Financial Market Reforms

The last decade witnessed the maturity of India's financial markets. Since 1991, every governments of India took major
steps in reforming the financial sector of the country. The important achievements in the following fields is discussed
under separate heads
!inancial markets
"egulators
The #anking system
$on%#anking finance companies
The capital market
&utual funds
'verall approach to reforms
(eregulation of #anking system
)apital market developments
)onsolidation imperative
$ow let us discuss each segment separately.
Financial Markets
In the last decade, *rivate Sector Institutions played an important role. They grew rapidly in commercial #anking and
asset management #usiness. +ith the openings in the insurance sector for these institutions, they started making de#t
in the market.
)ompetition among financial intermediaries gradually helped the interest rates to decline. (eregulation added to it. The
real interest rate was maintained. The #orrowers did not pay high price while depositors had incentives to save. It was
something #etween the nominal rate of interest and the e,pected rate of inflation.
Regulators
The !inance &inistry continuously formulated major policies in the field of financial sector of the country. The
-overnment accepted the important role of regulators. The "eserve .ank of India /".I0 has #ecome more
independant. Securities and 1,change .oard of India /S1.I0 and the Insurance "egulatory and (evelopment
2uthority /I"(20 #ecame important institutions. 'pinions are also there that there should #e a super%regulator for the
financial services sector instead of multiplicity of regulators.
The banking system
2lmost 345 of the #usiness are still controlled #y *u#lic Sector .anks /*S.s0. *S.s are still dominating the
commercial #anking system. Shares of the leading *S.s are already listed on the stock e,changes.
The ".I has given licences to new private sector #anks as part of the li#eralisation process. The ".I has also #een
granting licences to industrial houses. &any #anks are successfully running in the retail and consumer segments #ut
are yet to deliver services to industrial finance, retail trade, small #usiness and agricultural finance.
The *S.s will play an important role in the industry due to its num#er of #ranches and foreign #anks facing the
constrait of limited num#er of #ranches. 6ence, in order to achieve an efficient #anking system, the onus is on the
-overnment to encourage the *S.s to #e run on professional lines.
Development finance institutions
!Is's access to S7" funds reduced. $ow they have to approach the capital market for de#t and e8uity funds.
)onverti#ility clause no longer o#ligatory for assistance to corporates sanctioned #y term%lending institutions.
)apital ade8uacy norms e,tended to financial institutions.
(!Is such as I(.I and I)I)I have entered other segments of financial services such as commercial #anking, asset
management and insurance through separate ventures. The move to universal #anking has started.
Non-banking finance companies
In the case of new $.!)s seeking registration with the ".I, the re8uirement of minimum net owned funds, has #een
raised to "s.9 crores.
:ntil recently, the money market in India was narrow and circumscri#ed #y tight regulations over interest rates and
participants. The secondary market was underdeveloped and lacked li8uidity. Several measures have #een initiated
and include new money market instruments, strengthening of e,isting instruments and setting up of the (iscount and
!inance 6ouse of India /(!6I0.
The ".I conducts its sales of dated securities and treasury #ills through its open market operations /'&'0 window.
*rimary dealers #id for these securities and also trade in them. The (!6I is the principal agency for developing a
secondary market for money market instruments and -overnment of India treasury #ills. The ".I has introduced a
li8uidity adjustment facility /72!0 in which li8uidity is injected through reverse repo auctions and li8uidity is sucked out
through repo auctions.
'n account of the su#stantial issue of government de#t, the gilt% edged market occupies an important position in the
financial set% up. The Securities Trading )orporation of India /ST)I0, which started operations in ;une 199< has a
mandate to develop the secondary market in government securities.
7ong%term de#t market The development of a long%term de#t market is crucial to the financing of infrastructure. 2fter
#ringing some order to the e8uity market, the S1.I has now decided to concentrate on the development of the de#t
market. Stamp duty is #eing withdrawn at the time of dematerialisation of de#t instruments in order to encourage
paperless trading.
The capital market
The num#er of shareholders in India is estimated at 9= million. 6owever, only an estimated two lakh persons actively
trade in stocks. There has #een a dramatic improvement in the country's stock market trading infrastructure during the
last few years. 1,pectations are that India will #e an attractive emerging market with tremendous potential.
:nfortunately, during recent times the stock markets have #een constrained #y some unsavoury developments, which
has led to retail investors deserting the stock markets.
Mutual funds
The mutual funds industry is now regulated under the S1.I /&utual !unds0 "egulations, 199> and amendments
thereto. +ith the issuance of S1.I guidelines, the industry had a framework for the esta#lishment of many more
players, #oth Indian and foreign players.
The :nit Trust of India remains easily the #iggest mutual fund controlling a corpus of nearly "s.?4,444 crores, #ut its
share is going down. The #iggest shock to the mutual fund industry during recent times was the insecurity generated in
the minds of investors regarding the :S >< scheme. +ith the growth in the securities markets and ta, advantages
granted for investment in mutual fund units, mutual funds started #ecoming popular.
The foreign owned 2&)s are the ones which are now setting the pace for the industry. They are introducing new
products, setting new standards of customer service, improving disclosure standards and e,perimenting with new
types of distri#ution.
The insurance industry is the latest to #e thrown open to competition from the private sector including foreign players.
!oreign companies can only enter joint ventures with Indian companies, with participation restricted to 9> per cent of
e8uity. It is too early to conclude whether the erstwhile pu#lic sector monopolies will successfully #e a#le to face up to
the competition posed #y the new players, #ut it can #e e,pected that the customer will gain from improved service.
The new players will need to #ring in innovative products as well as fresh ideas on marketing and distri#ution, in order
to improve the low per capita insurance coverage. -ood regulation will, of course, #e essential.
Overall approach to reforms
The last ten years have seen major improvements in the working of various financial market participants. The
government and the regulatory authorities have followed a step%#y%step approach, not a #ig #ang one. The entry of
foreign players has assisted in the introduction of international practices and systems. Technology developments have
improved customer service. Some gaps however remain /for e,ample lack of an inter%#ank interest rate #enchmark,
an active corporate de#t market and a developed derivatives market0. 'n the whole, the cumulative effect of the
developments since 1991 has #een 8uite encouraging. 2n indication of the strength of the reformed Indian financial
system can #e seen from the way India was not affected #y the Southeast 2sian crisis.
6owever, financial li#eralisation alone will not ensure sta#le economic growth. Some tough decisions still need to #e
taken. +ithout fiscal control, financial sta#ility cannot #e ensured. The fate of the !iscal "esponsi#ility .ill remains
unknown and high fiscal deficits continue. In the case of financial institutions, the political and legal structures hve to
ensure that #orrowers repay on time the loans they have taken. The phenomenon of rich industrialists and #ankrupt
companies continues. !urther, frauds cannot #e totally prevented, even with the #est of regulation. 6owever,
punishment has to follow crime, which is often not the case in India.
Deregulation of banking system
*rudential norms were introduced for income recognition, asset classification, provisioning for delin8uent loans and for
capital ade8uacy. In order to reach the stipulated capital ade8uacy norms, su#stantial capital were provided #y the
-overnment to *S.s.
-overnment pre%emption of #anks' resources through statutory li8uidity ratio /S7"0 and cash reserve ratio /)""0
#rought down in steps. Interest rates on the deposits and lending sides almost entirely were deregulated.
$ew private sector #anks allowed to promote and encourage competition. *S.s were encouraged to approach the
pu#lic for raising resources. "ecovery of de#ts due to #anks and the !inancial Institutions 2ct, 199@ was passed, and
special recovery tri#unals set up to facilitate 8uicker recovery of loan arrears.
.ank lending norms li#eralised and a loan system to ensure #etter control over credit introduced. .anks asked to set
up asset lia#ility management /27&0 systems. ".I guidelines issued for risk management systems in #anks
encompassing credit, market and operational risks.
2 credit information #ureau #eing esta#lished to identify #ad risks. (erivative products such as forward rate
agreements /!"2s0 and interest rate swaps /I"Ss0 introduced.
Capital market developments
The )apital Issues /)ontrol0 2ct, 19<?, repealed, office of the )ontroller of )apital Issues were a#olished and the
initial share pricing were decontrolled. S1.I, the capital market regulator was esta#lished in 1999.
!oreign institutional investors /!IIs0 were allowed to invest in Indian capital markets after registration with the S1.I.
Indian companies were permitted to access international capital markets through euro issues.
The $ational Stock 1,change /$S10, with nationwide stock trading and electronic display, clearing and settlement
facilities was esta#lished. Several local stock e,changes changed over from floor #ased trading to screen #ased
trading.
rivate mutual funds permitted
The (epositories 2ct had given a legal framework for the esta#lishment of depositories to record ownership deals in
#ook entry form. (ematerialisation of stocks encouraged paperless trading. )ompanies were re8uired to disclose all
material facts and specific risk factors associated with their projects while making pu#lic issues.
To reduce the cost of issue, underwriting #y the issuer were made optional, su#ject to conditions. The practice of
making preferential allotment of shares at prices unrelated to the prevailing market prices stopped and fresh guidelines
were issued #y S1.I.
S1.I reconstituted governing #oards of the stock e,changes, introduced capital ade8uacy norms for #rokers, and
made rules for making client or #roker relationship more transparent which included separation of client and #roker
accounts.
!uy back of shares allo"ed
The S1.I started insisting on greater corporate disclosures. Steps were taken to improve corporate governance #ased
on the report of a committee.
S1.I issued detailed employee stock option scheme and employee stock purchase scheme for listed companies.
Standard denomination for e8uity shares of "s. 14 and "s. 144 were a#olished. )ompanies given the freedom to
issue dematerialised shares in any denomination.
(erivatives trading starts with inde, options and futures. 2 system of rolling settlements introduced. S1.I empowered
to register and regulate venture capital funds.
The S1.I /)redit "ating 2gencies0 "egulations, 1999 issued for regulating new credit rating agencies as well as
introducing a code of conduct for all credit rating agencies operating in India.
Consolidation imperative
2nother aspect of the financial sector reforms in India is the consolidation of e,isting institutions which is especially
applica#le to the commercial #anks. In India the #anks are in huge 8uantity. !irst, there is no need for 9? *S.s with
#ranches all over India. 2 num#er of them can #e merged. The merger of *unja# $ational .ank and $ew .ank of
India was a difficult one, #ut the situation is different now. $o one e,pected so many employees to take voluntary
retirement from *S.s, which at one time were much sought after jo#s. *rivate sector #anks will #e self consolidated
while co%operative and rural #anks will #e encouraged for consolidation, and anyway play only a niche role.
In the case of insurance, the 7ife Insurance )orporation of India is a #ehemoth, while the four pu#lic sector general
insurance companies will pro#a#ly move towards consolidation with a #it of nudging. The :TI is yet again a #ig
institution, even though facing difficult times, and most other pu#lic sector players are already e,iting the mutual fund
#usiness. There are a num#er of small mutual fund players in the private sector, #ut the #usiness #eing comparatively
new for the private players, it will take some time.
+e finally come to convergence in the financial sector, the new #uAAword internationally. 6i%tech and the need to meet
increasing consumer needs is encouraging convergence, even though it has not always #een a success till date. In
India organisations such as I(.I, I)I)I, 6(!) and S.I are already trying to offer various services to the customer
under one um#rella. This phenomenon is e,pected to grow rapidly in the coming years. +here mergers may not #e
possi#le, alliances #etween organisations may #e effective. Barious forms of #ancassurance are #eing introduced,
with the ".I having already come out with detailed guidelines for entry of #anks into insurance. The 7I) has #ought
into )orporation .ank in order to spread its insurance distri#ution network. .oth #anks and insurance companies have
started entering the asset management #usiness, as there is a great deal of synergy among these #usinesses. The
pensions market is e,pected to open up fresh opportunities for insurance companies and mutual funds.
It is not possi#le to play the role of the 'racle of (elphi when a vast nation like India is involved. 6owever, a few trends
are evident, and the coming decade should #e as interesting as the last one.
India's !inancial Sector 2n 1ra of "eforms, Byuptakesh Sharan, Sage *u#lications India /*vt.0 7imited, $ew (elhi,
9449, *ages 9@>, *rice >=4C%
1conomic reforms can #e classified #roadly into two categories structural adjustments and macroeconomic reforms.
The macroeconomic reforms involve an immediate change in policies and aims at achieving short term o#jectives. 2
structural adjustment on the other hand, involves more fundamental changes in the way economy will operate. It
modifies the very structure of the economy towards meeting long term o#jectives. &acroeconomic policy reforms
encompass production, saving and investment, sectoral development, monetary and #udgetary targets and the
e,ternal sector. Structural adjustment programmes are wide ranging from reducing the role of government in the
matter of private sector, to allow prices and income to respond freely to market forces and to open economy to foreign
trade and investment. India initiated this process on a full fledged scale as #ack as early mid%1991. The measures of
economic reforms in India#conomic reform in $ndia is something which is under close study. The phrase is
commonly used to descri#e post%1991 events. The country however has seen a num#er of distinct eras, which had
definite differences from the economic practices of the previous eras. are #road #ased covering all the vital sectors of
the economy and conse8uently, the policies%fiscal, financial, monetary, industrial and e,ternal%underwent a #ig
change. The present #ook DIndia's !inancial Sector 2n 1ra of "eformD #y Byuptakesh Sharan presents a #rief account
of major economic reforms in the financial sector in India from early years of reforms /1991%990 to the present time
/944?%430.
The #ook starts with e,plaining the critical link #etween developed financial sector and economic growth of a
nation. Sharan reviews the wide literature availa#le on the topic from various countries across the glo#e in general and
India in particular. 6e first gives an overview of Indian financial sector and then he e,plains the nature of reforms in the
Indian financial sector. The discussion in this #ook is divided into three parts.
The first part deal with financial intermediaries which include Indian #anking sector, non%#anking finance companies,
and mutual funds. 2uthor has presented pre reform state of affairs in a#ove three sectors, followed #y the measure of
reforms initiated #y the -overnment in the early 1994s and then finally the impact of these reforms is anlysed keeping
in view the economic growth along with operating efficiency, financial sta#ility and financial inclusion.
The second part facilitates discussion on financial markets and instruments. 6ere author presents the pre reform state
of affairs of primary markets, secondary markets, money market and foreign e,change market in India. Impact of
reforms measures has #een analysed keeping in view the siAe of recourse mo#iliAation, composition of the de#t and
e8uity in market and participation of private and pu#lic sector companies. Secondary market reforms focus mainly on
esta#lishment of S1.I
as a statuary #ody, esta#lishment of national level stock e,changes and improvements in listing, trading, clearing and
settlement system. Second part also facilitate detail discussion on market for government securities, money market
instruments call money market, repo 2n agreement in which one party sells a security to another party and agrees to
repurchase it on a specified date for a specified price. market, commercial paper market, market for certificates of
deposits. !inally there is the discussion of the foreign e,change market as an integral part of financial market.
The third part focuses on the linkages of Indian financial market with international financial market. 7inkages are
e,plained in terms of capital flows from international market to Indian market in the form of !oreign (irect Investment
/!(I0
and Indian companies raising funds from international financial market through the issue of foreign currency
converti#le #onds /!)).s0 and the issue of the shares under 2("C-(" arrangement.
In the end entire discussion is summarised in view of the impact of glo#al financial crisis, 9443, the concluding remarks
are followed #y a postscript that focuses on the recent trends.
This #ook serves as a ready reference for the researchers in the area of financial reforms. It covers financial reforms
and impact of reform measures in almost all the areas including #anking sector, non #anking finance companies,
financial intermediaries, primary and secondary capital markets, foreign e,change market and finally activities and
impact of !(I and !*I!*I !ormal in India.
C%$T%& M%R'#T R#FORM(
The Indian regulatory and supervisory framework of securities market has #een ade8uately strengthened through the
legislative and administrative measures in the recent past. The regulatory framework for securities market is consistent
with the #est international #enchmarks, such as, standards prescri#ed #y International 'rganiAation of Securities
)ommissions /I'S)'0.
Capital Market Reforms
E 1,tensive )apital &arket "eforms were undertaken during the 1994s encompassing legislative
regulatory and institutional reforms. Statutory market regulator, which was created in 1999, was
suita#ly empowered to regulate the collective investment schemes and plantation schemes through
an amendment in 1999. !urther, the organiAation strengthening of S1.I and suita#le empowerment
through compliance and enforcement powers including search and seiAure powers were given
through an amendment in S1.I 2ct in 9449. 2lthough dematerialiAation started in 199? after the legal
foundations for electronic #ook keeping were provided and depositories created the regulator
mandated gradually that trading in most of the stocks take place only in dematerialiAed form.
E Till 9441 India was the only sophisticated market having account period settlement alongside the
derivatives products. !rom middle of 9441 uniform rolling settlement and same settlement cycles
were prescri#ed creating a true spot market.
E 2fter the legal framework for derivatives trading was provided #y the amendment of S)"2 in
1999 derivatives trading started in a gradual manner with stock inde, futures in ;une 9444. 7ater on
options and single stock futures were introduced in 9444%9441 and now IndiaFs derivatives market
turnover is more than the cash market and India is one of the largest single stock futures markets in
the world.
E IndiaFs risk management systems have always #een very modern and effective. The Ba" #ased
margining system was introduced in mid 9441 and the risk management systems have withstood
huge volatility e,perienced in &ay 944@ and &ay 944<. This included real time e,posure monitoring,
disa#lement of #roker terminals, Ba" #ased margining etc.
E India is one of the few countries to have started the screen #ased trading of government
securities in ;anuary 944@.
E In ;une 944@ the interest rate futures contracts on the screen #ased trading platform were
introduced.
E India is one of the few countries to have started the Straight Through *rocessing /ST*0, which will
completely automate the process of order flow and clearing and settlement on the stock e,changes.
E ".I has introduced the "eal Time -ross Settlement system /"T-S0 in 944< on e,perimental
#asis. "T-S will allow real delivery vCs. payment which is the international norm recogniAed #y .IS
and I'S)'.
E To improve the governance mechanism of stock e,changes #y mandating demutualiAation and
corporatiAation of stock e,changes and to protect the interest of investors in securities market the
Securities 7aws /2mendment0 'rdinance was promulgated on 19
th
'cto#er 944<. The 'rdinance has
since #een replaced #y a .ill.