced in 1955. It was decided between the government and
RBI that the government could maintain cash of 50 crore with the reserve bank on
Friday and 4 crore of other days free of obligations to pay interest thereon and
when ever the balance fell below the minimum the government account would be
replenished by the ad hoc bill in favour of RBI.
AUCTIONED T-bills:
Auctioned T-bill the most active money market instrument, were first introduced in
april1992. The reserve bank receives bids in an auction from various participants
and issues the bills subject to some cut off limits.
BENEFITS OF INVESTMENT IN TREASURY BILLS
No tax deducted at source
Zero default risk being sovereign paper
Highly liquid money market instrument
Better returns especially in the short term
Transparency
Simplified settlement
High degree of tradability and active secondary market facilitates
meeting unplanned fund requirements.
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PARTICIPANTS IN TRESURY BILLS
The reserve bank of India, banks, mutual funds, financial institutions, primary
dealers, provident funds, foreign banks, foreign institutional investor.
TYPES OF AUCTIONS
There are two types of auction for treasury bills:
Multiple Price Based or French Auction: Under this method, all
bids equal to or above the cut-off price are accepted. However, the bidder
has to obtain the treasury bills at the price quoted by him. This method is
followed in the case of 364days treasury bills and is valid only for
competitive bidders.
Uniform Price Based or Dutch auction: Under this system, all the
bids equal to or above the cut-off price are accepted at the cut- off level.
However, unlike the Multiple Price based method, the bidder obtains the
treasury bills at the cut-off price and not the price quoted by him. This
method is applicable in the case of 91 days treasury bills only.
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COMMERCIAL PAPERS INTRODUCTION:-
Commercial paper, or CP as it is popularly known, is in the nature of an unsecured
short term promissory note, transferable by endorsement and delivery. It is of fixed
maturity.
Corporate, primary dealers (PDs) and the all-India financial institutions (FIs) that
have been permitted to raise short-term resources under the umbrella limit fixed by
Reserve Bank of India are eligible to issue CP. The following are the eligibility
criteria, as per the extant guidelines:1] The company should have a minimum
tangible net worth of Rs. 40mn, as per the latest audited balancesheet.2] The
company should have been sanctioned working capital limits by banks/FIs and
should be classified as a 'Standard Asset' by the financing bank(s) / FIs.3] The
company should have minimum credit rating from an agency approved by RBI
Process for issuing CP
Once a company decides to issue CP for a specific amount, a resolution is required
to be passed by the Board of Directors approving the issue and authorising the
official(s) to execute the relevant documents, as per RBI norms. The CP issue is
required to be rated by an approved credit rating agency .The company selects the
Issuing and Paying Agent, which has to be a scheduled bank. The issuer should
disclose to its potential investors its financial position. The company may also
arrange for dealers for placement of CPs. The issue has to be completed within two
weeks of opening. CP may be issued on a single date or in parts on different dates
provided that in the latter case, each CP shall have the same maturity date.
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COMMERCIAL BILLS
INTRODUCTION:-
The working capital requirement of business firms is provided by banks through
cash-credits / overdraft and purchase/discounting of commercial bills.
Commercial bill is a short term, negotiable, and self-liquidating instrument with
low risk. It enhances liability to make payment in a fixed date when goods are
bought on credit. According to the Indian Negotiable Instruments Act, 1881, bill or
exchange is a written instrument containing an unconditional order, signed by the
maker, directing to pay a certain amount of money only to a particular person, or to
the bearer of the instrument. Bills of exchange are negotiable instruments drawn by
the seller (drawer) on the buyer (drawee) or the value of the goods delivered to
him. Such bills are called trade bills. When trade bills are accepted by commercial
banks, they are called commercial bills. The bank discounts this bill by keeping a
certain margin and credits the proceeds. Banks, when in need of money, can also
get such bills rediscounted by financial institutions such as LIC, UTI, GIC, ICICI
and IRBI. The maturity period of the bills varies from 30 days, 60 days or 90 days,
depending on the credit extended in the industry.
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Types of Commercial Bills:
Commercial bill is an important tool finance credit sales. It may be a
demand bill or a usance bill. A demand bill is payable on demand, that is
immediately at sight or on presentation by the drawee. A usance bill is
payable after a specified time. If the seller wishes to give sometime for
payment, the bill would be payable at a future date. These bills can either be
clean bills or documentary bills. In a clean bill, documents are enclosed and
delivered against acceptance by drawee, after which it becomes clear. In the
case of a documentary bill, documents are delivered against payment
accepted by the drawee and documents of bill are filed by bankers till the
bill is paid.
Commercial bills can be inland bills or foreign bills. Inland bills must (1) be
drawn or made in India and must be payable in India: or (2) drawn upon any
person resident in India. Foreign bills, on the other hand, are (1) drawn
outside India and may be payable and by a party outside India, or may be
payable in India or drawn on a party in India or (2) it may be drawn in India
and made payable outside India. A related classification of bills is export
bills and import bills. While export bills are drawn by exporters in any
country outside India, import bills are drawn on importers in India by
exporters abroad.
The indigenous variety of bill of exchange for financing the movement of
agricultural produce, called a „hundi‟ has a long tradition of use in India. It is
vogue among indigenous bankers for raising money or remitting funds or to
finance inland trade. A hundi is an important instrument in India; so
indigenous bankers dominate the bill market. However, with reforms in the
financial system and lack of availability of funds from private sources, the
role of indigenous bankers is declining.
With a view to eliminating movement of papers and facilitating multiple
rediscounting, RBI introduced an innovation instruments known as
„Derivative Usance Promissory Notes,‟ backed by such eligible commercial
bills for required amounts and usance period (up to 90 days). Government
has exempted stamp duty on derivative usance promissory notes. This has
simplified and streamlined bill rediscounting by institutions and made the
commercial bill an active instrument in the secondary money market. This
instrument, being a negotiable instrument issued by banks, is a sound
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investment for rediscounting institutions. Moreover rediscounting
institutions can further discount the bills anytime prior to the date of
maturity. Since some banks were using the facility of rediscounting
commercial bills and derivative usance promissory notes of as short a period
as one day, the Reserve Bank restricted such rediscounting to a minimum
period of 15 days. The eligibility criteria prescribed by the Reserve Bank for
rediscounting commercial bills are that the bill should arise out of a genuine
commercial transaction showing evidence of sale of goods and the maturity
date of the bill should to exceed 90 days from the date of rediscounting.
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Features of Commercial Bills
Commercial bills can be traded by offering the bills for rediscounting. Banks
provide credit to their customers by discounting commercial bills. This
credit is repayable on maturity of the bill. In case of need for funds, and can
rediscount the bills in the money market and get ready money.
Commercial bills ensure improved quality of lending, liquidity and
efficiency in money management. It is fully secured for investment since it
is transferable by endorsement and delivery and it has high degree of
liquidity.
The bills market is highly developed in industrial countries but it is very
limited in India. Commercial bills rediscounted by commercial banks with
financial institutions amount to less than Rs 1,000 crore. In India, the bill
market did not develop due to (1) the cash credit system of credit delivery
where the onus of cash management rest with banks and (2) an absence of an
active secondary market.
Measures to Develop the Bills Market:
One of the objectives of the Reserve Bank in setting up the Discount and
finance House of India was to develop commercial bills market. The bank
sanctioned a refinance limit for the DFHI against collateral of treasury bills
and against the holdings of eligible commercial bills.
With a view to developing the bills market, the interest rate ceiling of 12.5
per cent on rediscounting of commercial bills was withdrawn from May 1,
1989.
To develop the bills market, the Securities and Exchange Board of India
(SEBI) allowed, in 1995-96, 14 mutual funds to participate as lenders in the
bills rediscounting market. During 1996-97, seven more mutual funds were
permitted to participate in this market as lenders while another four primary
dealers were allowed to participate as both lenders and borrowers.
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In order to encourage the „bills‟ culture, the Reserve Bank advised banks in
October 1997 to ensure that at least 25 percent of inland credit purchases of
borrowers be through bills.
Size of the Commercial Bills market:
The size of the commercial market is reflected in the outstanding amount of
commercial bills discounted by banks with various financial institutions.
The share of bill finance in the total bank credit increased from 1993-94 to
1995-96 but declined subsequently. This reflects the underdevelopment state
of the bills market. The reasons for the underdevelopment are as follows:
The Reserve Bank made an attempt to promote the development of the bill
market by rediscounting facilities with it self till 1974. Then, in the
beginning of the 1980s, the availability of funds from the Reserve Bank
under the bill rediscounting scheme was put on a discretionary basis. It was
altogether stopped in 1981. The popularity of the bill of exchange as a credit
instrument depends upon the availability of acceptance sources of the central
bank as it is the ultimate source of cash in times of a shortage of funds.
However, it is not so in India. The Reserve Bank set up the DFHI to deal in
this instrument and extends refinance facility to it. Even then, the business in
commercial bills has declined drastically as DFHI concentrates more on
other money market instruments such as call money and treasury bills.
It is mostly foreign trade that is financed through the bills market. The size
of this market is small because the share of foreign trade in national income
is small. Moreover, export and import bills are still drawn in foreign
currency which has restricted their scope of negotiation.
A large part of the bills discounted by banks are not genuine. They are bills
created by converting the cash-credit/overdraft accounts of their customers.
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The system of cash-credit and overdraft from banks is cheaper and more
convenient than bill financing as the procedures for discounting and
rediscounting are complex and time consuming.
This market was highly misused in the early 1990s by banks and finance
companies which refinanced it at times when it could to be refinanced. This
led to channelling of money into undesirable use
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CERTIFICATE OF DEPOSITE
INTRODUCTION:-
Certificates of deposit are unsecured, negotiable, short term instrument in bearer
form, issued by commercial banks and development financial institutes.
Certificates of deposits were introduced in 1989. Only scheduled commercial
banks excluding regional rural banks and local area banks were allowed to issue
them initially. Financial institutions were permitted to issue certificates of deposit
within the umbrella limit fixed by the reserve bank in 1992.
GUIDELINES FOR ISSUE OF CERTIFICATE OF DEPOSITE
Eligibility:-
CDs can be issued by scheduled commercial banks and excluding regional rural
banks. Local area banks (2) and select all India financial institution that have been
permitted by RBI.
Aggregate amount:-
Should not exceed 100% of its net owned funds.
Minimum size of issue and denomination:-
Minimum amount of CDs should be 1 lacks i.e. the minimum deposit that can be
accepted from a single subscriber should not be less than 1 lacks.
Who can subscribe:-
CDs can be issued to entities like individuals, corporations, companies, trusts,
funds, and association.
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Maturity:-
Not less than 7 days and not more than 1 year. and not exceeding 3 years from the
date of issue.
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COMPARISION OF CERTIFICATE OF
DEPOSITE AND COMMERCIAL PAPERS
CDs and commercial papers are both forms of money market instruments and are
issued in the money markets by organizations that wish to raise funds, and are
traded by investors who wish to profit from the interest rate fluctuations.
However, there are many differences between these two forms of instruments,
since
CDs
commercial papers
CDs are issued as a proof of an
investment of funds in the bank by a
depositor while
Commercial papers are issued to an
investor as a proof of purchase of the
issuer‟s debt (purchasing debt means
providing funds like a bank gives out a
loan).
While a CD is usually for a longer term.
A promissory note is for a shorter period
The issuance of a CD, owing to this
difference in maturity, entails higher
responsibility on the issuer‟s part
The issuance of commercial papers
entails lower responsibility of the
issuer‟s part.
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COLLATERALISED BORROWING AND
LENDING OBLIGATION The clearing corporation of India limited (CCIL) launched a new product-
collateralised borrowing and lending obligation (CBLO) on January 20 2003. To
provide liquidity to non bank entities. Hit by restrictions on access to call money
market. The minimum order lot for auction market is fixed rs.50,000 and in
multiples of 500000 thereof.
The minimum order for normal market is fixed at 500000 and in multiples of
500000 there of. The reserve bank has prescribed the mode of operation in the
CBLO segment. In the auction market, on the platform provided by CCIL the
borrowers will submit their offers and the lenders will give their bids. Specifying
the discount rate and maturity period.
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CALL/NOTICE MONEY MARKET INTRODUCTION:-
The call/notice/term money market is a market for trading very short term liquid
financial assets that are readily convertible into cash at low cost. The money
market primarily facilitates lending and borrowing of funds between banks and
entities like Primary Dealers. An institution which has surplus funds may lend
them on an uncollateralized basis to an institution which is short of funds. The
period of lending may be for a period of 1 day which is known as call money and
between 2 days and 14 days which is known as notice money. Term money refers
to borrowing/lending of funds for a period exceeding 14 days. The interest rates on
such funds depend on the surplus funds available with lenders and the demands for
the same which remains volatile.
This market is governed by the Reserve Bank of India which issues guidelines for
the various participants in the call/notice money market. The entities permitted to
participate both as lender and borrower in the call/notice money market are
Scheduled Commercial Banks (excluding RRBs), Co-operative Banks other than
Land Development Banks
Scheduled commercial banks are permitted to borrow to the extent of 125% of
their capital funds in the call/notice money market, however their fortnightly
average borrowing outstanding should not exceed more than 100% of their capital
funds (Tier I and Tier II capital). At the same time SCBs can lend to the extent of
50% of their capital funds on any day, during a fortnight but average fortnightly
outstanding lending should not exceed 25% of their total funds
Co-operative Banks are permitted to borrow up to 2% of their aggregate deposits
as end of March of the previous financial year in the call/notice money market
Primary Dealers can borrow on average in a reporting fortnight up to 200% of the
total net owned funds (NOF) as at end-March of the previous financial year and
lend on average in a reporting
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The average daily turnover in the call money market is around Rs. 12,000-13,000
cr every day and trading occurs between 9.30 am to 5.00 pm on Monday to Friday.
The trades are conducted both on telephone as well as on the NDS Call system,
which is an electronic screen based system set up by the RBI for negotiating
money market deals between entities permitted to operate in the money market.
The settlement of money market deals is by electronic funds transfer on the Real
Time Gross Settlement (RTGS) system operated by the RBI. The repayment of the
borrowed money also takes place through the RTGS system on the due date of
repayment.
Participants in the call money market:-
Participants in the call money market are scheduled commercial banks, non-
scheduled commercial banks, foreign banks, state, district and urban, cooperative
banks, Discount and Finance House of India (DFHI) and Securities Trading
Corporation of India (STCI). The DFHI and STCI borrow as well as lend, like
banks and primary dealers, in the call market. At one time, only a few large banks.
Over time, however, the market has expanded and now small banks and non-
scheduled banks also participate in this market. However, now their participation
as borrowers has increased for meeting CRR requirements.
Difficulties in tapping deposits through branch expansion, and an increase in the
cost of servicing (FCNR) deposits have also compelled foreign banks to borrow in
the call money market.
Among the large commercial banks, the SBI kept away from the call market till
1970 after which it has been regularly participating in this market. Because of its
large size and formidable cash position, its participation made the market more
active. The SBI group is a major lender but a small borrower in the call market.
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Call rate:-
The interest rate on a type of short-term loan that banks gives to brokers who in
turn lend the money to investors to fund margin accounts. For both brokers and
investors, this type of loan does not have a set repayment schedule and must be
repaid on demand.
MIBOR:-
The Committee for the Development of the Debt Market that had studied and
recommended the modalities for the development for a benchmark rate for the call
money market. Accordingly, NSE had developed and launched the NSE Mumbai
Inter-bank Bid Rate (MIBID) and NSE Mumbai Inter-bank Offer Rate (MIBOR)
for the overnight money market on June 15, 1998.
Call rate volatility:-
In India money and credit situation is subject to seasonal fluctuation every year. A
decrease in call money requirement is greater in the slack season (mid April to mid
October) than in a buy session (mid October to mid April).
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Factors influencing call money market rate:-
The National Stock Exchange (NSE) developed and launched the NSE Mumbai
Inter bank Bid the (MIBID) and NSE Mumbai Inter-bank Offer Rate (MIBOR) or
the overnight money markets on June 15, 1998, NSE MIBID/ MIBOR are based on
rates pooled by NSE from a representative panel of 31 banks/institutions/primary
dealers. Currently, quotes are polled and processed daily by the exchange at 9:40
(IST) for the overnight rate and at 11:30 (IST) for the 14 day, 1 month, and 24
month rates. The rates pooled are then processed using the boost trap method to
arrive at an efficient estimate of the references rates. This rate is used as a
benchmark rate or majority of the deals stuck for floating rate debentures and term
deposits. Benchmark is rate at which money is raised in financial markets. These
rates are used in hedging strategies as reference points in forwards and swaps.
Reuters MIBOR (Mumbai Inter-bank Overnight Average) is arrived at by
obtaining weighted average of call money transactions of 22 banks and other
players.
MIBOR is a better official benchmark rate for interest rate swaps (IRs) and
forward rate agreements (FRAs). MIBOR is transparent, market determined and
mutually acceptable to counterparties as reference.
Call Rates Volatility:
In India, money and credit situation is subject to seasonal fluctuation every year.
The volume of call money transactions and the amount as well as call rate levels
characterize seasonal fluctuation/volatility. A decrease in the call/notice money
requirements is greater in the slack season (mid-April to mid-October) than in the
buy season (mid-October to mid-April).
Liquidity conditions:
Liquidity conditions are governed by factors on both the demand and supply side
of money. Liquidity conditions are governed by deposit mobilization, capital flows
and reserve requirements on the supply side, and tax outflows, government
borrowings programs, non-food credit off take and seasonal fluctuations on the
demand side. When easy liquidity conditions prevail, call rates move around the
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Reserve Bank‟s repo rate. During times of tight liquidity, call rates tend to move
up towards the bank rate.
Reserve requirement prescriptions and
stipulations regarding average reserve
maintenance:
A cut in CRR reduces call rates while an increase in CRR increases call rates.
Moreover, banks do not plan the demand for funds to meet their reserve
requirements which increase call rate volatility.
Till April 1997, inter-bank transactions were included in the reserve calculation.
This led to a halt in money market activity every second Friday (reserve
calculation day) when banks tried to reduce their reserve requirements by
eliminating inter-bank borrowing. Due to this, the overnight call rates fell to zero
per cent very second Friday. This inhibited the development of liquid money
market yield curve beyond 13 days.
Structural factors:
Structural factors refer to government legislation, conditions of the stock markets
and so on which affect the volatility of the call money rate.
Investment policy of non-bank participants in the call market who are the major
lenders of funds in the call market: money market is asymmetrical in the sense
there are few lenders and chronic borrowers. This asymmetry leads to fluctuations
in the call money market rate.
Liquidity changes and gaps in the foreign exchange
market:
Call rates increase during volatile forex market conditions. This increase is a result
of monetary measures for tightening liquidity conditions and short position taken
by market agents in domestic currency against long positions in US dollars in
anticipation of higher profits through depreciation of the rupee. Banks fund foreign
currency positions by withdrawing from the inter bank call money market which
leads to a hike in the call money rates.
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Steps to convert Call Money market into a
pure Inter-bank Market
A four phased exit of non bank institutions from the call money market
commenced from May 5, 2001. As part of stage in non-bank institutions,
were permitted to lend, on an average up to 85 per cent of their average daily
call money lending during 2000-01. This would be followed by reductions in
their access to 75 per cent in stage II when the clearing corporation is made
fully operational. Subsequently such limits would be reduced to 40 percent
and 10 per cent in stage III and stage IV respectively, before affecting a
complete withdrawal of non-bank participants from the call money market.
Moreover access to other short term instruments for non-bank institutions
were made attractive. In 2000-01, the minimum maturity of certificates of
deposit was reduced to 15 days and restriction on the transferability period
for CDs issued by banks and financial institutions was withdrawn.
Prudential limits on exposure to call/notice money lending of primary
dealers have been issued by RBI. With effect from October 5, 2002, primary
dealers will be permitted to lend in call/notice money market up to 25 per
cent of their net owned funds (NOF). Access of primary dealers to borrow in
call/notice money market would be gradually reduced in two stages. In stage
I primary dealers would be allowed to borrow up to 200 percent of their net
owned funds as at end-March of the preceding financial year. In stage II
primary dealers would be allowed to borrow up to 100 per cent of their net
owned funds. The limits under both the stages would not be applicable for
days on which government dated securities are issued in the market.
In order to reduce market participants‟ reliance on call/notice money market,
collateralized borrowing and lending obligation (CBLO) has started
operations as a money market instrument through Clearing Corporation of
India (CCIL) on January 20,2003.
The RBI has issued prudential norms to reduce the chronic reliance of banks
on call money market. With effect from the fortnight beginning December
14, 2002, lending of scheduled commercial banks on a fortnightly average
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basis should not exceed 25 per cent of their owned funds (paid-up capital
and reserves); however banks are allowed to lend a maximum of 50 per cent
on any day during a fortnight. Similarly borrowings by scheduled
commercial banks should not exceed 100 per cent of their owned funds or 2
per cent of aggregate deposits, whichever is higher however banks are
allowed to borrow a maximum of 125 percent of their owned funds on any
day during a fortnight.
The repo market was expanded later to non-bank entities holding both
current and SGL accounts with the Reserve Bank. The minimum repo tenor
was reduced to one day and state government securities were made eligible
for repos.
The development of the repo market would help in transforming the call
money market into a pure inter-bank market.
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Term Money Market:
Introduction:-
Beyond the call/notice market is the term money market. This money market is one
beyond the overnight tenor, with maturity ranging between three months to one
year. In other words, a term money market is one where funds are traded up to
period three to six months. The term money market in India is still not developed.
The turnover in this market remained mostly below Rs 200 crore in 2001-02. The
volumes are quite small in this segment as there is little participation from large
players and a term money yield curve is yet to develop. Banks do not want to take
a view on term money rates as they feel comfortable with dealing only in the
overnight money market. Foreign and private sector banks are in deficit in respect
of short term resources; hence they depend heavily call/notice money market. The
public sector banks are generally in surplus and they exhaust their exposure limit to
term there by constraining the growth of the term money market. Corporate prefer
„cash credit‟ rather than „loan credit‟ which forces banks to deploy a large amount
of resources in the call/notice money market rather than in term money market to
meet their demands.
The Reserve bank has permitted select financial institutions such as IDBI, IOCICI,
IFCI, HBI, SIDBI, EXIM Bank, NABARD, IDFC and NHB to borrow from the
term money market from the three to six months.
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Money market intermediaries
The discount and finance house of India (DFHI)
The DFHI was set up in April 1988 by the Reserve Bank with the objective of
deepening and activating the money market. It has commenced its operations from
July 28, 1988.
It is a joint stock company in form and is jointly owned by the Reserve Bank,
public sector banks and all-India financial institutions which have contributed to its
paid-up capital of Rs200crore in the proportion of 5:3:2. In addition to refinance
facility with the Reserve Bank and a credit of Rs100crore from 28 public sector
banks on a consortium basis are the sources of its funds.
The role of the DFHI is to function as a specialized money market intermediary for
stimulating activity in money market instruments and develop secondary market in
these instruments. It also undertakes short-term buy-back operations in the
government and approved dated securities. DFHI mobilizes funds/resources from
commercial/cooperative banks, financial institutions, and corporate entities having
resources to lend (which individually may not represent tradable volumes in
wholesale market) which are pooled and lent in the money market. The two-way
regular quotes in money market instruments provided by DFHI serve as a base to
broaden the secondary market and give an assured liquidity to the instruments.
DFHI was categorized as an eligible institution under the relevant provisions of the
RBI Act, 1934, in November 1989 so that the placement of funds with DFHI can
be included as an asset with the banking system for netting purposes while
calculating the net demand and time liabilities for reserve purposes. DFHI is also
an authorized institution to undertake repo transactions in treasury bills and all
dated government securities to impart greater liquidity to these instruments.
Since November 13, 1995, DFHI is an accredited primary dealer. With this
accreditation, its role has undergone a transformation. Now it acts as a market
maker, giving two-way quotes and takes large positions on its account in
government securities.
The DFHI deals in treasury bills, commercial bills, certificates of deposits,
commercial paper, short-term deposits, call/notice money market and government
securities. The presence of the DFHI as an intermediary in the money market
has helped the corporate entities, banks, and financial institutions to raise
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short-term money and invest short-term surpluses. The DFHI also extends repos,
that is, buy-back facility up to 14 days, to banks and financial institutions in
respect of money market instruments.
The cumulative turnover of the DFHI in all financial transactions increased four
fold in a span of nine years. The major part of the turnover was in call money
followed by government dated securities and treasury bills. Its business in CDs and
CPs was negligible and business in commercial bills declined sharply in the 1990s.
Its dealings in government securities exceeded those in treasury bills after being
accredited as a primary dealer.
The DFHI has been concentrating on the call money market rather than activating
other money market instruments like CPs, CDs and CBs. These instruments need
to be developed further for activating and deepening the money market.
Money Market Mutual Funds (MMMFs):-
MMMFs were introduced in April 1991 to provide an additional short-term avenue
for investment and bring money market investment within the reach of individuals.
These mutual funds would invest exclusively in money market instruments.
MMMFs bridge the gap between small individual investors and the money market.
MMMF mobilizes savings from small investors and invests them in short-term
debt instruments or money market instruments.
A Task Force was constituted to examine the broad framework outlined in April
1991 and consider the implications of the scheme. Based on the recommendations
of the Task Force, a detailed scheme of MMMFs was announced by the Reserve
Bank in April 1992.
The MMMFs portfolio consists of short-term money market instruments. An
investor investing in MMMFs gets a yield close to short-term money.
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Link between Money Market and Monetary
Policy in India
The monetary policy represents policies objectives and instruments directed
towards regulating money supply and the cost and availability of credit in the
economy. In the monetary policy framework broad objectives are prescribed and
an operating framework of policy instruments to achieve them is formulated. The
monetary policy in India is an adjunct of the economic policy. The objectives of
the monetary policy are not different from those of the economic policy. The three
major objectives of economic policy in India have been growth price stability and
social justice. The emphasis between the first two objectives has changed from
year to year, depending upon the conditions prevailing in that year and the
pervious year. The objectives of the monetary policy are also price stability and
growth. The government of India tries to manipulate its monetary policy through
the Reserve Bank, the monetary authority in India. The objectives of the monetary
policy are pursued by ensuring credit availability with stability in the external
value of the rupee as well as an overall financial stability.
The Reserve Bank seeks to influence monetary conditions through management of
liquidity by operating in varied instruments. These instruments can be categorized
as direct and indirect market based instruments.
In an administered or controlled regime of money and financial markets, the
Reserve bank directly influences the cost, availability and direction of funds
through direct instruments. The management of liquidity is essentially through
direct instruments such as varying cash reserve requirements, limits, on refinance
administered interest rates, and qualitative and quantitative restrictions on credit.
Since 1991, the market environment has been deregulated and liberalized wherein
the interest rates are largely determined by market forces. The objective of the
monetary policy operations is to make the interest rate regime more flexible and
responsive to the economic fundamentals. In such an environment, the Reserve
Bank influences monetary conditions through market based, indirect instruments
such as open market operations and refinance / discount / repo windows.
The success of market based indirect instruments depends upon the existence of a
vibrant liquid and efficient money market that is well integrated with the other
segments financial markets such as government securities market an foreign
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exchange market. The effectiveness of the monetary policy depends on the market
and institutional framework available for transmitting monetary policy impulses.
The financial sector in India is still in a state of transition because of ongoing
reforms. However, a growing integration among the different segments of the
financial markets has been witnessed. Still, the markets do not have adequate depth
and liquidity – a major constraint in the conduct of the monetary policy. The
Reserve Bank therefore still relies on the cash reserve ratio as an operating
instrument. The bank activated the bank rate on 1997 as a reference rate and as a
signalling device to reflect the stance of the monetary policy. The interest rates on
different types of accommodation from the reserve bank including refinance are
linked the banks rate. The announcement impact of bank rate changes has been
pronounced in the prime lending rates (PLRs) of commercial banks.
The Reserve bank also set up a framework of interim liquidity (ILAP) which
helped in injecting liquidity through collateralized lending facility (CLF) to banks,
export credit refinance to banks, and liquidity support to primary dealers. All these
facilities were formula based and depended on the bank rate. The ILAF was
gradually converted into a full-fledged LAF. The liquidity adjustment facility
(LAF) has evolved as an effective mechanism for absorbing and/or injecting
liquidity on a day-to-day basis.
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Tools for Managing Liquidity in the Money
Market
Reserves requirements:-
Reserve requirements are of two types: (i) cash reserve requirements and (ii)
statutory liquidity ratio (SLR). They are techniques of monetary control used by
the Reserve Bank to achieve specific macro-economic objectives. CRR refers to
the cash that banks have to maintain with the Reserve Bank as a certain percentage
of their total demand and time liabilities (DTL) while statutory liquidity ratio refers
to the mandatory investment that banks have to make in government securities.
The statute governing the CRR under section 42(1) of the Reserve Bank of India
Act requires every bank in the second schedule to maintain an average daily
balance with the Reserve Bank of India, the amount of which shall not be less than
3% of the total demand and time liabilities. CRR is an instrument to influence
liquidity in the system as and when required. SLR is the reserve that is set aside by
the banks for investment in cash, gold, or unencumbered approved securities. It is
mandatory under section 24(2A) of the Banking Regulation Act, 1949, as amended
by the Banking Laws (Amendment) Act, 1983 for banks to maintain this reserve.
The reserve is supposed to provide a buffer in case of a run on the bank.
The CRR has been brought down from 15% in March 1991 to 4.75% in October
2002 and 4.5% in April 2003 while the SLR was brought down from its peak of
38.5% in April 1992 to 25% on October25, 1997. Thus, till the early 1990s, both
the CRR and SLR were pre-empting around 63.5% of the incremental deposits.
Even though the SLR has been brought down to 25%, most banks currently hold a
volume of government securities higher than required under the SLR as the interest
rate on government securities is increasingly market-determined.
The daily minimum CRR was reduced from 85% to 65% to enable a smooth
adjustment of liquidity between the surplus and the deficit segment and better cash
management to avoid a sudden increase in the overall call rates.
The Reserve Bank has announced that it would like to see the CRR level down to
3%. The key constraint in reducing the CRR is the continuing high level of fiscal
deficit which cannot be financed entirely by the market and, therefore, requires
substantial support by the Reserve Bank.
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A cut in CRR increases the liquidity in the economy. It also means lower cost for
the banks which translates into lower prime lending rates. It also sets a broad
direction for interest rates in the future. Since October 2001, the interest rate paid
on eligible balances under CRR was linked to the bank rate. From August 11,
2001, the inter-bank term liabilities with an original maturity of 15days and up to
one year were exempted from the prescription of minimum CRR requirement of
3%. The CRR will continue to be used in both directions for liquidity management
in addition to other instruments.
Interest rates:-
Interest rate is one of the distinct monetary transmission channels. An administered
interest rate structure was the central feature of the Indian monetary and credit
system during the 1980s. The rationale behind the administered rate structure was
to enable certain preferred or priority sectors to obtain funds at concessional rates
of interest. This brought about an element of cross-subsidization resulting in higher
lending rates for the non-concessional commercial sector. The deposit rates also
had to be maintained at a low level. This system became complex with the
proliferation of sectors and segments to which concessional credit was to be
provided.
Repos :-
The major function of the money market is to provide liquidity. To achieve this
function and to even out liquidity changes, the Reserve Bank uses repos. Repo is a
useful money market instrument enabling the smooth adjustment of short term
liquidity among varied market participants such as banks, financial institutions,
and so on.
Repo refers to a transaction in which a participant acquires immediate funds by
selling securities and simultaneously agrees to the repurchase of the same or
similar securities after a specified time at a specified price. In other words, it
enables collateralized short term borrowing and lending through sale/purchase
operations in debt instruments. It is a temporary sale of debt involving full transfer
of ownership of the securities, that is, the assignment of voting and financial rights.
Repo is also referred to as a ready forward transaction as it is means of funding by
selling a security held on a spot basis and repurchasing the same on a forward
basis.
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Reverse repo is exactly the opposite of repo – a party buys a security from another
party with a commitment to sell it back to the latter at a specified time and price. In
other words, while for one party the transaction is repo, for another party it is
reverse repo. A reverse repo is undertaken to earn additional income on idle cash.
In India, repo transactions are basically fund management/SLR management
devices used by banks.
The different between the price at which the securities are bought and sold is the
lender‟s profit or interest earned for lending the money. The transaction combines
elements of both securities purchase/sale operation and also a money market
borrowing/lending operation. It signifies lending on a collateral basis. It is also a
good hedge tool because the repurchase price is locked in at the time of the sale
itself. The terms of contract are in terms of a „repo rate‟, representing the money
market borrowing/lending rate. Repo rate is the annual interest rate for the funds
transferred by the lender to the borrower. The repo rate is usually lower than that
offered on unsecured inter-bank rate as it is fully collateralized. The factors which
affect the repo rate are the creditworthiness of the borrower, liquidity of the
collateral, and comparable rates of other money market instruments.
Importance of repos: Repos are safer than pure call/notice/term money and inter-
corporate deposit markets which are non-collateralized; repos are backed by
securities and are fully collateralized. Thus, the counter party risks are minimum.
Since repos are market based instruments, they can be utilized by central banks as
an indirect instrument of monetary control for absorbing or injecting short term
liquidity. Repos help maintain an equilibrium between demand and supply of short
term funds. The repos market serves as equilibrium between the money market and
securities market and provides liquidity and depth to both the markets. Monetary
authorities can transmit policy signals through repos to the money market which
has a significant influence on the government securities market and foreign
exchange market. Hence, internationally it is versatile and the most popular money
market instrument. In India, too, it was a rapidly developing and thriving market
until the scam of 1992-93 where this facility was grossly misused.
Two types of repos are currently in operation – inter-bank repos and RBI repos.
Inter bank repos: The Reserve Bank itself, allowed it resort to repo transactions
among themselves and with DFHI, and STCI. Inter bank repos were popular in
1991-92 as banks did not wish to buy the securities outright because of the risk of
depreciation. Moreover, since there were not many money market instruments of
different maturities repos served as a hedge for interest rate fluctuations.
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The reserve repos: The Reserve Bank also undertakes repo/reverse repo operation
with primary dealers and scheduled commercial banks as part of its open market
operations. The Reserve Bank introduced repo operations (selling government
securities to repurchase later) on December 10, 1992 to influence short term
liquidity. The Reserve Bank provides liquidity support to primary dealers, and 100
percent gilt mutual funds in the form of reverse repo facility. The Reserve bank
indirectly interferes in the market through reverse repo operations to ease undue
pressure on overnight call money rates. This also enables the repo market to forge
close links between the money market and security market.
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Definition of 'Interest Rate Swap'
An agreement between two parties (known as counterparties) where one stream of
future interest payments is exchanged for another based on a specified principal
amount. Interest rate swaps often exchange a fixed payment for a floating payment
that is linked to an interest rate (most often the LIBOR). A company will typically
use interest rate swaps to limit or manage exposure to fluctuations in interest rates,
or to obtain a marginally lower interest rate than it would have been able to get
without the swap.
Definition of 'Plain Vanilla Swap'
The most basic type of forward claim that is traded in the over-the-counter market
between two private parties, usually firms or financial institutions. There are
several types of plain vanilla swaps, such as the plain vanilla interest rate swap, the
plain vanilla commodity swap and the plain vanilla foreign currency swap.
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THE CAPITAL MARKET
INTRODUCTION:-
Capital Market is one of the significant aspects of every financial market. Hence it
is necessary to study its correct meaning. Broadly speaking the capital market is a
market for financial assets which have a long or indefinite maturity. Unlike money
market instruments the capital market instruments become mature for the period
above one year. It is an institutional arrangement to borrow and lend money for a
longer period of time. It consists of financial institutions like IDBI, ICICI, UTI,
LIC, etc. These institutions play the role of lenders in the capital market. Business
units and corporate are the borrowers in the capital market. Capital market involves
various instruments which can be used for financial transactions. Capital market
provides long term debt and equity finance for the government and the corporate
sector. Capital market can be classified into primary and secondary markets. The
primary market is a market for new shares, where as in the secondary market the
existing securities are traded. Capital market institutions provide rupee loans,
foreign exchange loans, consultancy services and underwriting.
Functions and role of the capital market.
1. Mobilization of Savings: Capital market is an important source for
mobilizing idle savings from the economy. It mobilizes funds from people
for further investments in the productive channels of an economy. In that
sense it activates the ideal monetary resources and puts them in proper
investments.
2. Capital Formation: Capital market helps in capital formation. Capital
formation is net addition to the existing stock of capital in the economy.
Through mobilization of ideal resources it generates savings; the mobilized
savings are made available to various segments such as agriculture, industry,
etc. This helps in increasing capital formation.
3. Provision of Investment Avenue: Capital market raises resources for
longer periods of time. Thus it provides an investment avenue for people
who wish to invest resources for a long period of time. It provides suitable
interest rate returns also to investors. Instruments such as bonds, equities,
units of mutual funds, insurance policies, etc. definitely provides diverse
investment avenue for the public.
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4. Speed up Economic Growth and Development: Capital market
enhances production and productivity in the national economy. As it makes
funds available for long period of time, the financial requirements of
business houses are met by the capital market. It helps in research and
development. This helps in, increasing production and productivity in
economy by generation of employment and development of infrastructure.
5. Proper Regulation of Funds: Capital markets not only helps in fund
mobilization, but it also helps in proper allocation of these resources. It can
have regulation over the resources so that it can direct funds in a qualitative
manner.
6. Service Provision: As an important financial set up capital market
provides various types of services. It includes long term and medium term
loans to industry, underwriting services, consultancy services, export
finance, etc. These services help the manufacturing sector in a large
spectrum.
7. Continuous Availability of Funds: Capital market is place where the
investment avenue is continuously available for long term investment. This
is a liquid market as it makes fund available on continues basis. Both buyers
and seller can easily buy and sell securities as they are continuously
available. Basically capital market transactions are related to the stock
exchanges. Thus marketability in the capital market becomes easy.
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Primary and secondary capital market
The term capital market refers to facilities and institutional arrangements through
which long-term funds; both debt and equity are raised and invested. It consists of
a series of channels through which savings of the community are made available
for industrial and commercial enterprises and for the public in general. It directs
these savings into their most productive use leading to growth and development of
the economy. The capital market consists of development banks, commercial
banks and stock exchanges. An ideal capital market is one where finance is
available at reasonable cost.
The process of economic development is facilitated by the existence of a well
functioning capital market. In fact, development of the financial system is seen as a
necessary condition for economic growth. It is essential that financial institutions
are sufficiently developed and that market operations are freed, fair, competitive
and transparent. The capital market should also be efficient in respect of the
information that it delivers, minimize transaction costs and allocate capital most
productively. The Capital Market can be divided into two parts – Primary Market
and Secondary Market
Primary Market
The primary market is also known as the new issues market. It deals with new
securities being issued for the first time. The essential function of a primary market
is to facilitate the transfer of investable funds from savers to entrepreneurs seeking
to establish new enterprises or to expand existing ones through the issue of
securities for the first time. The investors in this market are banks, financial
institutions, insurance companies, mutual funds and individuals.
A company can raise capital through the primary market in the form of equity
shares, preference shares, debentures, loans and deposits. Funds raised may be for
setting up new projects, expansion, diversification, modernization of existing
projects, mergers and takeovers etc.
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Secondary market
It is a market for the purchase and sale of existing securities. It helps existing
investors to disinvest and fresh investors to enter the market. It also provides
liquidity and marketability to existing securities. It also contributes to economic
growth by channelizing funds towards the most productive investments through the
process of disinvestment and reinvestment.
Securities are traded, cleared and settled within the regulatory framework
prescribed by SEBI. Advances in infosrmation technology have made trading
through stock exchanges accessible from anywhere in the country through trading
terminals. Along with the growth of the primary market in the country, the
secondary market has also grown significantly during the last ten years.
History of the Indian Capital market
The history of the capital market in India dates back to the eighteenth century
when East India Company securities were traded in the country. Until the end of
the nineteenth century securities trading was unorganized and the main trading
centres were Bombay (now Mumbai) and Calcutta (now Kolkata). Of the two,
Bombay was the chief trading centre wherein bank shares were the major trading
stock During the American Civil War (1860-61). Bombay was an important source
of supply for cotton. Hence, trading activities flourished during the period,
resulting in a boom in share prices. This boom, the first in the history of the Indian
capital market lasted for a half a decade. The bubble burst on July 1, 1865 when
there was tremendous slump in share prices.
Trading was at that time limited to a dozen brokers; their trading place was under a
banyan tree in front of the Town hall in Bombay. These stock brokers organized
informal association in 1897 – Native Shares and Stock Brokers Association,
Bombay. The Stock exchanges in Calcutta ad Ahmadabad also industrial and
trading centres came up later. The Bombay Stock Exchange was recognized in
May 1927 under the Bombay Securities Contracts Control Act, 1925.
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The capital market was not well organized and developed during the British rule
because the British government was not interested in the economic growth of the
country. As a result many foreign companies depended on the London capital
market for funds rather than in the Indian capital market.
In the post independence period also, the size the capital market remained small.
During the first and second five year plans, the government‟s emphasis was on the
development of the agricultural sector and public sector undertakings. The public
sector undertakings were healthier than the private undertakings in terms of paid
up capital but shares were not listed on the stock exchanges. Moreover, the
Controller of Capital Issues (CI) closely supervised and controlled the timing,
composition; interest rates pricing allotment and floatation consist of new issues.
These strict regulations de-motivated many companies from going public for
almost four and a half decades.
In the 1950s,Century textiles, Tata Steel, Bombay Dyeing, National Rayon,
Kohinoor mills were the favourite scripts of speculators. As speculation became
rampant, the stock market came to be known as Satta Bazaar. Despite speculation
non-payment or defaults were very frequent. The government enacted the
Securities Contracts (regulation) Act in 1956 to regulate stock markets. The
Companies Act, 1956 was also enacted. The decade of the 1950s was also
characterized by the establishment of a network for the development of financial
institutions and state financial corporations.
The 1960s was characterized by the wars and droughts in the country which led
bearish trends. These trends were aggravated by the ban in 1969 on forward
trading and Badla technically called contracts for clearing Badla provided a
mechanism for carrying forward positions as well as for borrowing funds.
Financial institutions such as LIC and GIC helped to revive the sentiment by
emerging as the most important group of investors. The first mutual fund of India,
the Unit Trust of India (UTI) came into existence in 1964.
In the 1970s Badla trading was resumed under the disguised forms of hand
delivery contracts – A group. This revived the market. However, the capital market
received another severe setback on July 6, 1974, when the government
promulgated the Dividend Restriction ordinance, restricting the payment of
dividend by companies to 12 per cent of the face value or one-third of the profit of
the companies that can be distributed as computed under section 369 of the
Companies Act, whichever was lower. This lead to a slump in market capitalism at
the BSE by about 20 per cent overnight and the stock market did not open for
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nearly a fortnight. Later came buoyancy in the stock markets when the
multinational companies (MNCs) were forced to dilute their majority stocks in
their Indian ventures in favor of the Indian public under FERA 1973. Several
MNCs opted out of India. One hundred and twenty three MNCs offered shares
worth Rs 150 crore, creating 1.8 million shareholders within four years. The offer
prices of FERA shares were lower than their intrinsic worth. Hence, for the first
the FERA dilution created an equity cult in India. It was the spate of FERA issues
that gave a real fillip to the Indian stock markets. For the first time, many investors
got an opportunity to invest in the stocks of such MNCs as Colagte and Hindustan
Liver Limited. Then in 1977, a little known entrepreneur, Dhirubhai Ambani
tapped the capital market. The scrip Reliance Textiles is still a hot favorite and
dominates trading at all stock exchanges.
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History of the Indian Stock Market - The Origin
One of the oldest stock markets in Asia, the Indian Stock Markets have a 200
years old history.
18th
Century
East India Company was the dominant institution and by end of the
century, busyness in its loan securities gained full momentum
1830's Business on corporate stocks and shares in Bank and Cotton presses
started in Bombay. Trading list by the end of 1839 got broader
1840's Recognition from banks and merchants to about half a dozen brokers
1850's Rapid development of commercial enterprise saw brokerage business
attracting more people into the business
1860's The number of brokers increased to 60
1860-61 The American Civil War broke out which caused a stoppage of cotton
supply from United States of America; marking the beginning of the
"Share Mania" in India
1862-63 The number of brokers increased to about 200 to 250
1865 A disastrous slump began at the end of the American Civil War (as an
example, Bank of Bombay Share which had touched Rs. 2850 could
only be sold at Rs. 87)
Pre-Independence Scenario - Establishment of Different Stock Exchanges
1874 With the rapidly developing share trading business, brokers used to
gather at a street (now well known as "Dalal Street") for the purpose
of transacting business.
1875 "The Native Share and Stock Brokers' Association" (also known as
"The Bombay Stock Exchange") was established in Bombay
1880's Development of cotton mills industry and set up of many others
1894 Establishment of "The Ahmadabad Share and Stock Brokers'
Association"
1880 -
90's
Sharp increase in share prices of jute industries in 1870's was
followed by a boom in tea stocks and coal
1908 "The Calcutta Stock Exchange Association" was formed
1920 Madras witnessed boom and business at "The Madras Stock
Exchange" was transacted with 100 brokers.
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1923 When recession followed, number of brokers came down to 3 and the
Exchange was closed down
1934 Establishment of the Lahore Stock Exchange
1936 Merger of the Lahoe Stock Exchange with the Punjab Stock Exchange
1937 Re-organisation and set up of the Madras Stock Exchange Limited
(Pvt.) Limited led by improvement in stock market activities in South
India with establishment of new textile mills and plantation companies
1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange
Limited was established
1944 Establishment of "The Hyderabad Stock Exchange Limited"
1947 "Delhi Stock and Share Brokers' Association Limited" and "The Delhi
Stocks and Shares Exchange Limited" were established and later on
merged into "The Delhi Stock Exchange Association Limited"
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Reforms of Capital Market
The 1991-92 securities scam prompted the governments to increase the pace of
reforms in the capital market. Several reform measures have been undertaken since
then in both the primary and secondary segments of the equity market.
Primary Capital Market
1) The Securities and Exchange Board of India was set up in early 1988 as a non-
statutory body under an administrative arrangement. It was given statutory powers
in January 1992 through the enactment of the SEBI Act, 1992 for regulating the
securities market. The two objectives mandated in the SEBI Act are investor
protection and orderly development of the money market 2) The Capital Issues
(Control) Act, 1947 was repealed in May 1992, allowing issuers of securities to
raise capital from the market without requiring the consent of nay authority either
for floating an issue or pricing it. Restrictions on right and bonus issues were also
removed. The interest rate on debentures was freed. However, the new issue of
capital has now been brought under SEBI‟s purview and issuers are required to
meet the SEBI guidelines for disclosure and investor protection, which are being
strengthened from.
3) The requirement to issue shares at a par value of Rs 10 and Rs 100 was
withdrawn. This gave companies the freedom to determine a fixed value per share.
This facility is available to companies which have dematerialized their shares.
Moreover, the shares cannot be issued in the decimal of a rupee. The companies
which have already issued shares at Rs 10 or Rs 100 per value also eligible for
splitting and consolidation.
4) To reduce the cost of issue, underwriting by issuer was made optional, subject to
the condition that if an issue was not underwritten and in case it failed to secure 90
per cent of the amount offered to the public, the entire amount so collected would
be refunded.
5) One of the significant steps towards integrating the Indian capital market with
the international capital markets was the permission given to foreign institutional
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investors such as mutual funds, pension funds, and country funds, to operate in the
Indian market. Foreign institutional investors were initially allowed to invest only
in equity shares; later, they were allowed to invest in the debt market, including
dated government securities and treasury bills. The ceiling for investment by
foreign institutional investors was increased from 40 per cent to 49 per cent in
2000-01. This increase can be made with the approval of shareholders through.
a special resolution in the general body meeting.
6) Indian companies have also been allowed to raise capital from the international
capital markets through issues of Global Depository Receipts, American
Depository Receipts, Foreign Currency Convertible Bonds (FCCBs) and External
Commercial Borrowings (ECBs). Companies were permitted to invest all ADR /
GDR proceeds abroad. Two way fungibility was announced for ADRs/ GDRs in
2000-01 for persons residing outside India. Converted local shares could be
reconverted into ADRs / GDRs while being subject to sect oral caps.
7) Merchant bankers are prohibited from carrying on fund based activities other
than those related exclusively to the capital market. Multiple categories of
merchant bankers have been abolished and there is only one entity the merchant
banker.
8) Besides merchant bankers, various other intermediaries such as mutual funds,
portfolio managers, registrars to an issue, share transfer agents, underwriters,
debentures trustees, bankers to an issue, custodian of securities, venture capital
funds and issues have also been brought under the preview of SEBI.
.
9) It is mandatory for listed companies to announce quarterly results. This enables
investors to keep a close track of the scrip in their portfolios. The declaration of
quarterly results is in line with the practice prevailing in the stock market in
developed countries.
10) To check price manipulation mandatory client code and minimum floating
listing stipulated in2001
11) The government amended the Securities Contracts (Regulation) Rules, 1957
12) The central government has notified the establishment of the Investor
Education and Protection Fund (IEPF) with effect from October 1, 2001. The IEPF
will be utilized for the promotion of awareness amongst investors and protection of
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their interest
13) The restriction on short sales announced in March 7, 2001 was withdrawn with
effect from July 2, 2001, as all deferral products stand banned after the date.
Secondary Capital Market
1. Since the establishment of Securities and Exchange Board of India (SEBI) in
1992, the decade‟s old trading system in stock exchanges has been under
review. The main deficiencies of the system were found in two areas: (i) the
clearing and settlement system in stock exchanges whereby physical
delivery of shares by the seller and the payment by the buyer was made, and
(ii) procedure for transfer of shares in the name of the purchaser by the
company. The procedure was involving a lot of paper work, delays in
settlement and non-transparency in costs and prices of the transactions. The
prevalence of „Badla‟ system had often been identified as a factor
encouraging speculative activities. As a part of the process of establishing
transparent rules for trading, the „Badla‟ system was discontinued in
December 1993. The SEBI directed the stock exchanges at Mumbai,
Kolkata, Delhi and Ahmadabad to ensure that all transactions in securities
are concluded by delivery and payments and not to allow any carry forward
of the transactions.
2. The floor-based open outcry system has been replaced by on-line electronic
system. The period settlement system has given way to the rolling settlement
system. Physical share certificates system has been outdated by the
electronic depository system. The risk management system has been made
more comprehensive with different types of margins introduced. FII‟s have
been allowed to participate in the capital market. Stringent steps have been
taken to check insider trading. The interest of minority shareholders has
been protected by introducing takeover code. Several types of derivative
instilments have been introduced for hedging.
3. As a result of the reforms/initiatives taken by Government and the
Regulators, the market structure has been refined and modernized. The
investment choices for the investors have also broadened. The securities
market moved from T+3 settlement periods to T+2 rolling settlement with
effect from April 1, 2003. Further, straight through processing has been
made mandatory for all institutional trades executed on the stock exchange.
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Real time gross settlement has also been introduced by RBI to settle inter-
bank transactions online real time mode.
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What is Primary Market?
Primary market is the part of capital market where issue of new securities takes place. Public sector institutions, companies and governments obtain funds for further growth of the company after the sale of their securities or bonds in primary market. The selling process of new issues in primary market is called as Underwriting and this process is done by a group of people called underwriters or security dealers. From a retail investor’s point of view, investing in the primary market is the first step towards trading in stocks and shares. Role of Primary Market Capital formation - It provides attractive issue to the potential investors and with this company can raise capital at lower costs. Liquidity - As the securities issued in primary market can be immediately sold in secondary market the rate of liquidity is higher. Diversification - Many financial intermediaries invest in primary market; therefore there is less risk if there is failure in investment as the company does not depend on a single investor. The diversification of investment reduces the overall risk. Reduction in cost - Prospectus containing all details about the securities are given to the investors hence reducing the cost is searching and assessing the individual securities. Features of Primary Market
It is the new issue market for the new long term capital. Here the securities are issued by company directly to the investors and not
through any intermediaries. On receiving the money from the new issues, the company will issue the security
certificates to the investors. The amount obtained by the company after the new issues are utilized for
expansion of the present business or for setting up new ventures. External finance for longer term such as loans from financial institutions is not
included in primary market. There is an option called ‘going public’ in which the borrowers in new issue market raise capital for converting private capital into public capital.
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Prerequisites for Investor to Participate in Primary market Activities:
PAN Number Bank Account Demat Account
Types of issues
Public issues can be classified into 3 types: Initial Public Offering (IPO) – Fresh issue of shares or selling existing securities by an unlisted company for the first time is known as IPO. Listing and trading of securities of a company takes place in IPO. Rights Issue – Rights issue is when the listed company issues new securities and provides special rights to its existing shareholders for buying the securities before issuing it to public. The rights are issued on particular ratio based on the number of securities currently held by the share holder. Preferential Issue – It is the fresh issue of securities and shares by listed company. It is called as preferential as the shareholders with preferential shares get the preference when it comes to dividend disbursement.
Benefits
Price manipulation is very less in primary market compared to secondary market. There is no payment of brokerage, transaction fees, and stamp duty or service
tax. Investors get the shares at same prices so market fluctuations do not affect it.
Disadvantages
The shares are allotted proportionately if there is over subscription which means, the small investors may not get any allotment.
Money is locked in for longer time, as it is a long term investment. The shares allotment for the investor takes few days in primary market compared
to secondary market where it takes only 3 days to allot the shares.
Primary Market
As you know, business requires money in order to grow and expand and they can raise money in
the form of equity or debt. Such business entities may then approach public at large/institutional
investors (banks, financial institution, MF House) for raising money. Business entity raises
money from investors by issuing newly created securities or may sell securities already held by
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some investors. This is Primary Market transaction.
1. Public Issue
When a company raises funds by selling (issuing) its shares (or debenture / bonds) to the public
through issue of offer document (prospectus), it is called a public issue.
IPO(Initial Public Offer)
As the name suggests, IPO‟s are fresh issue of shares to the public. When a (unlisted) company
makes a public issue for the first time and gets its shares listed on stock exchange, the public
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issue is called as initial public offer (IPO). This process is undertaken at the primary market.
Sarvajeet: Uncle, how do I apply to public Issue?
Uncle: Sarvo, when a company comes with an IPO, it prints and circulate/distribute IPO applica-
tion forms among the investors. To subscribe to an IPO, Investors have to fill an application
form. These forms are available with syndicate members, brokers, sub-brokers, investment advi-
sors and stalls outside stock exchanges, banks and with vendors in various other areas. Once you
get the forms, you have to fill it, remit the amount after calculating the number of shares applied
for the bank that is designated in the form as collecting centre for that IPO. Investors have to pro-
vide the details of their demat account and bank account in the form.
Amit: How do I decide on a good new issue?
Uncle: This is important, especially when a large number of new companies are floating public
issues. While a large number of these companies are genuine, quite a few may want to exploit
investors. An investor must therefore, identify the exploit investors. An investor must therefore,
identify the future potential of a company before applying for its issue.
A part of the guidelines issued by the SEBI (Securities and Exchange Board of India– Regulator)
is the disclosure of information to the public. This disclosure allows the public to know the rea-
son for raising the money, the new way the money is proposed to be spent, the returns expected
on the money and so on.
This information is in the form of a prospectus, which includes information regarding the size of
the issue, the current status of the company and its credibility, its equity capital, its current and
past performance, promoters, the project, cost of the project, means of financing, product and
capability.
New issue also contains a lot of mandatory information regarding underwriting and statutory
compliances. This gives the investor a fair chance to evaluate the prospectus of the company in
the short and lot term period and make investment decision.
Sarvajeet: Uncle what should a layman look for in the prospectus?
Uncle: The important factors to be considered are:
Promoters, their credibility and track record
Past performance of the company
Products of the company and future potential of a products
Technology tie-up, if any, and the reputation of the collaborators
Project cost, means of financing and profitable projections
Risk factors
Rating given by a credit rating agency
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FPO (Further public offer)
Existing companies, who have already issued shares, may require additional money for further
expansion. If they wish, they can tap if from the primary market. Such share issues will be called
„follow on issues‟.
2. Offer for sale
Institutional investors like venture funds, private equity funds etc. invest in unlisted company
when it is very small or at an early stage. Subsequently, when the company becomes large, these
investors sell their shares to the public, through issue of offer document and the company‟s
shares are listed in stock exchange. This is called as offer for sale. The proceeds of this issue go
the existing investors and not to the company.
3. Rights issue (RI)
When a company raises funds from its existing shareholders by selling (issuing) them new
shares / debentures, it is called as rights issue. The offer document for a rights issue is called as
the Letter of Offer and the issue is kept open for 30–60 days.
Existing shareholders are entitled to apply for new shares in proportion to the number of shares
already held. For e.g. in a rights issue of 1:5 ratio, the investors have the right to subscribe to
one (new) share of the company for every 5 shares held by the investor.
This is all about primary market. Now let‟s discuss in brief about secondary market.
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Secondary market
Secondary market refers to a market where securities are traded after being initially offered to
the public in the primary market. Secondary market comprises of equity markets and debt mar-
kets. Secondary market provides liquidity for shares issued in the primary market and determines
the fair prices of the security. The platform for trading is provided by the stock exchanges which
are recognized by SEBI.
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Primary Markets: The initial market that securities come from is called the “primary market.”
The companies that the securities come from, the federal government and whatever other entities
distribute the securities that they create are included in this category. Now, I know you‟re asking
“Well, don‟t stocks have to come from companies in the first place?” Indeed, they do. But in
order for a stock to be considered in the primary market, the company or other entity must
distribute it themselves. Usually these groups rely on secondary markets to distribute their
stocks, but companies will often offer new securities or expand old ones through the primary
market first.
The primary market is also unique that the initial buyer is the only person who can exchange the
securities for funds. So, basically, primary markets are not “exchanges” like you will see on Wall
Street. They‟re from the company, you don‟t trade them, you keep them until you decide to sell
them back. Very simple.
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Secondary Markets
Secondary Markets: When you hear about the New York Stock Exchange or other exchanges
that operate on Wall Street, you are talking about secondary markets. These markets are used for
trading stocks between persons and other entities that may purchase them. Needless to say,
people involved in the secondary market usually are the ones who buy the securities in the
primary markets anyway.
So, if primary markets can just sell the securities themselves, then why do they put securities into
the secondary market? Wouldn‟t it be more profitable to just sell the securities?
Possibly. But, the reasoning is this: the American economic system requires the secondary
market in order to maintain efficiency. The biggest reason? Rising and falling stocks allow for
investors to accumulate more money. In this process, it assists the companies which originally
sold the securities in receiving some sort of profit that they can put back into the company or
create more securities.
Also, secondary markets assist with market liquidity. What‟s the point of investing if there‟s not
a possibility of making some sort of profit? You‟d sooner put the money in a bank account. So,
the liquidity attract potential investors; the solid increase that a bank account provides is nice, but
what if I could double or triple that profit by investing in some stock? The appeal and the risk
help in the decision that one may make.
So, now we know a little bit more as we continue on our journey through the stock market.
Understanding the difference between these two is important when deciding how and what to
invest your money into, and understanding why both are important is vital to having a more rich
understanding of the stock market as a whole.
What is meant by Secondary market?
Secondary market refers to a market where securities are traded after being initially offered
to the public in the primary market and/or listed on the Stock Exchange. Majority of the
trading is done in the secondary market. Secondary market comprises of equity markets and the debt markets.
What is the role of the Secondary Market?
For the general investor, the secondary market provides an efficient platform for trading of
his securities. For the management of the company, Secondary equity markets serve as a
monitoring and control conduit—by facilitating value-enhancing control activities, enabling
implementation of incentive-based management contracts, and aggregating information that guides management decisions.
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What is the difference between the Primary Market and the Secondary Market?
In the primary market, securities are offered to public for subscription for the purpose of
raising capital or fund. Secondary market is an equity-trading venue in which already
existing/pre-issued securities are traded among investors. Secondary market could be
either auction or dealer market. While stock exchange is the part of an auction market, Over-the-Counter (OTC) is a part of the dealer market.
Functions of Secondary Market
Function
Secondary marketing is vital to an efficient and modern capital market.[citation needed] In the
secondary market, securities are sold by and transferred from one investor or speculator to
another. It is therefore important that the secondary market be highly liquid (originally, the only
way to create this liquidity was for investors and speculators to meet at a fixed place regularly;
this is how stock exchanges originated, see History of the Stock Exchange). As a general rule,
the greater the number of investors that participate in a given marketplace, and the greater the
centralization of that marketplace, the more liquid the market.
Fundamentally, secondary markets mesh the investor‟s preference for liquidity (i.e., the
investor‟s desire not to tie up his or her money for a long period of time, in case the investor
needs it to deal with unforeseen circumstances) with the capital user‟s preference to be able to
use the capital for an extended period of time.
Accurate share price allocates scarce capital more efficiently when new projects are financed
through a new primary market offering, but accuracy may also matters in the secondary market
because: 1) price accuracy can reduce the agency costs of management, and make hostile
takeover a less risky proposition and thus move capital into the hands of better managers, and 2)
accurate share price aids the efficient allocation of debt finance whether debt offerings or
institutional borrowing.
Importance of Secondary Market:
Secondary Market has an important role to play behind the developments of an efficient capital market.
Secondary market connects investors' favoritism for liquidity with the capital users' wish of using their
capital for a longer period.
For example, in a traditional partnership, a partner can not access the other partner's investment but
only his or her investment in that partnership, even on an emergency basis. Then he or she can break
the ownership of equity into parts and sell his or her respective proportion to another investor. This kind
of trading is facilitated only by the secondary market.
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What is the role of the Secondary Market?
1. INVESTMENT BASICS
2. SECURITIES
3. PRIMARY MARKET
4. SECONDARY MARKET
5. DERIVATIVES
6. DEPOSITORY
7. MUTUAL FUNDS
8. MISCELLANEOUS
9. CONCEPTS & MODES OF ANALYSIS
10. RATIO ANALYSIS
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REPO MARKET
Definition
A form of short-term borrowing for dealers in government securities. The dealer sells the
government securities to investors, usually on an overnight basis, and buys them back the
following day.
Meaning
Repo or repurchase agreement is a window which enables a bank or a financial institution to
borrow money in the short-term. In the transaction, the entity in question sells government
securities or bonds to the lender with an agreement to buy the securities back after specified time
and price. It is also called a repurchase agreement.
Advantages
1. Repo entails instanneous legal transfer of ownership of the legible securities .
2. It helps to promote greater integrations between the money market and the government
securities
3. Repo can be used to facilitate government „s cash management
4. Repo is a very powerful and flexible money market instrument for modeling market
liquidity
5. Repo also seers the purpose of an indirect instrument of monetary policy at the short end
of the yield curve.
Significance of repo transactions
Repo or repurchase agreement is a window which enables a bank or a financial institution to
borrow money in the short-term.
In the transaction the entity in question sells government securities or bonds to the lender
(another bank or institution), with an agreement to buy the securities back after a specified time
and price.
How is it different from other kinds of borrowing?
A repo transaction is in the nature of secured borrowing; the difference between the sale and
repurchase price is the borrowing cost.
It is usually very short-term in nature with the market practice being to conclude the sale and
repurchase within a timeframe of one day, to a fortnight.
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How is the interest on a repo calculated?
Although there is no separate interest pay-out, there is an implicit interest cost in the form of a
higher repurchase price. Thus, interest cost on the repo is calculated by dividing the difference
between the sale and repurchase price by the initial sale price.
Who can execute a repo/reverse repo?
In India, only select institutions in the financial sector have RBI's permission to enter into repo
and reverse repo transactions. Significantly, in the April 28 policy, RBI has for the first time
allowed listed corporate to participate in the repo market as lenders.
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GOVERNMENT SECURITY MARKET
Introduction
The Govt sec. market is at the core of financial markets in most countries. It deals with tradable
debt instruments issued by the Govt. for meeting its financial requirement.
Meaning of government security market
A Government security is a tradable instrument issued by the Central Government or the State
Governments. It acknowledges the Government‟s debt obligation. Such securities are short term
(usually called treasury bills, with original maturities of less than one year) or long term (usually
called Government bonds or dated securities with original maturity of one year or more). In
India, the Central Government issues both, treasury bills and bonds or dated securities while the
State Governments issue only bonds or dated securities, which are called the State Development
Loans (SDLs). Government securities carry practically no risk of default and, hence, are called
risk-free gilt-edged instruments. Government of India also issues savings instruments (Savings
Bonds, National Saving Certificates (NSCs), etc.) or special securities (oil bonds, Food
Corporation of India bonds, fertilizer bonds, power bonds, etc.).
Trading in government security market
Trading in government security is refered to as the gilt edged market. This is mostly over the
counter market and trading is confide to bank , financial institution and pfs . The role of brokers
is to intermediate as between the above institutions through their contacts with the money
market .
The government sector is a major borrower in Indian and government security represent
government debt to the other sector of the economy .
The government sector include the central and state government. These agencies or bodies
borrow every year from capital market in the form of new loans and bond floatation .
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PRINCIPLE FUNCTION
WHOLESELL MARKET RETAIL MARKET
GILT EDGED
MARKET
SECONDARY
MARKET
PRIMARY
MARKET
RBI , BANKS FSI
LIC GIC PFS OTHERS
RBI BROKERS
BANKS FIS PFS ETC
OPERATIONS
LOAN ISSUE
UNDERWRITING ETC
.
OPERATIONS
RBI
BAN
KS FSI ,
PFS , ETC
BROK
ERS
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Salient feature of government securities
1. These securities are normally issued in denomination of Rs.1,000.
2. The interest on Government securities is payable half yearly. Interest in respect of Central and
State Government securities exempt from income tax subject to certain limits.
3. Central Government securities are more liquid than State Government and Semi-Government
securities. The market activity in respect of semi-Government securities is very less.
4. There are three forms of Central and State Government Securities, (i) Inscribed stock or Stock
certificate (SC) (ii)Promissory note (PN) and (iii) Bearer bond. However, at present most
government securities are in the form of promissory notes(PN). Promissory notes of any loan can
be converted into stock certificates of any other loan or vice versa.
5. The specific features of stock certificates (SC) are. They are safer than PN as the name of the
holder is registered in the books of the Public Debt office (PDO).ii. The half-yearly interest is
remitted to the holder directly by an interest warrant drawn at par on Treasury or SBI. On the
other hand, interest on PN is payable only on the presentation of the note at the office at which it
is enfaced.iii. Stock Certificates (SC) are not easily transferable and degree of negotiability is
less. PN is a superior instrument in transferability. The title is transferable by endorsement and
delivery and it is a negotiable financial instrument. Thus,PNs are mostly preferred by Banks and
SCs are preferred by LIC etc.
6. Government Securities are issued through the Public Debt Office (PDO) of the RBI.
7. The RBI does have its approved brokers for marketing of government securities.
8. The gilt-edged market is an „over-the counter‟ market and each sale and purchase has to be
separately negotiated. Orders received locally by members of the stock exchange are passed on
to the security brokers and dealers who then try various sources, among which are banks.
9. Maturity Structure of Debt : With the developments taken place in the financial system, the
maturity structure of government debt has considerably shortened. The longest maturity is kept at
ten years. Further, with the funding of Treasury Bills into maturities of less than ten years, the
overall term structure of debt has shortened. However, institutional investors like LIC prefer
relatively longer maturities of more than 15 years.
10. Market Structure: Government Securities are deemed to be listed on stock exchanges and as
such there is no separate listing requirement for them. The primary issues of government
B
AN
KS
,FS
I ,PF
S
ET
C
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securities are notified to the public through issue of government notification and press
communication. SEBI has also been granted „No objection‟ to these issues without insisting on
vetting of offer document. The RBI has advised the banks that, securities transactions should be
undertaken directly between banks and no bank should engage the services of any brokers. In
such transactions banks may however undertake securities transactions among themselves or
with non-bank clients through members of the NSE wherein transactions are transparent.
11. Tax Deduction at Source (TDS) Interest on government securities is subject to tax deducted
at source. This has led to the unhealthy practice of voucher trading around interest payments
dates purely to gain tax advantage. The Union of Budget of 1997 has removed TDS on interest
income of government securities. This helps in improving the secondary market for government
securities.
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FOREIGN EXCHANGE MARKET
INTRODUCTION
The foreign exchange market is one of the important components of the international
financial system. Especially, for the developing economy, the foreign exchange market is
necessary for the conversion of currencies for short- term capital flows or long term investments
in the financial physical assets of another country. The service of the foreign exchange markets is
necessary not only for trade truncation but also other financial receipts or payments between
countries involving a foreign exchange truncation.
globally, operations in the foreign exchange market started in a major „way after the
breakdown of the bretton woods system in 1971, which also marked the beginning of floating
exchange rate regimes in several countries. Over the years, the foreign exchange market has
emerged as the largest market in the world. The decade of the 1990s witnessed a perceptible
policy shifts in many emerging markets towards reorientation of their financial markets in term
of new products and instrument of regulatory structure consistent with the liberalized operational
framework.
DEFINITION
According to dr.paul elinzing “foreign exchange is the system or process of converting
one national currency into another, and of transferring money from one country to another.
The market where foreign exchange transaction takes place is called a foreign exchange market.
It does not refer to a market place in the physical sense of the term. In fact, it consists of a
number a dealers, banks and brokers engaged in the business of buying and selling foreign
exchange. Those engaged in the foreign exchange biasness are controlled by the foreign
exchange maintenance act (fema)
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EVOLUTION OF THE FOREIGN EXCHANGE MARKET IN INDIA
The origin of the foreign exchange market in india could be traced to the year 1978 when
banks in india were permitted to undertake intra-day trade in foreign exchange. However, it was
in the 1990s, that the indian foreign exchange market witnessed far reaching changes along with
the shifts in the currency regime in india. There exchange rate of the rupee that was pegged
earlier was floated partially in march 1992 and fully in march 1990, following the
recommendation of the report of the high level committee on balance of payments.
A further impetus to the development of the foreign exchange market in India was
provided with the setting up of an expert group on foreign exchange markets in India, which
submitted its report in June 1995.the group made several recommendations for deepening and
widening of the Indian foreign exchange market. Consequently beginning from January 1996,
wide –ranging reforms have been undertaken in the Indian foreign exchange market.
The momentous developments over the past few years are reflected in the enhanced risk-
bearing capacity of banks along with rising foreign exchange trading volumes and finer margins.
The foreign exchange market has acquired depth. The conditions in the foreign exchange market
have also generally remained orderly.
FUNCTIONS
The most important function of this market are:
1. To make necessary arrangements to transfer purchasing power from one country to
another.
2. To provide adequate credit facilities for the promotion of foreign trade.
3. To cover foreign exchange risks by providing hedging facilities.
In india, the foreign exchange business has a three –tiered structure consisting of :
a. Trading between banks and their commercial customers
b. Trading between banks through authorized brokers.
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c. Trading with banks abroad.
STRUCTURE OF THE FOREIGN EXCHANGE MARKET
The foreign exchange market is a three – tier structure comprising
a. The reserve bank at the apex.
b. Authorized dealers licensed by the reserve bank
c. Customer such as exports and imports, corporate and other foreign exchange earners.
Dealing in the foreign exchange market include transaction between authorized dealers and the
exports, importers and other customers, transaction among authorized dealers themselves,
transactions with overseas banks and transaction between authorized dealers and the reserve
bank.
Foreign exchange
dealers association of india
(FEDAI)
AUTHORISED
DEALERS
RESERVE
BANK OF INDIA
CUSTO
MERS
FOREIGN EXCHNAGE
MONEY CHANGES
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MARKET PLAYERS
The players in the Indian market include
a. Ads, mostly banks who are authorized to deal in foreign exchange.
b. Foreign exchange brokers who act as intermediaries, and
c. Customer –individuals, corporate, who need foreign exchange for their transactions.
INSTRUMENT OF CREDIT TRADED
In addition to conversion of foreign currency notes and cash, a number of instruments of credit
are used for effecting conversion in the foreign exchange market. These instruments are:
1. Telegraphic transfer (tt)
2. Mail transfer (mt)
3. Drafts and cheques
4. Bills of exchange
FOREIGN EXCHANGE MARKET COMPONENTS
There are three major components in this market, depending upon the transaction:
1. Transaction between the public and the banks at the base level:
2. Transaction between the banks dealing in foreign exchange involving conversion of
currencies: and
3. Transaction between banks and the central bank involving purchase and sale of foreign
currencies.
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ASIAN CLEARING UNIONS
For many years now, regional co-operation for benefiting trade and payments has been a
subject of serious consideration all over the world. In the Asian region, the initiative on
these matters was taken by the ecafe (since renamed as economics and social council for
Asia and pacific) and as a first step for securing regional co-operation amongst its
members, the Asian clearing unions was established on 9th
December 1974.
ACU was set up with the objectives of-
1. Facilitating payments for current international transactions within the ecafe region on
a multilateral basis:
2. Reducing the use of extra –regional reserve currencies to settle such transaction by
promoting the use of the participants currencies or asian monetary units
3. Effecting their by economies in the use of foreign exchange and a reduction in the
cost of making payment foe such transaction and
4. Contributing to the expansion of trade and promotion of monetary co- operation
among the countries of the area.
DOLLAR CERTIFICATES OF DEPOSIT
an extension to the eurodollar market began in 1966 with the issue in London of
negotiable dollar certificate of deposit. These are interest –bearing securities of six
month or one year but with a maximum of five years. Cds were an American
innovation introduced on a wide scale in the United States 1961. Their success,
notably with corporate customers of united sates banks, promoted New York based
banks to issue them on the London market.