Introduction to Indian Financial system

Overview of Indian Financial Markets

 Financial System
• An institutional framework existing in a country to enable
financial transactions
• Three main parts
– Financial assets (loans, deposits, bonds, equities, etc.)
– Financial institutions (banks, mutual funds, insurance
companies, etc.)
– Financial markets (money market, capital market, forex market,
etc.)
• Regulation is another aspect of the financial system (RBI,
SEBI, IRDA, FMC)
 Financial assets/
instruments
• Enable channelising funds from surplus units to deficit
units
• There are instruments for savers such as deposits,
equities, mutual fund units, etc.
• There are instruments for borrowers such as loans,
overdrafts, etc.
• Like businesses, governments too raise funds through
issuing of bonds, Treasury bills, etc.
• Instruments like PPF, KVP, etc. are available to savers who
wish to lend money to the government
 Financial Institutions
• Includes institutions and mechanisms which
– Affect generation of savings by the community
– Mobilisation of savings
– Effective distribution of savings
• Institutions are banks, insurance companies,
mutual funds- promote/mobilise savings
• Individual investors, industrial and trading
companies- borrowers
 Financial Markets
• Money Market- for short-term funds (less than
a year)
– Organised (Banks)
– Unorganised (money lenders, chit funds, etc.)

• Capital Market- for long-term funds

– Primary Issues Market
– Stock Market
– Bond Market
 Organised Money Market
• Call money market
• Bill Market
– Treasury bills
– Commercial bills
• Bank loans (short-term)
• Organised money market comprises RBI,
banks (commercial and co-operative)
 Purpose of the
money market
• Banks borrow in the money market to:
– Fill the gaps or temporary mismatch of funds
– To meet the CRR and SLR mandatory requirements
as stipulated by the central bank
– To meet sudden demand for funds arising out of
large outflows (like advance tax payments)

• Call money market serves the role of

equilibrating the short-term liquidity position of
the banks
 Call money market (1)
• Is an integral part of the Indian money market
where day-to-day surplus funds (mostly of
banks) are traded.
• The loans are of short-term duration (1 to 14
days). Money lent for one day is called ‘call
money’; if it exceeds 1 day but is less than 15
days it is called ‘notice money’. Money lent for
more than 15 days is ‘term money’
• The borrowing is exclusively limited to banks,
who are temporarily short of funds.
 Call money market (2)
• Call loans are generally made on a clean basis- i.e. no
collateral is required
• The main function of the call money market is to
redistribute the pool of day-to-day surplus funds of banks
among other banks in temporary deficit of funds
• The call market helps banks economise their cash and yet
improve their liquidity
• It is a highly competitive and sensitive market
• It acts as a good indicator of the liquidity position
 Call Money Market
Participants
• Those who can both borrow and lend in the
market – RBI (through LAF), banks and primary
dealers
• Once upon a time, select financial institutions
viz., IDBI, UTI, Mutual funds were allowed in
the call money market only on the lender’s side
• These were phased out and call money market
is now a pure inter-bank market (since August
2005)
 Developments in
Money Market
• Prior to mid-1980s participants depended heavily on the
call money market
• The volatile nature of the call money market led to the
activation of the Treasury Bills market to reduce
dependence on call money
• Emergence of market repo and collateralised borrowing
and lending obligation (CBLO) instruments
• Turnover in the call money market declined from Rs.
35,144 crore in 2001-02 to Rs. 14,170 crore in 2004-05
before rising to Rs. 21,725 crore in 2006-07
 Bill Market
• Treasury Bill market- Also called the T-Bill market
– These bills are short-term liabilities (91-day, 182-day, 364-day) of
the Government of India
– It is an IOU of the government, a promise to pay the stated
amount after expiry of the stated period from the date of issue
– They are issued at discount to the face value and at the end of
maturity the face value is paid
– The rate of discount and the corresponding issue price are
determined at each auction
– RBI auctions 91-day T-Bills on a weekly basis, 182-day T-Bills and
364-day T-Bills on a fortnightly basis on behalf of the central
government
 Money Market
Instruments1)
• Money market instruments are those which
have 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
 Money Market Instruments
• Certificates of Deposit
• Commercial Paper
• Inter-bank participation certificates
• Inter-bank term money
• Treasury Bills
• Bill rediscounting
• Call/notice/term money
• CBLO
• Market Repo
 Certificates of Deposit
• CDs are short-term borrowings in the form of UPN issued by all
scheduled banks and are freely transferable by endorsement and
delivery.
• Introduced in 1989
• Maturity of not less than 7 days and maximum up to a year. FIs are
allowed to issue CDs for a period between 1 year and up to 3 years
• Subject to payment of stamp duty under the Indian Stamp Act, 1899
• Issued to individuals, corporations, trusts, funds and associations
• They are issued at a discount rate freely determined by the
market/investors
 Commercial Papers
• Short-term borrowings by corporates, financial institutions, primary
dealers from the money market
• Can be issued in the physical form (Usance Promissory Note) or demat
form
• Introduced in 1990
• When issued in physical form are negotiable by endorsement and
delivery and hence, highly flexible
• Issued subject to minimum of Rs. 5 lacs and in the multiple of Rs. 5 lacs
after that
• Maturity is 7 days to 1 year
• Unsecured and backed by credit rating of the issuing company
• Issued at discount to the face value
 Market Repos
• Repo (repurchase agreement) instruments enable
collateralised short-term borrowing through the selling
of debt instruments
• A security is sold with an agreement to repurchase it at a
pre-determined date and rate
• Reverse repo is a mirror image of repo and reflects the
acquisition of a security with a simultaneous
commitment to resell
• Average daily turnover of repo transactions (other than
the Reserve Bank) increased from Rs.11,311 crore during
April 2001 to Rs. 42,252 crore in June 2006
 Collateralised Borrowing and
Lending Obligation (CBLO)

• Operationalised as money market instruments by the

CCIL in 2003
• Follows an anonymous, order-driven and online trading
system
• On the lenders side main participants are mutual funds,
insurance companies.
• Major borrowers are nationalised banks, PDs and non-
financial companies
• The average daily turnover in the CBLO segment
increased from Rs. 515 crore (2003-04) to Rs. 32, 390
crore (2006-07)
 Indian Capital Market
• Market for long-term capital. Demand comes
from the industrial, service sector and
government
• Supply comes from individuals, corporates,
banks, financial institutions, etc.
• Can be classified into:
– Gilt-edged market
– Industrial securities market (new issues and stock
market)
• Development Financial Institutions
– Industrial Finance Corporation of India (IFCI)
– State Finance Corporations (SFCs)
– Industrial Development Finance Corporation (IDFC)
• Financial Intermediaries
– Merchant Banks
– Mutual Funds
– Leasing Companies
– Venture Capital Companies
 Corporate Securities Market

• Refers to the market for shares and

debentures of old and new companies
• New Issues Market- also known as the primary
market- refers to raising of new capital in the
form of shares and debentures
• Stock Market- also known as the secondary
market. Deals with securities already issued by
companies
 Financial Intermediaries (1)
• Mutual Funds- Promote savings and mobilise funds
which are invested in the stock market and bond market
• Indirect source of finance to companies
• Pool funds of savers and invest in the stock market/bond
market
• Their instruments at saver’s end are called units
• Offer many types of schemes: growth fund, income fund,
balanced fund
• Regulated by SEBI
• Merchant banking- manage and underwrite new issues,
undertake syndication of credit, advise corporate clients
on fund raising
• Subject to regulation by SEBI and RBI
• SEBI regulates them on issue activity and portfolio
management of their business.
• RBI supervises those merchant banks which are
subsidiaries or affiliates of commercial banks
• Have to adopt stipulated capital adequacy norms and
abide by a code of conduct
 Conclusion

• There are other financial intermediaries such as

NBFCs, Venture Capital Funds, Hire and Leasing
Companies, etc.
• India’s financial system is quite huge and caters
to every kind of demand for funds
• Banks are at the core of our financial system
and therefore, there is greater expectation from
them in terms of reaching out to the vast
populace as well as being competitive.
 Assignment
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