** **

INDIAN FINANCIAL
SYSTEM AND
FINANCIAL MARKETS
MBA, THIRD SEMESTER
According to the New syllabus of ‘Maharshi Dayanand
University’, Rohtak

Priyanka Singh
M. Phil, MBA, M.Com
Editor-in-Chief
Thakur Publishers

Raj Kumar Singh

MBA, BBA
Senior Editor
Thakur Publishers

THAKUR PUBLISHERS, ROHTAK

 Ahmedabad  Bengaluru  Bhubaneswar  Bhopal  Chennai  Dehradun  Ernakulam 
Hyderabad  Jaipur  Jalandhar  Kolkata  Lucknow  Nagpur  Pune  Patna 
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** **

INDIAN FINANCIAL SYSTEM AND FINANCIAL MARKETS

- Priyanka Singh
- Raj Kumar Singh

Published by:
Thakur Publishers
Head Office: House No.645B/187 Abhishekpuram, 60 Feet Road, Jankipuram,
Near- Ramkishore Convent Inter College, Lucknow-226021
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ISBN No. 978-93-5163-788-2

First Edition 2020

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Copyright © All Rights Reserved

This book is sole subject to the condition that it shall not, by way of trade or otherwise,
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(electronic, mechanical, photocopying, recording or otherwise), without the prior written
permission of both the copyright owner and the below mentioned publisher of this book.
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** **

“Dedicated
to
The Almighty,
My Grandparents,
My Parents, Mr. R.B. Singh & Mrs. Mithilesh Singh,
&
My husband, Mr. Vinay Pratap Singh
whose values of decency and dignity will always be an inspiration.”

- Priyanka Singh

“Dedicated to

My Parents

Mr. Tribhuwan Singh & Mrs. Meera Singh

for their enduring support and encouragement.”

- Raj Kumar Singh

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** **

Preface
This book of “Indian Financial System and Financial Markets” has been
written in accordance with the prescribed syllabus of MBA Third Semester of
Maharshi Dayanand University, Rohtak. However, it will also prove useful
for the students of other universities.

In the financial sector, Indian Financial System and Financial Markets play
a very significant role. Financial market together contributes to the efficient
functioning of the financial system of a country. Commercial Bank encourages
a higher level of savings and investment, leading to economic growth. Hence, it
becomes necessary to understand the financial system of a country. Banks
delivers various kinds of financial services to the consumers or agencies.

This book is a straight and humble attempt to sketch the various aspects of
Indian Financial System and Financial Markets. The book is divided into four
units:
1st Unit of this book is concern with the Introduction of Indian financial system,
various reforms in Indian financial system and money market with its
segments.
2nd Unit covers the capital market.
3rd Unit deals with commercial banks and development banks.
4th Unit deals with LICI, SIDBI, NABARD, micro finance and financial
inclusion.

We are expecting valuable suggestions for improvements from our dear

students and lecturers, which will be useful for our next edition.

Please e-mail us at, [email protected]

Website, www.tppl.org.in

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** **

Acknowledgement
I am especially grateful to my beloved Parents for inspiring me to take this
work. I dedicate my hard work to my Daddy, Mummy and siblings Ms.
Monika Singh and Mr. Ravi Prakash Singh thank you for your unconditional
support and love.
I owe special thanks to my husband, Mr. Vinay Pratap Singh for their
understanding to continue my career.
I express my appreciation to Mr. Raj Kumar Singh for their invaluable
guidance and constant source of cooperation till the completion of the work.
I take this opportunity to express my profound gratitude and deep regards to
Dr. Saroj Kumar (Director of Thakur Publishers) for their guidance.
I would like to thank all the people who have helped me during the revision of
this text. I would also like to thanks Many Reviewers of previous editions for
their valuable contribution. The constructive comments and suggestions made
by reviewers were instrumental in developing, reorganizing and improving the
quality, accuracy of this book.
Finally, I would extend to acknowledge the services of the total team of
Thakur Publishers and everyone who collaborated in producing this work.

- Priyanka Singh
My first and foremost acknowledgement is to my “Omnipresent Almighty
God” without his blessing this would not be possible.
My special gratitude to my parents, Shri. Tribhuwan Singh and Smt. Meera
Singh for their support and encouragement throughout my life.
I thank my brother Mr. Dilip Kumar Singh for standing beside me and for
their constant inspiration starting from childhood.
It is really a matter of great pleasure to acknowledge the invaluable guidance,
enormous assistance and excellent co-operation extended to Ms. Priyanka
Singh for completing this book.
I also extend special thanks to Dr. Saroj Kumar and Ms. Veera Thakur
(Directors of Thakur Publishers) and the whole team of Thakur Publishers
who directly and indirectly make this work success.
I actually dedicate my success to my dear grandfather Late Shri. Awadhesh
Singh. He has given me the drive and discipline to tackle any task with
enthusiasm and determination.
- Raj Kumar Singh
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Syllabus
MBA: 20IMG23GF1
Indian Financial System and Financial
Markets

UNIT-I
Financial System- Meanings, Components and Functions; Reforms in
Indian Financial System; Money Market and its Segments.

UNIT-II
Capital Market- New Issue Market; Stock Exchange and its Functions;
Trading in Stock Exchange; NSE; OTCEI; Depositories and Custodians;
Role and Functions of SEBI; New Financial Instruments.

UNIT-III
Commercial Banks; RRBs; Development Banks; NBFCS; EXIM Bank,
RBI.

UNIT-IV
LICI; UTI; SIDBI; NABARD; Micro Finance; Financial Inclusion.

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Contents
Unit 1: Financial System
1.1. Financial System 13
1.1.1. Meaning and Definition of Financial System 13
1.1.2. Evolution of Indian Financial System 14
1.1.3. Characteristics of Financial System 15
1.1.4. Functions of Financial System 16
1.1.5. Importance of Financial System 17
1.1.6. Limitations/Issues of Financial System 19
1.2. Components of Indian Financial System 20
1.2.1. Indian Financial Institutions 21
1.2.2. Indian Financial Markets 22
1.2.3. Indian Financial Assets and Instruments 24
1.2.4. Indian Financial Services 26
1.2.5. Role of Financial System in Economic Development 28
1.3. Reforms in Indian Financial System 29
1.3.1. Introduction 29
1.3.2. Indian Banking Sector and Financial Reforms 31
1.3.3. Forex Market and Financial Reform 33
1.3.4. Capital Market and Financial Reform 33
1.3.4.1. Regulatory Framework 34
1.3.4.2. Opening the Capital Market to Foreign Investors 34
1.3.4.3. Modernization of Trading and Settlement Systems 35
1.3.4.4. Futures Trading 35
1.3.5. Insurance Sector and Financial Reform 35
1.4. Money Market 36
1.4.1. Meaning and Definition of Money Market 36
1.4.2. Features of Money Market 37
1.4.3. Functions of Money Market 39
1.4.4. Advantages of Money Market 39
1.4.5. Disadvantages of Money Market 40
1.4.6. Structure and Components of Money Market 41
1.4.7. Participants in Indian Money Market 43
1.5. Segments/Instruments of Money Market 44
1.5.1. Call and Notice Money Market 45
1.5.1.1. Features of Call Money Market 45
1.5.1.2. Advantages of Call Money 46
1.5.2. Bill of Exchange 46
1.5.2.1. Features of Bill of Exchange 47
1.5.2.2. Advantages of Bill of Exchange 48
1.5.3. Treasury Bills (T-Bills) 49
1.5.3.1. Features of T-Bills 49
1.5.3.2. Advantages of T-Bills 50
1.5.4. Commercial Papers (CPs) 50
1.5.4.1. Features of Commercial Papers 51
1.5.4.2. Advantages of Commercial Papers 52
1.5.5. Certificates of Deposits (CDs) 52
1.5.5.1. Features of Certificate of Deposits 53
1.5.5.2. Advantages of Certificate of Deposits 53
1.5.6. Money Market Mutual Funds 54
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 -8-
1.5.6.1. Features of Money Market Mutual Funds 55
1.5.6.2. Advantages of Money Market Mutual Funds 55
1.5.7. Inter Corporate Deposits (ICDs) 55
1.5.7.1. Features of Inter Corporate Deposits 56
1.5.7.2. Advantages of Inter Corporate Deposits 56
1.5.8. Recent Developments in Indian Money Market 56
1.6. Exercise 59

Unit 2: Capital Market

2.1. Capital Market 60
2.1.1. Introduction 60
2.1.2. History of Indian Capital Market 60
2.1.3. Characteristics of Capital Market 61
2.1.4. Functions of Capital Market 62
2.1.5. Importance of Capital Market 63
2.1.6. Limitations/Disadvantages of Capital Market 63
2.1.7. Capital Market Instruments 64
2.1.8. Difference between Money Market and Capital Market 66
2.1.9. Constituents of Capital Market 66
2.2. New Issue Market/Primary Market 67
2.2.1. Meaning of New Issue Market/Primary Market 67
2.2.2. Nature of New Issue Market 67
2.2.3. Role/Functions of the New Issue Market 68
2.2.4. Advantages of New Issue Market 69
2.2.5. Disadvantages of New Issue Market 70
2.2.6. Recent Developments in Primary Market 71
2.3. Types of Issues in New Issue Market 72
2.3.1. Public Issue 72
2.3.1.1. Regulation of Public Issue 73
2.3.1.2. Classification of the Public Issue 73
2.3.1.3. Advantages of Public Issue 76
2.3.1.4. Disadvantages of Public Issue 76
2.3.2. Rights Issue 76
2.3.2.1. Rules Regarding Rights Issue 76
2.3.2.2. Advantages of Rights Issue 77
2.3.2.3. Disadvantages of Rights Issue 77
2.3.3. Private Placement 77
2.3.3.1. Advantages of Private Placement 77
2.3.3.2. Disadvantages of Private Placement 78
2.3.4. Preferential Allotment 78
2.3.4.1. Advantages of Preferential Allotment 78
2.3.4.2. Disadvantages of Preferential Allotment 79
2.3.5. Offer for Sale Method 79
2.3.6. Other Methods 81
2.3.6.1. Tender Method/Offer 81
2.3.6.2. Bonus Shares 81
2.3.7. Methods of Determining Prices of New Shares 83
2.3.7.1. Fixed Offers Method 83
2.3.7.2. Book-Building Method 84
2.4. Stock Exchange/ Secondary Market 92
2.4.1. Meaning of Secondary Market/Stock Exchange 92
2.4.2. Nature of Secondary Market 93
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 -9-
2.4.3. Functions of Secondary Market 93
2.4.4. Intermediaries in Secondary Market 94
2.4.5. Structure of Stock Exchange 96
2.4.6. Advantages of Secondary Market 97
2.4.7. Disadvantages of Secondary Market 97
2.4.8. Relationship between Primary Market and Secondary Market 98
2.4.9. Difference between Primary Market and Secondary Market 99
2.5. Trading & Settlement Procedure in Stock Exchange 100
2.5.1. Trading Procedure 100
2.5.2. Settlement Procedure 104
2.5.2.1. Settlement Process in India 104
2.5.2.2. Current Scenario 105
2.6. Leading Stock Exchanges in India 105
2.6.1. Bombay Stock Exchange (BSE) 105
2.6.1.1. Features of BSE 106
2.6.1.2. Organization of BSE 106
2.6.1.3. Trading Timing in BSE 107
2.6.1.4. Services Offered by BSE 107
2.6.1.5. BSE Indices 108
2.6.2. National Stock Exchange (NSE) 108
2.6.2.1. Features of NSE 108
2.6.2.2. Organization of NSE 109
2.6.2.3. Advantages of NSE 110
2.6.2.4. Difference between BSE and NSE 111
2.6.3. Over the Counter Exchange of India (OTCEI) 111
2.6.3.1. Promoter of OTC Market 112
2.6.3.2. Features of OTC Market 112
2.6.3.3. Objectives of OTC Market 113
2.6.3.4. Benefits of OTC Market 113
2.6.3.5. Relationship between NSE and OTCEI 114
2.6.3.6. Difference between NSE and OTCEI 115
2.7. Depositories 115
2.7.1. Meaning of Depository 115
2.7.2. Objectives of Depository 116
2.7.3. Role/Functions of Depositories 116
2.7.4. Advantages of Depository 116
2.7.5. Disadvantages of Depository 117
2.8. Custodians 117
2.8.1. Meaning of Custodial Services 117
2.8.2. Registration of Custodians 118
2.8.3. Obligations/Responsibilities of Custodian 119
2.8.4. Inspection and Audit of Custodian 121
2.8.5. Cancellation of Registration of Custodian 121
2.9. Securities Exchange Board of India (SEBI) 122
2.9.1. Introduction 122
2.9.2. Constitution of Management of SEBI 122
2.9.3. Objectives/Purpose of the SEBI Act 122
2.9.4. Structure/Organization of SEBI 123
2.9.5. Role of SEBI in Capital Issues 124
2.9.6. Functions of SEBI 125
2.9.7. Powers of SEBI 126
2.9.8. SEBI Guidelines with Respect to IPO 126
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2.9.9. SEBI Rules and Regulations 130
2.10. New Financial Instruments 135
2.11. Exercise 137

Unit 3: Commercial & Development

Banks
3.1. Commercial Banks 138
3.1.1. Meaning and Definition of Commercial Banks 138
3.1.2. Features of Commercial Banks 139
3.1.3. Functions and Working of Commercial Banks 139
3.1.4. Primary Functions 140
3.1.5. Secondary Functions 143
3.1.6. Advantages of Commercial Banks 145
3.1.7. Disadvantages of Commercial Banks 146
3.2. Types of Commercial Banks 148
3.2.1. Public Sector Banks 148
3.2.1.1. State Bank of India Group 148
3.2.1.2. Other Nationalized Banks 149
3.2.2. Private Sector Banks 149
3.2.3. Regional Rural Banks 151
3.2.4. Foreign Banks 151
3.2.5. Difference between Central Bank and Commercial Bank 152
3.3. Regional Rural Banks (RRBs) 153
3.3.1. Meaning of Regional Rural Banks (RRBs) 153
3.3.2. History of Regional Rural Banks 153
3.3.3. Features of Regional Rural Banks 153
3.3.4. Objectives of RRBs 154
3.3.5. Functions of RRBs 155
3.4. Development Banks 155
3.4.1. Meaning of Development Banks 155
3.4.2. Features of Development Banks 155
3.4.3. Objectives of Development Banks 156
3.4.4. Functions of Development Banks 156
3.5. Non-Banking Financial Companies (NBFCs)/Non-Banking Financial 157
Institutions (NBFIS)
3.5.1. Meaning and Definition of NBFCs/NBFIs 157
3.5.2. Features of NBFCs 158
3.5.3. Functions and Working of NBFCs 158
3.5.4. Services Rendered by NBFCs 160
3.5.5. Types of NBFCs 161
3.5.6. Structure of NBFCs 163
3.5.7. Importance of NBFCs 163
3.5.8. Difference between Banks and NBFCs 164
3.6. Export Import (EXIM) Bank of India 164
3.6.1. Introduction 164
3.6.2. Objectives of EXIM Bank 165
3.6.3. Functions and Working of EXIM Bank 165
3.6.4. Facilitative Role of EXIM Bank in Financing Exports 166
3.6.5. EXIM Bank Finance 168
3.7. Reserve Bank of India (RBI) as a Central Bank 170
3.7.1. Introduction 170
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3.7.2. Meaning of Reserve Bank of India 170
3.7.3. Features of Reserve Bank of India 171
3.7.4. Subsidiaries of RBI 171
3.7.5. Purpose/Objectives of Reserve Bank of India 171
3.7.6. Structure/Organisation of Reserve Bank of India 172
3.7.7. Departments of RBI 173
3.7.8. Functions and Working of Reserve Bank of India 174
3.7.9. Monetary Functions 175
3.7.10. Non-Monetary Functions 177
3.7.10.1. Supervisory Functions 178
3.7.10.2. Promotional Functions 180
3.7.11. Role of Reserve Bank of India in Indian Economy 181
3.7.12. Recent Monetary Policy of RBI 185
3.7.13. RBI’s Regulatory Environment 186
3.7.14. Achievements of Reserve Bank of India 187
3.8. Monetary Policy/Credit Control Methods of RBI 188
3.8.1. Introduction 188
3.8.2. Methods/Instruments of Credit Control of RBI 189
3.8.3. Bank Rate 189
3.8.4. Open Market Operations by RBI 190
3.8.5. Variations in the Reserve Requirement 190
3.8.5.1. CRR (Cash Reserve Ratio) 191
3.8.5.2. SLR (Statutory Liquidity Ratio) 191
3.8.6. Repo Rate and Reverse Repo Rate 192
3.8.7. Liquidity Adjustment Facility 192
3.8.8. Selective Credit Controls (Qualitative) Method 192
3.9. Exercise 194

Unit-4: LICI & Microfinance

4.1. Insurance 195
4.1.1. Concept of Insurance 195
4.1.2. Features of Insurance Services 195
4.1.3. Need of Insurance Services 196
4.1.4. Principles of Insurance 197
4.1.5. Functions of Insurance Services 198
4.1.6. Significance of Insurance 200
4.1.7. Type/Classification of Insurance 201
4.2. Insurance Companies in India 203
4.3. Life Insurance Corporation of India (LICI) 204
4.3.1. Introduction 204
4.3.2. Features of LIC 205
4.3.3. Objectives of LIC 206
4.3.4. Role of LIC 207
4.3.5. Functions of LIC 207
4.3.6. Procedure of Taking Life Insurance Policy 208
4.3.7. Investment Pattern of LIC 209
4.3.8. Criticisms of Investment Policy 211
4.4. Unit Trust of India (UTI) 212
4.4.1. Introduction 212
4.4.2. Objectives of UTI 212
4.4.3. Functions and Working of UTI 212
4.4.4. Operational Policies and Practices of UTI 212
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4.4.5. Achievements of UTI 213
4.5. Small Industries Development Bank of India (SIDBI) 214
4.5.1. Introduction 214
4.5.2. Objectives of SIDBI 214
4.5.3. Organisation Chart 215
4.5.4. Functions and Working of SIDBI 217
4.5.5. Schemes for Promotion of Small Business 218
4.5.6. Benefits of SIDBI 219
4.6. NABARD 220
4.6.1. Introduction 220
4.6.2. Objectives of NABARD 221
4.6.3. Functions and Working of NABARD 221
4.6.4. Organisation and Structure of NABARD 223
4.6.5. Major Activities of NABARD 224
4.7. Microfinance 226
4.7.1. Meaning and Definition of Microfinance 226
4.7.2. Nature of Microfinance 227
4.7.3. Need for Microfinance 228
4.7.4. Types of Microfinance Products 229
4.7.5. Advantages of Microfinance 230
4.7.6. Disadvantages of Microfinance 231
4.8. Financial Inclusion 232
4.8.1. Introduction 232
4.8.2. Process of Financial Inclusion 233
4.8.3. Benefits of Financial Inclusion 233
4.8.4. Various Initiatives Undertaken for Financial Inclusion 233
4.9. Exercise 235

Model Question Paper 236

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Financial System (Unit 1) (tppl.org.in) 13

UNIT 1 Financial System

1.1. FINANCIAL SYSTEM

1.1.1. Meaning and Definition of Financial System

For economic transformation of a country, the financial system is the
key for the institutional and functional vehicle. Finance assists in
reducing the gap between the present and the future, and covers every
aspect like channelisation and effective usage of savings and making an
efficient investment. It formulates the base, the sets and the tone for the
accomplishment of wider national objectives.
According to Christy, the objective of the financial system is to
“Supply funds to various sectors and activities of the economy in ways
that promote the fullest possible utilisation of resources without the
destabilising consequence of price level changes or unnecessary
interference with individual desires”.
According to Robinson, the primary function of the financial system is
“To provide a link between savings and investment for the creation of
new wealth and to permit portfolio adjustment in the composition of the
existing wealth”.
A financial system acts as an intermediary where there is surplus and
deficiency of funds. It bridges the gap between the two segments. It
comprises of various institutions, markets, regulations, laws, money
managers, experts and many others. The flow of funds in Indian
financial system is explained by figure 1.1 given below:
Seekers of Funds Flow of Funds (Savings) Suppliers of
(Mainly Funds (Mainly
Business Firms Households)
and
Government) Incomes and Financial
Claims
Figure 1.1: Flow of Funds

In the context of “financial system” the term system means a sequence

of complex and closely attached variables like institutions, agents,
practices, markets, transactions, claims and liabilities in an economy.
The main function of a financial system is to take care of the money,
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14 MBA Third Semester (IFS&FM) MDU
credit and finance. However, these three terms may appear to be same
but still there is some difference among each term. The Indian financial
system comprises of the financial market, financial instruments,
financial intermediary and also the financial services.

1.1.2. Evolution of Indian Financial System

A robust financial system is essential for proper development of an
economy. The process of economic development comes with the growth
of financial institution, which in turn affected by multiple factors, such
as, regulatory framework, legal scenario, institutional structure, and
operating policies. In India, the economic growth has been affected
through different regulations. The process of liberalisation, privatisation
and globalisation was started in the early 90s. The process of economic
development in India may be explained through the following three
different time periods:
1) The period up to 1951, were coinciding with the post-independence
time period. It marked as the starting period for planning the
economic development.
2) The period between 1951 and the mid-eighties were reflecting as a
commission period of planned economic growth.
3) The Post-early 90s period was characterised by necessities of
liberalisation, deregularisation and globalizsation in an economic
environment.

Following is the brief description of each phase of development in the

Indian financial system:
Phase 1: Pre-1951 Organisation: During this phase, the financial
system was in its initial stage.Under this period the nature of industrial
sector was completely under-developed where the rate of capital
formation was low and the progress in industrial sector is slow.
Phase 2: 1951 to Mid-Eighties: India has adopted the mixed-economy
model during this time period and pursued highly charged
industrialisation programs. This development leads to higher growth in
financial services segment. The country also comes up with the
modified institutional structure as well as regulatory framework.
Following are the main characteristics of planned economic
development phase in India:
1) Public or government ownership of financial institutions.
2) Strengthening the institutional structure.
3) Providing protection to investors.
4) Growing role of financial institutions in corporate management.
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Financial System (Unit 1) (tppl.org.in) 15
It can be said that India had developed a unique financial system by the
mid-eighties. The system was created corresponding to the necessities of
planning and the leading role of government in an economy.
Phase 3: Post Nineties: India started the process of liberalisation,
privatisation and globalisation in the „90s. During this period, the
financial system of India wasundergonewith drastic changes. Following
are the identifiable aspects of developments in this regard:
1) Privatisation of financial institutions,
2) Re-organisation of institutional structure, and
3) Investor‟s protection
The growth in financial sector was unplanned and disorganised. The
country had very weak banking system at the time of its independence.
There were nearly 648 banks and it was not easy to have close
supervision and control on them. These banks had 4,288 branches out of
which maximum branches are located in urban areas.
Only few banks had their branches in smaller town and rural areas. India
also had 15 exchange banks which are operating in Bombay, Calcutta
and Madras. Many of the banks had limited geographical reach which
provide their services to the limited areas. The Imperial Bank was also
operating with its authoritarian right, which was completely out of the
reach for a common man. Almost all the commercial banks are featured
as conservatism, rigid, and nearsighted banks. This scenario continues to
prevail until year 1951.

1.1.3. Characteristics of Financial System

Following are the characteristics of the Indian financial system:
1) Financial system establishes a link between the one having surplus
funds with those who are in need of such funds. Both the investment
and the savings aspects are encouraged.
2) Financial system contributes towards the expansion and the
development of financial markets.
3) Financial system facilitates the efficient allocation of financial
resources for the benefit of the society and the public at large.
4) Financial system boosts the economic quality and accelerates
economic development.
5) Financial system lays the foundation for an ideal economy.
6) Financial system builds an efficient portfolio for the fund seeker.
7) Financial system reduces the transaction costs.
8) Financial system ensures availability of all the price-related
information.
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16 MBA Third Semester (IFS&FM) MDU

1.1.4. Functions of Financial System

Following are the functions of the Indian financial system:
1) To Connect the Investors with the Savers: The key function of a
financial system is to bridge the gap between the one who saves
money and the one who needs the funds. Thereby, the financial
system helps in channelising the savings in an effective manner to
reap the best possible outcome. The resources are allocated in such a
manner that there is a regular advancement in technology and
sustained growth can be achieved.
Functions of Financial System

To Connect the Investors

with the Savers Assistance in Selection of a
Project
Risk Allocation
Availability of Information
Reducing the Cases of
Asymmetric Information Reduction in the Borrowing
and the Transaction Cost
Liquidity Promotion
Financial Broadening and
Deepening

2) Assistance in Selection of a Project: A good financial system helps in

selection of an optimum project for investment purpose. Alongside, it
also constantly monitors the outcome of the project. It facilitates in the
payment process for goods and services and the movement of the
products to different industries and geographical areas.
3) Risk Allocation: A good financial system assists in the optimum
distribution of the risk component. It restricts and controls the
investment in the form of savings in a particular risky venture. The
basic idea is to set a tolerance limit and to ensure that investments
are made only within the prescribed limits.
4) Availability of Information: It further ensures that the information
associated with the price is available all the time which helps in
taking economic and financial decisions.
5) Reducing the Cases of Asymmetric Information: An ideal
financial system aims in avoiding the occurrence of cases when the
information available is found to be asymmetric. Such situations are
highly adverse in nature and affect the motivation among the
operators and also to a person who possesses information which the
other person does not have. Besides this, it provides other services
like insurance pension and adjustment of portfolio, etc.
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Financial System (Unit 1) (tppl.org.in) 17
6) Reduction in the Borrowing and the Transaction Cost: A sound
financial system creates an ideal financial scenario that reduces the
cost of the transactions. By reducing the cost, the returns for the
investors are likely to rise. The borrowing cost is similarly reduced.
So, this builds the habit of saving among the society.
7) Liquidity Promotion: In a financial system, the key function is to
have adequate resources of money for the manufacturing of goods
and services. In case of a production firm, the money should not fall
short. Here, the term “money” and “monetary resources” signify
liquidity. Liquidity in liberal sense is that form of the asset that can
be readily converted into cash. In a financial system, all the
activities are thus related with money and focus is on having a better
liquidity position to ensure that the activities carry on in a smooth
and effective manner.
8) Financial Broadening and Deepening: An ideal financial system
encourages the process of financial deepening and broadening.
Financial deepening refers to an increase of financial assets as a
percentage of the Gross Domestic Product (GDP). Financial
broadening refers to building an increasing number and a variety of
intermediary and instruments.

1.1.5. Importance of Financial System

Following are the importance of the financial system:
Importance of Financial System

Increment in the Output and

Production of the Economy Accelerating the Quantum and
Pace of Savings
Facilitates Innovation
Evaluation of Assets, Increasing
the Liquidity, Production and
Provide Risk Management
Services Spreading of Information

Introduction of Discipline in To Ensure Stability and

Management Companies and Resilience
Guiding them
Accelerating the Rate of
Economic Growth

1) Increment in the Output and Production of the Economy: The

surplus savings are channelised in such a manner that adequate
resources are available for the production sector. This eventually
results in the increase in output of the economy. The market,
institutions and instruments are the basic market transformers who
* *
18 MBA Third Semester (IFS&FM) MDU
get adequate funds which leads to economic development. The
financial system directs towards savings and contributing more
value added areas which lead to national development.
2) Accelerating the Quantum and Pace of Savings: Apart from
channelising of savings, a financial system also drives the rate of
savings by diversifying the financial instruments, thus making
number of options available for the investors to invest in. This
creates competition among the intermediary; hence the investor gets
the maximum return.
3) Facilitates Innovation: Healthy competition is promoted in the
financial system. This leads to innovation of new products and
investment opportunities. The overall cost is reduced which
enhances profitability. Countries having a well-diversified financial
system maintain national competitiveness and their products are
regularly updated.
4) Evaluation of Assets, Increasing the Liquidity, Production and
Spreading of Information: Apart from having an effect on the rate
of return, it also influences economic development. A good
financial system evaluates the assets, increases the liquidity and
transmits the required information.
5) Provide Risk Management Services: A financial system is a need-
based system. It changes with the change in requirement for funds.
During the current scenario, the world has observed an increase in
demand for better risk management services. This was fulfilled by
increasing the trading volume and by introducing risk management
products. So, the economic growth and the financial system work
hand in hand.
6) To Ensure Stability and Resilience: Financial market is a part of
the main branch of the financial system. There will be more stability
and resilience as the system gets deeper. The Central Bank of the
country can make effective policies if it is supported by well
organised money and capital market instruments. The onus is on the
financial markets to create a well-balanced and efficient financial
system which comprises of both the financial market and the
financial institutions. If there is any imbalance, similar problems
will arise as experienced in South-East Asia.
7) Introduction of Discipline in Management Companies and
Guiding them: The financial system also ensures that management
companies work under the discipline and constantly guides for the
same. When the domestic and the foreign financial system are
* *
Financial System (Unit 1) (tppl.org.in) 19
linked together, the flow of the capital is increased. This
combination reduces the risk by diversifying the portfolio and
boosts the growth.
8) Accelerating the Rate of Economic Growth: There exists a
bilateral and mutual relation between the financial system and the
economic growth. A well developed and balanced financial system
boosts the rate of the economic growth.

1.1.6. Limitations/Issues of Financial System

Industrialisation has happened at a very fast rate since the concept of
planning has been introduced. Growth can thus be observed in both the
corporate as well as in government sector.

So, to cater the increasing requirement of the industry, new and strategic
financial instruments have phased in. Dramatic change has also been
observed in the financial system of the country. Apart from all these
measures, there still exists some issues that need to be given proper
consideration.

Indian financial system faces the following issues:

1) Missing Coordination among the Financial Institutions:
Significant number of financial institutions exists and the
government controls and operates the most important ones.
Alongside controlling the FIs, government also exercises control
over the regulatory of the financial institutions.
Such situation leads to lack of coordination. With the presence of
number of institutions in the financial system, there always exists
lack of coordination in their operations.
2) Monopolistic Market Structure: In India, some of the financial
institutions capture the major portion of the market share and thus it
leads to a monopolistic structure in the financial system.
For example, LIC holds majority stake of the life insurance
business in India. So the presence of these large corporations may
disrupt the entire financial system of the nation.
3) Major Hold of Development Banks in the Industrial Financing:
Development banks are considered as the most indispensible part of
the financial system and hold a significant role in the capital market.
In India, majority of the industrial financing is routed through the
financial institutions which are created by the government at the
national as well as the regional level.
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20 MBA Third Semester (IFS&FM) MDU
However, new methods of raising finance from the public have been
introduced in the recent past like issuing bonds or debentures.
4) Inactive and Erratic Capital Market: At present, due to regular
frauds and scams taking place, the public at large is losing
confidence in the market and thus is not an attractive and
dependable segment for the investors. This causes a serious area of
concern in the capital market.
5) Imprudent Financial Practice: The development banks hold
majority of the market share among the corporate clients and has
lead to the development of imprudent market practices. Majority of
the funds are provided by them in form of term loans giving rise to
the debt content in the capital structure.
Thus, there exists an unfavourable balance between owners‟
contribution and the debt portion. In the past, to curb this practice,
actions have been taken to promote capital market. Different FIs are
also being integrated.

Thus, rapid changes are taking place in the Financial System to make it
a developed one.

1.2. COMPONENTS OF INDIAN

FINANCIAL SYSTEM
There are four segments or components of the Indian financial system.
These are financial institutions, financial markets, financial instruments
and financial services.
The structure of financial system in an economy is shown in the
figure below:
Structure of Financial System

Financial Institutions Financial Financial

Assets/Instruments Services

Regulatory Intermediaries Non- Primary Secondary

Intermediaries
Financial
Markets

Organised Unorganised

Capital Money
*
Market Market *
Financial System (Unit 1) (tppl.org.in) 21

1.2.1. Indian Financial Institutions

Different kinds of organisations which act as an intermediary and
facilitator in financial transactions at the individual and the corporate
level are included in the term financial institutions. Thus, it covers both
the institutions providing finance and the investing institutions in it.
They are the ones who channelise the savings and allocate the funds in
the most optimum manner.
They are further classified in three different categories:
1) Regulatory: Regulatory are the ones who provides rules and
guidelines for a particular market. It comprises of RBI, SEBI,
IRDA, AMC, etc. Primarily, an investor would want the funds to be
under the control and to be safe to invest. This assurance is rendered
by the regulatory authority that is regulating the particular market.
For example, money market instruments are regulated by the RBI
whereas the capital market instruments are regulated by SEBI.
2) Intermediaries: Intermediaries are the ones who fulfil the short-term
requirement of funds of corporate as well as the individual clients.
They comprise of banking as well as non-banking intermediaries. For
example, banks like SBI, PNB, etc. whereas examples of non-banking
intermediaries comprise of GIC, UTI, LIC, etc.
Other important services like credit rating, leasing, merchant
banking, hire-purchase are also provided by these financial
intermediaries. These services are required while creating a new
firm, during expansion and the economic growth. These are of the
following four types:
i) Commercial Banks: These banks hold deposits on behalf of the
customers and thus ensure the safety of the funds. The primary
purpose was thus to hold the same for the customers who do not
wish to hold the same on their own. As a result, the need for the
customers to keep funds in the form of cash has reduced and he can
thus use the services of credit cards, cheques, net banking for
entering into any financial transaction. These banks also provide
loans to individuals and businesses for long-term purposes and also
for financing the working capital requirements.
ii) Non-Banking Financing Institutions (NBFI): A Non-Banking
Financing Institution (NBFI)/Non-Banking Financing
Intermediary has alternate roles in different parts of the world:
a) It is an institution which is not just a bank but is engaged in
the function of finance;
b) Financial institutions who do not accept demand deposits;
*
c) Financial institutions who do not accept any deposit. *
22 MBA Third Semester (IFS&FM) MDU
iii) Investment Companies: They may be called a trust or a
corporation which facilitates an individual to invest in different
diversified and professionally managed securities by arranging
pool of funds from other investors. The individual need not
invest in single company stocks but can rather purchase units
directly from the investing company which are well diversified.
For example, UTI and Mutual Fund.
iv) Insurance Companies: They create a risk pool by way of
collection of premium from the people at large who wishes to
buy a protection either for a person or for a property. It helps to
mitigate the loss and preserve the wealth and meet out the
uncertainties. By insuring large groups, risk is spread over the
entire insured and even in the event of paying claims, they end-
up with sufficient amount of profits unless there is a natural
calamity or disaster.
3) Non-Intermediaries: They are engaged in providing funds on long-
term basis to individuals as well as corporate clients. They comprise
of institutions who are lending on term basis. For example,
financial corporations and investment institutions like IDBI,
NABARD, IFCI, etc.

1.2.2. Indian Financial Markets

There does not exist a physical or geographical location that can be termed
as a financial market but all the financial transactions are deemed to occur
in the financial market. So, it can be said that as financial transactions are
pervasive in nature, financial markets are also pervasive. Basically, a
financial market is a common place where the buyers and the sellers of
financial instruments meet and exchange products. Stock exchange may be
termed as a place where these transactions take place and a location for the
financial market. In India, financial markets are classified as follows:
1) Unorganised Markets: Under the unorganised market, there exists a
large number of indigenous bankers, money lenders, traders, etc., who
lends the money to the public at large through informal sources. The
indigenous bankers are responsible for collecting deposits while the
others may lend. Some other forms like private financing companies,
Nidhi‟s, chit funds are also available and are engaged in the same line
of activity. Presently, they are not monitored by RBI, but recently RBI
is making efforts to convert the same into an organised sector.
2) Organised Markets: Under this, standardised regulations and
norms are framed that governs financial trading. RBI exercises strict
supervision and control on the financial transactions taking place
*
under this type of market. *
Financial System (Unit 1) (tppl.org.in) 23
This market is further classified in four types of market:
i) Capital Market: It is a market where the securities are usually
held for long-term basis, i.e., more than one year. They do not
have a fixed maturity or expiry date. The buyer can hold the
same, till the time he wishes to do so.
a) Equity Market: It comprises of the equity shares of the
company. Equity shares are further classified in two categories:
 Primary Market: Where the shares are being sold for
the very first time, i.e., Initial Public Offer (IPO) and
Right Issues.
 Secondary Market: Where the existing shares are
bought or sold, after they were originally issued to the
public. These shares are listed on stock exchange
through which they can be traded.
b) Debt Market: It is the financial market in which debt
securities are bought and sold by the investors. These
securities are in the nature of bonds or debentures and carry
a fixed rate of return. Therefore, they are fixed income
bearing securities that are issued by the Central and State
Governments, municipal corporations, other government
bodies, and commercial entities like financial institutions,
banks, PSU, public limited companies, etc.
ii) Money Market: It means a ready market or a short-term market
where securities are bought or sold only for a very short
duration. The tenure usually does not exceed one year thus is
considered to be an equivalent to cash only. The securities are
highly liquid in nature and can be readily converted to the cash.
The transaction cost is also the minimum.
iii) Derivative Market: Derivatives markets are markets that are
based upon another market, which is known as the underlying
market. Derivatives markets can be based upon almost any
underlying market, including individual stock markets (e.g. the
stock of company XYZ), stock indices (e.g. the Nasdaq 100
stock index), and currency markets (i.e. the forex markets).
iv) Foreign Exchange Market: The Foreign exchange (currency
or FOREX or FX) market refers to the market for currencies.
Transactions in this market typically involve one party
purchasing a quantity of one currency in exchange for paying a
quantity of another. The FX market is the largest and most
liquid financial market in the world, and includes trading
between large banks, central banks, currency speculators,
*
corporations, governments, and other institutions. *
24 MBA Third Semester (IFS&FM) MDU

1.2.3. Indian Financial Assets and Instruments

A financial instrument is an acknowledgement for a person entitling him
against the claim that is receivable from another person or institution,
while the person is in regular receipt of interest or dividend. These
financial instruments assist the market in routing the funds from the
lender to the borrower in consideration of interest. There are number of
products that are available and they vary in terms of return, liquidity,
marketability, reversibility, types of assets, risk and the transaction cost.
Following are the three major forms of the Indian financial instruments
and assets:
1) Money Market Instruments: It is a component of the financial
market for assets involved in short-term borrowing, lending, buying
and selling with original maturities of one year or less. Some of the
types of money market instruments are as follows:
i) Call and Notice Money Market: Call money market is a place
where borrowings and lending take place for a very short
period, ranging between overnight and fortnight
ii) Commercial Paper: It is a short duration instrument. They can be
purchased directly from the market or through the intermediary and
the amount is repayable on a certain future date.
iii) Treasury Bills: They are short-term (till 91 days) money
market instrument, issued by the Government to meet its short-
term deficiency of funds.
iv) Bill of Exchange: Bill of exchange is also a money market
instrument, which is in the form of an order in writing by the
drawer of the bill to the drawee for the payment of money to the
payee.
v) Certificates of Deposits (CDs): They are unsecured, negotiable
and short-term in nature, which are payable to the bearer.
vi) Money Market Mutual Funds (MMMFs): They constitute a
category of open-ended mutual funds, which specializes in
channelizing investors‟ funds to the short-term money market
instruments.
2) Capital Market Instruments: Capital market instruments are long-
term financial instruments in the form of debt or equity that are traded
either on a securities exchange or directly between investors and
borrowers. Some of the instruments of capital market are as follows:
i) Equity Shares: They represent the ownership of the company.
They have the voting rights and part of decision-making process
on major issues relating to the affairs of the company.
* *
Financial System (Unit 1) (tppl.org.in) 25
ii) Preference Shares: Preference shareholders enjoy a fixed rate
of dividend even though the company does not make profit in a
year. The rate of return is fixed and is not dependent on the
volume of the profits earned and they get preference over the
equity in terms of dividend.
iii) Debentures: They are the kinds of bonds that are issued by
companies carrying a fixed coupon rate which is normally
payable half-yearly on pre-determined dates and the principal
amount is repayable at the time of redemption. Usually the
debenture holders carry some kind of charge on the debentures
held by them.
iv) Bond: It is a certificate of the indebtedness of the firm and
normally does not carry any security. Usually they are issued by a
company, municipality or government agency. An investor in this
case, lends out money to the issuer in lieu of regular payment of
interest and principal payment on the specified maturity date. The
interest is paid during the entire life span of the bond.
v) Rights Issue or Rights Shares: They are issued to the existing
shareholders in a pre-determined ratio of their holding.
vi) Bonus Shares: These are issued by companies for free to their
shareholders by capitalising the reserves. They are declared out
of the profits of the previous years.
vii) Government Securities: They are also termed as G-Secs. They
are sovereign (risk-free credit) interest bearing instruments
issued by RBI on behalf of the Government to comply with the
Central Government‟s market borrowing programme. The
securities issued carry a fixed interest rate payable on pre-
determined rates semi-annually basis.
3) Derivatives: A derivative instrument is a financial instrument
which derives its value from the underlying asset. Following are the
types of derivatives:
i) Forwards: This type of contract is a tailor-made contract,
catering the need of the two parties. Under this, the contract is
settled at a certain future date at a predetermined price.
ii) Futures: This is an arrangement between two parties, where
they agree to purchase or sell a particular asset on a
predetermined time in future on a specific price. They are just
like the forward contracts, the only difference being that the
forwards contracts are standardised and dealt on the stock
*
exchange. *
26 MBA Third Semester (IFS&FM) MDU
iii) Options: An option buyer acquires the right to buy or sell a
specified amount of currency for another currency at a specific
rate.
iv) Swaps: They are private contracts among two persons for
exchange of cashflows at a future date on pre-decided terms.
They may also be termed as the portfolios of forward contracts.

1.2.4. Indian Financial Services

Important financial services like that of leasing, credit rating, hire
purchase, merchant banking, etc., are rendered by these financial
intermediaries. These services are crucial in reducing the gap resulting
out of ignorance and unavailability of information among the investors
and the rising complexity in financial instruments and the markets.
These financial services play a crucial role in the creation of the firms,
expansion of the industry and thus leading to the economic growth. The
financial services are classified further in two categories:
1) Asset and Fund-Based Financial Services: Asset based finance is
termed as funding against a range of corporate assets including
accounts receivable, inventory, plant and machinery, real estate and
sometimes even intellectual property and brands. It is the method of
making a loan secured by an asset. It includes the following:
i) Lease Financing: It is a financial contractual arrangement
where one party having ownership of an asset lends the same to
another for usage for certain duration in lieu or regular and
periodic payments known as rent. At the expiry of the lease
period the assets comes back to the original owner known as the
lessor from the lessee. However, the parties may further renew
the agreement.
ii) Hire Purchase: It refers to hiring of an asset for a certain
period and after the expiry of the period acquiring the same
asset. The concept of time sharing is followed in this case. The
person who hires the asset eventually ends up purchasing it. It is
used as a tool in financing capital goods like industrial finance,
consumer goods.
iii) Factoring: The term „factoring‟ is originated from Latin word
„Factor‟ which means „doer‟. The Webster‟s New Collegiate
Dictionary has defined a factor as „one that lends money to
producers and dealers on the security of accounts receivables‟.
iv) Forfaiting: Forfaiting is a form of financing of receivables
arising in the course of overseas trade. It refers to the
purchasing of trade bills or promissory notes issued by the
* *
Financial System (Unit 1) (tppl.org.in) 27
banks or the financial institutions without recourse to seller.
Finance is carried out by discounting the instruments and taking
over the entire risk involved in case of default payment.
v) Mutual Fund: Under this the investment made by the investors
are pooled together and the same is invested in securities like stock,
bonds and money market instrument and other allied assets.
vi) Exchange Traded Fund: It is just like other investment funds
that are traded on the stock exchange. Assets like stock,
commodities, bonds, etc., are traded close to their NAV during
the daily trading. Majority of these funds track an index like
stock or the bond index.
vii) Consumer Credit or Consumer Finance: It is the
phenomenon of providing credit to the consumers for the
purchase of consumer durable goods for everyday use. There
are other names for the same concept like deferred payments,
credit merchandising, instalment buying, pay as you earn
scheme, pay out of income scheme, hire purchase, easy
payment, instalment credit plan, credit buying, etc.
viii) Bill Discounting: It denotes a short-term money market
instrument and assists in financing credit trade related
transactions. Normally, bills are discounted with the bank in the
ordinary course of the trading activity.
ix) Housing Finance: It is a set of financial arrangements which
are rendered by the Housing Finance Companies to finance the
need of funds for the construction and the purchase of house.
x) Venture Capital: It consists of two words that are, „venture‟
and „capital‟. The first term venture means a course or a
proceeding where the result is uncertain but the risk of loss
arising exists. While the other term capital means the funds
required to initiate the venture.
2) Fee-Based Financial Services: Fee-based financial services do not
create funds on the outset, rather, they ensure that the funds are
created via their services for which a fee is charged by them. It
comprises of:
i) Merchant Banking: It may be an institution or an individual
who may be an agent for the corporation and the municipalities
issuing securities. Further, broker or dealer operations are also
maintained by them alongside and they also trade in existing
issued securities. They also offer advice related to the
investments to the investors in general.
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28 MBA Third Semester (IFS&FM) MDU
ii) Credit Rating: It is the process of allocating symbols having
unique reference to the different instruments being rated, that
indicate the opinion of the issuer to issue debt-related
instruments on the ability to pay off the debt in timely manner is
known as credit rating.
iii) Stock Broking: The mechanism under which the buyer and the
seller of the securities come to a particular place like stock
exchange for transaction dealing is termed as stock broking.
iv) Debt Securitisation: It is the process by which assets like auto
loan receivables, cash credit receivables, mortgage loans are
converted into tradable investment.
v) Letters of Credit: It is commonly referred as LC. It is a written
document which is issued by the buyers bank to the sellers bank
to reimburse the cost of goods and services that are supplied by
the seller to the buyer when the documents are submitted within
the particular timeframe at a specified time and specified place,
upto a certain amount and to a particular bank on the condition
that the documents are submitted in accordance with terms and
the conditions implied.
vi) Bank Guarantees: It is the contract between the client and the
issuing bank where the bank assumes the responsibility to settle
the claims of the client for the customer for which the guarantee
was given.

1.2.5. Role of Financial System in Economic

Development
The various roles of financial system in the economic development of
the country are as follows:
1) Saving Mobilisation: The financial markets collect funds from the
savers or surplus units like household individuals, business firms,
public sector units, central governments, etc. The borrowers like
bond issuers and lenders like bond buyers are connected in the
financial markets.
2) Investment: The financial system helps in investing funds. The
firms and individuals by the help of financial markets make
investments by buying stocks of various companies.
3) Banking Systems: The banks play an important role in national
financial system. The banks provide individuals the way to save
their earnings. It gives capital to the companies which either want to
start the operation or want to stay in the market by giving loans. If
*
the companies do not get the sufficient amount of capital then their *
Financial System (Unit 1) (tppl.org.in) 29
growth will decrease and they will not be able to earn profit for the
owner and investors. The banks invest the savings into the business
in the form of loans. They also offer various kinds of loans like car
loan, home loan, etc., to individuals who indirectly help in
increasing the economic growth and development of the country.
4) National Growth: The financial system enables continuous
movement of surplus funds to required sectors which helps in
maintaining the national growth. The financial system provides
funds to various firms and industries according to the demand and
supply of the products.
5) Monetary Policy: The financial system is required for issue of
currency and also provides interest rates for the central bank. They
are also required for framing monetary policy. It sets high interest
rate for helping the currency value and low interest rate helps in
increasing the lending and investment along with the risk of
currency devaluation and price inflation. The constant monetary
policy helps in increasing the economic stability and growth.
6) Entrepreneurship Growth: The financial system gives various
kinds of assistance to an entrepreneur like providing funds required
for the projects and companies.

1.3. REFORMS IN INDIAN FINANCIAL

SYSTEM

1.3.1. Introduction
The major boost and pillar for an economy is the financial sector. It is
the major contributor in the distribution and mobilisation of the various
financial resources. The reforms in the financial sector are of prime
importance while discussing about national development. At the
inception, it was expected that better resource mobilisation would result
and impact growth in real economy. But in the recent times, they are
also found to impact the stability in the macro-economic field. But
because of the repression in East Asia, the weakness found in financial
sector was regarded as the prime reason for the major collapse.

The banks and the financial institutions comprise the financial sector. It
comes down to the market and the instruments which collect the resources
from the sectors having the surplus and channelize to the ones facing the
deficit. This phenomenon of mobilising the savings towards the
investment criteria boosts the economic growth. At the very beginning, it
* *
30 MBA Third Semester (IFS&FM) MDU
was realised that for economic growth to take place, the financial sector
has to be the lead runner. The process of economic reforms however
faced two serious issues in the beginning, there were balance of payment
that threatened the creditability of the country in the global market and
was virtually on the mark of being termed as a defaulter and another being
the threat of getting insolvent. Apart from this, there were some more
issues in the initial part of the nineties that again had a major impact on
the financial system like pre-empting of the resources from banking
culture in order to finance the financial deficiency.
There was also an increased structural and micro regulation that
restricted the innovation in the financial sector and increased the
transaction cost. Reasonable regulations and control in financial sector
was also missing. The money market was facing poor development and
obsolete technology. The capital formation and investment was not
noticed, thus making the entire financial system quite inefficient.
The basic purpose behind carrying out the reforms in the financial sector
was the efficient utilisation of the resources, increasing the output on the
investments and promotion of growth in the contributing sectors of the
economy. For this purpose, many schemes and reforms were initiated by
the Government of India so that the economy could take a positive turn
and move towards overall development.
Following are some major facts that were found in the financial sector
reforms:
1) The present financial repression system was removed.
2) A profitable, high yielding and efficient financial sector was
created.
3) The price was being determined by market forces and the resources
were distributed in an optimum manner.
4) Functional and operational autonomy was provided to the financial
institutions.
5) Financial system was strengthened to face international competition.
6) The external sector was opened and promoted in a systematic
manner.
7) Focus was on the financial stability by providing cushion from
external and domestic collapse.
In the global environment, there are two forces that drive the reforms in
the financial sector:
1) Being liberalized, which means decreasing the quantum of direct
control on the financial markets and banks.
2) Providing strict regulation for the financial sector.
* *
Financial System (Unit 1) (tppl.org.in) 31

1.3.2. Indian Banking Sector and Financial Reforms

The basic purpose behind bringing the reforms in the financial sector
was the formulation of an efficient and diversified financial system
which could experiences well and equitable distribution of the resources
by promoting flexibility, solid institutional base and improvement in the
financial sector.

During August 1991, a high level Committee called as “The

Narasimham Committee” was formulated by the Government for the
purpose of reviewing all the aspects of financial system and
recommended the improvements that could be made in the system. The
report was however submitted in November 1991, which contained
several reforms that were required to be made in the capital market and
the banking sector. Immediately afterwards, the recommendations were
accepted and process for bringing the reforms in the capital market and
banking sector was initiated. The process is still followed as on date.
Narasimham Committee Report on Banking Sector Reforms

Strengthening Systems and Structural Technological

the Banking Asset Methods in Issues Upgradation
Sector Quality Banks

Public Sector Banks (PSB) in India regulate majority of the businesses

and commercial banking is still under the control of the PSB‟s. As part
of promoting commerce and bringing liberalisation, new licences have
been issued to the private sector banks. Some of the biggest industrial
houses have also been granted licences. It has been notices that the
desired performances are coming in the consumer and the retail sectors
but the retail trade, industrial finance, agricultural finance and small
business are yet to make a mark. A major change can be noticed in the
operations of the banks. The statutory pre-emptions have been reduced
and focus is now customer. Deregulation in the interest rates for the
deposits and the loans have also taken place.

Financial Reforms in the Banking System

Following are some of the salient reforms in the banking system:
1) By re-capitalisation, subordinated debt & public issues the capital
base of banks was strengthened.
2) Introduction of prudential norms and tightening of the income
recognition norms. They were required to make adequate provision
for the bad debts and classification of the assets.
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32 MBA Third Semester (IFS&FM) MDU
3) There was a major reduction in the pre-emption of the banking
resources.
4) Relaxation was made in the branch licences and new licences were
given to the private sector banks.
Apart from this, many other operational reforms have been introduced
in credit policy:
1) Abolishment of regulations regarding the Maximum Permissible
Bank Finance (MPBF).
2) There was substantial relaxation in the consortium regulations.
3) There was shift on to the loan method from cash credit method.

Other Reforms in Banking System

1) The banks have now been allowed to set-up shops and this fact has
been mentioned in number of reports and relevant steps have also
been taken to implement the same.
2) RBI will take into consideration the applications that are submitted
by the NBFC‟s, Public sector units and private corporate for
opening of the new banks. As the number of banks will increase, the
competition is bound to increase in the sector which will ultimately
benefit the customers and development of the economy. The
financial enclosure is also likely to be increased as majority people
will now have an access to banking facilities.
3) Already existing banks have been now allowed to raise or decrease
their capital without requiring an overall ceiling on the same. This
will ensure flexibility to the banks in raising the funds on the basis
of their requirements.
4) The restrictions that are imposed in case of the voting rights have
also been relaxed which will further lead to development. The
persons who have invested in bulk will now be contributing more in
the functioning and the operations in the days to come.

Result of Financial Reforms in Banks

A growth in the balance sheet can be noticed after the reform period in
majority of the banks. Their operations are now more smooth and
flexible as compared to the pre-reform period. The financial health of
the banks have increased significantly and the same can be observed
through the quality of their assets and capital adequacy. This has
become possible because of the adoption of some of the internationally
recognised best policies and norms. The adoption of technology has
contributed to providing the best services to the customers and raising
the productivity level. The goals of the social as well as the commercial
goals have been achieved leading to growth in both the bank‟s balance
sheet and that towards the society.
* *
Financial System (Unit 1) (tppl.org.in) 33

1.3.3. Forex Market and Financial Reform

During the year 1993, reforms in the forex market took place by the
process of converting current accounts. In this, both the banks as well as
the dealers of the foreign exchange were allotted the power to execute
and perform number of activities and operations. Moreover, to promote
trade, foreign companies were allowed an easy entry in the Indian
market. Now, the non-residents could easily and effectively adapt the
capital accounts while for the residents, there were some reservations.
Impact on Reform Measures
Formation of clear policies for the improvement in the financial
environment and re-inforcement of the institutions are some of the
broader objectives of financial sector reforms. During the course of the
reforms, few private entrants were given the banking licence for
functioning in India. As a result of this, the competition was fierce and the
resources could now be utilised more efficiently. Earlier, the development
banks were sanctioning term loans to the industrial units and the
commercial banks were sanctioning the working capital requirements.

Now, there is transformation in the system and both the type of banks
are sanctioning both the type of loans to the industry. However, there is
a difference in the mode of operations of the banks. Now, industrial
units can approach a single bank to fulfil all its requirements. Still, the
development banks are preferred for the following reasons:
1) Unbiased support for the existing and the new industries.
2) Delay in the pay-off period for the loans.

Apart from providing the financial cushioning, it monitors the different

schemes that are sponsored by the government. So, industrial units are
always on the look-out for the financial leverage and other incentives
and subsidies that are offered under the development schemes by
adopting single window system. These institutions specialise in the
lending activities and possess good amount of knowledge and the same
can be used for the purpose of formulating various credit policies

1.3.4. Capital Market and Financial Reform

Capital market is a type of the financial market which works on the
economics principle of supply and demand but the difference being that
the demand and the supply of equity and debt is taken care of. The
finance generated from the petty savers and other depository institutions
like credit unions, banks and insurance companies is supplied to the
borrowers through the mode of various financial instruments like notes,
bonds, shares which are known as securities. Capital market comprises
* *
34 MBA Third Semester (IFS&FM) MDU
of three parts i.e. stock market, bond market and money market. The
sale and purchase of shares can also be done in this market. Securities
like equity and debt that are long term in nature can be traded at the
capital market. These securities may be issued by corporate or even the
government.

In 1992, the reforms began to take place in the capital market in India as
per the directions given by Narasimham Committee. The government
control was intended to be removed and it required a regulatory
framework as per the guidelines and the norms suggested by the
regulator. In 1992, it was initiated when SEBI (Securities and Exchange
Board of India) was established which was earlier a non- statutory body.
It was made the regulator for the entire capital market and given all the
statutory powers. The companies need not take the prior approval of the
government in order to access the capital market as well as for issue
pricing. The companies needed to abide by the disclosure norms issue
by SEBI and thus could have an access to the market and make the price
issues freely.

1.3.4.1. Regulatory Framework

With the passage of the time, a more simple and modern framework was
implemented by SEBI which comprises of certain regulations so as to
control the activities of the market participants like brokers, stock
exchange, mutual funds, merchant bankers and many others. Other
activities like insider trading and takeovers were also put under the
scanner for the purpose of protecting the interest of the investors. The
exchange boards were made broader and the governing was modified so
that the brokers could not significantly influence them. The major focus
in the new framework was the protection of interest of the investors by
ensuring all the practices under the control of SEBI. Different rules were
formulated for various offences made by the market participants and
strict punishment by way of imprisonment and hefty fine imposition was
experienced.

In the new regulatory framework, the requirement was to be a step

ahead and there were some loopholes that still need to be plugged.
These areas needed to be carefully addressed and required certain
disciplinary measures for effective outcome.

1.3.4.2. Opening the Capital Market to Foreign Investors

In 1993, the capital market was opened to the Foreign Institutional
Investors (FII‟s) and the Indian companies were allowed to raise the
capital from oversees by way of GDR‟s (Global Depository Receipts).
* *
Financial System (Unit 1) (tppl.org.in) 35
1.3.4.3. Modernization of Trading and Settlement Systems
In the post reform period, quite a number of developments have taken
place in the trading system which were never thought of earlier. NSE
(National Stock Exchange) was established in 1994 and was an
automatic electronic exchange. Brokers from 220 cities across the nation
could now connect with the NSE terminals via VSAT technology and
the buying and selling of securities took place in a real time
environment. In a way, there was complete transparency in the working.
Price delays no longer existed. This automated process carried out at the
NSE further forced BSE (Bombay Stock Exchange) to adopt electronic
trading in 1995.
Earlier, the settlement mechanism was more mechanical in nature. The
sellers use to deliver the share certificates to the registrar who would get
it transferred in the name of the buyer and deliver it to them. The entire
process used to take too much time. Apart from this, all the time there
was a risk of loss in transit. So, there was a need for change. For this,
the concept of dematerialisation was brought in. The investors could
open a Demat account with the depository participants and all their
holdings use to lie with the depository in an electronic form. The shares
could now be transferred. For this purpose, NSDL commenced the
operations of depository in 1996.

1.3.4.4. Futures Trading

In the present environment, there exists a gap in the future market in the
context of the Indian Capital Market. To overcome this, it requires a
well-established index future for effective risk management and
providing liquidity to market. Decision regarding presenting the future
trading is moved in the Parliament for the purpose of implementing it.

1.3.5. Insurance Sector and Financial Reform

The Insurance sector in India is directed by the Insurance Act, 1938,
Life Insurance Corporation Act, 1956 and General Insurance Business
(Nationalisation) Act, 1972, Insurance Regulatory and Development
Authority (IRDA) Act, 1999 and other related Acts. The concept of
bringing liberalisation in the banking sector and giving licences to the
private players also encouraged use of the same fundamentals in the
insurance sector. An attempt was made to reduce the monopoly held by
the public sector units and providing the customer with better services
keeping the same in a confined limit.
Data collected from different sectors of the nation suggested that the
institutions that are primarily into contractual savings actually determine
the rate of savings and the schemes like that of insurance and pension
* *
36 MBA Third Semester (IFS&FM) MDU
are quite significant from saving aspect. Presently, well diversified
insurance sector that could meet the diversified needs of the individuals
can ultimately raise the level of savings and the funds can be utilised
more efficiently. Capital formation can lead to national development.
Long term capital can be formed from the domestic funds itself and the
same can be utilised for the development and growth of the new
emerging sectors. Ideal reforms in the insurance sector are likely to
create cashflow and the same can be used for the industrial development
and will significantly reduce the fiscal deficit.
During 1994, Malhotra Committee suggested that insurance sector
should be opened for the private companies also. They took 5 years to
draft a policy and allowing foreign direct investment of 26% and the
report was forwarded in the Parliament in 1999.

1.4. MONEY MARKET

1.4.1. Meaning and Definition of Money Market
The money market is an important segment of the financial market,
wherein funds are either lend or borrowed for a short-term tenure, usually
for a period not exceeding one year. It is done through the financial
instruments of rather a short-term maturity. It is an institutional set up,
which offers a meeting ground for (i) the entities having surplus funds for
a short period, and (ii) entities which are in need of short-term funds.

The borrowing and lending takes place through the highly liquid
financial instruments having a short maturity period, which may be as
short as one day, and extend up to weeks or months but within one year.
Examples of such instruments are bill of exchange, bankers‟ acceptance,
treasury bills, certificate of deposits, commercial papers, etc. They are
also referred to as „near money‟.
According to Crowther, “The money market is the collective name
given to the various firms and institutions that deal in the various grades
of near money”.
Reserve Bank of India describes the Money Market as, “The center
for dealings, mainly of a short term character, in monetary assets; it
meets the short-term requirements of borrowers and provides liquidity
or cash to the lenders”.

According to the McGraw Hill Dictionary of Modern Economics,

“Money market is the term designed to include the financial institutions
which handle the purchase, sale, and transfer of short-term credit
* *
Financial System (Unit 1) (tppl.org.in) 37
instruments. The money market includes the entire machinery for the
channelizing of short-term funds. Concerned primarily with small
business needs for working capital, individuals‟ borrowing, and
government short-term obligations, it differs from the long-term or
capital market which devotes its attention to dealings in bonds,
corporate stocks and mortgage credit”.
The money market in our country is essentially a part of the banking
system, in which the participants take part in lending and borrowing of
short-term funds, through the use of financial instruments mentioned in
the above paragraph. It (the market) is also considered as the business
starting instrument, especially in Indian context. It is one of the major
sources for raising short-term funds to finance the areas of agricultural
and manufacturing activities undertaken by the entrepreneurs. The
Indian money market has shown remarkable progress during the last few
years.

The operations of the Indian money market are regulated by the Central
Bank of the country, viz. Reserve Bank of India. Such regulations
pertain to taking decision and controlling the level of money that needs
to be pumped into the economy, and also the industries to which money
needs to be diverted. Direct control of such kind encourages the banks
to ensure adequate flow of funds to the industries/companies, which
have the potential to generate more jobs and better cash circulation.

1.4.2. Features of Money Market

Indian money market is characterised by the following qualities:
1) Highly Organised Commercial Banking System: Commercial
banking network forms an important component of the money
markets in India. Existence of a well-structured banking network is
indicative of an evolved money market. The level of development of
a banking system is in direct proportion to the level of evolvement
of the money market. In a developed money market, the commercial
banks‟ linkage with other components of the market on one hand
and linkage with the Central bank of the country on the other is very
robust.
2) An Apex Central Bank: Money market of a country is considered
to be well developed, if it has the support and backing of a country‟s
Central Bank, which in Indian context is Reserve Bank of India
(RBI). The RBI acts as a facilitator, regulator, and supervisor as far
as the monetary and banking system of the country is concerned. It
is also empowered to exercise control over the other participants of
*
the money market. *
38 MBA Third Semester (IFS&FM) MDU
3) Adequate Availability of Credit Instruments: Availability of a
variety of various credit instruments such as promissory notes, bill
of exchange, treasury bills, short-period government bonds, etc. is
yet another feature of a developed money market.
4) Number of Dealers: The dealers and brokers play an important role
in facilitating the trading activities (buying and selling of financial
instruments) in a money market. Adequate number of such
dealers/brokers as well as that of financial instruments is an absolute
necessity for a market to be considered as a developed one. Lack of
sufficient number of dealers in a money market is an indication that
the market is yet to be developed.
5) Existence of a Large Number of Sub-Markets: A well-established
money market is characterised by the presence of a number of sub-
markets, e.g. call money market, bill market, collateral market,
acceptance market, etc., which specialises in facilitating specific
activities. More the number of such specialised sub-markets, higher are
the level of development of the money market.
6) Proper Co-ordination among Sub-Markets: In order to ensure
that the entire money market operates in a cohesive and co-
ordinated manner, it is necessary that different sub-markets of a
developed money market function inter-dependently and not on a
standalone basis.
7) Integrated Interest Structure: For the money market to be a
developed one, the interest structure needs to be well-coordinated
and integrated. Any change in interest rate structure of the country,
as indicated by the Central Bank, should be transmitted promptly in
the market and its impact needs to be visible.
8) Responsive: Any national or global event of political or economic
significance impacts the money market, and this is reflected in the
form of some response on the part of the money market. The
magnitude of response depends upon the scale of importance
attached to the specific event.
9) Remittance Facilities: Existence of a convenient and cost-effective
remittance facility is a hallmark of a developed money market.
Smooth functioning of a developed money market is not possible in
the absence of such infrastructure.
10) Other Factors: Some factors, other than those discussed in the
above points, are also considered as salient characteristics of a
developed money market. These factors may relate to volume of the
trade, stability of the political conditions, etc.
* *
Financial System (Unit 1) (tppl.org.in) 39

1.4.3. Functions of Money Market

Money markets play an important role in monetary and economic arena
of a country, as evident from the following:
1) Maintenance of monetary stability in the system by keeping a
balance between the demand for money and its supply for the
monetary transactions of short-term nature;
2) Money market acts as a stimulant for the economic growth by
ensuring that adequate funds are made available to entrepreneurs
engaged in various economic activities in different sectors, like
agriculture, MSME, etc.;
3) Supporting trade and industry by extending provisions of sufficient
funds to them, including credit facilities in the form of bill-discounting;
4) Money market is a facilitator of implementing the Monetary Policy
of the country‟s central bank. It has got an inbuilt mechanism of
ensuring implementation of the monetary policy in an efficient
manner; and
5) In the process of capital formation, money market plays a vital role.
It channelises the household savings and investments for short-term
investments in its financial instruments, such as treasury bills,
commercial papers, certificate of deposits, etc.

1.4.4. Advantages of Money Market

A well-developed money market of a country is beneficial to various
segments of its economy in the following manner:
1) Source of Capital: Through the various financial instruments, viz.
treasury bills, commercial papers, certificate of deposits, etc., the
money market is in a position to make available short-term funds for
the trade and industry.
2) Ideal Investment: Money market is a short-term investment
destination for its participants. They can invest their surplus funds,
available for a short period, in any of the money market instruments.
Such instruments are also eligible, for making investment into, for
meeting statutory reserve requirements for commercial banks.
3) Effective Monetary Management: A developed and efficient
money market also acts as a medium through which the monetary
policy of the country‟s central bank, viz. RBI may be implemented
successfully. It, thus, facilitates transmission of the policy of RBI in
respect of its monetary management of the country as a whole.
4) Economic Development: Money market is a vital component of the
monetary system prevailing in a country. It plays a significant role
in the overall economic development of a country. Its efficiency and
*
the country‟s fast economic development, in fact, go together. *
40 MBA Third Semester (IFS&FM) MDU
5) Efficient Banking System: The efficiency and effective
functioning of a country‟s financial and banking systems, to a large
extent, depends upon the manner in which the money market
functions. A well-evolved money market ensures that the banking
and financial systems run in a hassle-free manner.
6) Facilitating Trade: Trade and industries are benefitted from the
money market in the following manner:
i) A payment mechanism is offered by the money market, which
enables the traders and industrialists to transfer money promptly
(even huge amounts);
ii) Working capital needs of a business entity can be effectively
met through the money market, which facilitates their day-to-
day production and marketing activities.
iii) Money market provides a short-term investment opportunity for
its participants in the instruments, which are highly liquid and
as such can be converted into money, when required, without
any loss of time.
7) Helpful to Government: Money market facilitates the short-term
borrowing programs of Government, as the treasury bills are
floated, subscribed, and traded in the money market.

1.4.5. Disadvantages of Money Market

Despite the advantages of Indian money market mentioned above, it
also suffers from the following deficiencies:
1) Limited Transactions: There are certain restraints as regards the
number of transactions undertaken by a market participant. Such
restrictions relate to deposits as well as withdrawals; normally three
deposits and three withdrawals are permitted for individual
participant. This limitation acts as a deterrent in the development of
money market.
2) Potential Loss of Investment: Participants of money market invest
in the market through banks. If due to some unforeseen
circumstances, a bank is compelled to wind up its business, there is
a possibility that the investor may lose all the money or a part
thereof. This risk of losing money is always lurking in the minds of
investors despite the DICGC guarantee available for a limited
amount of `1,00,000 (Rupees one lakh).
3) Interest Rate Fluctuation: Wavering interest rate is another risk,
which the participants of money market are exposed to. Movement
of interest rates may be in favour or they may be against the
investors/borrowers. There is absolutely no safeguard against the
*
adverse movement of interest rates. *
Financial System (Unit 1) (tppl.org.in) 41
4) Easy Access: It may sound ironical, but it is a fact that a stress-free
access to the money market account may prove to be a possible
disadvantage. This is in the sense that the tendency of impulsive
expenditures is, at times, quite over-powering.
5) Minimum Balance Requirements: Most of the banks stipulate a
minimum balance to be maintained by their constituents in a money
market account. The chances of going the balance below the
required level are high, especially in cases where the money market
account is linked with a checking account as overdraft protection.

1.4.6. Structure and Components of Money Market

Various components of the money market in India may be broadly
grouped into two categories viz. (i) organized or authorized segments,
and (ii) unorganized or unauthorized segments. Following table reflects
the detailed organizational structure of the Indian money market:
Structure and Components of
Money Market

Organised Money Unorganised Money

Market Market
 Reserve Bank of India  Indigenous Bankers
 Commercial Bank  Unregulated Non-Bank
 Co-operative Banks Financial Intermediaries
 Money Lenders
1) Organized Money Market: Components of the organized money
market consists of certain institutions, which function under the
control and regulations of Government. They are as under:
i) Reserve Bank of India: The central bank of the country, viz.
Reserve Bank of India is the apex body of the Indian money
market. Commercial banks can park their surplus funds with
RBI and they can also borrow from RBI for a short period.
ii) Commercial Bank: Commercial banks, which include SBI &
its associate banks, other public sector banks, private sector
banks, Regional Rural Banks (RRBs), etc., are the major players
of the Indian money market. They can borrow or lend monies
for short-term amongst each other, either directly or through a
financial instrument, when they require short-term funds or
when they have surplus funds for a short period.
iii) Co-operative Banks: Co-operative banks are also an important
constituent of the Indian money market. They have a three-tier
*
organizational set-up, with the State Co-operative Bank as the *
42 MBA Third Semester (IFS&FM) MDU
apex body at the State level, followed by the District Co-
operative Banks at District level. At the lowest level of the set-
up are rural primary co-operative banks and urban co-operative
banks. The role played by the co-operative banks in the money
market is similar to that of the commercial banks.
2) Unorganized Money Market: The unorganized money market
consists of entities, which do not come under the control and
regulation of Government. They are mostly non-banking financial
intermediaries, indigenous bankers and money lenders
predominantly operating in rural areas and small towns, although
some of them have registered their presence even in big cities. Their
lending activities are restricted to the borrowers from the
communities of farmers, artisans, small traders and small-scale
manufacturers, which do not have an easy access to the organized
sector of the money market. Various components of the unorganized
money market have been discussed in the following points:
i) Indigenous Bankers: Indigenous bankers are individuals or
private firms, who operate like a bank, i.e. they accept deposits
and grant loans. They are out of the purview of any regulation
or control of any authority whatsoever. With the increase in the
outreach of commercial and co-operative banks, the number of
indigenous bankers is dwindling day-by-day.
ii) Unregulated Non-Bank Financial Intermediaries: Non-
bank financial intermediaries are also not regulated or
supervised by any authority. They operate in the market as
loan or finance companies. Their sources of funds include
deposits accepted from public, borrowings from various
sources, and other receipts, whereas they deploy their funds
as lending to wholesale traders, retailers, artisans, and other
self-employed people, etc. at a high rate of interest (at times
as high as 48%).
iii) Money Lenders: Money lenders are yet another group
representing unorganized sector of the Indian money market.
They specialize in extending loans to small borrowers, such as
marginal and small farmers, agricultural labourers, artisans,
factory and mine workers, low paid staffs, small traders, etc.
The rate of interest charged by them is also very high. In
addition, they are infamous for indulging in various unethical
practices to cheat their borrowers, who happen to be
illiterate/semi-literate, by falsifying the loan records maintained
by them.
* *
Financial System (Unit 1) (tppl.org.in) 43
Money lenders may be classified into the following three
categories:
i) Professional money lenders, who have expertise in the field
and are engaged exclusively in the business of money lending;
ii) Nomadic money lenders, who are engaged in the business
of money lenders as their secondary activity, for example
Kabulis and Pathans; and
iii) Non-professional money lenders.

1.4.7. Participants in Indian Money Market

Money market is characterised by the voluminous transactions involving
substantial amounts. The number of money market players is limited but
they are very active and in a dominant position. Some of the significant
market participants are as follows:
1) Reserve Bank of India (RBI): Central bank of the country, i.e. RBI is
the key participant of the money market. It is responsible for the
formulation and implementation of the monetary policy of the country.
With a view to injecting liquidity in the market or using the same from
the system, it has got a number of instruments at its disposal. Bank rate,
repo mechanism, CRR, etc. are some of them, which are put to use, as
and when required, by the central bank from time to time.
2) Schedule Commercial Banks (SCBs): Scheduled Commercial Banks
form the core of the money market, as they are the most prominent
players in short-term borrowing as well as short-term lending.
Household savings of the people find their way to banks in the form of
deposits, a part of which is utilized by the banks for onward lending to
the business entities for meeting their short-term working capital
requirements. Deployment of the remaining funds is done by way of
investment in Government securities (medium to long-term), treasury
bills (short-term), equities and bonds issued by corporates, etc.
3) Cooperative Banks: Participation of cooperative banks in the
money market is similar to that of scheduled commercial banks.
4) Financial and Investment Institutions: Certain financial and
investment institutions like Life Insurance Corporation of India,
Unit Trust of India, General Insurance Company, development
banks, etc. are also active players in the money market. However,
their role is restricted in the market as lender only; they are not
permitted to borrow.
5) Corporates: Participation of companies in the money market is
manifold: (i) demand of funds is generated by them through the
banking system, (ii) one of the money market instruments, viz.
* *
44 MBA Third Semester (IFS&FM) MDU
Commercial Papers (CPs) are issued by the corporates, (iii) they
accept public deposits and also undertake activities like inter-
corporate deposits (ICDs) and investments.
6) Mutual Funds: Mutual Funds, as part of their investment activities,
prefer to invest in various money market instruments, especially if
their investment horizon is for a short period. They are also
permitted, in addition to the SCBs, to participate in the call money
market. Money Market Mutual Funds (MMMFs) have been created
with the specific purpose of mobilising short-term funds to be
invested in various money market instruments. They have played a
significant role in the evolution of the Indian money market.
7) Discount and Finance House of India (DFHI):The Discount and
Finance House of India Limited (DFHI) was promoted in the year
1988 by the Reserve Bank of India in collaboration with public
sector banks and all-India financial institutions (AIFII) with a view
to popularising short-term money market instruments, and thereby
deepening and widening the Indian money market. The present
activities of DFHI includes (i) participation in the inter-bank
call/notice money market and term deposit market, as a lender as
well as a borrower, (ii) rediscounting of instruments like 182 days
treasury bills, commercial bills, Certificates of Deposits (CDs) and
Commercial Papers (CPs).

1.5. SEGMENTS/INSTRUMENTS OF
MONEY MARKET
Financial instruments, which are generally common in the Indian money
market, have been depicted in the following table:

Segments/Instruments of Money Market

Call and Notice Money

Market Bill of Exchange

Treasury Bills (T-Bills) Commercial Papers

Certificates of Deposits Money Market Mutual

(CDs) Funds

Inter Corporate Deposits

(ICDs)
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Financial System (Unit 1) (tppl.org.in) 45

1.5.1. Call and Notice Money Market

Call money market is a place where borrowings and lending take place
for a very short period, ranging between overnight and fortnight. The
amounts lent or borrowed in this market are considered to be highly
liquid, as they can be recalled/repaid at the option of either the lender or
the borrower.
Call money market is dominated by the banks, who may be either
lenders or borrowers. Majority of the participants (approximately 80%)
are Public Sector Banks, remaining 20% of the participants are private
sector banks and foreign banks. The size of the Indian call money
market is between 60,000 million to 70,000 million. Non-bank entities
(financial institutions such as IDBI, LIC, GIC, etc.) also participate in
this market, but only as lenders. However, their role as a lender is very
significant, as approximately 80% funds needed by the call money
market are replenished by these non-bank entities, which are generally
pulled with funds.

1.5.1.1. Features of Call Money Market

The salient features of call money market are as under:
1) Banks and other non-bank financial institutions can manage their
funds through the call money market by deploying surplus funds or
by borrowing for meeting their short-term financial requirements;
2) Banks, including the primary dealers are permitted to access the
market for borrowing or lending in order to manage their statutory
obligation, i.e. Cash Reserve Requirement (CRR);
3) Certain financial entities like specified All-India Financial
Institutions (AIFI), mutual funds, LIC, GIC, etc. are entitled to
participate in the market only as lender (they can‟t borrow from the
market);
4) As far as borrowing and lending activities together are concerned,
only the banks are considered to be full-fledged participants in the
money market, and as such it is considered as inter-bank market.
Other participants, i.e. non-banking entities have limited role to play
in the market;
5) Interest rates in the call money market are fast-changing and
decided on day-to-day basis by the market forces;
6) As all the transactions (borrowings and lending) are short-term in
nature, all the participants need to maintain current accounts with
Reserve Bank of India; and
7) Money market is the most preferred avenue for the placement of
surplus funds for a short period, especially for the lenders with
stable influx of funds.
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46 MBA Third Semester (IFS&FM) MDU
1.5.1.2. Advantages of Call Money
Call money market is extremely useful and beneficial for its participants
in view of the following:
1) Banks, including the primary dealers access the market for
borrowing or lending with a view to managing their cash on a daily
basis and also to manage their statutory obligation pertaining to
Cash Reserve Requirement (CRR);
2) It offers a convenient platform for its participants for
investing/lending their surplus funds on a short-term basis. Their
short-term funds requirements may also be fulfilled by way of
borrowing from the market;
3) Certain financial entities like specified All-India Financial
Institutions (AIFI), mutual funds, LIC, GIC, etc. are allowed to
access the market only as lenders (and not as borrowers);
4) Call money market is moving towards becoming an exclusive inter-
bank market;
5) With a view to ensuring promptness and efficiency in the settlement
of transactions, there is a stipulation for the participants to maintain
current accounts with the Reserve Bank of India;
6) Interest rates in the call money market are not prescribed; they are
variable and decided by the market forces; and
7) Participants with surplus funds available for a short period, find
money market as the most attractive destination. It suits the lenders
with stable influx of funds.

1.5.2. Bill of Exchange

Bill of exchange is also a money market instrument, which is in the
form of an order in writing by the drawer of the bill to the drawee for
the payment of money to the payee. A typical bill of exchange is the
cheque, drawn by a customer (drawer), defined as bill of exchange, on
his banker (drawee) and payable by the banker to the payee on demand.
Bills of exchange are mostly used in international trade. They are in the
shape of written orders by a bank‟s constituent to his bank directing it to
pay the bearer of the bill of exchange an amount as specified in that
order on a date indicated in the said order. A bill of exchange, also
referred to as a commercial bill, is characterised by its short tenure,
negotiability, and self-liquidating nature.

A Bill of Exchange as defined under Section 5 of the Negotiable

Instruments Act, 1881 is “an instrument in writing containing an
unconditional order, signed by the maker, directing a certain person to
pay a certain sum of money only to, or to the order of, a certain person
or to the bearer of the instrument”
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Financial System (Unit 1) (tppl.org.in) 47
Three parties, as indicated in the following points, are involved in a bill
of exchange:
1) Drawer: Drawer of a bill of exchange is the person who
writes/draws the bill.
2) Drawee: Once the bill of exchange is drawn by the drawer, it is
required to be accepted by the person on whom the bill is drawn.
Such a person (the acceptor) is referred to as the drawee.
3) Payee: Payee is the person, mentioned by the drawer in the bill of
exchange, to whom (or to whose order) the money indicated of the
instrument is payable.

1.5.2.1. Features of Bill of Exchange

A bill of exchange is expected to exhibit the following salient features:
1) It must be in Writing: A bill of exchange needs to be necessarily
in writing.
2) Order to Pay: Bill of exchange is an order from the drawer to the
drawee to pay money to the payee. This is the basic characteristic of a
bill of exchange. Here the term „order‟ need not be taken in a literal
sense to be a command. It is a sort of request or direction, indicating the
drawer‟s intent to ensure payment to the payee by the drawee. In this
regard, a moderate level of politeness is acceptable, but excessive
politeness is unwarranted, as it may lack the element of „order‟.
3) Unconditional Order: No condition should be associated with the
order to pay in a bill of exchange. Whatever may be the
circumstances, the bill must be paid to the payee by the drawee as
per the order of the drawer. Any condition attached with a bill of
exchange makes the instrument null and void.
4) Signature of the Drawer: A bill of exchange must be signed by its
drawer. In the absence of a proper signature of the drawer, an
instrument is rendered invalid/unacceptable in law. However, if the
signature is obtained even subsequent to the issue of a bill of
exchange, it is acceptable.
5) Drawee: A bill of exchange must contain the name of a
drawee/acceptor, who is responsible for the payment to the payee. In
the absence of drawee‟s name, the instrument is considered flawed.
6) Parties: There are three parties to a bill of exchange, viz. the drawer,
the drawee (acceptor) and the payee. They are required to be
specifically mentioned in the instrument without any room of doubt.
7) Certainty of amount: The amount mentioned in a bill of exchange
should be definite without any ambiguity.
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48 MBA Third Semester (IFS&FM) MDU
8) Payment in kind is not valid: The order to make payment should
be in terms of money only. A bill of exchange containing an order
to pay anything in kind would render the instrument invalid.
9) Stamping: In terms of the Indian Stamp Act, a bill of exchange is
required to be duly stamped. Failure to comply with this statutory
requirement makes the instrument null and void.
10) Cannot be made Payable to bearer on Demand: A bill of
exchange is not permitted to be drawn as payable to the bearer on
demand.

1.5.2.2. Advantages of Bill of Exchange

Due to the following benefits of the bills of exchange, they are
considered as one of the most popular instruments of credit, and are
used in business transactions on a regular basis:
1) Framework for Relationships: A bill of exchange is a tool, which
offers a platform for smooth business transactions between a seller
and buyer and/or creditor and debtor on mutually agreed terms.
2) Certainty of Terms and Conditions: Various terms and conditions
i.e. date, amount, place of payment, amount of interest to be paid,
etc. in respect of a bill of exchange are definite and known to all the
concerned parties, as such details are clearly mentioned in the
instrument. Therefore, there is no ambiguity in the minds of debtor
or creditor.
3) Convenient Means of Credit: Extending credit in the form of bill
of exchange is very convenient for the seller of goods (creditor), as
the date of payment is known to him and he is sure to get the
payment on due date. He has an option of getting payment
immediately by discounting the instrument or endorsing the same in
favour of a third party. As far as the buyer of goods (debtor) is
concerned, he gets the convenience of buying goods on credit and
making the payment after the period of credit.
4) Conclusive Proof: Any business transaction taking place through
the medium of bill of exchange is a documentary proof of the credit
transaction having taken place; that the buyer has purchased goods
from the seller on credit and he is bound to make the payment after
the credit period is over. Legally, the buyer (debtor) cannot refuse to
make payment on due date, and if he does so, the seller (creditor)
has legal recourse against him. All he has to do is to approach a
Notary and get a certificate from him to make it a conclusive
evidence of the transaction.
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Financial System (Unit 1) (tppl.org.in) 49
5) Easy Transferability: A debt, represented by a bill of exchange,
can be transferred by way of endorsement and delivery of the
instrument in favor of a third party.

1.5.3. Treasury Bills (T-Bills)

Treasury bills are finance bills issued in the form of promissory notes by
the Government of India on discount for a fixed short period (not more
than one year). They contain a promissory clause to pay the amount
stated in the instrument to the bearer thereof. By their very nature they
are highly liquid, as they can be bought and sold freely in the “Treasury
Bills Market”.
Although all the money market instruments are characterized by their
marketability, the treasury bills are considered to be the most
marketable out of all the money market securities. T-bills are the most
sought after instrument because of their inbuilt simplicity (short tenure
and convenience) in undertaking their transactions. For an individual
investor, they offer an affordable investment opportunity.
Treasury Bills issued by the Government of India are of three types
according to their tenures; they are 91-day, 182-day and 364-day. T-
Bills are issued through the process of auction on weekly basis. Whereas
the auction of 91 day T-Bills takes place on every Wednesday, T-Bills
of 182 day and 364 day duration are auctioned on Wednesdays of every
alternate week.

1.5.3.1. Features of T-Bills

The salient features of treasury bills (T-Bills) are as under:
1) Issuer: Government of India resort to the issue of T-Bills with a
view to manage a temporary mismatch between its receipts (revenue
as well as capital) and expenditure. Subscribers of such bills are
individuals and institutions, who find such instruments attractive
enough to invest their surplus funds for a short period.
2) Finance Bills: Treasury Bills do not represent any genuine trade
transactions. They are, therefore, purely finance bills.
3) Liquidity: Although Treasury Bills are highly liquid, they are not
self-liquidating (which is the characteristics of genuine trade bills).
4) Vital Source: Treasury Bills are one of the most preferred routes for
the Government of India for raising short-term funds.
5) Monetary Management: Central Bank of the country (RBI) uses the
Treasury Bills as one of its vital tools for injecting liquidity in the
*
market as part of its responsibility for the monetary management. *
50 MBA Third Semester (IFS&FM) MDU
1.5.3.2. Advantages of T-Bills
T-Bill, as one of the most important money market instruments, is
advantageous to the Central Bank of the country (RBI), and other
market participants in the following manner:
1) Liquidity: High liquidity of treasury bills makes them a popular
instrument for various market players like the DFHI, STCI,
commercial banks, etc. Besides it is a good source of short-term
funds for the Government of India. T-Bills‟ liquidity is additionally
enhanced in view of the bank that RBI is always willing to
buy/discount them.
2) No Default Risk: In view of supporting of the Central Government
in the form of guarantee, the risk of default by the issuer (which is
none other than the Government itself) remains totally eliminated.
3) Low Cost: DFHI offers two-way quote every day, with a thin
margin, in respect of treasury bills, which makes their transaction
cost at a lower level.
4) Safe Return: Treasury bills are a safe investment choice for the
short-term investors, with a stable and assured rate of return, as the
discount rates of TBs are not volatile. Instead of keeping a high
level of idle cash, the investors prefer to keep them at the lowest,
and invest the balance in TBs, which are considered as money-
equivalent (due to their high liquidity).
5) No Capital Depreciation: Possibilities of capital depreciation in the
case of T-Bills are almost negligible, in view of their being highly
liquid, safe and yielding better returns.
6) Funds Mobilisation: For the Central Government, T-Bills offer an
ideal money market instrument raising short-term funds, which they
need quite often for bridging the budgetary gap, which is transitory
in nature.
7) Better Spread: T-Bills are not only auctioned on a fortnightly basis,
but they are also available on-tap basis. Investors find this a great help
for appropriate spread of asset mix with various maturity periods.
8) Perfect Hedge: T-Bills may also be used as a protective mechanism
against the interest rate instabilities and fluctuations prevailing in
the call money markets.

1.5.4. Commercial Papers (CPs)

Commercial Papers (CPs) are money market debt instruments in the
form of unsecured promissory notes, which can be issued by
distinguished corporates with good market reputation. Generally, banks,
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Financial System (Unit 1) (tppl.org.in) 51
insurance companies, unit trust and firms are the potential investors in
CPs. Minimum face value of a commercial paper is kept at `5 lac. Such
papers are issued by the companies with a view to meet the demand
arising out of seasonal/working capital requirements, which are of short-
term nature. The issuer of Commercial Papers has an option to sell them
directly or indirectly (through some agency).

1.5.4.1. Features of Commercial Papers

The salient features of commercial papers are as follows:
1) Nature: Commercial Papers are debt instruments, which are
unsecured and issued in the form of promissory notes by renowned
companies having a good market reputation. Holders of CP can
redeem the instrument at par on maturity. There are certain conditions
which are required to be fulfilled by a company desirous of issuing
CPs. The tangible net-worth of such company should not be less than
Rs.4 crore. Its working capital (fund-based) limit should also be more
than Rs.4 crore, which makes the company eligible for issuing CPs up
to 100% of its fund-based working capital limits. CPs may be issued
with face value of Rs.5 lakh and multiple thereof at discount. CPs is
subjected to applicable stamp duty. The companies need not approach
the RBI for prior approval of the issue of CPs. Similarly, underwriting
is also optional for the CP issuing company. However, CP issuing
company is required to bear all the expenses pertaining to the issue,
e.g. dealer‟s fees, rating agency fee, charges for provision of stand-by
facilities, etc. Commercial Papers route for raising funds provides an
opportunity for the corporates (with good rating) to borrow directly
from the market. It also takes the pressure off the bank funds for
small and medium sized borrowers.
2) Market: CPs issued by top-rated corporates (private as well as public
sectors) isare viewed as preferred investment opportunities by
prospective investors. The „Commercial Papers Market‟ is considered a
well-developed one. With effect from September 1996, Primary
Dealers (PDs) were also allowed by RBI to issue CPs for
supplementing their resources. As a result of this initiative taken by
RBI, CP market gained further popularity.
3) Rating: The issuing companies are required to grade their CPs as per
the instructions of RBI. It facilitates the decision making exercise to be
taken by the prospective investors as per the grade allocated by the
issuer; higher the grading, better is the quality of the instrument.
4) Interest Rates: As the interest rates are decided by the market
forces, they keep on changing frequently. The factors responsible
*
for determining the interest rates include rating of the instrument, *
52 MBA Third Semester (IFS&FM) MDU
economic phase, the present rate of interest in CPs market and call
money market, conditions prevailing in the foreign exchange
market, etc.
5) Marketability: The interest rates prevailing in the call money market
and foreign exchange market are two important factors impacting the
marketability of CPs. CPs demand increases if the interest rates in the
other markets are unfavourable, and vice-versa. Investors tend to get
attracted to call money market and foreign exchange market, if the
interest rates ruling therein are attractive.
6) Maturity: With a view to making the Commercial Papers more
attractive and giving a boost to CP market, the minimum maturity
period of CPs was brought down in phases from 3 months to the
present 15 days.
7) CPs in Lieu of Working Capital: This is another measure taken by
RBI to boost the CP market. The credit policy announced by RBI
permits an automatic restoration of working capital limits on the
repayment of CP by well-rated corporates. Similarly, short-term
working capital loans may also be replaced by cheaper CPs.

1.5.4.2. Advantages of Commercial Papers

Commercial Papers are beneficial for the investors as well as the
corporates issuing them, as evident from the following:
1) Convenience and Simplicity: The raising of funds through
Commercial Paper by corporates is the biggest benefit to its credit
as it is very convenience and simple to understand.
2) Liberty of Raising Funds: The corporates have the liberty of
raising funds from the money market, through the issue of CPs,
whenever they find market favourable for doing so;
3) Raising Out of Scope: CP holders may use the instrument for
raising funds from the inter-corporate market – a market which is
out of the purview of any regulatory/monetary authority; and
4) Low-cost and Better Rate of Interest: Commercial Papers offer an
opportunity for the corporates, to raise funds at low-cost and for the
investors, a better rate of interest.

1.5.5. Certificates of Deposits (CDs)

Certificates of Deposits (CDs) are yet another money market instrument
issued by Commercial Banks (CBs) and Development Financial
Institutions (DFIs). They are unsecured, negotiable and short-term in
nature, which are payable to the bearer. CDs are different from the Term
Deposit in as much as they involve creation of paper and are
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Financial System (Unit 1) (tppl.org.in) 53
transferable between various owners before maturity. Further, they
generally bear a higher rate of interest, when compared with the FDs.
There exists a market for trading in CDs, which is termed as „Certificate
of Deposit Market‟. However, the secondary market activities in respect
of CDs are limited, due to the fact that such instruments are generally
held till maturity. Most of the banks resort to CDs route for borrowing
in a scenario, where there is a mismatch in credit demand (which tends
to be high) and incremental deposits (which tends to be rather low).

Issue of Certificate of Deposits (CDs) by a CB/DFI is subject to various

guidelines and directives issued by RBI from time to time. The genesis
of introduction of CD scheme by RBI may be traced back to the period
when the deregulation of interest rates on deposits was taking place.

Initially, the scheme envisaged issue of CDs by any scheduled

commercial bank or cooperative bank (excluding land development
banks) for a maturity period ranging between three months and one
year. Designated Development Financial Institutions were permitted to
issue CDs for a maturity period ranging between one year and three
years.

1.5.5.1. Features of Certificate of Deposits

The salient features of Certificate of Deposits (CDs) are as follows:
1) Negotiable Instruments: Certificates of Deposits are issued at
discount to the face value at market rates by Commercial Banks
(CBs) and Development Financial Institutions (DFIs). Due to the
negotiable nature of CDs, various provisions of Negotiable
Instruments Act, 1881 are applicable to them.
2) Maturity: The minimum and maximum maturity periods of CDs are
15 days and one year respectively.
3) Nature: CDs are promissory notes with fixed maturity period, and
as such they can be negotiated by endorsement and delivery.
4) Ideal Source: CDs offer a good and safe investment opportunity for
prospective investors, as their issuers, viz. commercial
banks/specified financial institutions are responsible for their timely
payments.

1.5.5.2. Advantages of Certificate of Deposits

Following advantages in favour of the Certificates of Deposits (CDs)
makes them an attractive investment option:
1) Better Return: Returns available from the investment in CDs are
*
more than those available from saving banks account in a bank. *
54 MBA Third Semester (IFS&FM) MDU
2) Safe Return: Safety of investment and assured returns are twin
benefits of Certificate of deposits. It is especially meant for those
investors who are interested in returns as good as those available
from the equity market, but without the struggling of that market.
3) Good Long Term Effect:The long-term impact of the Certificate of
Deposits is safely coupled with rich returns for the investors looking
for these traits in their long-term investment options.

1.5.6. Money Market Mutual Funds

Money Market Mutual Funds (MMMFs) constitute a category of open-
ended mutual funds, which specializes in channelizing investors‟ funds
to the short-term money market instruments. These instruments, like
other money market instruments, provide a high level of liquidity and
safety of investments. Therefore, MMMFs are also rightly referred to as
„Liquid Mutual Funds‟. Investment in a MMMF is considered to be the
safest of all other mutual funds. The only risk they are exposed to
pertains to interest rate variations. The investment portfolio of a MMMF
typically consists of investment in “Treasury Bills”, “Commercial
Papers” and “Certificate of Deposit”.

A money market mutual fund may be viewed as a substitute of bank

savings, with the only theoretical difference being absence of
Government insurance in the case of a MMMF. Practically, a MMMF is
almost as good as a bank deposit as far as safety of funds is concerned.
As regards return on investment, MMMF is definitely a better option,
because of accrual of better income in the form of dividends, while the
principal amount remains intact. The risk arising out of inflationary
forces is the only risk an investment in MMMF is exposed to, which can
impact the purchasing powers of investors negatively. Financial
framework of a country‟s economy is based on two markets/pillars viz.
stock market and money market. The idea of MMMF is historically
considered to be even older than some of the stock exchanges.

The operation of a MMMF scheme is simple and unsophisticated. Its

shares, referred to as units, are subscribed by the prospective investors.
The funds so channelized are invested in the most appropriate money
market instruments, like treasury bills, commercial papers, certificates
of deposits, etc. Such instruments may either be retained till their
maturity or they may be traded from time to time depending upon the
market conditions. These funds are managed by individuals having
highest level of competence and professionalism. Out of all other
mutual funds, MMMF is considered to be the safest one, which gives
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Financial System (Unit 1) (tppl.org.in) 55
better returns. The investor is assured of earning a stable and sustainable
return on the investments made by him, as the MMMF remain immune
to the economic instabilities and volatilities.
1.5.6.1. Features of Money Market Mutual Funds
The distinguishing characteristics of the money market mutual funds are
as follows:
1) Diversification: The portfolio of a money market mutual fund is
required to be well-diversified. Its investment in a specific
instrument cannot exceed more than 5% of the total value of that
MMMF.
2) Maturity: There exists a ceiling with regard to the period for which
the investments can be made by a MMMF, which is 397 days at
present.
3) Credit Quality: A minimum of 5% of the total investment needs to
be in short-term categories of funds.
1.5.6.2. Advantages of Money Market Mutual Funds
Money Market Mutual Funds are well-regulated entities with following
additional advantages of making investments in such funds:
1) Safety: For an investor, especially those who are risk-averse, safety
of their funds is foremost in their minds before making any
investment. This aspect is fully taken care of by a MMMF. Even in
comparison of other mutual funds, they are viewed to be the safest
by all classes of investors, and as such most preferred ones.
2) Return on Investment: These funds get a stable but conservative
type of income on the amount received from the investors, and
invested by them in money market instruments. The income
received is generally reinvested by purchasing a new fund.

1.5.7. Inter Corporate Deposits (ICDs)

Inter Corporate Deposits (ICDs) represent the unsecured loans, which
are granted by one company to another. This instrument is used by the
companies to accommodate each other; a company, having surplus
funds, extends loan to another company, which is in the needs of funds.
Further, a well-rated company, even if it does not have surplus funds, is
allowed to borrow from the banking system for further lending to
another company in the ICD market. The interest rates prevailing in this
market are comparatively higher, due to the reason that for the „lending
corporates‟ the cost of funds is at a higher level. In addition, as the ICDs
are unsecured in nature, they carry an inbuilt risk with them. As a
consequence, the element of risk-premium is also taken into account
while deciding the rates of interest.
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56 MBA Third Semester (IFS&FM) MDU
The tenure of ICD is generally 90 days, although they may be issued for
a period ranging from one day to one year. The ICD market is not that
transparent in as much as some element of confidentiality is maintained
by each broker with regard to his clients (both lenders and borrowers),
which are not shared with other brokers. They are apprehensive of
sudden fall in interest rates, if such information is not kept secret.
Personal contacts play an important role behind the activities of
borrowing and lending in this market.

1.5.7.1. Features of Inter Corporate Deposits

The salient characteristics of Inter Corporate Deposits are as follows:
1) It offers a convenient and hassle-free source of short-term finance
from one day to one year;
2) Processes involved in borrowing and lending are very simple;
3) Interest rates on ICDs are variable depending up on the amount and
tenure involved in the deposit;
4) Borrowing through this route is fraught with risk of uncertainty, as
the amount may be called-back by the lender at any time by giving a
short notice;
5) ICDs are out of the purview of any statute/regulation;
6) The entire ICD market functions on the foundation of personal
contacts;
7) Lending in the ICD market is associated with „high risk and high
returns‟; and
8) Borrowing from ICD market is useful for tiding over temporary
financial constraints.

1.5.7.2. Advantages of Inter Corporate Deposits

Inter Corporate Deposits are beneficial for the borrowers as well as
lenders of the ICD market in the following manner:
1) It offers an opportunity for the deployment of surplus funds lying
with a corporate for a short period;
2) Short-term financial crunch may be overcome by a corporate; and
3) Procedure involved in lending/borrowing in the form of ICDs is
very convenient for both the corporates.

1.5.8. Recent Developments in Indian Money Market

On the recommendations of S. Chakravarty Committee and
Narasimhan Committee, the RBI has initiated a number of reforms:
1) Deregulation of Interest Rates: RBI has deregulated interest rates.
Banks have been advised to ensure that the interest rates changed
remained within reasonable limits. From May 1989, the ceiling on
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Financial System (Unit 1) (tppl.org.in) 57
interest rates on call money, inter-bank short-term deposits, bills
rediscounting and inter-bank participating was removed and rates
were permitted to be determined by market forces.
2) Reforms in Call and Term Money Market: To provide more
liquidity RBI liberalised entry in to call money market. At present
Banks and primary dealers operate as both lenders and borrowers.
Lenders other than UTI and LIC are also allowed to participate in
call money market operations. RBI has taken several steps in recent
years to remove constrains in term money market. In October 1998,
RBI announced that there should be no participation of non-banking
institutions in call/term money market operations and it should be
purely an interbank market.
3) Introducing New Money Market Instruments: In order to widen
and diversify the Indian Money Market, RBI has introduced many
new money market instruments like 182 days. Treasury bills,
364days Treasury bills, CD3 and CPs. Through these instruments,
the government, commercial banks, financial institutions and
corporates can raise funds through money market. They also
provide investors additional instruments for investments.
4) Repo: Repos were introduced in 1992 to do away. With term
fluctuations in liquidity of money market. In 1996 reverse repos
were introduced. RBI has been using Repo and Reverse repo
operations to influence the volume of liquidity and to stabilise term
rate of interest or call rate. Repo rate was 6.75% in March 2011 and
reverse repo rate, was 5.75%.
5) Refinance by RBI: The RBI uses refinance facilities to various
sectors to meet liquidity shortages and control the credit conditions.
At present two schemes of refinancing are in operations: Export
credit refinance and general refinance. RBI has kept the refinance
rate linked to bank rate.
6) MMMFs: Money Market Mutual Funds were introduced in 1992.
The objective of the scheme was to provide an additional short-term
avenue to the individual investors. In 1995, RBI modified the
scheme to allow private sector organisation to set up MMMFs. So
far, three MMMFs have been set up one each by IDBI, UTI and one
in private sector.
7) DFHI: The Discount and Finance House of India was set up on 25th
April 1988. It buys bills and other short term paper from banks and
financial institutions. Bank can sell their short term securities to
DFHI and obtain funds in case they need them, without distributing
their investments.
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58 MBA Third Semester (IFS&FM) MDU
8) Clearing Corporation of India Limited (CCIL): CCIL was
registered in 2001 under the Companies Act, 1956 with the State
Bank of India as Chief Promoter. CCIL clears all transaction in
government securities and repos reported on NDS (Negotiated
Dealing System) of RBI and also Rupee/U.S.$ foreign exchange
spot and forward deals.
9) Regulation of NBFCs: In 1997, RBI Act was amended and it
provided a comprehensive regulation for Non-Bank Financial
Companies (NBFCs) sector. According to amendment, no NBFC
can carry on any business of a financial institution including
acceptance of public deposit, without obtaining a Certificate of
Registration from RBI. They are required to submit periodic returns
to RBI.
10) Recovery of Debts: In 1993 for speedy recovery of debts, RBI has
set up special Recovery Tribunals. The Special Recovery Tribunals
provides legal assistance to banks to recover dues.
11) Merging of Banks: On September 4, 1993 Government of India
merged the New Bank of India with Punjab National Bank.
12) Issue an Order Sanctioning and to Introduce Bill: On July 24,
2008 Govt. of India decided to issue an order sanctioning the
Scheme of Acquisition of State Bank of Saurashtra by State Bank of
India and to introduce Bill:
i) Repealing the State Bank of Saurashtra Act, 1950 in the
Parliament.
ii) To make consequential amendments in the State Bank of India
(Subsidiary Banks) Act, 1959 to remove references to State
Bank of Saurashtra wherever it occurs in the State Bank of India
(Subsidiary) Banks Act, 1959. The Bill is called State Bank of
India (Subsidiary Banks) Amendment Bill, 2008. State Bank of
Saurashtra merged on 13 August, 2008.
13) Approving the Merger of its Subsidiary: On June 20, 2009 the
State Bank of India (SBI) board has approved the merger of its
subsidiary, the State Bank of Indore, with itself. This would be the
second acquisition by SBI of a subsidiary bank after the merger of
State Bank of Saurashtra.
The State Bank of Indore board, too, has approved the merger
proposal. SBI holds 98.3% in the bank, and the balance 1.77% is
owned by individuals, who held the shares prior to its takeover by
the government.
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Financial System (Unit 1) (tppl.org.in) 59

1.6. EXERCISE

1.6.1. Short Answer Type Questions

1) What Financial System?
2) List the components of Indian financial system.
3) Give the meaning of Forex market.
4) State the meaning of futures trading.
5) What is money market?
6) State the the two money market player.
7) What is capital market?
8) Give the meaning of primary market.
9) State any two functions of money market.
10) What is secondary market?
11) Give the features of money market.
12) State the functions of money market.

1.6.2. Long Answer Type Questions

1) Discuss the evolution of Indian financial system.
2) What are the characteristics of the Indian financial system?
3) Elaborate the componets of Indian financial system.
4) “Financial markets and Financial institutions play an important role in
Financial system”. Do you agree? Justify your answer.
5) Discuss the importance and limitations of Indian financial system.
6) Describe the major reforms of Indian financial system.
7) Explain the forms of the Indian financial instruments.
8) Illustrate the Indian financial instuments and services.
9) Explain the functions of Indian financial system.
10) Explain the advantages and disadvantages of money market.
11) Describe the composition of money market in detail.
12) Discuss the money market instrument in detail.
13) Explain the money market players and institutions.
14) What are the recent developments in Indian money market?

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60 MBA Third Semester (IFS&FM) MDU

UNIT 2 Capital Market

2.1. CAPITAL MARKET

2.1.1. Introduction
Capital market (securities market) means a common place where the
borrowers and lenders meet to finance the requirement of long-term
funding. In a broader aspect, it involves all those channels from where
the savings are mobilised and the same are used in funding the industrial
and government expenditure. It comprises of savings that includes both
corporate as well as personal savings which are utilised for making
investments in the new IPO‟s and other public offerings that are issued
by the government authorities.

So, a capital market is a well organised market structure where the

money is transferred from the lender to the borrower in lieu of certain
interest or other compensatory benefits. The individual investors are the
primary savers who lends the same to the entrepreneurs for circulation
of money in the industry which may be either owned privately or belong
to the government.

According to P.K. Dhar, “This is not a market for capital goods; rather
it is a market for raising and advancing money capital for investment
purposes”.
According to M.Y. Khan, “It is a market for long-term funds. Its focus
is on financing of fixed investments in contrast to money market which
is the institutional source of working capital finance”.

2.1.2. History of Indian Capital Market

Indian stock market is one of the oldest markets in Asia. It was
established nearly 200 years ago, though the records pertaining to that
time are scarce. The market was dominated by the East India Company
which traded its loan securities in the market till the end of the 18 th
century. By 1830s, Bombay stock exchange was dealing in corporate
shares and stocks of bank and cotton presses. The range of securities
traded was increased in 1839. Between 1840 and 1850, only half a
dozen brokers were recognised by various banks and merchants.
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Capital Market (Unit 2) 61
In 1850s, there was accelerated development of commercial enterprise
and brokerage business, which leads to increase in the number of
brokers to 60.

With the American Civil War in 1860-61, the United States stopped the
supply of cotton to Europe. This trade situation led to Share Mania in
India; again it leads to sharp increase in the number of brokers to nearly
250. The end of the Civil War in 1865 brought about slump in India
which is evident from the fall in the price of share of Bank of Bombay
from `2,850 to `87.

As when the American Civil War ended, the brokers who do well in the
market moved to a street, which is now known as Dalal Street. It was a
place where brokers easily come together to transact their business
activities. „The Native Share and Stock Brokers Association’ was
formed in 1887. It was also known as The Stock Exchange. This
exchange purchased a premise in the same street in 1895 which later
inaugurated in 1899, and in this way The Stock Exchange at Bombay
was formed.

2.1.3. Characteristics of Capital Market

The various characteristics of capital market are as follows:
1) Link between Savers and Investment Opportunities: The capital
market acts as channel between the process of saving and
investment. The capital market sends money from savers to
entrepreneurial borrowers.
2) Provides Long Term Investment: The capital market supplies the
funds required for long and medium investment. The capital market
does not make use of short-term savings of less than one year.
3) Utilizes Intermediaries: Capital market uses various intermediaries
such as brokers, underwriters, depositories, etc. by which all the
work of capital market is performed and it is also the important part
of capital market.
4) Determinant of Capital Formation: The various task of the capital
market decide the rate of capital formation in an economy. The
capital market gives choices to the firm about utilising excess funds
to invest more in capital market which helps in increasing the saving
in the profitable manner.
5) Government Rules and Regulations: The capital market works
according to the rules and regulations framed by the government.
They are free but need to work according to the government
policies.
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62 MBA Third Semester (IFS&FM) MDU
6) No Entry Barriers: The capital market is accessible to all the
people. Any number of suppliers or users of funds can enter the
market and deal with each other.
7) Absence of Transaction Cost: The participant does not have to pay
transaction costs for buying and selling of securities.
8) No Tax Differences: The tax should be such that it should treat
every investor in the same manner. It should not be favourable to
one over other.
9) Liquidity: The capital market is more liquid as compared to real
estate or commodity market because they have various institutions
like banks, mutual funds, retail investors, hedge funds, etc. which
helps the investors in easily exiting from the market as the investors
can sell their investments whenever they want.
10) Variety of Instruments: The capital market has different type of
instruments like bonds, debentures, equity stocks, futures and
options. There are many more choices available according to the
risk bearing capacity of the investors. The company with high
leverage can increase their capital by investing in equity and the
company having less leverage can raise their capital by investing in
bond and debenture.

2.1.4. Functions of Capital Market

Following are the main functions of the capital market:
1) Allocation Function: Many times the investors are unaware
about the investment opportunities that are available to them and
thus are deprived of investing. Capital market in this situation
assists in channelizing the savings on behalf of the investors in
different available modes. So, the present savings are attributed
among the respective borrowers. The market acts a magnet where
different lenders having different perspectives are invited for
making their investment.
2) Liquidity Function: Capital market aims at bringing the lenders and
the borrowers at a common platform where they can exchange their
funds at mutually agreed interest rates and lending period. Thus, the
liquidity is always available at the discretion of both the parties.
3) Other Functions: Apart from the basic function of allocating the
funds and the liquidity function, capital market also serves the
following important functions:
i) Indicative Function: In addition to showing the progress report
of a company, capital market is also a good indicator of the
economic position of a country.
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Capital Market (Unit 2) 63
ii) Savings and Investment Function: The long-term debts can be
easily converted into liquid funds in less time. Thereby, the
lenders can redeem their funds at their own will. This helps in
restoring the confidence of the lenders as they earn a good rate
of interest with an assurance of liquid funds.
iii) Transfer Function: This market organises the movement of the
assets i.e. the tangible assets and the intangible assets in
different individual units or the groups.
iv) Merger Function: This market facilitates merging between the
willing companies and companies having a slack in their
management with the pioneers of the industry.

2.1.5. Importance of Capital Market

Following points illustrate the importance of the capital market:
1) Capital market provides direction to the company in achieving its
financial targets.
2) Amalgamations and mergers can be facilitated through the available
share price.
3) The element of liquidity assists in encouraging the growth.
4) Foreign investment is also attracted which brings about uniformity
in the reporting norms.
5) In case of insufficient availability of funds in the money market, the
funds can be arranged from the capital market.
6) Interests/dividend rates, liquidity, security entails the investors to do
in-depth study of the market and make the investments.

2.1.6. Limitations/Disadvantages of Capital Market

The disadvantages of capital market are as follows:
1) The capital market has the risk of losing money.
2) The capital market involves various charges which decrease profit
from various investment done.
3) The capital market has the problem of volatility as it does not
remain stable for long time especially in case of the long-term
investments.
4) The capital market has the risk for the people who pursue their
career in capital market. The businesses in which the investment is
done is liable for the working performance and also has the burden
of delivering goods. If the goods are not according to the customers,
it will indirectly lead to loosing the investors.
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64 MBA Third Semester (IFS&FM) MDU

2.1.7. Capital Market Instruments

Following instruments are found in the capital market:
1) Equity Shares: They are also termed as ordinary shares or common
stock. One might understand both the terms „shares‟ and „stocks‟ as
the same but there is some basic difference that is involved. Shares
denote the small units of equal denomination constituting the share
capital of the company. On the other hand, stock is the aggregate of
fully paid shares of the company that is taken together. In other
words, it is the collection of the shares. A stock has a value and
represents as to what quantum it contains. Thus, stock can be further
divided into fractions but again the denomination will be in terms of
money and not in terms of number of shares.
2) Preference Shares: Preference shares are like a hybrid instrument
as they possess the features of a bond as well as that of an equity
share. Unlike bonds, the preference shareholders have right to
receive dividend even if there are no profits or less profits. Also in
the event of liquidation of a company, their money is paid in
preference to the equity shares. And unlike equity shares, they
possess the characteristic of perpetual liability. Only the rate of
dividend is fixed, but it is at the discretion of the Board of Directors
to pay dividend or not.
3) Debentures: They constitute a type of debt payment and a
substitute to the shares. Basically, they are issued by the private
sector companies for raising desired funds from the general public.
Under this, the money is borrowed with a promise of redemption on
a certain fixed date and with the promise of periodic payment of
interest. In India, Debentures are treated like bonds only but
generally the bonds are issued by public sector companies.
4) Derivatives: Derivatives are the instruments whose value is
determine from the underlying instruments.
5) Sweat Equity: Sweat equity shares are equity shares issued by a
company to its employees or directors at a discount or as a
consideration other than cash for providing know-how or making
available rights in the nature of intellectual property or value
additions, by whatever name called.
As per Section 2(88) of the Companies Act, 2013 “sweat equity
shares” means such equity shares as are issued by a company to its
directors or employees at a discount or for consideration, other than
cash, for providing their know-how or making available rights in the
nature of intellectual property rights or value additions, by whatever
name called.
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Capital Market (Unit 2) 65
Sweat equity is used to describe the non-financial investment that
employees contribute to the development of a project such as a new
venture. For example, sweat equity is offered to the founders of the
company, as well as advisors and board members.

In many situations, where some members of a partnership are

contributing their money and others are spending time, the
partnership may be composed of cash and non-cash (or sweat
equity). Ultimately, sweat equity is regarded the same as
cash equity through a distribution of stock or other forms of equity
in a start-up venture. Sweat equity can also be considered literal.

For example, a homeowner may spend time fixing, repairing, and

renovating their home. The value of their efforts is considered sweat
equity and adds to the value of the home.
6) Warrant: A warrant is a bearer document of title to buy a
specified number of equity shares at a specified price. Usually,
warrants can be exercised over a number of years.
The life periods of warrants are long. Warrants are generally
offered in the form of the bond or preferred stock. Bonds may
bear low interest rate but the warrants offered along with them
helps the investor to enjoy the equity appreciation value.
Warrants are detachable. The investor can sell the warrants
separately and they are traded in the market.
7) Secured Premium Notes (SPNs): SPN is a secured debenture
redeemable at premium issued along with a detachable warrant,
redeemable after a notice period, i.e. four to seven years. The
warrants attached to SPN gives the holder the right to apply and
get allotted equity shares; provided the SPN is fully paid.
There is a lock-in period for SPN during which no interest will
be paid for an invested amount. The SPN holder has an option to
sell back the SPN to the company at par value after the lock-in
period. If the holder exercises this option, no interest/ premium will
be paid on redemption.

In case the SPN holder holds it further, the holder will be repaid the
principal amount along with the additional amount of interest/
premium on redemption in instalments as decided by the company.
The conversion of detachable warrants into equity shares will have
to be done within the limited time notified by the company.
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66 MBA Third Semester (IFS&FM) MDU

2.1.8. Difference between Money Market and

Capital Market
The basic differences between money market and capital market are as
follows:
Basis of Money Market Capital Market
Difference
1) Time-period Money market deals with Capital market deals with
of Investmentthe short-term investment. the long-term investment.
2) Use of The finance is used for The finance is used for both
Finance working capital in the fixed and working capital.
company.
3) Functions The basic functions of The basic functions of
money market are lending capital market are to
and borrowing for helping mobilise funds and have
the adjustment of liquidity effective use of resources
position. by lending.
4) Components The basic components of The basic components of
money market are call loan capital market are primary
market, collateral loan market and secondary
market, bill market and market.
acceptance houses.
5) Link The money market acts as The capital market acts as
the link between depositor the link between investors
and borrowers. and entrepreneur.
6) Underwriting The underwriting acts as The primary function of
the secondary function of capital market is
money market. underwriting.
7) Capital It raises capital from the It raises capital from the
Raising short-term surplus funds. public and invests in
selected securities for
getting high possible return
with low risk.
8) Customers The customer of money The customers of capital
market is Government as market are Central and
they purchase treasury bill State Government, public
of the government. and local bodies.

2.1.9. Constituents of Capital Market

The capital market can be divided into the following two categories:
Constituents of Capital Market

New Issue Market/

Primary Market Secondary Market
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Capital Market (Unit 2) 67

2.2. NEW ISSUE MARKET/PRIMARY

MARKET
2.2.1. Meaning of New Issue Market/Primary
Market
The new issue market is also known as primary market. This denotes
the New Issue Market i.e. where the shares are issued for the very first
time. In other words, the same were never issued before in the market.
Under this, the existing companies and the new entrants can bring the
new issues. The basic objective is to procure funds from the investors
and transfer the same to the new and existing entrepreneurs who are
either establishing a new set-up or expanding the existing one.
Primary market serves the dual purpose of investing the funds of the
investors as well as meeting the financial requirements of the companies.
The issuing companies are the ones who create the demand for the funds
whereas the investors facilitate the supply function of the funds. To bring
out a new issue in the market, services of various intermediaries,
specialised agencies, institutions are hired who undertake the activities of
promotion, transferring, selling, underwriting, etc.
Under this segment of the market, the savings are transformed into long-
term debts or investments. This is a major contributor to the economic
development and growth of the nation. The status of new issue, market
vibes and expert opinions derive a new public offer towards success.

2.2.2. Nature of New Issue Market

Points highlighting new issue market‟s nature are as follows:
1) It is a new source of procuring long-term capital.
2) Securities are brought for the first time in the market.
3) Also termed as the New Issue Market (NIM).
4) The investors directly deal with new securities.
5) Investors are issued the security certificates after the trading take place.
6) Securities are issued by the new companies or the existing ones
looking for their expansion.
7) Economy experiences capital formation.
8) Fixed assets are purchased from the procured funds in this market.
9) Those loans from financial institutions that are of long-term nature
are not considered in this market.
10) Under this, the private capital is converted into public capital.
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68 MBA Third Semester (IFS&FM) MDU

2.2.3. Role/Functions of the New Issue Market

New issue market performs the following functions:
1) Origination: It signifies that the issue is being carried out for the
first time i.e., its origin with the primary market. The proposal for
issue is further analysed by considering the size of issue, nature of
security, floatation methods that are used and the timing when the
issue was carried out.
Origination is carried out before an issue is brought in the
market. So, it basically includes the home assignments that are
done to ensure whether the ideal time exists for issuing new
securities in the market. The factors that can influence and affect
the issue are considered before hand to judge the viability of the
project. Financial viability and economic viability are some of
the major areas that have to be looked upon while deciding about
the issue.
The conditions that are to be considered for an issue are:
i) Time of Floating of an Issue: It comprises of the market
sentiments and the present prevailing conditions. Timing is
very important as it can affect the volume that is subscribed
by the public.
ii) Type of Issue: Type of issue i.e., whether the issued security is
preference, equity, bond or a debenture also decides the success
of an issue to a large extent.
iii) Price: The price at which the issue is quoted in the market also
influences the success of the issue. Some of the existing firms
who have a reputation of distributing the dividend may even
have a very high amount of premium while the ones who are
issuing for the first time have to be at par with the market. There
always exists a danger of price being over-or under-charged.
This situation has to be eliminated.
2) Underwriting: Under the underwriting agreements, services of the
underwriters (institution or broking firm) are hired who agree to sell
the shares of the company and even subscribe them in case the same
are not taken up by the public.
3) Distribution: Finally, the distribution of the shares is put into
execution. It means selling of shares and debentures to the public.
This is often carried out by the agents and the brokers on behalf of
the company. A list of frequent buyers is maintained by them, and
they are contacted for sale of the securities.
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Capital Market (Unit 2) 69

2.2.4. Advantages of New Issue Market

Few of the major advantages of primary market are as follows:
1) Raising of Funds: A company can easily raise funds from this
segment of the market. The new issues are most of the time capable
of raising funds from the dull market if they are priced adequately.
Investment in the equity component leads to the economic
development of the nation.
2) Safety: There is not much manipulation of the prices. So investing
in the primary market is considered as a safe option.
3) Attractive Scheme: No taxes like service tax, securities transaction
tax, stamp duty are leviable in the primary market, thereby making
it attractive.
4) Opportunity for Existing and the New Companies: A company
can either set-up a new business or diversify the existing one. Both
the companies have the opportunity to raise funds from the market
by new issue. The voluntary investors transfer their savings to the
companies who are in need of the funds.
5) Long-Term Requirements: The long-term requirements of the
companies are satisfied by raising money from the prospective
investors.
6) Good Returns: Apart from the routine investment opportunities,
the investors are provided with new options with better returns in
terms of dividend and long-term appreciation.
7) Attracting Small Investors: It does not necessarily require big
corporate investors. The savings of the small investors can be
mobilised.
8) Setting up New Business: Those entities who are the new entrants
also find the primary market quite attractive to raise funds and
satisfy their requirements.
9) Business Expansions: In case the company is looking for its
expansion and diversification, it requires funds. In such case, either
they have to borrow the funds from the banks or the financial
institutions or float their shares in the market. Raising funds by
issuing shares is considered as a better option as there is no burden
of regular payment of interest for a newly set-up company.
10) Formation of Capital: As the investor‟s savings are mobilized,
there accumulates a substantial portion of capital with the company.
The company then utilises the same for carrying out the production
function and this substantially contributes to the economy.
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70 MBA Third Semester (IFS&FM) MDU

2.2.5. Disadvantages of New Issue Market

Following are the disadvantages of the primary market:
1) Slackness in the Economy: The general depression in the
market in the late nineties did not encourage the fresh issues
much. The main reason behind economic slowdown was poor
performance of the industry. Investors feel reluctant if there is
poor response in the economy.
2) Reduced Fund Requirement: The reduction in demand for funds
by the industries also hampers the confidence of the investors.
Substantial reduction is noticed in the number of IPO‟s that are
being offered to the public. As a result, the public has already made
its own alternatives.
3) Sluggish Capital Market: Whenever the market faces depression, the
growth of the market is likely to be affected. This also influences poor
response of the investors towards primary market investments.
4) Lack of Confidence among Investors: The new issues were not
welcomed with the same degree of trust and enthusiasm that earlier
existed among the retail investors. Apart from this, because of poor
show of the market, the investors had already incurred substantial
losses and they felt reluctant for any fresh investments. The
investors had now realized the exact functioning of the market and
had clear knowledge of the same. They could now easily ascertain
the fair prices and the overpriced issue thus goes unsubscribed.
5) Inadequate Disclosure: The companies were making an inadequate
disclosure regarding the information that was required by the
investors for decision-making. They could not fulfill the purpose of
requirement publically available. One can easily say that good
corporate practice was missing. So, the investors often restrained
themselves from investing. As compared with the companies in the
developed capital market, the domestic companies were not
disclosing the requisite information in the desired manner. Charges
were imposed on the companies for diversion of the funds for other
purpose than the one that were stated in the offer document.
6) Lack of Liquidity: The primary market movement is also
influenced by the movement and trend in secondary market. Apart
from few securities, the rest were not offering the liquidity to the
investors and they were locked up in the secondary market and did
not have idle funds for investing in the primary market. Factors that
caused blockage of funds in the secondary market are:
i) The fluctuations in the market were based upon speculation and
not on the performance.
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Capital Market (Unit 2) 71
ii) Unpopularity of the money market took investors towards the
secondary market.
iii) The speculators could not short sell as that was again a
possibility if they were not able to lend the stock.
7) Re-Structuring of Business: Cases of amalgamations and mergers
were constantly reported as a result of globalization that took place in
the nineties. That further boosted the concept of re-structuring among
the corporates and they began to reorganise their businesses. The
performances of the companies were noticeably declining and the
investors were un-willing to spare their money for the money market.
8) Private Placement: Reduction in the issue cost and other allied costs
took the company towards offering the shares by way of private
placement. Majority of the time, the investors were unaware of any
new issue coming and that led to ignorance in this type of the market.

2.2.6. Recent Developments in Primary Market

The fresh capital raised through new issue markets has enhanced from
decade to decade. The primary market has become an important source
of mobilising fund for Indian issuers since the commencement of the
economic reformed process in 1991-92. There is a preference for raising
resources in the primary market through private placements of debt
instruments. Private placements accounted for about 91% of total
resources mobilised through domestic resources issued by the corporate
sector during 2000-01.
A major development in the Indian primary market has been the
introduction of “screen based book building”, where securities are
auctioned through an anonymous screen based system, and the price at
which securities are sold is discovered on the screen. This eliminates the
delays, risks and implementation difficulties associated with traditional
procedures. Despite considerable scepticism about the extent to which
computers could replace the services of highway skilled investment
bankers, it is reported that resource mobilisation through book building
rose steadily from 25% of public equity offerings in 2001 to 53% in
2002, 64% in 2003 and 99% in 2004. In this process, the primary market
has matched the secondary market in terms of using technology to
achieve an impersonal system of price discovery with widespread retail
participation that spans the country.
During 2015-16, 108 companies accessed the primary market and raised
58,166 crore through 95 public and 13 rights issues, as against 88
companies which raised 19,202 crore in 2014-15 through public (70)
and rights issues.
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72 MBA Third Semester (IFS&FM) MDU
Factors Affecting the Growth of Primary Market Instrument
The factors affecting the growth of primary market instrument are as
follows:
1) Industrial Growth: The industrial growth and exhausting
production capacities in the industry has necessitated further
expansion of industrial capacities. It induced the companies to
mobilise resources for further investment in future.
2) Buoyancy of the Secondary Market: Buoyancy of the secondary
market led all-round rise in prices of shares. This factor induced the
investors put higher amount of their savings in investment in the
primary market.
3) Fiscal Incentives: The fiscal incentives given to investors in
schemes of mutual funds and reduction in capital gain tax attracted
investors in the primary market.
4) Tightening of Norms: On-going process of improving the quality
of issues and tightening of norms relating to merchant bankers and
credit rate agencies probably created more confidence among
investors.

2.3. TYPES OF ISSUES IN NEW

ISSUE MARKET
Following are the four different ways of issue in the new issue market:
Types of Issues in New Issue Market

Public Issue
Rights Issue
Private Placement
Preferential Allotment

2.3.1. Public Issue

Public issue refers to issuing securities to the general public and is one
of the most commonly used methods in the primary market. Companies
Act, 2013 governs and monitors the issues that are made to the general
public. Apart from this, guidelines from SEBI are issued for the general
protection of the investor‟s interest and drawing up of an agreement
between the company and the exchanges for listing of the securities.
Companies Act lays the procedure that should be followed while
offering the shares to the public and the particulars of the information
that should be made available to the investors.
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Capital Market (Unit 2) 73
2.3.1.1. Regulation of Public Issue
The Capital Issues (Control) Act, 1947 was revised on May 29, 1992.
So, it became compulsory for the companies to reveal the information
relating to issue and pricing of the shares to the public at the time of
making an issue. To ensure this, SEBI has already issued certain
guidelines which are required to be adhered to. These guidelines cover
the companies who are issuing new securities for the first time and the
existing ones that are used for raising money. So, such guidelines are
applicable to all types of issues in the primary market.

Detailed guidelines have been issued by SEBI in relation to issuing

securities to the public. These were issued first on 11 th June, 1992 and
subsequently amended from time to time. To take it further,
consolidated guidelines have been issued by SEBI known as SEBI
(Disclosure and Investor Protection) Guidelines, 2000. Such guidelines
will be made applicable to both listed as well as unlisted companies
when they offer new securities and rights issue to the public, with the
only exception being that the rights issue, where the total value does
not exceed `50 lacs. In order to issue securities, following three
methods are used:
1) Historical method of receiving the applications via bankers and
others,
2) Book-building, and
3) Online system of stock exchange (e-IPO).

2.3.1.2. Classification of the Public Issue

There are two types of public issues:
1) Initial Public Offer (IPO): When shares are offered to the public
for the first time, it is referred to as IPO or public offering. They are
basically carried out by the new and young companies who are
targeting expansion and require capital for the same. Apart from
this, IPO can also be carried out by large companies who require
funds for their further expansion.
The services of an underwriter may be hired by an issuer company
for selling their shares in the market and timing the issue.
Investment in IPO can be a risky element. It is not always possible
to make the correct prediction of the behaviour of the stock while
trading in the initial days and even later on. The companies are new
to the market and have no track record based on which their
performance can be judged. Also it is difficult to predict the future
of the IPO of the existing companies who are in the phase of
expansion.
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74 MBA Third Semester (IFS&FM) MDU
Reasons for Listing in IPO
The listing in IPO is done because of the following reasons:
1) At the time of listing the companies‟ shares on the public
exchange, the company will try to issue some extra shares so that
the capital of the company can be increased. For buying newly-
issued shares investors have to pay a certain amount of money and
that money reaches directly in the account of the company.
2) The company for acquiring the maximum part of the stock market
issues IPO (Initial Public Offering) so that the capital of their
company can be raised which will be helpful for future growth.
The investors who invest in the IPO‟s are the shareholders of the
company and the company need not pay this capital back to them,
except in the case of dissolution. The shareholders are entitled to
get a share in the profit earned by the company.
After listing of the company, a company can go for its expansion by
issuing some more shares in the market so as to raise more capital with
the help of right issues, without raising any liability for the company.
This will also reduce the practice of finding and negotiating the single
investors. This can help the company to raise more capital easily from
the market. It will also motivate the others to list their companies.
Advantages of IPO
Following are the advantages of IPO:
i) Creating Awareness Among the Public: IPO assists in
marketing and making the public aware of the securities that are
being offered by the company. This provides publicity to the
company and the product appears on the shelves and the
investors can have a detailed view.
ii) Maximising the Capital: It is one of the best long-term sources
of raising funds for satisfying the requirement of the company.
By giving brief detail in the prospectus, the money can be raised
for mergers, amalgamations, take-overs, research and
development, working capital, etc.
iii) Liquidity: The allotted shares have a market value of their own.
They can be further resold in the market to the willing buyers.
So, the same can be transformed into money when desired.
Even the same can happen on the first day of the listing.
iv) Valuation: When public trades in the shares, certain standards
in terms of the base price are set for a share of a particular
company. This situation is an ideal one for the company. A
slight fall in the price will attract investors for purchasing the
shares. Thus, the value of the company is maintained.
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Capital Market (Unit 2) 75
v) Increase in Wealth: Normally, it has been noticed that price at
which the shares were initially offered to the public have grown
many a times over the years and thereby contributing in
maximising wealth for the shareholders.

Disadvantages of IPO
Following are the disadvantages of the IPO:
i) Significant Amount of Expenses: Issuing of an IPO does not
guarantee improvement in the financial conditions of the
company. Issuing of an IPO requires continuous infusion of
funds at the inception by the company. Such expenses incurred
may be in the nature of printing costs, advisory fees, legal fees,
accounting fees, ROC charges which are in relation with getting
the IPO registered. The total of such expenditures may
constitute a significant amount. Costs are one of the main
factors, similarly, there may be other factors also that influence
issuing of the IPO.
ii) Require Expert Personnel: Issuing of an IPO also requires
services of an expert personnel from different fields, as there
are number of compliances to be abided by.
iii) Invest Lot of Time: To ensure the execution of the IPO does
not attract much trouble, many companies hire the services of
experts who have years of experience in handling the inception
of the IPO. Once the basic compliances are done, then it
becomes a routine activity. The CEO also needs to invest a lot
of his time and getting the SEC regulations complied with. All
these aspects need to be handled with utmost care; otherwise the
same may cause serious disruption.
iv) Loss of Control: Some other disadvantages to the company
may in terms of loss of control, flexibility and confidentiality.
The companies are required to disclose all the information as
required by the SEC to the general public. This information may
at times contain sensitive elements as to profit margins, market
share, future endeavours, etc.
2) Follow on Public Offer (FPO): A company which had already
made a public issue at an earlier stage and is listed on the stock
exchange, when makes another issue, it is known as the Follow on
Public Offer (FPO). So, all the public offer of the existing listed
company that comes after the IPO is termed as the FPO. Such FPO
unlike IPO is also required to satisfy the listing and the other
norms as directed by SEBI and other regulatory authorities from
time to time.
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76 MBA Third Semester (IFS&FM) MDU
2.3.1.3. Advantages of Public Issue
Following are the advantages of the public issue:
1) The issue and the company get noticed by the general public and get
the desired publicity.
2) The issue is highly characterized by transparency.
3) There is adequate distribution of the issue among the public. This
ensures equal distribution of the wealth.
4) No discrimination is made among the applicants while issuing the
securities.
5) The prices are controlled, there is no artificial upward and
downward movement of it.
2.3.1.4. Disadvantages of Public Issue
Following are the disadvantages of the public issue:
1) The whole process involved with huge publicity costs.
2) Floatation Costs like underwriting expenses, brokerage, etc. also
need to be incurred.
3) Administrative costs like stationery and prospectus printing, postage
etc. also need to be incurred.
4) Legal costs like registration fees, stamp duty are also required to be
incurred.
5) Due to involvement of huge costs, this mode is only beneficial for
large issues.

2.3.2. Rights Issue

Rights issue is the offering of new shares by the company in the primary
market to its existing shareholders. As per Sec, 81 of Companies‟ Act
1956, when an addition is made by the company in its equity share
capital, it has to offer the existing shareholders to subscribe on pro-rata
basis. A cut-off date is notified for making such subscription after which
the right will cease to exist. The shareholders on the other hand may
even sell their rights in the market for a certain sum.

2.3.2.1. Rules Regarding Rights Issue

The following conditions need to be satisfied by the company for
making a rights issue as per Sec. 81:
1) Those companies, whose shares are already issued in the market,
can make a rights issue.
2) Pro-rata method should be adopted for issuing the rights shares i.e.
the existing shareholders are offered shares in proportion to their
existing holdings.
3) The shareholders are generally served a notice for specifying the
shares issued to them.
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Capital Market (Unit 2) 77
4) Minimum 15 days time to be given for acceptance of the rights shares.
5) The shareholders may subscribe, surrender or renounce their rights.
6) If there are any unsubscribed shares left after the expiry of the stated
period, the Board of Director may issue the same to the public.
2.3.2.2. Advantages of Rights Issue
The advantages of rights issue are as follows:
1) The capital can be raised in an economical manner.
2) Even after issuing rights shares, the pattern of shareholding remains
the same.
3) There is certainty in offering rights issue over the public issue.
4) The shareholders are offered rights shares at a subsidized price. So,
there is a monetary benefit involved for them.
5) The shareholders prefer investing as they are well known to the
company and the company is also a known investment for them.
2.3.2.3. Disadvantages of Rights Issue
Following are the disadvantages of the rights issue:
1) Rights issue can only be made by those companies who have made
an earlier issue.
2) The issue is offered only to the existing shareholders.
3) The wealth is accumulated only in limited hands.

2.3.3. Private Placement

Under private placement, the securities are not offered to the general
public, rather the same are issued privately to investors like mutual
funds, banks, venture capital funds, financial institutions, etc.
In India, making an Institutional Placement is termed as Qualified
Institutional Placements. This is another method of raising the capital
wherein, an already listed company issues fully or partly convertible
debentures, equity shares or other securities except warrants which can
be converted into equity shares by a Qualified Institutional Buyer (QIB).
Qualified institutional placement refers to the private selling of shares or
other securities that are convertible into shares to the qualified
institutional buyers as per the guidelines prescribed by SEBI.
2.3.3.1. Advantages of Private Placement
Following are the advantages of private placement:
1) Cost Effective: Cost involved as compared to public issue is quite
less. Public issue which was featured with printing, brokerage,
promotion, mailing, etc. contributed around 10% of the total size of
the issue. Whereas in case of private placement, majority of the
expenses can be saved.
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78 MBA Third Semester (IFS&FM) MDU

2) Time Effective: In case of public issue, approximately 6 months are

required to comply with all the requisite formalities but the same is
reduced to about 2-3 months in the case of the private placement.
3) Structure Effectiveness: The issue can be customised as per the
will of the entrepreneurs. It suits both the requirements of the
financial intermediaries and the entrepreneurs. For promoting the
issue, further discounts can be offered to the intermediaries who are
subscribing the issue. The same is not the case in public issue as it is
governed by the fixed guidelines.
4) Access Effective: A listed as well as an unlisted company can mobilise
its capital by way of a private placement. The issue size can be altered
and the pricing can be modified to cater the requirements of everyone.
While the same is not possible in case of public issue.
2.3.3.2. Disadvantages of Private Placement
Following are the disadvantages of private placement:
1) There are only few subscribers of the issue.
2) The prices may be influenced by the intermediaries.
3) The public may not be confident enough about the prospects of the
company.

2.3.4. Preferential Allotment

When the equity shares are issued to a selected group of investors and the
price is not the same that is quoted in the market is known as the
Preferential Allotment. A preferential allotment is not a public issue but
the shares are offered to a preferred category of investors among the
public. In India, normally preferential allotment is exercised while
awarding shares to the promoters or to the friendly and accustomed
investors where the company knows that there does not exist any threat of
takeover. The price that is set for the purpose of preferential allotment is
generally not less than the higher of average of weekly high and low of
closing prices of shares that are quoted on stock exchange during 6
months just before the relevant date or 2 weeks prior to the relevant date.
2.3.4.1. Advantages of Preferential Allotment
Advantages of preferential allotment are as follows:
1) Reduced Cost and Time: The costs and the time that are involved
are substantially reduced in case of preferential allotment. Also in
case where the performance of the company is not as per the
standard and the public is unwilling to subscribe to the shares, the
same may be allotted to some of the preferred investors. The reason
behind them investing is that they might see the slowdown in the
performance as temporary and hopeful for the future.
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Capital Market (Unit 2) 79
2) Promoter Control: Allotment of more shares to the promoters
increases the number of shares that are held by them. This is a
healthy sign for the company as the control will remain with only
the promoters.
3) No Legal Guidelines: No offer document or prospectus needs to be
filed with SEBI and there also does not exist any eligibility norms
for making the preferential allotment.
4) Accumulation of Funds: Preferential allotment of shares is
normally made in large number and thus the funds accumulated are
also healthy and capable of satisfying huge requirement with much
additional cost.
5) Eliminates Takeover: Number of takeovers taking place in the
present market conditions is characterized by. So, in this
atmosphere, issuing shares in the open market can be a risky affair.
Thus, when the same are issued to the friendly investors and
promoters, it eliminates the risk of the takeover.

2.3.4.2. Disadvantages of Preferential Allotment

Preferential allotment has the following disadvantages:
1) Consolidated Holding: The promoters have a belief that by holding
more shares and that too at a lesser price, they are in a sort of
secured position. For making a preferential allotment, a resolution
needs to be passed and the members as well as the proxies present
are considered.
2) Insider Trading: Insider trading is an inherent risk in issuing
preferential allotment.
3) Concentrated Control: Inside preferential allotment may be termed
as anti-democratic as the control is concentrated only in few hands.
4) Profit from Bull Run: In the situation of bull-run, promoter can
be biased by having preferential allotment at minimum price and
earn profit.

2.3.5. Offer for Sale Method

The offer for sale refers to the invitation given to the public for buying
existing shares of a company. The present shareholders take the benefit
of floatation of shares by linking offers for sale with initial public offers
for getting free from all or part of company holdings. The offer for sale
is the sale of present share by owners which are of high net worth
individuals who have till now invested a lot in the company to either a
targeted group or the general public. It is done to diversify the risk. The
offer for sale may be given in debt or equities. It is basically used by the
private company for becoming public company or by public company
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80 MBA Third Semester (IFS&FM) MDU
for asking quotation on exchange. The share proceeds after the sale is
given to the owner of the shares. The government can also use it for
making attempt to divest the interest in the company. There are two
main ways by which the company lists new share. They are as follows:
1) Through offer for sale as it is a public invitation by a sponsoring
intermediary, basically the investment bank.
2) Through offer for subscription or direct offer which is a public
invitation by the company issuing it itself. The price of the offer is
fixed in advance or there can be tender where the investors are
going to bid for price. Once all the bids are received, a strike price is
set which is paid by all the investors.
Features of Offer for Sale Method
The features of offer for sale method are as follows:
1) It is a public invitation for buying new or existing securities given
by sponsoring intermediary such as bank or broker. It is different
from offer for subscription in which there is invitation directly
from the issuer to subscribe.
2) It is the way of inviting the company to the stock market for
trading by selling shares in the new issue. The company sponsor
offers shares to the public by inviting subscription from investors:
i) By the offer for sale by fixed price- In this the sponsor fixes
prices before the offer is made.
ii) By the offer for sale by tender- In this the investor decides the
price of offer. A strike price is fixed by the sponsor after receiving
all the bids. Every investor has to pay the strike price.
3) The prospectus of offer for sale is given in the national newspaper
which contains all the information.
Advantages of Offer for Sale Method
1) It has the same advantages of that of public issue method.
2) The offer for sale method helps the issue company to save the cost
and also from various problems which may arise due to selling the
shares to the public.
3) It helps in sale of new issue at the time when there are unfavourable
circumstances in the market.
Disadvantages of Offer for Sale Method
1) It is the expensive method same as public issue method.
2) The issuing company may sell the shares at the premium price and
the difference between the actual and premium price will be kept by
the issuing company or the existing shareholders but not to the
issuer company.
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Capital Market (Unit 2) 81

2.3.6. Other Methods

The other methods under the primary market are:
Other Methods

Tender Method/Offer
Bonus Shares

2.3.6.1. Tender Method/Offer

In tender method, the Company A offers to tender the shares of
Company B at a given price. The price is paid in cash only. There can
only be stock or the combination of both cash and stock of Company B.

It uses the method in which the bidders have to put the offer direct to the
shareholders of the target company. Once the offer is declared, the buyer
stales the price then it is upto the shareholders of the target company to
decide whether they agree to the terms and will give their shares in the
offer or not. The buyer can also decide the form of payment of and the
expiry date of offer.

The tender offer is basically friendly because the board of the buyer and
the target company will agree on the terms of the offer. Thus, the tender
offer is the method for the buyer to have direct interaction with the
shareholders of the target firm and the way to adopt the fact of their own
company avoiding the opinion of the board of directors and they are
perfect method for unfriendly bids.

2.3.6.2. Bonus Shares

Dividends are generally paid in the form of cash. However, due to
paucity of liquid funds or some other reasons, a company may
choose to distribute its profits in some other forms also. In such
cases, the company may decide to issue Bonus Shares. Such shares
may be issued in lieu or in addition to the payment of cash dividend.
These shares are issued on Pro-rata basis of the current holding. It
does not change equity ownership proportion. Bonus shares defines
as “a premium or gift, usually of stock, by a corporation to
shareholders” or “an extra dividend paid to shareholders in a joint
stock company from surplus profit”.

However, the legal definition of bonus shares is slightly different. A

bonus share is not a dividend as Section 205 of the Companies Act,
1956 prohibits the payment of dividend in any form other than cash.
Similarly, bonus shares are not a gift either as these are the previous
profits not claimed by the shareholders.
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82 MBA Third Semester (IFS&FM) MDU
Features of Bonus Shares
The main features of Bonus Shares are as follows:
1) Issue of Bonus Shares does not change the proportion of ownership.
2) It leads to the fall of share price in the stock market.
3) Issue of bonus shares causes decline in book value of each share.
4) The number of shares issued increases after the release of Bonus
Shares.
5) Per share income decreases after the issue of bonus shares.

Advantages of Issue of Bonus Shares

Following are the main advantages of issuing bonus shares:
1) Advantages to the Company
i) Proper Utilisation of Cash: Bonus shares allow the company
to reward its shareholders with dividend, without using its cash
balance. The company can retain its cash for investment in
lucrative activities and for maintaining its liquidity.
ii) Compliance with Stipulations: A company may be under
restrictions inform its creditors regarding payment of dividends
in cash. In such cases, the company may issue equity shares to
keep its shareholders in confidence.
iii) Correcting Under-Capitalisation: A company may
rationalise its dividend payment rate by issuing bonus shares
inspite of payment of cash dividend as it brings down the
effective rate. Thus, under-capitalisation can be reduced by
issuing bonus shares.
iv) Rationalising Market Price: Issue of bonus shares brings
down the market price per share. This helps in increasing its
appeal to small investors. This may also help in increasing its
turnover rate.
v) Economical: Issue of bonus shares is a relatively inexpensive
exercise. Various expenses like brokerage and underwriting
commissions should be avoided at the time of allocating bonus
shares to the existing shareholders.
2) Advantages to Shareholders
i) Tax Saving: Shareholders are not liable to pay tax on bonus
shares as income whereas cash dividend is treated as income for
shareholders.
ii) Increased Marketability: If certain shareholders are not
interested in bonus shares but want cash instead, they can sell
their shares for liquidity. Thus, marketability increases by
issuing bonus shares.
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Capital Market (Unit 2) 83
iii) Increased Future Profits: When the company‟s Board of
Directors expect higher future profits, they declare bonus shares
to pay-off outstanding shares. This payment indicates higher
profitability of the company.
iv) Higher Future Dividends: If the company continues to pay
same rate of dividend even after bonus issue, the shareholders
are entitled to higher dividend in absolute terms.
v) Psychological Value: Bonus shares lead to increased
confidence among shareholders as they facilitate robust health
of the company.
Disadvantages of Issue of Bonus Shares
Bonus shares have some shortcomings as well which are mentioned as
below:
1) No Change in Shareholders’ Wealth: Bonus shares do not
increase overall wealth of a shareholder. While the number of shares
held by a shareholder increases, the corresponding decrease in their
market value leads to unchanged shareholders‟ wealth.
2) Expensive: Bonus shares have high cost to issue. It needs printing
of new share certificates and corresponding postal charges. Some of
the shareholders may sell their shares, increasing the number of
shareholders requiring their name to be entered on the register.
3) Speculation: Issue of bonus share may lead to increased speculation.
4) Complicated Procedure: A company needs to obtain various
approvals including approval of the SEBI before issuing bonus
shares. These steps make the procedure of issue lengthy, exhaustive
and complicated.

2.3.7. Methods of Determining Prices of New Shares

Methods of Determining Prices
of New Shares

Fixed Offer Method

Book Building Method

2.3.7.1. Fixed Offers Method

In fixed price offers, an issuer company has the right to price the issue.
The essential of issue price is given in the offer document in which the
issuer reveals about the qualitative and quantitative factors maintaining
the issue price. In other words, when the company prepares the
organised and real offer to its shareholders, there is fixed price offer
done for offering the way to buy a particular number of shares at a pre-
determined price. The fixed price is not too high for the investors.
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84 MBA Third Semester (IFS&FM) MDU
The Issuer company should be at the price band of 20% (cap in the price
band will not be in excess of 20% of the floor price) in the Draft offers
documents filed with SEBI and actual price is decided at a later date
prior to the filing of the final offer document with SEBI/ROCs.
2.3.7.2. Book-Building Method
In book-building method, the company offers the price range instead of
fixing a particular price of shares. It is also known as price discovery
method. The investors while bidding for the shares need to decide the
price at which they would bid for shares. The bid is also in the range
like `80, `90 or `100.
The final price is determined according to the demand and supply of the
shares. The floor price is the lowest price (`80) and the cap price is the
highest price (`100). The cut off price is the price at which the shares
are allotted. The process is started after choosing the lead manager and
investment banker. The investment banker does the work of making the
issue public. The book-building by the help of public bidding decides
the demand and price of a proposed issue of securities of the company.
It is done to determine the issue amount according to the price book-
built. After the price and the amount of issue are decided by the issuer,
the issue will be offered by private placement or the public offer
category or by both according to the SEBI law.
Characteristics of Book-Building
The characteristics of book building are explained as below:
1) Tendering Process: In the process of book building, the invitation is
given to a large number of public for the purchase of securities and
this is done through the tendering process. The investor who is
willing to purchase the security, comes and bids for the shares. The
lead manager decides that how much quantity of shares is to be issued
and the highest price at which demand is equal to the size of the issue.
2) Floor Price: Floor price refers to the lowest price at which the
bidding for securities is started by the investors. This price is
decided by the lead manager.
3) Price Band: This refers to the price for which invitation is given to
the public, i.e., it includes both the floor price and cap price.
Investors can bid any price in price band.
4) Bid: When any security needs to be sold, the various prices for which
the investor is ready to purchase the securities is called bid and those
prices are within the price band. The bidding for security is closed at
the cap price (maximum price). The investor gets the right to bid for
three optional prices for which an application form is to be filled.
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Capital Market (Unit 2) 85
5) Allotment: The final price for which allotment is to be made is decided
by the lead manager for which the investor has bid at or above fixed
price. The shares to the investor are allotted at a fixed price hence the
price for the allotment is equal to or less than the bid price.
6) Participants: As book building is the offer for a subscription which
is made publicly hence anyone can come and invest in securities.
But in case if the issue of securities is restricted, then only the
eligible investor is allowed to have a bid.
Book Building Process
The company can take two options for deciding the process of book
building i.e. 75% book building and 100% book building. Both of these
options are given by SEBI. The conditions of both the options are as
follows:
1) 75 Percent Book-Building: In 75% of book building, the securities
are given on the „firm basis‟ in which minimum of 25% of securities
is offered to the public. The basic conditions of this process are as
follows:
i) Eligibility: The companies which are qualified for issuing
public shares are also qualified for issuing capital by the book-
building process.
ii) Earmarking Securities: The decisions taken by the corporate
for issuing the securities by the help of book building process
and the used securities is earmarked separately by the help of
book-building is known as the placement portion category in the
prospectus. The excess securities left are referred as „net offer to
the public‟ category.
iii) Draft Prospectus: The draft prospectus to be filed with the
SEBI should have all the information excluding the price of the
issue. The actual mention is not done. The price band shows the
price range according to which subscription of the securities is
done. The prospectus at the final issue price is to be filled with
the ROC within two days.
iv) Appointment of Book Runner: The issuing company should
show in the prospectus the merchant banker which is appointed
as book runner. The institutional buyers which are qualified for
firm allotment and to the intermediaries which will work as
underwriter and will invite them to issue securities are given the
copy of draft prospectus to the book runner and he also keeps
the record of the names and the number of securities being
given to the intermediary buyer and the subscription price of the
issue in the placement portion.
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86 MBA Third Semester (IFS&FM) MDU
The information about the subscriptions received from
underwriters and other intermediaries is accumulated by the
book runner. The book runner totals the received subscriptions
after the specified time period is over. The underwriters will
make the payment for the total amount of the subscription of the
issues. The underwriter and institutional buyer give the payment
to the book runner by a day before the opening of the issue to
the public. The payment also includes the application money of
all the applications by which subscription of securities is done.
v) Price Setting: The issuing company and book runner decide the
accurate price of the issue of the offer to the public according to
the data collected from the intermediaries of the total order. The
issue price is decided according to the various bids received by
the book runner from the syndicate members which is formed
and the issue price would be for both the private placement and
public category. The number of securities to be issued is set
according to the amount and issue price. It is shown as below:
Number of Securities = Amount of Issue  Price per Security
vi) Underwriting: The underwriting agreement is made by the
member of the syndicate for the whole offer so that it is not
offered to the promoters, permanent employees and shareholders.
The price and number of shares for underwriting is given in the
agreement for book-building. It is important for the issues which
are kept as the „net offer to the public‟. The underwriters keep the
record of the subscription received for the issue in the placement
portion and give these records to the book runner. The book
runner has to subscribe to the shares which would be taken by the
underwriters if the underwriter is not in the position for taking the
same number of shares as agreed.
vii) Bank Account: The issuer opens two bank accounts, one for
collecting the application money by the private placement while
the other for the 25% offer of the total issue made by the public.
viii) Allotment: The intermediaries whose bid price is at or above the
determined issue price will be now suitable for the allotment of
securities. The intimation is sent to them for the subscription after
the eligibility is decided. The issuer might choose to allot
securities under the book-building method for both private
placement and public offer method on the same day if the
allotment in the private placement category needs to be done two
days prior to the closure date of the issue. Under the public offer
method, the guidelines are given for the allotment of securities.
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Capital Market (Unit 2) 87
The orders in the private placement are to be used for filling
public subscription if there is under-subscription to the public
offer method. The individual investors are given preference
in this process. In the same way, the spill over is allowed
when there is deficient subscription to the private placement
category from the public offer category. The issuer pays the
interest for the period between the closure date of the issue
and allotment date.
ix) Listing: The shares allotted in the private placement category
are listed by the 11th day of issue closure after the collection of
committed money from the underwriters and the other securities
also which are issued under the public offer category is eligible
for listing. The various securities which are offered on the
internet are not listed.
x) Inspection: The inspection of the book-building process is
controlled by SEBI. The SEBI can inspect the books and
records which are supported by intermediaries like book runner,
underwriter and others.
2) 100 Percent Book-Building: The 100 percent of securities is
offered according to the „firm basis‟ or is retained for promoters,
permanent employees of the issuer company in the 100 percent
book-building process. The minimum required issue of capital is
`25 crore. These shares are presented to the shareholder on the two
basis i.e. competitive basis or firm allotment basis. The process for
100 percent book-building process is explained as follows:
i) Conditions: The following conditions need to be satisfied for
100 percent of book-building which are as follows:
a) The required minimum capital is `25 crore.
b) The SEBI guidelines decide the reservation or firm
allotment to promoters. In the issuer company, promoters
can be the permanent employees and in the new company,
the permanent employees of the promoting company are the
promoters.
c) The allotment is done according to the competitive basis or
the firm allotment basis. In the case of the new company, it
is given to the shareholders of the promoting company and
in the existing company to the shareholders of group
companies.
d) The lead book runner is the eligible merchant bankers. The
draft prospectus should have the name of the merchant
bankers to be filed with the SEBI.
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88 MBA Third Semester (IFS&FM) MDU
ii) Lead Book Runner: The appointment of lead book runner is
important for the 100 percent book-building process by the
issuer and book runner does the work of book-building for
estimating the accurate price and amount of issue. The syndicate
which has the SEBI registered underwriters and another
qualified merchant as the member is formed by the lead book
runner. The lead merchant bankers need to manage the shortage
if there is any under-subscription of issue. The suggestion given
by SEBI in the draft prospectus need to be done by the book
runners. The book runner also maintains the records of the
book-building process which is guided by SEBI for inspecting
the way book-building is done by the company.
iii) Draft Prospectus: The draft prospectus having the information
about the required disclosure like the total size of issue
according to the SEBI norms is to be filed with SEBI by the
lead book runner. It is not necessary to show the issue price and
amount of issue. The SEBI gives the suggestions on the draft
prospectus within 21 days after receiving the draft prospectus.
iv) Essential Disclosures: The various information need to be
disclosed in the draft prospectus prior to the filing to SEBI are:
a) The details of the member of the syndicate made by the lead
book runner for objective of bidding for the issue.
b) The information of the registrars and bankers to the issue.
c) The information about the factors determining the issue
price by the issuer and book runner.
d) The information about the accounting ratios like pre-issue
EPS, P/E, average return on net worth, etc., of three years
and also helps in the comparison with industry average. The
ratio is calculated once the effect to the consequent rise in
the capital according to the compulsory outstanding
conversions.
e) The information of NAV per share as per the previous
balance sheet.
v) Advertisement: The advertisement according to the provision
of Section 2A of the Companies Act is given in the national
newspapers after getting the revised prospectus from SEBI. It is
important for the issuing company to give 10% of the total issue
to the public.
vi) Stock Brokers: The stock brokers which are SEBI-registered
are selected for placing orders with the company by the stock
exchange which would be as the collection centers for the
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Capital Market (Unit 2) 89
applications. The brokers should be such that they can take up
the issue in case of the failure on behalf of their clients for
fulfilling the commitment. The brokers are given commission to
the issuer for their services.
vii) Bidding Process: The bidding is done by the syndicate for
securities to be issued by the issuer. The process for bidding is as
follows:
a) The advertisement of the bidding having the information of
the date of opening and closing of the bidding, name and
address of the syndicate members, bidding terms and
conditions and the way bidding is to be done.
b) The bidding is done by members who are present at the
designated centers by the help of internet.
c) The SEBI guidelines decide the number of collection
centers and bidding centers.
d) The individuals and institutions which are not the members
of the syndicate can bid by the help of syndicate members.
e) The information about the investor, price and number of
securities in the bidding is to be given.
f) The serial number of the bidding form will be system
generated and will be stamped automatically.
g) The bidding form will be two which should be signed by the
investor and countersigned by the book runner or syndicate
member.
viii) Allotment Process: The allotment process of allotment of
securities is as follows:
a) The minimum 15% of the issue will be kept for allotment to
individual investors to a maximum of 10 tradable lots by the
syndicate member.
b) The individual investors who have not taken part in the
book-building process will be allotted the minimum of 10%
of the issue which is being reserved.
c) The proportionate allotment system decides the allotment to
be done to individual investors.
d) In case there is under-subscription of issue, shares are kept
for the individual investors and the issuer company does the
allotment according the way it is fit.
e) Before the commitment, investor quality, price quoted, etc.,
the allotment of other categories of investors will be
according to the book runner.
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90 MBA Third Semester (IFS&FM) MDU
f) The allotment will be done within 15 days from the date of
final closure of the issue. If the company will not be able to
do so, then it will lead the company to pay interest @ 15%
p.a. to the investors.
ix) Refund: If there is any unsuccessful applicants within 3 days of
receipt of allotment, the broker will get the refund. The amount
received from the successful applicants will be provided to the
stock exchange by the help of electronic medium.
x) Certificate: After the completion of the procedure of the
subscription and allotment, the registers issue post the share
certificate to the applicants or will demat the shares by the help
of depository.

Difference between Fixed Offer Method and Book Building Method

Basis of Difference Fixed Price Method Book Building Method
1) Knowledge The price of the securities is The prices of the securities
about Pricing known to the investors of the are not known in advance to
firm before the securities are the investors before the
offered or allotted. investors are offered or
allocated. There is
knowledge of only indicative
price range.
2) Demand After the closure of the issue, The demand of the securities
the demand of the securities is is known after the book
known. building.
3) Payment Payment is done at the time of The payment is done after
subscription whereas refund is the allocation.
done after the allocation.
4) Pricing of In the fixed price method, the In the book building, the
Issue issue price is fixed before 60 to issue price is fixed one or
70 days prior to the opening of two weeks prior to the
the issue and the issuer does not opening of the issue. Thus,
have the knowledge about the the issue price is more
market perception of estimated accurate.
price
5) Over- In the fixed price method, there In the book building, there
Subscription is possibility of over- are less possibility of under-
and Under- subscription and under- subscription and over-
Subscription subscription. subscription. The issuer can
exist from the market if the
demand of the shares is not
present.
6) Issue Cost The fixed price issue has very In book building, issue cost
high cost as it has a pre-issue is less.
cost of 2-3%.
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Capital Market (Unit 2) 91
Advantages of Book Building
The various advantages of book building are as follows:
1) It helps to determine the intrinsic value of the security and leads to
price discovery.
2) By taking into account the demand for security, the price is
determined in an accurate way.
3) The price for security is extreme for the issuer.
4) There exist insecurity regarding the success of the issue as it is pre-
sold.
5) The process of book building is cheaper as it incurs low cost in
advertisement and brokerage. Hence, the net fund which the issuer
gets will be high.
6) The trustworthiness of the issue will increase as it includes the many
syndicate members.
7) The issuer has more elasticity with reference to price discrimination
and size of the issue.
8) There is more transparency in the allotment of securities to the investor.
9) The investors have greater assurance on the issue due to the
middlemen.
10) Normally, the market price of the security does not go below the
issue price as the prices are affected according to the market.
11) The quality investors are selected by the issuing firm.
12) It generates enthusiasm in the capital market.
13) It does not lead to delay in time between the date of opening of the
issue and the allotment of securities.
14) There is a provision of minimum subscription.

Disadvantages/Limitations of Book Building

Besides having the advantages the book building suffers from
limitations too which are described as follows:
1) The Indian process of book building is different from the USA
where the issue price is decided just before the opening of the issue.
The bidding in the USA is done also on paper i.e., it provides two
ways for the bidding process (verbally and written) which is not
there in India.
2) In India, the book building process depends on the honesty of the
investor hence some investors are invited to the process.
3) There is lack of clarity in the bidding process and in the strong
regulation.
4) This method is not considered as an appropriate tool for price
discovery.
5) Issuer may have to sell the security at low cost.
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92 MBA Third Semester (IFS&FM) MDU

2.4. STOCK EXCHANGE/

SECONDARY MARKET
2.4.1. Meaning of Secondary Market/Stock
Exchange
The secondary market is also known as the „after-market‟. It refers to
the financial market to buy and sell financial instruments and securities
which have been previously issued. These financial instruments include
stock, bonds, futures and options. The term also refers to the market for
any previously used assets or goods. It includes alternative use of the
commodity. For example, corn is generally used as a foodstuff,
however its secondary market involves the use of corn for producing
ethanol. Other names used for such markets are Stock Market or Stock
Exchange.
In such markets, currently existing securities are traded among investors
or traders. These markets comprise organised stock exchanges, over-the-
counter and other such platforms.
Under primary issue, securities or other financial instruments are brought
directly from the issuers through an IPO, private placement or similar
modes. In case of treasuries, these instruments are bought directly from
the federal government. However, once primary issue is over, other
investors can obtain these instruments from original purchasers and so on.
The stocks are listed and traded on stock exchanges. These exchanges are
corporate or mutual entities which specialize in bringing buyers and
sellers of such instruments together. Stock exchanges serve as an
organized market for the trading of securities and financial instruments. It
helps in smooth exchange of the securities.
According to Pyle, “Security exchanges are marketplaces where
securities that have been listed thereon may be bought and sold for
either investment or speculation”. Stock exchanges allow trading in
securities both to the genuine investors and speculators.
According to Securities Contract (Regulation) Act, 1956, “Stock
exchange means anybody or individuals whether incorporated or not,
constituted for the purpose of assisting, regulating or controlling the
business of buying and selling in securities”.
According to Husband and Dockeray, “Securities or stock exchanges
are privately organized markets which are used to facilitate trading in
securities”.
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Capital Market (Unit 2) 93

2.4.2. Nature of Secondary Market

Following are the main characteristics of secondary market:
1) Stock exchanges engage in formerly issued securities.
2) The beginning of the security does not take place through this
source i.e., Stock exchange.
3) Securities are not allotted directly by the corporation to investors.
4) Securities are traded by the current investors to other investors.
5) The proposing buyer and seller can purchase and sell securities via
brokers.
6) Stock exchange delivers liquidity to the investment and augments
the marketability of securities.
7) Stock exchange simply transmits existing securities between buyers
and sellers.
8) Stock exchanges are not considered as the direct source of
generating capital.

2.4.3. Functions of Secondary Market

Following are the main functions of a secondary market:
1) Ensure Liquidity of Capital: The stock exchanges help to convert
shares and stocks into cash. These exchanges ensure that there is
always a ready market for the sale and purchase of securities. It
helps in converting stock holding into hard cash as and when
required by the holder. In the absence of stock exchanges, many
investors would have hesitated in blocking their money.
2) Continuous Market for Securities: The stock exchanges offer a ready
market for the exchange of securities. Once listed on the exchange, the
securities keep on trading despite continuous change in its owners. The
exchanges thus act as a regular market for such securities.
3) Evaluation of Securities: The investors can determine the true
value of their holding by using the price quotations offered by stock
exchanges. These prices are determined by free demand and supply
forces and thus are according to the rules of free market.
4) Mobilising Surplus Savings: Stock exchanges facilitate free
exchange of securities, making it easier for people with surplus
funds to invest in securities and financial instruments. In the
absence of stock exchanges, such people will not have a proper
avenue for investing their surplus.
5) Helpful in Raising New Capital: Capital is required by both new
as well as existing business concerns. New concerns require capital
for starting their business while existing concerns require funds for
their diversification and expansion.
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94 MBA Third Semester (IFS&FM) MDU
6) Safety in Dealings: Stock exchanges are governed by Securities
Contract (Regulation) Act, 1956 and thus the chances of frauds
and manipulations are minimised. All the contracts are executed
as per the given procedures. So, no parties have any doubt
regarding the deals.
7) Listing of Securities: Stock exchanges permit the trading of only
listed securities. A corporation is required to apply to the exchange
authorities if it is willing to get its securities listed. Various factors
such as prospects of the company, its management and capital
structure are critically examined for determining its eligibility.
8) Platform for Public Debt: Stock exchanges can also be used for raising
public debts, which are important for carrying out economic
development activities. Apart from public debts, stock markets are also
used for issuing government securities. There is no separate platform for
government securities and these instruments are dealt through brokers.
9) Clearing House of Business Information: The business desirous
of getting their securities listed need to provide financial
information including annual reports and financial statements etc.
Such information is required by investors for making informed
decisions and framing policies.

2.4.4. Intermediaries in Secondary Market

Following are the main participants in secondary market:
Intermediaries in Secondary Market

Stock Broker
Financial Intermediaries

Individual Investors

1) Stock Broker: A stock broker is a professional with proper

qualifications and regulatory knowledge. This professional deals in
stocks and other securities on behalf of their clients. Brokers are
also responsible for providing advisory services to their clients, so
that their funds are properly allocated. There are different types of
stock brokers such as jobber, commission broker, odd lot dealer,
security dealers and taraniwalla, etc.
2) Financial Intermediaries: Financial intermediaries are all those
participants which intermediate and enable financial transactions.
They assist individual as well as corporate clients. Financial
intermediaries can help in facilitating the movement of funds as
they can accept funds from one organization and lend it to another.
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Capital Market (Unit 2) 95
Thus, it acts as a mediator between net borrowers and the net savers
of funds in an economy. These institutions borrow from the net
savers and lend the funds to the net borrowers. Following are the
main financial intermediaries which facilitate the flow of funds:
i) Commercial Banks: Commercial Banks are also known as
joint stock banks as they have the same constitution such as
joint stock companies. Commercial banks are the banks which
carry out all the banking functions including accepting deposits,
disbursing loans, granting credit facility and also performing
agency functions.
ii) Development Financial Institutions: After independence, the
country felt a strong need for development financial institutions.
These institutions are required for supporting and accelerating
the pace of industrialization. The existing firms needed funds
for expansion, modernisation and diversification while new
firms had massive investment requirements. Development
Financial Institutions were required to fill the gap between
requirements and existing banking system.
iii) Insurance Companies: Insurance may be defined as a social
instrument for reducing or eliminating risk related to the loss of
life or property. It implies collective undertaking of risk.
Insurance companies help in spreading the risks and losses of
few people among a large number of people. This is based on
the assumption that people prefer to have a small fixed liability
instead of large and uncertain liability. It is economic co-
operation for sharing unavoidable risks.
iv) Mutual Fund: A mutual fund is a form of collective investments
which are managed by professionals. These professionals pool
money from a large number of investors and invest them in
various instruments such as stocks, bonds, money market
instruments and others. Fund‟s underlying securities are traded by
the fund manager or the portfolio manager. The fund grows
through capital gains or losses, interest income and dividend.
3) Non-Banking Financial Institutions: These institutions perform a
variety of banking functions; however, as they do not hold the banking
licence, these are not called banks. Such non-banking financial
institutions are the companies which are registered under the
Companies Act, 1956 and are directed by the Reserve Bank of India.
Such companies deal in loans, leases, housing finance, hire purchase,
investments, etc. but exclude stock broking companies, stock
exchanges or insurance.
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96 MBA Third Semester (IFS&FM) MDU
4) Individual Investors: Individual investors generally do not engage
in elaborate research for making investment decisions. They are
simply required to communicate their requirements to their brokers.

2.4.5. Structure of Stock Exchange

The structure of stock exchange is divided into four groups:
1) First Market (Organised Stock Exchanges): The stock exchange
is the central trading place, where the securities of the various
companies are bought and sold. These securities comprises of
equity, debt instruments, and derivatives. The equity shares can only
be traded, if they are part of the stock exchange trading list of an
organised exchange. This list consists of various instruments which
fulfill the needs fixed by the exchange comprising of minimum
earning needs, net tangible assets, market capitalisation, and number
and distribution of the publicly held shares. The different stock
exchange have different type of needs.
2) Second Market (Over-The-Counter Market): The marketplace
needed for trading the financial instruments which are usually
unlisted financial instruments is known as Over-the-counter
(OTC) market. It consists of network of dealers who make markets
in individual securities. The listed and unlisted equity shares are
traded in this market.
The types of OTC market are as follows:
i) Unorganised OTC Markets: The market where the
unorganised trading is done between the individuals is known as
unorganised OTC markets. It does not limit the chances to buy
and sell the shares outside the organised exchange.
ii) Highly Organised and Sophisticated OTC Markets: The
markets specialises in trading in certain company shares is
known as Highly Organised and Sophisticated OTC
Markets. For example, NASDAQ and upstairs markets in the
United States, etc. The trading is to be done with the help of
computer network. The market makers shows the prices at
which they are ready to buy and sell and the investor trade with
the market markers by the help of brokers.

The institutional investors uses the upstairs market and need to

monitor the buying and selling orders of large quantity. The
institutions place orders by the brokers, who try to locate transaction
counterparty. The broker needs to apply the order with market
makers, if there is no counterplay.
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Capital Market (Unit 2) 97
3) Third Market: The OTC market stock related to exchange is the
third market. There are various transactions in the listed stock which
has been done on exchange, a brokerage firm which is not the
member of exchange and do the market in a listed stock. The OTC
dealer is the part of the third market gives less number of services to
their customers which are only buying and selling of orders and
keeping a record. They are ready to implement the large trades at
the low commission. The third market works, if the OTC market in
these stocks is as good as the exchange market and the relative cost
of the OTC transaction is compared with the cost on the exchange.
4) Fourth Market: The process of lowering the commission costs in the
security process may be leading to full removal of broker-dealer firm as
a middlemen in the fourth market. The trading in the fourth market is
done when one investor sells the security directly to another without the
involvement of middlemen. The communication network between
block traders helps in doing the direct investor-to-investor trading.
There are almost 10,000 or more shares in a block in a single
transaction. The normal dealer system is bypassed by the participants of
the fourth markets. The organiser of the fourth market, however, gets
only a small commission for assisting to organise the block process.

2.4.6. Advantages of Secondary Market

Following are the main advantages of Secondary Market:
1) Industrial Growth and Development: Secondary markets are
important for facilitating the growth of industry by offering
sufficient amount of capital.
2) Capital Formation: Stock exchanges help in capital formation by
inspiring investment and savings. These exchanges offer liquidity,
profitability and safety of funds to the investors.
3) Investment Decisions: The stock exchanges provide important
information such as prices of the securities to facilitate investment
decisions. The trend in stock prices indicates the company‟s current
financial position.
4) Stock Exchanges as Measuring Tool of the Economy: A stock
exchange as a measuring tool reflects the environment changes and
shows the trends in the economy and industrial status of a country.

2.4.7. Disadvantages of Secondary Market

Following are the main shortcomings of a secondary market:
1) Rampant Speculation: In the recent past, Indian stock exchanges
have seen various booms and crashes. Share prices are also much
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98 MBA Third Semester (IFS&FM) MDU
more volatile than general price trend. These factors indicate the
presence of speculative tendencies which are not very healthy.
2) Insider Trading: This refers to use of the information which is not
available to general market. Such price sensitive information may
provide extra edge to speculators.
3) Oligopolistic: Indian stock market is dominated by big financial
institutions and brokers, making it oligopolistic in nature. This
hinders true competitiveness.
4) Limited Forward Trading: Stock exchanges deal in hand delivery,
forward delivery and spot delivery. Forward trading was banned in
India in 1969, adversely affecting the share prices.
5) Outdated Share Trading System: Various aspects of Indian
trading system such as margin system , carry forward and settlement
periods are entirely outdated.
6) Lack of a Single Market: There is no cohesiveness between
regional stock markets. Such limited interaction between them
increases the costs and risks involved, especially for investors in the
smaller markets.
7) Problems of Interface between Primary and Secondary
Markets: Recent boom in primary market has caused problems
related to secondary markets. Such stock exchange still deals with
old infrastructure and hinders the growth process.
8) Inadequacy of Investor Service: Stock exchanges, primarily the
smaller ones, are not able to provide proper services to their
investors and thus they do not contribute to increase in the scope of
equity markets.

2.4.8. Relationship between Primary Market

and Secondary Market
The relationship between primary and secondary market may be
explained as below:
1) Liquidity: Primary market cannot exist without the secondary
market. It is the secondary market which provides liquidity. Once
the stocks are listed, those are traded on secondary market.
2) Listing: The stock exchanges control the primary markets through
listing requirements. This helps in maintaining law and order as the
companies are required to comply with set rules and regulations.
3) Marketability: The primary market offers connection between the
potential buyer and the company. Stock exchanges promote
investment in new issues by offering safety and liquidity. The
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Capital Market (Unit 2) 99
capital appreciation and marketability are the main factors which
attract potential investors. Stock exchanges thus provide a link
between the company and the savers.
4) Complementary: While primary and secondary markets differ in
their organisational structure and operations but both are necessary
for their overall robustness.

2.4.9. Difference between Primary Market and

Secondary Market
Basis of Difference Primary Market Secondary Market
1) Issues Primary market transacts only It deals primarily in
with new issues. Issues are existing securities.
fresh or new when such issues
are made for the first time
either by the new company or
by the existing company.
2) Location It does not require any fixed It requires a fixed place
geographical location. to carry out their trading.
3) Transfer of Securities are created for the Securities are transmitted
securities first time and are transferred from one investor to
from corporate to investors. another through the use
of stock exchange
mechanism.
4) Entry All companies can come into Securities are required to
new issue market and offer be listed for their trading
fresh issue of securities. in secondary market.
5) Administration It does not have any tangible For the purpose of
administrative set-up. facilitating trading, it
must has a definite
administrative set-up.
6) Regulation It is governed by regulatory It is regulated both inside
bodies such as SEBI, Stock and outside the stock
Exchanges, Companies Act, etc. exchange structure.
7) Aim It creates long-term It offers liquidity by
instruments for borrowing. providing marketability
to its instruments.
8) Price Pricing of new issues is Stock prices are affected
Movement affected by stock price by micro and macro
movements in secondary price movements.
market.
9) Depth It varies with the number and Depth is contingent upon
the volume of issue. the actions of the
primary market as it
brings in more corporate
entities and more
financial instruments for
raising funds.
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100 MBA Third Semester (IFS&FM) MDU

2.5. TRADING & SETTLEMENT

PROCEDURE IN STOCK EXCHANGE
2.5.1. Trading Procedure
In order to carry out trading at the stock exchange, the investor is
required to have some basic knowledge of the operations at the stock
market. The existing or the new securities can be either purchased or
sold only through the members dealing at the stock exchange which
may have any status that of an individual or partnership. Unless the
investor is registered to carry out trading on his own, he must use the
services of any of the members for trading purpose. Any trading is
carried on under the yardstick of the statutory compulsions imposed by
the stock exchange. Members are also referred to as the brokers and they
are permissible to trade only in the listed securities. Customer‟s orders
relating to buying and selling are executed and they receive commission
against the services rendered by them. Nearly 25% of the total members
of the stock exchange hold specialisation in making a market. To build
the relation between the investor and the broker there is a need of a
transaction (i.e., the activity of buying and selling of securities) which is
also referred to as the trade. The power to select the broker lies with the
individual investor.
The following steps enumerate the procedure for trading at the stock
exchange:
1) Finding a Broker: A broker is compulsorily required for trading at
the stock exchange. So, trading at the stock exchange initiates with
finding a broker, who can carry out the transactions on behalf of the
investor.
2) Select the Broker: There are a large number of brokers that are
available to carry out the transactions. It is upto the investors to
select one broker based upon their creditability. However, the
following yardsticks can prove to be helpful:
i) Facilitation services like payment pick-up and early
disbursement,
ii) Rate of brokerage,
iii) Other facilities like online trading, funds transfer, online access
to ledger accounts,
iv) Advisory and recommendations functions,
v) Staff is capable and skilled,
vi) Ease in approaching and contacting, and
vii) Knowledge regarding capital market and future projections.
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Capital Market (Unit 2) 101
3) Opening an Account with Broker: After the selection of the
broker is done, the next step is opening a trading account with the
broker. For such purpose, the relevant KYC documents are required
to be submitted. Opening of the trading account indicates that the
investor authorises the broker to purchase and sell securities on his
behalf. Once the trading account is opened, the investor is issued a
unique client code and the same is required to be mentioned while
carrying out any of the transactions.
4) Opening a Demat Account: Since 2002, it has been made
mandatory to hold all the securities in a demat form i.e. the physical
form has been terminated. Demat signifies electronic holding of the
securities. Such demat account can be opened with a bank or a
Depository Participant. All the holdings of the investor will be kept
in an electronic form in the demat account. Any physical shares
lying with the investors need to be converted into the demat
account, only then it can be sold further. For conversion, the same is
required to be dispatched to the registrar through the broker.
5) Placing an Order: Whenever the investor sees an opportunity and
finds that a stock is being traded at a price that is quite low from his
benchmark, he asks the broker to purchase the securities on his
behalf and the price is paid within the settlement period. Care
should be taken while placing the order to mention the unique client
code issued earlier.
6) Execution of the Order in the Stock Exchange: Generally, the
investor quotes the price at which he is willing to purchase. The
same is then matched with the willing seller who is ready to sell at
that designated price. If both match, a trade takes place. For
example, a buyer while placing a purchase order has quoted 100
shares of ABC Ltd. at `60. The same order will be put in the queue.
Then a seller arise who is willing to sell 100 shares of ABC Ltd. at
`60, the trade will take place. Now supposing, the seller quotes a
higher price, then the trade will not take place. So, for a trade to
happen, it is necessary that the ordered price and the quantity should
match with the sellers quantity and the price.

Different Type of Orders

The orders can be categorised as:
i) Market Order: It is the type of order where the broker is
intimated to purchase or sell a certain quantity of the shares on
behalf of the investor immediately. Broker in this case is
expected to adhere to due diligence and get the best price for the
investor as and when placing of the order is done. When the
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102 MBA Third Semester (IFS&FM) MDU
investor places an order, it is quite certain the shares will be
purchased but there can be a slight variation in the price. Market
orders are also referred to as the day orders which means the
validity of the orders last only for that particular day.
ii) Limit Order: In this type of order, when an order is placed by
the investor, certain limit is also specified with instructions to
make the contract at the price specified or even lower than the
specified price. However, in case of a sell order the limit is to
sell the securities at the specified price or higher than that price.
So, in a way, both at the time of purchase or sale a limit is
specified to execute the transactions. In case, the desired price
never occurs, the contract is not executed. Thus, this does not
guarantee a contract.
iii) Stop Order: In this case, a stop price needs to be specified by the
investor. If the contract is for a sale, the price must be less than the
market price, similarly, in case of a purchase; it must be above the
market price. At a later stage, if someone trades in the same
security, and the stop price is reached, the contract is executed. So,
stop order basically denotes a market order that is conditional.
iv) Stop Limit Order: It is an improvement over the stop order. The
investors under this are provided more specifically the associated
price alongside a stop order. Apart from one, the investor is
specified two prices i.e. a stop price and limit price. As and when
some other investor trades or reaches at stop price, a limit order
gets created alongside a limit price. So, it can be said that a stop
order is merely a limit order with further condition.
v) Day Order: Under this, usually an order is placed to purchase
or sale at a certain price or even better than that price. If, during
the day, the price is not reached, the order expires. All orders
placed with the broker, usually adopts the nature of day order
unless the same is instructed to be GTC.
vi) Good-Till-Cancelled (GTC) Order: It is similar to a day
order, but the difference being that the same remains open till
execution or cancelled by the investor himself. These types of
orders require a semi-annual confirmation. However, the dates
are communicated by the stock exchange. These orders are also
referred as the open orders.
vii) All-or-None Order (AON): In this type of order, the investor
wishes that the entire lot of the order for purchase or sell to be
executed. This requires close monitoring by the floor broker so
that the exact quantity is booked at the desired price of the
customer. Such orders need too much time for execution.
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Capital Market (Unit 2) 103
viii) Immediate-or-Cancel (IOC): This type of order requires
immediate execution and even if the execution is partial, the
same is acceptable. The part of the order that could not be
executed gets cancelled.
7) Receiving Contract Note: After the execution of the trade, the
client gets informed about the trade by way of execution of a
contract note. It is basically a written acknowledgement of trade
being conducted on behalf of the client during the day. It contains
all required details like client unique code, client‟s name, details of
the transactions entered into, effective price, brokerage and other
charges levied and the payment required to be made by the investor.
Statutory guidelines are required for delivery of the contract notes
within 24 hours of the day trade. If the same is not abided by, the
broker is penalised by stock exchange. With the advancement in the
technology, in the present time, such contract notes are delivered
through e-mail to the investors.
8) Payment for the Shares Bought, or Delivery Instruction Slip
(DIS) for Shares Sold: After receiving of the contract notes, it is
now the duty of the investor to discharge the obligations by making
the payment for the securities purchased by the following day (using
T+1 settlement mechanism). Once the broker collects the payment
from the investor, the same is required to be submitted to exchange
by the next day using T+2 mechanism.
In case, the shares are being sold by investor, the same needs to be
delivered to the broker to ensure that the same are remitted to stock
exchange and converted in the mode of the payment. These shares
are then reduced from the demat account and DIS (Delivery
Instruction Slip) is to be given to broker by investor in T+1 days.
DIS contains the complete particulars about the shares that are to be
reduced along with the client code. The signatures are then matched
with that in the records of the DP. If the same is found to be correct,
the transaction is finalised.
9) Receiving Shares or Funds on T+2 nd Day: A settlement
mechanism of T+2 days is followed in India. The buyers of
shares on the trading day will be credited with the shares in their
respective demat accounts after 2 days. In the same way, the
seller of the shares will receive the payment after the expiry of 2
days. For example, if trading is done on Monday, settlement will
take place on Wednesday. This complete the whole process of
trading at stock exchange.
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2.5.2. Settlement Procedure

Settlement is a procedure wherein the securities themselves or the
interest on the securities is to be handed over only after a receipt of
payment so as to complete the obligations arising out of the contract.
This requires the securities to be delivered to fulfil the contractual
obligations. It further requires the payment price to be paid-off. Trading
requires purchase and the sale of the securities which further leads to the
settlement.
Settlement can be defined as, “The exchange of cash or assets in return
for other assets or cash and transference of the ownership of those assets
and cash”.
Presently, the settlement procedure is happening much faster than before
in some of the other country markets. Time lag in trading and the
settlement is almost getting vanished day by day. In case of marketable
stocks, the settlement is usually done in 2 days of the execution of the
trade and 1 day in case of government securities and listed options.
During the period of settlement, one may counter several risks which are
taken care by the clearing process. Clearing refers to the modification of
the contractual obligations which brings facilitation in the settlement
process i.e., netting & novation.

2.5.2.1. Settlement Process in India

In Jan. 2000, rolling settlement was introduced by SEBI which means
that the transactions need to be settled on daily basis. The concept of
„badla‟ i.e. carrying forward was prohibited. Earlier the settlement
procedure which was of T+ 5 days was initially reduced to T+3 days
and further to T+2 days. The procedure for settlement was undertaken
by the clearing house of stock exchange. National Securities Clearing
Corporation Limited (NSCCL), a subsidiary of NSE was allotted with
the responsibility of clearing and settlement.
The aspect of clearing is basically intended for:
1) The members who are due to deliver, and
2) The members who are due to be receiving on the due date.
During the course of the settlement, both the funds and the securities
inter change with each other. NSCCL is responsible to account for dues
and the pendency towards the members and further ensures that the
obligations meets the timeline. To facilitate this, it itself becomes the
counterparty for settling the obligations of the trading members. This is
also called Novation.
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Capital Market (Unit 2) 105
The day on which buying and selling of securities carried out is known
as trading day. The clients make payment to their brokers after 1 day of
his trade take place i.e., T+1 day and the broker send this payment to the
exchange after 2 days of trade takes places i.e., T+2 days and same
happens in case of sale of securities too. The process goes through
demat accounts (receiving and selling the shares). This completes the
settlement of trade.

2.5.2.2. Current Scenario

The present mechanism of T+2 days settlement is all ready to undergo a
revolutionary change. SEBI is taking it seriously to bring it down to T+1
day system so that the settlement is made even more quickly. Even
talking about some of the developed economies like Singapore, where
they still follow T+3 days system i.e. the transfer of the funds and the
securities will take 3 days further, this new settlement system will
change the course of the trade.

2.6. LEADING STOCK EXCHANGES

IN INDIA
The buying and selling of the shares and securities is done at the stock
exchange which means a marketplace where the buyers and the sellers
take their securities. Stock exchanges are floated as a body corporate or
as the mutual organisation which is specialised in the business of trading
in securities. Various securities of the public and the private sector are
listed at the stock exchange and all the activities of the stock exchange
are controlled and monitored by SEBI.
There are three major stock exchanges in India:
Stock Exchanges in India

Bombay Stock Exchange (BSE)

National Stock Exchange
(NSE)

Over The Counter Exchange of

India (OTCEI)

2.6.1. Bombay Stock Exchange (BSE)

BSE (Bombay Stock Exchange) was the first stock exchange that was
set up in Asia. In the year 1875, it was basically formed as the “ Native
Share and Stock Brokers Association”.
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106 MBA Third Semester (IFS&FM) MDU
During the course of its journey, BSE has been highly responsible for
the growth and development of Indian economy and the corporate sector
as it has duly access to a mechanism for fund raising. Presently, more
than 6000 companies are listed at BSE and that makes it the biggest
stock exchange when considering the size. While talking about the
volume of the transactions, it is 5th largest in the world. In terms of listed
companies‟ market capitalisation, it falls in the top 10 list globally. The
aggregate of the market capitalisationof the companies listed at BSE is
1.28 trillion in Feb 2010. The first stock exchange in India to get an ISO
9001:2000 certification is BSE and it is also the first in the country to
receive ISMS ( Information Security Management System). The index
of BSE is SENSEX. At BSE, trading in F&O is also provided and
recognised.
2.6.1.1. Features of BSE
BSE has the following features:
1) BSE is the oldest stock exchange in India.
2) BSE is the 5th largest stock exchange globally.
3) More than 6000 companies are listed at BSE.
4) In India, BSE was the first stock exchange to introduce the concept
of Equity Derivatives.
5) BSE was the first one to launch Internet Trading, US$ trading at the
BSE index and the Free Float Index.
6) BSE was the first in the country to get the ISO 9001:2000
certification for clearing, surveillance and settlement.
7) The concept of financial training was first adopted by BSE.
8) The system of BOLT ( BSE online trading system ) was adopted by
BSE and it was one of the limited stock exchanges to use the
system.

2.6.1.2. Organization of BSE

The day-to-day operation is managed by the Board of Director. The
other members involved are the professionals, representatives of
Trading Members and the Managing Director. The Board works to
benefit from the market intermediaries participation. The Board has the
full authority to control and formulates large trade policies.
A Governing Board having 20 directors is the apex body, which decides
the policies and regulates the affairs of the Exchange. The Governing
Board consists of 9 elected directors, who are from the broking
community (one third of them retire every year by rotation), three SEBI
nominees, six public representatives and an Executive Director and
Chief Executive Officer and a Chief Operating Officer.
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Capital Market (Unit 2) 107
The regular working of the organisation is governed and managed by
the Board of Directors and the other members who are the professionals,
representatives of Trading Members and the Managing Director are
included in the organisation. The board of directors has the power to
plan and control the trade policies.

The board consists of 20 directors who are responsible to take decisions

regarding the formulation of policies and to control the matters
concerned with the Exchange. Among the 20 directors, 9 are elected
directors from the broking community, 3 SEBI nominees, 6 public
representatives and an Executive Director and Chief Executive Officer
and a Chief Operating Officer. The one-third of the elected directors
retire each year on rotational basis.

2.6.1.3. Trading Timing in BSE

Apart from Saturdays, Sundays, declared holidays, the trading at BSE
takes place between 9:15 am till and 3:30 pm.

2.6.1.4. Services Offered by BSE

The services offered by BSE are as follows:
1) Investor Services: The department of investor services helps the
investors by resolving their grievances.
2) Indo Next: The Indo Next is launched for helping the Small and
Medium Enterprises for raising the equity and debt and also for
facilitating trading in these enterprises.
3) BSE Training Institute (BTI): BTI provides training in capital
market and trading and certification by the help of various business
schools and universities. They offer 40 courses on various types of
the capital market and financial sector.
4) BSE On-line Trading (BOLT): BOLT helps in on-screen trading
in securities. The BSE On-line Trading is working in 8,000 trader
workstations present in 409 cities in India.
5) BSEWEBX.com: The Exchange introduced the world the first
centralised exchange based on Internet trading system in February
2001 known as BSEWEBX.com. It helps the worldwide investors to
trade on BSE platform.
6) BSE On-line Surveillance (BOSS): BOSS anticipates the real time
basis price movements, volume positions and member position and
real time measurement of default risk, market reconstruction and
generation of cross market alerts.
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2.6.1.5. BSE Indices
The Bombay Stock Exchange Sensitive Index (Sensex) is a value-
weighted index, calculated out of 30 stocks taking April 1979 as its
base. These 30 stocks depict the largest and most active trading stocks
from various sectors. Around one-fifth of BSE‟s market capitalization is
related to these companies. On 1st April 1979, the base value of the
Sensex is 100 while its base year is 1978-79. The BSE authorities assess
and revise composition of the Sensex at intervals, to ensure that it
reveals the existing market conditions.
Bombay Stock Exchange is a market capitalisation weighted index of 30
stocks which represents a large, well established and financially sound
companies. BSE indices are computed by making use of market
capitalisation weighted method. The authorities of BSE timely evaluate
and review the composition of Sensex from time-to-time to safeguard
and provide the current situation of the market.

2.6.2. National Stock Exchange (NSE)

In terms of the trading numbers, NSE (National Stock Exchange) is the
largest stock exchange in India. The traders and investors are provided
with the service of trading in multiple securities which includes the debt
and equity that is issued by the central or the state government. Apart
from this, trading can also be done in commercial papers, commercial
bills, certificate of deposits, etc. Around 1000 members are listed at the
NSE and the exchange is owned and managed by more than 20 financial
and insurance institutions. Basically investors approach NSE for dealing
in 3 types of segments i.e. capital markets, F&O, wholesale debt. The
operations at NSE began in the year 1994.
The National Stock Exchange was promoted as a joint stock company
under the Companies Act, 1956 and was initially promoted by
ICICI, IDBI, IFCI, LIC, GIC, SBI, SBI Capital Market Ltd., IL &
FS, SHCIL. In 1993, it was initially given approval for a span of 5
years by Government of India. IDBI in regard was appointed as the lead
promoter of the NSE. IDBI further appointed a Hong Kong based
consulting firm in the name of M/s International Consulting Securities
Ltd. to develop the infrastructure required for operations at the NSE.

2.6.2.1. Features of NSE

NSE has the following features :
1) NSE accounts for nearly 66% of the total turnover in India and has
the largest network of terminals in the country which is followed by
BSE at 33.4%.
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Capital Market (Unit 2) 109
2) NSE stands as the second largest exchange globally in terms of
market capitalisation.
3) The concept of screen based trading i.e. online trading was first
adopted by NSE.
4) On Nov 3, 1994, it started the operations in the capital market segment.
5) NSE has equity capital of 25 crores.
6) NSE was jointly promoted by SHCIL and IL&FS.
7) NSE holds NSCCL as a subsidiary to take care of the clearing and
the settlement operations which started functioning in April 1996.
8) NSE holds an amount of 300 crores in Settlement Guarantee Fund
to ensure the settlements are made in a smooth and uninterrupted
manner and the defaults are taken care of.
9) NSDL was promoted by NSE to handle the demat activities.
10) The headquarters of NSE is situated in Mumbai and Chennai holds
the back office.
11) NSE is basically professionally managed which is not there with other
stock exchanges and the management is different for the brokers.
12) Since NSE is a joint stock company, it also pays taxes.
13) A company should have capital of 10 crore and a market
capitalisation of 25 crore if it wishes to get listed at the NSE, if the
same is already listed at some of the other stock exchange.
14) At NSE, very strict norms are followed for the listing and
disclosures. Manipulation, insider trading and price rigging is
comparatively quite less.

2.6.2.2. Organization of NSE

NSE has adopted the form of a demutualised exchange – the ownership,
management and trading is in the hands of three different sets of people.
NSE is owned by a set of leading financial institutions, banks, insurance
companies and other financial intermediaries and is managed by
professionals, who do not directly or indirectly trade on the Exchange.
Its Board comprises of senior executives from promoter institutions,
eminent professionals in the fields of law, economics, accountancy,
finance, taxation, etc., public representatives, nominees of SEBI and one
full time executive of the Exchange.
While the Board deals with broad policy issues, decisions relating to
market operations are delegated by the Board to various committees
constituted by it. Such committees include representatives from trading
members, professionals, the public and the management. The day-to-day
management of the Exchange is delegated to the Managing Director
who is supported by a team of professional staff.
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110 MBA Third Semester (IFS&FM) MDU
The ownership, management and trading is performed by different group
of people so NSE has followed the form of demutualised exchange. NSE
is owned and controlled by the set of prominent financial institutions,
banks, insurance companies, other financial intermediaries and also
professionals. The trading in exchange may not be directly done by the
professionals. The Board comprises of senior executives from promoter
institutions, renowned professionals in the fields of law, economics,
accountancy, finance, taxation, etc., public representatives, nominees of
SEBI and one full time executive of the Exchange.

The issues related to broad policy is handled by the board while the
decisions about the market operations are taken by the committees
formulated by the board. These committees consist of representatives
from trading members, professionals, public and management. The
routine operations of exchange are handled by the Managing Director
with the help of qualified employees.

2.6.2.3. Advantages of NSE

NSE has the following advantages:
1) Wider Accessibility: VSAT technology is used at NSE for trading
purposes. All the computer systems are linked through satellite
communication channel and the transactions takes place in real time.
2) Screen Based Trading: The buying and selling prices are displayed
at the computer terminals. All other records also exist inside the
computer and without taking much time customers‟ requirements
are fulfilled.
3) Non-Disclosure of the Identity: It is ensured that the identity of the
traders is not displayed to others.
4) Transparent Trading: NSE follows the concept of full transparency.
The timing and rate at which the deal strikes, other related expenses
like brokerage, stamp duty, etc. are displayed to the investors.
5) Matching of Orders: When a purchase order is made inside the
system, it then further searches for a relevant sales order. Both the
orders are then co-related and a transaction is executed with the
permission of the investor.
6) Effective Settlement: In case of a monetary benefit like interest,
dividend, redemption amount, any claims on objections made by the
company, the credit entries are directly made in the client‟s
portfolio.
7) Trading in Dematerialised Form: As per the SEBI guidelines,
trading is now made mandatory in the demat form and the
settlement is made on the basis of (T+S) system.
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Capital Market (Unit 2) 111
8) Facility of SGL: NSE provides the facility of the Subsidiary General
Ledger (SGL) wherein the trading done by the retail customers and
the trusts is settled by way of electronic book transfers.

2.6.2.4. Difference between BSE and NSE

Basis of BSE NSE
Difference
1) Automation The BSE is not fully automatic. The NSE is fully automatic
electronic order processing
exchange.
2) Major The BSE has SENSEX as major The NSE has Nifty as major index.
Index index. It includes 30 scrips from It includes 50 scrips from different
different sectors. sectors.
3) Number of It has the listing of over 4000 It has more than 2000 stocks from
Listing stocks with it. different sectors listed with it.
4) Year of Its operations started from 1964 It operations started from 1994
Operation onwards taking base of 100. from taking base of 1000.
5) Regulatory The regulatory body of BSE is The NSE has its own regulatory
Body SEBI. body as it works according to its
own rules and regulation for
trading.

2.6.3. Over the Counter Exchange of India

(OTCEI)
During the mid-eighties, several steps were taken to analyse the benefits
of creating a second tier stock market. Various committees such as GS
Patel Committee on Stock Exchange reforms were formed for this
purpose. Another important committee was the Abid Holi Committee on
Capital Markets.

The OTC markets were incorporated in October 1990. These markets

were formed under Section 4 of the Securities Contracts (Regulation)
Act, 1956. It started its operations in 1992. The listing on an OTC
markets confers the same rights to a corporation as they get from listing
on any other regular stock exchange. The OTC market in India is known
as “Over the Counter Exchange of India (OTCEI)”.

The OTC markets are based on the NASDAQ system which is National
Association of Security Dealers-Automated Quotations in the United
States. Appropriate modifications were made to the system to make it
suitable for Indian conditions. The measure was undertaken to ensure
that the unlisted securities are brought under the ambit of regulations.
The listing on the OTCEI is treated as national listing right from the
beginning. There is no requirement of separate listing.
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2.6.3.1. Promoter of OTC Market
Over the Counter (OTC) markets were promoted by:
1) UTI,
2) IDBI,
3) IFCI,
4) LIC,
5) GIC,
6) SBI Capital Market and
7) Canbank Financial Services as a non-government banking company
under Section 25 of the Companies Act, 1956.

2.6.3.2. Features of OTC Market

Following are the main features of OTC Market:
1) Ringless Trading: OTC market is a modern market which does not
require traditional trading methods. Trading takes place through a
series of computers connected to a network. The OTC dealers are
generally scattered through different geographical regions.
2) National Network: The OTC market has generally wider reach
than other exchanges. This is made possible through the use of
computer networks. Thus, the companies may enjoy national
exposure by listing on just one exchange.
3) Totally Computerised: OTC trading is done exclusively through
computer network. This helps in making the market more efficient
and transparent.
4) Exclusive List of Companies: The companies listed on the OTC
are not allowed to list on other stock markets. Thus, their shares are
only available on the OTC. However, recently the OTC allowed 25
companies to be listed on it despite having earlier presence on other
stock markets.
5) Two Ways of Making a Public Offer: Another distinctive feature of
OTCEI is that it offers two ways of floating a public offer. The first
route is „direct offer‟ which allows the company to offer its shares to
the public in direct manner. However, the company is required to
obtain a sponsor. Under „indirect approach‟, the company transfers its
shares to the sponsor, who later makes an offer.
6) Faster Transfers and Trading without Shares: OTC trading
may also be used for transferring shares to registrars. However, it
is limited to a certain percentage of the portfolio. This helps in
making the process of transfer a lot faster and is also beneficial to
the investors which use a tradeable document known as counter
receipt (CR).
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Capital Market (Unit 2) 113
7) Investor Registration: OTCEI also provides for investor
registration and is the first one in India to offer this facility. This
registration is required to be done only once and thus allows for
trading on any OTC counter in any scrip throughout India.
8) Trading Mechanism: Any investor can use OTC for buying or
selling any listed scrip. Such counters also provide other facilities
such as share splits, share transfer, nomination and revocation,
registration of power of attorney and many other allied services. The
various parties involved in this process are investors, custodians,
banks and companies.

2.6.3.3. Objectives of OTC Market

Following are the main objectives of OTC market:
1) To increase liquidity for investors.
2) To improve the availability of securities at fair market price to small
investors.
3) To offer liquidity for securities and for lesser known companies.
4) To make the process of buying and selling securities faster and
simpler.
5) To increase public awareness for risky yet profitable ventures.
6) To introduce new methods of offering new issues to the public.
7) To provide listing services to the companies which cannot afford
listing on regular exchanges or do not meet the listing criterion.

2.6.3.4. Benefits of OTC Market

Following are the main benefits of OTC Market:
1) Benefits to Listing Companies
Following are the main benefits to listed companies:
i) OTCEI may be used for trading in stocks of the companies
which were hitherto unlisted.
ii) The company is in position to negotiate the issue pricing with
their sponsors.
iii) It also enables the company to discuss the issue of premium
with its sponsors.
iv) It helps the companies in avoiding the costs associated with
public issues.
v) The listing on the OTCEI is also available to the companies
which offer only 40 per cent of their total equity.

2) Benefits to Investors
Following are the main benefits accruing to the investors:
i) The investors are able to settle their deals across the counter.
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114 MBA Third Semester (IFS&FM) MDU
ii) Two-way quotes are shown on the screen, bringing transparent.
iii) OTCEI provides for various ways of trading such as options,
futures, forward contracts and so on.
iv) The investigation process employed by the OTCEI provides
more security for the investors.
v) The deals and settlements are carried out in a much faster
manner.

3) Benefits to Stock Market Environment

OTCEI has worked towards improving overall stock market
environment in the following ways:
i) OTCEI has national level network and thus it helps to
consolidate the market in the country.
ii) It has paved the way for privately held companies to go public
as it has far less regulatory norms than conventional stock
exchanges. The companies offering as low as 20 per cent of
their overall equity can list on OTCEI.
iii) The various members of OTCEI which do not have different
memberships now may trade in different capital indices.
iv) It also helps in mobilising various investments and savings by
offering better avenues.
v) It helps in broadening the base for economic activities as it
provides incentives to small scale investors and companies.

2.6.3.5. Relationship between NSE and OTCEI

Following illustrates the relationship between these two organisations:
1) Ringless: Both the exchanges are ringless and therefore do not have
any trading floor. The trading is carried through a network of
computers belonging to the dealers of the exchanges. These dealers
are scattered throughout the country and may be different or in same
city. All these terminals are connected to each other through the
central computer belonging to NSE or OTCEI. The connection is
made via satellite link.
2) Screen-Based Trading: All the transactions made on the both the
exchanges are done electronically. The entire system is
computerized and it uses satellite telecommunication method for the
purpose of interacting. The trading is carried out electronically.
3) Transparency: Both the exchanges offer screen-based trading,
thus imparting an element of transparency to the entire process. It
also helps in ensuring that the rights of the investors are properly
protected.
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Capital Market (Unit 2) 115
4) Incorporated Entities Backed by Financial Institutions: Both the
exchanges have been supported by a number of established financial
institutions. Both NSE and OTCEI are incorporated as companies.
This helps in bringing about professionalism in the working of these
organisations.

2.6.3.6. Difference between NSE and OTCEI

Basis of NSE OTCEI
Difference
1) Established It was established in 1992. It was established in 1990.
2) Size of The company listed on NSE The company listed on
Company has paid-up capital of NSE is OCTEI has paid-up capital
`3 crore and above. of OTCEI `30 lac and
above.
3) Securities i) Equity and debentures Equity as well as debentures
Traded and other securities and other securities.
ii) T-Bills, PSU bonds and
other such instruments
4) Objectives It offers nationwide and It works as an exchange for
ringless transparent trading small company‟s securities.
facility for various instruments
of capital market as well as
money market.
5) Settlement Payment is to be made within Payment is to be made
15 days of carrying out within 7 days of such
transaction. transactions.

2.7. DEPOSITORIES
2.7.1. Meaning of Depository
The term Depository refers to “a place where something is deposited
for safekeeping; banks in which funds or securities are deposited by
others, usually under the terms of specific depository agreement”.
Depository means “one who receives a deposit of money, securities,
instruments, or other property, a person to whom something is
entrusted, a trustee, a person or group entrusted with the preservation or
safe keeping of something.”
A depository may be defined as an organisation which is entrusted with the
responsibility of keeping the securities of investors in an electronic form.
The depositor also performs the function of carrying out the transactions
related to securities by making book entries. However, it should be noted
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116 MBA Third Semester (IFS&FM) MDU
that a depository is different from a „custodian of security’. The
depository may make a legal transfer of securities by passing book entries
but a custodian cannot carry out such transactions. The services of a
depository may be availed through Depository Participants.

2.7.2. Objectives of Depository

Following are the main objectives of a depository:
1) To provides a copy of Certificates.
2) To avoid the misrepresentation of scripts due to poor handling.
3) To avoid the damage of scripts due to poor handling.
4) To avoid the possibility of missing certificates due to mishandling
by the postal authorities or investors.
5) To reduce down the liquidity due to low public interest.
6) To optimise document handling costs in the capital market.
7) To help in standardisation of Indian settlement practices.
8) To aid the growth and development of Indian capital market.
9) To develop a sustainable system of clearing, settlement, and
depository operations.

2.7.3. Role/Functions of Depositories

Following are the main functions of depositories:
1) Depositories facilitate the surrendering and withdrawal of securities
using Remat and Demat facilities.
2) It keeps the investor‟s holding in safe custody in an electronic form.
3) It carries out settlement of securities traded on the stock exchange
and receiving the other non-corporated benefits, such as, rights and
bonus in an electronic form.
4) It is also responsible for settling the activities related to off market
trades. The Off market trade activities are those which are not
carried out on the stock exchange.
5) It also post the status updates about the BOs to the Share Registrar
or Issuer.
6) It helps in the process of lending, borrowing, pledging, and
hypothecation of securities.

2.7.4. Advantages of Depository

Following are the main advantages of depository:
1) Depositories eliminate the risk of bad deliveries associated with the
transfer of physical certificates.
2) It reduces the volume of paper work required for various
transactions.
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Capital Market (Unit 2) 117
3) It helps in the process of faster disbursement of corporate benefits
such as Bonus Issues, Rights Issues etc.
4) It mitigates the costs of transactions such as brokerage, stamp duty
and transaction costs.
5) It provides the availableperiodical status report to the investors
about their holding stocks and transactions made.

2.7.5. Disadvantages of Depository

Following are the main shortcomings associated with depositories:
1) There are very rare chances of having a set–up depository.
2) Single individual may face difficulties on holding different accounts
in multiple depository system.
3) It may increase the number of embezzlements and frauds.
4) It increases the risks associated with corporate takeovers. As many
times it was not clear to the management when the depositories are
involving in the transaction.

2.8. CUSTODIANS
2.8.1. Meaning of Custodial Services
Custodial Services refer to the businesses which offer a wide range of
security services such as corporate actions, dividend actions, safe-
keeping, tax reclaims and reporting.
Custodians are the brokerage firms or other financial institutions which
provide services such as safe-keeping and management of a client‟s
securities or other assets. This helps in reducing the risk for the client.
Thus, a custodian provides a safe place for the owner to keep their
valuables. Brokerage houses charge a fee for providing these services.
These custodial services are important as these help stock market
system‟s evolution. Such services are also important for the growth of
secondary market. For the purpose of managing these services in a
better way, the SEBI Custodian of Securities Regulations, 1996 was
enacted.
Following are the main functions of custodial services as per SEBI
regulations:
1) Safe-keeping of the securities for their clients as per the
requirements of an agreement between them.
2) Offering related services such as:
i) Maintenance of securities accounts of the clients.
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ii) Proper collection of all the benefits accruing to the client as an
investor.
iii) Providing all the relevant information to the clients and keeping
them updated about their investments.
iv) Maintenance and reconciling of records of the service.
Following are the main characteristics of the SEBI framework of
regulations for directing custodians of securities:
1) Registration,
2) General role and responsibilities,
3) Carrying out proper checks and verification,
4) Proper follow-up in cases related to defaults, and
5) To implement uniform rules and regulations.

2.8.2. Registration of Custodians

It is mandatory for custodians to obtain registration from the SEBI. The
custodians are required to file an application in a prescribed form. The
application fee is `10,000. SEBI considers various facets of custodians
while undertaking the process of granting registration.
Following are the main points which are kept in mind by the SEBI:
1) The applicant should fulfill the net worth criterion of `50 crore in
paid up capital plus free reserves.
2) The applicant possesses adequate infrastructure such as office
spaces, safe custody vaults and other instruments to properly carry
out their operations.
3) The custodian has proper human resources in the form of qualified
employees.
4) A proper set up of manuals, systems, procedures to ensure
efficiency and compliance with regulations for the adequate
discharge of duties.
5) They should not have been denied registration by the SEBI or
should not have registration revoked by the SEBI.
6) No director or principal officer or employee should be involved in
any litigation related to the securities market. They should not have
been found guilty of any crimes related to economic offence or
immorality.
7) The custodian should be a corporation and the registration fee of
`15,00,000 is required to be paid.
The registration is granted contingent upon following conditions:
1) The custodian is required to fulfill capital adequacy norm of `50
crore before starting any operations.
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Capital Market (Unit 2) 119
2) The custodian is required to work as per the provisions of the SEBI
Act and other relevant regulations while carrying out its functions.
3) There should be proper and valid agreement between the custodian
and the clients before such services are provided.
4) The annual fee of `5,00,000 is required to be paid.

If a custodian is found guilty of providing any wrong or false

information or any particulars are changed after the granting of
information, such changes should be filed with the SEBI formally in
writing. The custodian should restrict itself to providing only financial
services.

2.8.3. Obligations/Responsibilities of Custodian

Following are the main responsibilities fixed for custodians:
1) Code of Conduct: The custodians are required to adhere to the
following code of conduct. The custodians:
i) Required to maintain proper standards of honesty, equity and
professionalism while discharging their duties.
ii) Required to be prompt in carrying out responsibilities such as
disbursal of accruals including dividend or interest collected on
behalf of the clients.
iii) It should properly monitor and execute movements of securities
to and from the client‟s accounts. It should also be able to
provide complete audit trail as and when required by the SEBI
or the client.
iv) Required to have proper infrastructure facilities for the proper
discharge of its custodial services. The operations should be
backed up and documented properly.
v) Required to maintain proper confidentiality of all the aspects of
a client‟s activities.
vi) They are expected to maintain electronic records and the proper
back-up system.
vii) They are required to maintain the system in such a way that a
proper trail is obtained in case of loss of data.
viii) They are also required to cooperate with other custodians,
depositories and clearing organisations for proper execution of
inter-custodial settlements and efficient transfer of funds and
securities. The custodians are also required to perform due
diligence in this regard.
ix) Any custodian or its employees should not engage in providing
any investment advice which is not in the public domain, until
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or unless relevant disclosure of their interest in related
information is made. If such information is provided by an
employee then the disclosure of interest held by their family
members as well as by their employers should also be disclosed.
2) Segregation of Activities: The custodian is required to keep their
custodial business separate from all other activities. This
requirement is applicable to the employees and officers of the
organisation as well.
3) Monitoring/Review/Evaluation/Inspection of Systems/Controls:
The custodians are required to implement proper control system to
facilitate review, monitoring and evaluation of the various
procedures. Such system should undergo annual inspection by the
experts. The report is required to be submitted to the SEBI within
three months of execution.
4) Separate Custody Account and Agreement with Clients: There
should be a separate account for each client and the assets of
different clients should not be mixed with each other. The custodian
should also have separate agreement with each client enumerating
the ways in which securities and money would be received or
released from the account and proper rights and entitlements related
to the securities held in account.
5) Internal Controls: The custodians are required to have proper
internal control system to ensure that the records and the securities
are not tempered with. It should also ensure that securities are not
exposed to theft or natural disasters.
6) Maintenance of Records: The custodians are required to keep
proper records for each of their clients. Such record should show
the securities released or received, all the rights and entitlements
attached to such securities, relevant ledgers, all the instructions
received from or sent to the clients and the filings made
with SEBI.
7) Appointment of Compliance Officer: Every custodian of
securities is required to appoint a compliance officer for the
effective monitoring of various laws and regulations enacted by
the SEBI and other governing bodies. In case of any non-
compliance, the officer is required to make immediate and
independent report to SEBI.
8) Information to SEBI: SEBI may seek any information related to
the operations of the custodians. Every custodian is under obligation
to furnish such information within required a certain time period.
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2.8.4. Inspection and Audit of Custodian

SEBI has the power to carry out inspection and investigations of a
custodian business for the following purposes:
1) Such inspection and investigation should be for the purpose of
ensuring that the custodian is maintaining the records in the
prescribed manner.
2) The investigation may be carried out for the purpose of responding
to a complaint made in this behalf.
3) To ensure that the custodian complies with all the requirements of
SEBI Act and related regulations.

SEBI may then direct the custodian to take appropriate actions to

address the situation.

2.8.5. Cancellation of Registration of Custodian

In following circumstances, the custodian may have their registration
cancelled or suspended by SEBI:
1) Suspension of Registration: The registration of a custodian may be
suspended due to following reasons:
i) If the custodian breach any of the provisions of SEBI Act.
ii) The custodian fails to provide the information asked for by
SEBI or provides false or misleading information.
iii) The required returns or reports are not furnished to the SEBI.
iv) The custodian does not cooperate with the enquiry or inspection
made by the SEBI.
v) It fails to upgrade its systems and procedures to meet with the
requirements of the SEBI.
vi) The custodian fails to properly address the concerns raised by
the SEBI.
vii) The custodian is engaged in any misconduct or breaches any
code of conduct.
viii) The custodian fails to pay annual fees.

2) Cancellation of Registration: SEBI may proceed to cancel the

registration in following circumstances:
i) The custodian is found guilty of any fraud or is found to have
been convicted for any offense related to immorality.
ii) It has been found that the culprit is a regular defaulter, leading
to suspension.
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2.9. SECURITIES EXCHANGE

BOARD OF INDIA (SEBI)
2.9.1. Introduction
In 1988, the Securities and Exchange Board of India was established by
the Government of India through an executive resolution and was
subsequently upgraded as a fully autonomous body (a statutory Board)
in the year 1992 with the passing of the Securities and Exchange Board
of India Act (SEBI Act) on 30th January 1992. In place of Government
Control, a statutory and autonomous regulatory board with defined
responsibilities, to cover both development & regulation of the market
and independent powers has been set up. Paradoxically, this is a positive
outcome of the Securities Scam of 1990-91.

2.9.2. Constitution of Management of SEBI

The SEBI is managed by a Board consisting of following members:
1) Chairman.
2) Two members from among the officials of the Ministries of Central
Government dealing with Finance and Law.
3) One member from amongst the officials of the Reserve Bank of
India.
4) Two other members to be appointed by the Central Government.

The management of SEBI is vested in the Board and Chairman shall

have the powers of general superintendence and direction.

2.9.3. Objectives/Purpose of the SEBI Act

The purpose of the SEBI Act is to provide for the establishment of a
Board called Securities and Exchange Board of India. The purpose of
the Board as laid down in its preamble is as below:
1) To provide a degree of protection to the investors and safeguard
their rights and to ensure that there is a steady flow of funds in the
market.
2) To promote fair dealings by the issuer of securities and ensure a
market where they can raise funds at a relatively low cost.
3) To regulate and develop a code of conduct for the financial
intermediaries and to make them competitive and professional.
4) To provide for the matters connecting with or incidental to the
above.
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Capital Market (Unit 2) 123

2.9.4. Structure/Organization of SEBI

SEBI has five different operational departments. Each department works
under an executive director. Such executive director reports to the
chairman. It also has legal department as well as the investigation
department. These departments are divided into various divisions:
1) Primary Market Policy, Intermediaries, Self-Regulatory
Organizations (SROs), and Investor Grievance and Guidance
Department: This department is mainly concerned with policy as
well as regulatory matters. It drafts regulations governing portfolio
managers, debenture trustees, guidance, investors, etc.
2) Issue Management and Intermediaries Department: This
department takes care of the prospectus issued for the purpose of
floating public issues and letters of offer. It also deals with rights
issues.
3) Secondary Market Policy, Operations and Exchange
Administration, New Investment Products and Insider Trading
Department: This department drafts policies and regulations for
secondary markets. It also deals with various investment products.
It‟s another purpose is to provide proper surveillance services.
4) Secondary Market Exchange Administration, Inspection and
Non-member Intermediaries Department: This department
manages smaller and regional stock exchanges such as Guwahati,
Magadh, Indore, Mangalore, Hyderabad, Bhubaneshwar, Kanpur,
Ludhiana and Cochin. It manages, inspects, registers and regulates
these exchanges.
5) Institutional Investment (Mutual Funds and Foreign
Institutional Investment), Mergers and Acquisitions, Research
and Publications, and International Relations and IOSCO
Department: This department drafts policy matters for foreign
institutional investors (FIIs) and domestic mutual funds and
International Organization of Securities Commissions (IOSCO)
membership.
6) Legal Department: This department works under the General
Counsel and takes care of legal matters.
7) Investigation Department: This department works under the Chief
of Investigation and carries out various inspecting and investigative
activities.

SEBI also has regional offices. These offices are located in Delhi,
Calcutta and Chennai. It also has two non-statutory advisory committees
which are the Primary Market Advisory Committee and Secondary
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Market Advisory Committee. Their members are drawn from various
investor associations and market components. SEBI is a member of the
International Organization of Securities Commissions, which is an
international body and consists of representatives from more than 100
countries. SEBI also participates in the organization‟s platform for
developing markets.

2.9.5. Role of SEBI in Capital Issues

To protect the interest of the investors and to bring back the small
investors to the market several measures have been undertaken by SEBI.
Entry and disclosure norms are tightened to prevent the exploitation of
investors by the unscrupulous promoters. Allocation of shares and
promoters' contribution are regulated.
1) Entry Norms: SEBI has issued guidelines to tighten the entry
norms for companies accessing the capital market.
i) A company should have a track record of dividend payments for
a minimum period of 3 years preceding the issue.
ii) A company whose shares are already listed would fulfill the
entry level requirement only if the post issue net worth becomes
more than five times the pre issue net worth.
iii) If a manufacturing company does not have such a track record,
it could access the public issue market, provided its project is
appraised by a public financial institution or a scheduled
commercial bank. The appraising entity should also participate
in the project fund.
iv) It would be necessary for a corporate body making a public
issue to have atleast five public shareholders for every `1 lac of
the net capital offer made to the public.
2) Promoters’ Contribution: Promoters' contribution means
contribution by those described in the prospectus as promoters,
directors, friends, relatives and associates.
i) Promoters' contribution should not be less than 20% of the
issued capital irrespective of the issue size.
ii) The entire promoters' contribution should be received before the
public issue. If the issue size exceeds `100 crores, the promoters
can bring in not less than 50% of their contribution before
opening of the issue and bring in the balance before the calls are
made on the shareholders.
iii) SEBI announced that not more than 20 per cent of the entire
contribution brought in by promoters cumulatively in public or
preferential issue would be locked in for 5 years. SEBI lifted the
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Capital Market (Unit 2) 125
provision of lock in period for promoters, contribution in case
of listed companies with 3 years track record of dividend
payment.
iv) According to the decision taken by the SEBI Board, in case of
non-underwritten public issue promoters could bring their own
money or procure subscription from elsewhere within 60 days
of the closure of the issue subject to such disclosures in the offer
document.
3) Disclosure: The draft prospectus filed with SEBI is made as a
public document to enhance transparency. The draft prospects
should provide all the needed information to the investor regarding:
the present position of the company, the future prospect and the risk
factors associated with the investment of the company.
4) Book Building: Book building has been accepted as one of the
modes of public issue. SEBI issued guidelines relating to 100 per cent
book-building in an issue of security to the public through prospectus.
5) Allocation of Shares: To bring back the small investors to the
primary market, the minimum application of share has been reduced
from 500 to 200. Proportionate allotment of shares is made. A
reservation of minimum 50 % of net offers to the small investors is
being made. Small investors mean those who have applied for 1000
or fewer shares or securities.
6) Market Intermediaries: Licensing of merchant bankers or
authorization by SEBI was the first step undertaken to regulate the
intermediaries. This licensing of merchant bankers is based on the
capital adequacy as well as the track record of the capital market related
activities. In course of time, other financial intermediaries such as
underwriters, registrars and transfer agents came to be licensed. SEBI
has the right to inspect the records of the intermediaries.

2.9.6. Functions of SEBI

Following are the functions of SEBI:
1) To register and regulate the working of stock brokers,
2) To register and regulate the working of bankers to an issue,
3) To control and regulate securities market,
4) To exercise the powers under Securities Contracts (Regulations) Act,
5) To regulate the working of mutual funds,
6) To perform such other functions as may be prescribed,
7) To control fraudulent and unfair trade practices relating to securities
market,
8) To conduct research for the above purposes,
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9) To control investment business,
10) To regulate issue of securities,
11) To regulate takeovers, and
12) To prohibit insiders-trading in securities.

2.9.7. Powers of SEBI

Following powers have been given to SEBI:
1) Power to conduct research and other functions,
2) Power to call for periodical returns from recognized stock exchanges,
3) Power to levy fees,
4) Power to call for any information or explanation from recognized
stock exchanges of its members,
5) Power to regulate substantial acquisition of shares and take over of
companies,
6) Power to direct inquires to be made in relation to affairs of stock
exchanges or its members,
7) Power to promote investors education and trading of intermediaries
in capital market,
8) Power to grant approval to bylaws of recognized exchanges,
9) Power to prohibit insider-trading,
10) Power to make or amend bylaws of recognized exchanges,
11) Power to prohibit fraudulent and unfair trade practices relating to
securities,
12) Power to declare applicability of Section 17 of the Securities
Contracts (Regulation) Act in any state or area and to grant licenses
to dealers in securities,
13) Power to promote and regulate self-regulatory bodies,
14) Power to compel listing of securities by public companies,
15) Power to control and regulate stock exchanges,
16) Power to register and regulate working of collective investment
schemes including mutual funds, and
17) Power to grant registration to market intermediaries.

2.9.8. SEBI Guidelines with Respect to IPO

Following are the main guidelines issued by SEBI for managing IPOs
floated by the companies:
1) Issues of Small Companies: These are the issues which are going
to raise less than `5 crores. These issues are managed through
OTCEI. There are separate rules and regulations for such issues.
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Capital Market (Unit 2) 127
2) Size of the Public Issue: The minimum 25% of the total issue
should be offered to general public. However, following regulations
are applicable to information technology, telecommunication and
media companies:
i) The net offering to the public should not be less than 10 percent
of the total issue.
ii) The offering made to the public should not be less than `20
lacs.
iii) The net offering to the public should not be less than `30 crore.
3) Promoter Contribution
i) Promoters are required to bring their contribution including the
total premium before the issue.
ii) Promoters should contribute minimum 20 to 25 percent of the
issue.
iii) The promoters‟ contribution is locked in for five years.
iv) The firm allotment is locked in for minimum three years period.
4) Collection Centres for Receiving Applications
i) Minimum 30 collection centres need to be established. These
places include where the stock exchanges are established.
ii) For the issues, not more than `10 crores, including premium,
the collection centres need to be:
a) At four metropolitan centres, which are Delhi, Mumbai,
Calcutta and Chennai.
b) Such centres should be at the stock exchange of the region
where the company‟s registered office is situated.
5) Regarding Allotment of Shares:
i) The net offer to the public may not be less than 25% of the
issue.
ii) The shares should be mandatorily registered at the stock
exchange of the region where the company‟s registered office is
situated.
iii) Issues of more than `25 crore may employ book building
method for entire placement.
iv) Minimum 50% of the net offer should be reserved for the
investors making application for less than 1,000 shares.
v) It should be ensured that there are minimum 5 investors for
every `1 lac worth of equity proposed. This rule is not
applicable to infrastructure companies.
vi) When the investment is for `50,000 or above, it is mandatory to
quote PAN or GIR no. in the application.
vii) Up to 5% of the issue may be allotted to Indian Development
Financial Institutions and Mutual Funds.
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128 MBA Third Semester (IFS&FM) MDU
viii) A venture capital fund may not get its securities listed on any
stock exchange before the expiry of 3 years from the time of
issue of securities.
ix) Only 24% or less allotment may be made to FIIs, NRIs and OCBs.
However, with a resolution passed in a general meeting and an
application to the RBI, the limit may be increased to 30%.
6) Time frames for the Issue and Post-Issue Formalities
i) The public issue should be kept open for minimum three
working days. The maximum duration is 10 working days. The
minimum and maximum duration for a rights issue is 15
working days and 60 working days respectively.
ii) A public issue comes into effect if it is able to generate 90% of its
total issue size in 60 days from the date of earliest closure of the
public issue. If the issue is over-subscribed, then the company may
retain the excess application money and may issue more shares
than the proposed number. This is known as green shoe.
iii) A rights issue needs to receive 90% subscription within 60 days
of opening the issue.
iv) Allotment of the shares is required to be made within 30 days of
closing of public issue. For rights issue, the limit is 42 days.
v) The company is required to meet all the listing formalities
related to the issue within 70 days of the close of the
subscription list.
7) Dispatch of Refund Orders
i) The firm needs to process refund orders within 30 days of
closing the public issue.
ii) The excess application money should also be refunded within
30 days of closing the public issue. Excess application money is
the money received from non-allotment of shares.
8) Other Regulations Pertaining to IPO
i) It is not mandatory to go for underwriting. However, 90%
subscription is mandatory for all the public issues. This rule is
not applicable to disinvestment cases.
ii) In case of under-subscription of issues, the collected amount
needs to be returned back. This rule is also not applicable to
disinvestment cases.
iii) In case of issues worth more than `500 crore, it is mandatory to
made the voluntary disclosure about the uses of the funds. It is
also mandatory to set up a monitoring system to ensure that the
proper compliance is made.
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Capital Market (Unit 2) 129
iv) At the time of making such public offering, the firm should not
have any outstanding warrants or any other financial
instruments.
v) For initial public offers with premium, where the rights under
warrants or any other instruments are exercised within twelve
months before such offering, then the resulting share are not taken
into account for determining minimum contribution made by the
promoters. It will also be subjected to the rules related to lock-in.
vi) Code of advertisement as prescribed by SEBI is required to be
followed.
vii) Draft prospectus should be submitted with the SEBI. It should
also be submitted to all the stock exchanges where the issue
intends to be listed.
9) Restrictions on other Allotments
i) Lock-in stipulations are not applicable to firm allotments made
to FIIs, mutual funds or employees.
ii) No bonus issue is allowed to be floated within twelve months of
the public/rights issue.
iii) Maximum percentage of the stock, which may be distributed to
employees, may not exceed 5 percent. Further, no employee
may receive more than 200 shares each.
10) Relaxations to Public Issues by Infrastructure Companies:
Following are the main relaxations provided to the infrastructure
companies. The definition of such companies is provided under
Section 10(23G) of the Income Tax Act, 1961. It stipulates that their
projects need to be checked by any Development
Financial Institution (DFI) or IDFC or IL&FS. There should be
minimum 5% participation of the appraising institutions towards the
project costs through equity or debt.
i) The infrastructure companies are not required to follow the
requirements related to the minimum public offer size to be
25% of its stock.
ii) These companies are not required to follow the rule of having 5
shareholders for every 1 lac of shares.
iii) These companies are not bound by minimum 90% subscription
requirement. However, such companies will be required to provide
voluntary disclosure about the alternate sources of funding to be
used by the company, in case the issue is under-subscribed.
iv) Infrastructure firms are allowed to go for free pricing of their
issues in the domestic market. However, promoter companies,
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equipment suppliers and other strategic investors are required to
subscribe to 50% of the equity at the same or higher price than
the price presented to the general public. The firm is also
required to provide the reasoning behind the pricing in their
offer document.
v) The infrastructure firms are allowed to keep the public issues
open for the duration of 21 days. This is done to help the
companies in getting proper time for mobilizing the proceeds
for their public issue.
vi) Infrastructure firms are not required to set up and maintain a
Debenture Redemption Reserve (DRR), if they issue
debentures.

2.9.9. SEBI Rules and Regulations

Following are the SEBI rules and regulations regarding stock markets:
1) SEBI Rules and Regulation for Primary Market: To protect the
interest of the investors and to bring back the small investors to the
market several measures have been undertaken by SEBI. Entry and
disclosure norms are tightened to prevent the exploitation of
investors by the unscrupulous promoters. Allocation of shares and
promoters‟ contribution are regulated.
i) Entry Norms: SEBI has issued guidelines to tighten the entry
norms for companies accessing the capital market.
ii) Promoters’ Contribution: Promoters‟ contribution means
contribution by those described in the prospectus as promoters,
directors, friends, relatives and associates.
iii) Disclosure: The draft prospectus filed with SEBI is made as a
public document to enhance transparency. The draft prospects
should provide all the needed information to the investor
regarding: the present position of the company, the future
prospect and the risk factors associated with the investment of
the company.
iv) Book Building: Book building has been accepted as one of the
modes of public issue. SEBI issued guidelines relating to 100%
book-building in an issue of security to the public through
prospectus.
v) Allocation of Shares: To bring back the small investors to the
primary market, the minimum application of share has been
reduced from 500 to 200. Proportionate allotment of shares is
made. A reservation of minimum 50 % of net offers to the small
investors is being made.
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Capital Market (Unit 2) 131
vi) Market Intermediaries: Licensing of merchant bankers or
authorisation by SEBI was the first step undertaken to regulate
the intermediaries. This licensing of merchant bankers is based
on the capital adequacy as well as the track record of the capital
market related activities. SEBI has the right to inspect the
records of the intermediaries.
2) SEBI Rules and Regulation for Secondary Market: SEBI has
introduced a wide range of reforms in the secondary market. The
important areas are as given below:
i) Governing Board: Governing Board of the stock exchanges
was reconstituted according to the SEBI‟s directives. Broker
and non-broker representations are made 50:50. Sixty per cent
of non-broker representation was given in the arbitration,
disciplinary and default committees of the exchanges.
ii) Infrastructure: To sophisticate the trade on the stock exchange
NSE was established with the screen based trading. Then SEBI
has allowed the stock exchanges to expand its on-line screen
based trading terminals to locations outside their jurisdiction
subjected to certain criteria.
iii) Settlement and Clearing: SEBI notified all stock exchanges to
introduce weekly settlement. Besides, auctions have to be
conducted by stock exchanges within eight days of the
settlement in case members fail to deliver the shares.
iv) Debt Market Segment: Wholesale debt market segment in the
NSE enables the traders to trade in debt instruments.
v) Price Stabilisation: SEBI has set up a division to monitor the
unusual movements in prices, in coordination with the stock
exchanges. SEBI has asked stock exchanges to monitor the prices
of newly listed permitted scrips from the first day of trading.
vi) Delisting: SEBI tightened the delisting norms by permitting
delisting in accordance with the norms specified by Chandratre
committee.
vii) Brokers and SEBI: The regulation of the functioning of the
brokers starts with the registration of the brokers. The
registration is given on the basis of the eligibility to be a
member of any stock exchange, infrastructure facilities like
adequate office space, equipment and man power.
3) SEBI Rules and Regulation for Stock Brokers: Stockbroker is a
member of a recognised stock exchange who buys sells or deals in
securities. To work as a stockbroker, registration with SEBI is
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132 MBA Third Semester (IFS&FM) MDU
mandatory. SEBI is empowered to impose conditions while granting
the certificate of registration.
i) Registration: A broker seeking registration with SEBI has to
apply through the stock exchange of which he is member. For
registering SEBI checks – eligibility of the applicant to become
the member of stock exchange, has the necessary infrastructure
to effectively discharge his duties, past experience, etc.
ii) Capital Adequacy Norms for Brokers: An absolute minimum of
`5 lacs as a deposit with the exchange is to be maintained by the
members of the BSE and CSE and `3.5 lacs for DSE and ASE
irrespective of volume of business. In case of other SE the minimum
requirement is `2 lacs. The security deposit kept by the members in
the SE forms part of the base minimum capital; 25% of the base
minimum capital is to be maintained in case with the exchange.
iii) Additional Capital Related to Volume of Business: The
additional or optional capital required from a member should, at
any point of time, be such that together with the base minimum
capital it is not less than 8% of the gross outstanding business in
the exchange defined as the aggregate of up-to-date sales and
purchases by a member broker in all the securities put together.
iv) Duty to the Investor: The duties of a broker to the investor are:
a) He should be faithful to the clients in his dealings with them
and execute orders as per the instructions.
b) He should issue to his clients a contract note without any
delay for all transactions in the form specified by the SE.
c) To avoid breach of trust, he should not disclose or discuss
with any other person details of investment and transaction
of clients.
d) He should not mislead clients merely to generate business.
e) He should avoid dealing with a client who is a defaulter in
his dealings with other brokers.
f) When dealing with a client, he is required to disclose
whether he is acting as a principal or as an agent.
g) He should not give investment advice to any client unless
sought by him.
h) A stockbroker should have adequately trained staff and
arrangements to render fair, prompt and competent services
to his clients.
i) He should extend full cooperation to other brokers in
protecting the interest of his clients regarding their rights to
dividends, bonus shares, rights issues and any other rights
related to such securities.
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Capital Market (Unit 2) 133
4) SEBI Rules and Regulation for Buy-back of Securities:
Following are the guidelines for buy-back of securities:
i) Conditions of Buy-back – Applicability: These regulations
shall be applicable to buy-back of shares or other specified
securities of a company listed on a stock exchange.
Notwithstanding anything contained in sub-regulation (1), a
company listed on a stock exchange shall not buy-back its
shares or other specified securities so as to de-list its shares or
other specified securities from the stock exchange.
ii) Methods of Buy-back of Securities: A company may buy-back
its shares or other specified securities by any one of the
following methods such as from the existing shares or other
specified securities on a proportionate basis through the tender
offer; from open market through book-building process, stock
exchange and from odd-lot holders.
5) SEBI Rules and Regulation for Acquisitions/Takeover: To
regulate the hostile takeovers and bailout takeovers, SEBI has framed
the SEBI (Substantial Acquisition of Shares and Takeovers)
Regulations, 1997. The regulations are not applicable as to allotment
of shares in public issue, firm allotment made in public issue,
allotment made under rights issue, inter se transfer of shares among,
group, relatives, Indian promoters, foreign collaborators, etc.
6) SEBI Rules and Regulation for Mutual Funds: The SEBI
regulations for the establishment and issue of schemes by mutual
funds are as follows:
i) Mutual fund shall be established in the form of trusts under the
Indian Trust Act and managed by separately formed Asset
Management Company.
ii) Money market mutual fund would be regulated by the RBI and
other mutual funds would be regulated by SEBI.
iii) 50% members of the board of AMC must be independent directors
and must have no connection with sponsoring organisation.
iv) The directors should have at least 10 years‟ experience in the
field of portfolio management, financial administration, etc.
v) The AMC should have a minimum net worth of Rs. 10 crore.
vi) The SEBI has the authority to withdraw the authorisation of
AMC if they fail to work for the interest of investors. This
stipulation is not applicable to banks sponsoring mutual funds.
vii) Closed-end schemes should not be kept open for subscription
for more than 45 days. For open-ended schemes, the first 45
days should be considered for determining the target figure.
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134 MBA Third Semester (IFS&FM) MDU
viii) If the minimum amount or 60% of the target amount is not
raised, the entire subscription has to be returned to the investors.
ix) For each scheme, there should be a separate and responsible
fund manager.
x) The SEBI guidelines (1999) restrict MFs to invest not more than
10% of NAV of a scheme in shares or share related instruments
of a single company.
xi) SEBI increased the maximum investment limit for MFs in listed
companies from 5 to 10% of NAV in respect of the open-ended
funds.
xii) The initial issue expenses should not exceed 6% of the funds
raised under each scheme.
xiii) All mutual funds must distribute a minimum of 90% of their
profits in any given year.
xiv)The SEBI shall lay down a common advertising code for all
mutual funds to comply with.
7) SEBI Rules and Regulation for Merchant Bankers: In modern times,
importance of merchant banker is very much, because it is the key
intermediary between the company and issue of capital. Main activities
of the merchant bankers are – determining the composition of the capital
structure, drafting of prospectus and application forms, compliance with
procedural formalities, appointment of registrars to deal with the share
application and transfer, listing of securities, arrangement of
underwriting/sub-underwriting, placing of issues, selection of brokers,
bankers to the issue, publicity and advertising agents, printers and so on.
8) SEBI Rules and Regulation for Credit Rating: They are as follows:
i) The credit rating agencies cannot rate a security issued by its
promoters.
ii) If the debt issue is more than `100 crore, dual rating must
compulsorily involve public and rights issue.
iii) The company should provide correct information to the rating
agencies.
iv) The net worth of rating agencies has been fixed at `5 crore.
v) The rating agencies can choose their own methodology of
operation.
vi) No chairman, director or employee of the promoters shall be a
director, chairman or employee of the rating committee.
9) SEBI Rules and Regulation for Follow on Public Offering
(FPO): Such public issue of securities or offer for sale to public is
required to satisfy the stock exchange listing obligations along with
SEBI guidelines.
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Capital Market (Unit 2) 135

2.10. NEW FINANCIAL

INSTRUMENTS
The new instruments in the capital market are as follows:
1) Global Depository Receipts (GDR’s): GDR is the global finance
method which helps the issuer to raise capital from different market
present across the world. It can be traded either in public or private
market that exist inside or outside US. They are mainly supplied to
international financial institutions. The global depository receipts
certificate is provided by the international banks which are related to
worldwide distribution of capital markets.
2) Foreign Currency Convertible Bond (FCCB): It is a quasi-debt
instrument which is given to the investors by various kinds of corporate
entity, international agency, sovereign state, etc. which are there all
over the world. They are expressed in freely convertible foreign
currency. The Euro convertible bonds are basically provided as the
unsecured obligation to the borrowers. FCCBs show the equity linked
debt security which can be easily converted into shares or depository
receipts. The investors of FCCB can change it into equity by the help of
fixed formula at fixed exchange rate or they can keep it as the bond.
3) Futures: The futures contract is an agreement done between two parties
to buy or sell an asset at a certain price in the future time period. They
are the special types of forward contract as they are formerly
standardised exchange-traded contracts. It is not exactly same as
forward contract. In future contract, the counter-party is the clearing
corporation on the accurate exchange. The future is basically in cash or
cash equivalent instead of physical delivery of the underlying asset. The
parties involved in future contract may buy or write options on futures.
4) Options: The options are the financial derivative showing the
contract which is sold by option writer to option holder. It does not
give the obligation but the right to the buyer to call or put the
security or any other financial asset at a strike price during certain
period of time or at an exercise date.
5) Tracking Stocks: The tracking stock is the kind of common stock
which “tracks” or is controlled by the financial performance of
certain business unit or operating department of a company instead
of whole company. Hence, the units or divisions perform well and
the value of the tracking stocks may increase even though the
performance of the company as the whole is not satisfactory. The
vice versa of the situation can also be true.
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136 MBA Third Semester (IFS&FM) MDU
6) Mortgage Backed Securities: The return of these securities
depends upon the performance of the specific assets. They have
maturity period of 3 to 10 years and is financed by assets like
mortgages, credit card receivables, etc. There is the obligation from
the loan originator and intermediary institution to provide the
minimum yield of maturity.
7) Hedge Funds: Hedge fund is known as fund of funds which is
unregistered private investment partnerships funds. They may be
invested and traded in different markets, strategies and instruments which
may include securities, non-securities and derivatives. They are different
from mutual funds as they have different regulatory requirement. Both
mutual funds and hedge funds need to provide information of some
periodic and standardised pricing and valuation to investors.
8) Domestic Hedge Fund: The domestic hedge funds are present in
U.S.A. which are basically in organised form as the limited partnerships
to collect the investors which are accountable to U.S. Income Tax Act.
The sponsor of the funds is basically a partner and investment advisor.
The hedge funds may be of limited liability company (LLC) or business
trust. These LLPs, LLCs and business trust are not taxed separately but
the income is taxed at the individual level of investors. These three kinds
of firms limit the investors according to their liability but LLCs provide
extra advantage of limited liability for fund advisors.
9) Off-shore Hedge Fund: These are basically present in countries
like Cayman Islands, British Virgin Islands, the Bahamas, Panama,
The Netherlands Antilles or Bermuda. They are basically for the
investments of U.S. tax exempt entities like pension funds,
charitable trusts, foundations and endowments, as well as non-U.S.
residents. The U.S. tax-exempt investors invest in off-shore hedge
funds as they are subject to taxation only if they invest in domestic
limited partnership hedge funds.
10) Exchange Traded Funds (ETF): Exchange Traded Funds has the
advantages of both closed-end and open-end mutual fund. They
work according to the stock market index and are traded on stock
exchange like a single stock at index linked prices. The merits of
these funds are that they provide variety, adaptability of holding a
single share at the same time. They are newly introduced in India
but are very popular in abroad.
11) Fund of Funds (FOF): These investments are also known as multi-
manager investments. The fund of funds has the portfolio of other
investment funds instead of investing directly in shares, bonds or
other securities.
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Capital Market (Unit 2) 137

2.11. EXERCISE
2.11.1. Short Answer Type Questions
1) What is capital market?
2) What is the nature of primary market?
3) What is public issue?
4) What do you mean by rights issue?
5) What is secondary market?
6) Discuss the features of secondary market.
7) Differentiate between BSE and NSE.
8) What is OTCEI?
9) What do you mean by depository system?
10) What is custodial service?
11) List the objectives of SEBI.

2.11.2. Long Answer Type Questions

1) What is capital market? Discuss its functions.
2) Discuss the capital market instruments in detail.
3) What are the importance and limitations of capital market?
4) Give the difference between money market and capital market.
5) What is new issue market? Explain the function of new issue market.
6) What are advantages and disadvantages of new issue market?
7) Discuss the types of new issue market in detail.
8) Explain the following terms:
i) Offer for Sale
ii) Public Issue
9) Discuss the methods of determining prices of new shares.
10) Explain the following terms:
i) Tender Method/Offer
ii) Bonus Shares
11) What is stock exchange? Explain the functions and stock exchanges of India.
12) What are the advantages and disadvantages of secondary market?
13) Differentiate between new issue market and secondary market.
14) What is procedure of trading in stock exchange?
15) Discuss the settlement process.
16) Describe the various services offered by BSE.
17) Discuss the features of BSE and NSE.
18) Explain the advantages of NSE and OTC.
19) What are the features and objectives of OTC market?
20) Discuss the relationship between NSE and OTCEI.
21) Differentiate between NSE and OTCEI.
22) Discuss the objectives and functions of depository.
23) What are the advantages and disadvantages of depository system?
24) Describe the responsibilities of custodian.
25) How is cancellation of registration custodial service done?
26) What is SEBI? Discuss the functions and powers of SEBI.
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138 MBA Third Semester (IFS&FM) MDU

Commercial &
UNIT 3 Development Banks

3.1. COMMERCIAL BANKS

3.1.1. Meaning and Definition of Commercial

Banks
Banks which engage themselves in all types of banking activities, viz.
acceptance of deposits, granting of loans and advances, credit creation,
investment operations, various agency functions, etc. are known as
commercial banks. As they are established as joint stock companies,
they are also referred to as joint stock banks. Besides providing short-
term loans for meeting out the day-to-day operating requirements of
industries, they also extend mid-term and long-term loans for setting up
new industries and expansion activities to be undertaken by the existing
industries.

In India, major 20 commercial banks operate as public undertakings

after their nationalization; other commercial banks operate as private
sector organizations. In other countries, Governments do not have any
stake in the commercial banks, and they are run as private sector
organizations. Some of the major commercial banks of India are State
Bank of India, Bank of Baroda, Bank of India, Canara Bank, Punjab
National Bank, etc.

Indian Companies Act, 1949, has defined the bank, ―The accepting for
the purpose of lending or investment of deposits of money from the
public repayable on demand or otherwise and withdrawable by cheque,
draft, and order or otherwise‖.

The term Banking Company has been explained in sub-section (c) of the
above Section as under:

―Banking company means any company which transacts the business of

banking [in India]‖.
Of late the role of commercial banks as lenders of short-term loans to
traders and small scale industries has undergone a major change; now
they are also referred to as ‗Universal Banks‘ and their operations include
extending short-term, medium-term and long-term loans to traders,
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Commercial & Development Banks (Unit 3) 139
retailers as well as small / medium / heavy industries, and various other
agency functions. Such changes have taken place due to the diminishing
role of term lending institutions like ICICI, IDBI, IFCI, etc.

3.1.2. Features of Commercial Banks

Following are the main features of commercial banks:
1) Mobilisation of Savings: The level of economic growth in a country
largely depends on the quantum of the available savings and
investment in its economy. The banks collect savings from the public,
thus helping in the mobilisation of savings. These savings are used for
lending purposes which helps in increasing the level of investment.
2) Facilitate Commerce and Trade: The Smooth and adequate
supply of finance for commercial and trading activities is vital for
the development of an economy.
3) Balanced Regional Development: Indian government had created
many policies for balanced regional development. In order to
comply with those policies, the banking system was developed in
such a manner that there is proper flow of funds in an economy.
Thus, banks are providing their services in those regions or part
which are under developed. This way the banks are rendering their
social objectives.
4) Provision of Finance to Backward Communities and Neglected
Segments of Society: In India, commercial and co-operative banks
are offering their services at concessional rates to the weaker
sections of society which leads to the growth in society in a more
balanced pattern.
5) Development of Agriculture and Other Priority Sectors in the
Economy: The banks are offering better services to certain priority
sectors of an economy. The important sector can be the small scale
industries (SSIs), agriculture, retail trade, small borrowers, self-
employed persons, etc. This accelerated growth in these sectors is at
fast rate. These sectors are responsible for pushing the economy to
generate more employment opportunities. Export sector is also an
important sector of an economy which avail different services from
banks for different purpose.

3.1.3. Functions and Working of Commercial Banks

Commercial banks have to perform a variety of functions which are
common to both developed and developing countries. These are known
as ‗General Banking‘ functions of the commercial banks. The modern
banks perform a variety of functions.
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140 MBA Third Semester (IFS&FM) MDU
These can be broadly divided into two categories:
Functions and Working of
Commercial Banks

Primary Functions
Secondary Functions
 Acceptance of Deposits  Agency
 Advancing Loans Functions/Services
 Creation of Credit  Other Functions
 Promote the Use of Cheques  Fulfilment of Socio-
 Financing Internal and Economic
Foreign Trade Objectives
 Remittance of Funds

3.1.4. Primary Functions

Primary banking functions of the commercial banks include the
following:
1) Acceptance of Deposits: There are following three types of
deposits which a commercial bank accepts:
i) Term Deposit Account: Term deposits are of following two
types:
a) Fixed Deposits: In this account depositor has to deposit a
particular sum of money at once and there is a restriction
that he/she cannot withdraw his money before certain
period, e.g., 1 year, 2 year, etc. This account offers the
highest rate of interests among all the types.
b) Recurring Deposits: In this account depositor has to deposit a
particular sum of money every month and in this he/she cannot
withdraw his money before a stipulated time period.
ii) Current Account: This account is mostly hold by those who
have to do multiple transactions in a day such as businessmen.
However, these accounts do not yield any interest for the
depositor because bank has to fulfil the cash demands of
depositor any time by maintaining sufficient amount of cash.
iii) Savings Bank Account: Rate of interest on saving account is
low but it promotes the habit of saving among public. This is
the reason behind its popularity among every citizen. This
account poses certain limits in front of depositor such as,
limited number of withdrawals in a week is allowed.
2) Advancing Loans: Out of the deposits received by bank, certain
percentage (as specified by RBI) of it is kept as cash reserve. The
*
amount left after that is provided against certain interest to needy *
Commercial & Development Banks (Unit 3) 141
persons in the form of loans. The bank checks all the required
documents thoroughly in order to ascertain the credibility of the
borrower, before lending him the money. The most common way of
lending is by:
i) Overdraft Facilities: The depositor of current account in the
overdraft facilities is allowed to withdraw more than the agreed
limit. These type of loan is very popular in India. For example, the
owner of the business has `40,000 as the limit of his current
account but he requires `80,000 for bearing the expenses. Than he
can withdraw the additional amount of `40,000 from the bank and
the amount will be given to him by issuing cheques. The bank will
charge interest from the overdrawn amount by the depositor.
ii) Cash Credit: In the cash credit, the bank provides loans to the
borrowers according to the mortgage given by the borrowers. In
this the whole amount of loan is credited in the bank account
but sometimes in emergency the amount is given in cash. The
interest is paid by the borrower only on the amount taken by
him. The borrower can withdraw only the amount allowed to
them by cheques. The bank can also give loan to a person
against the collateral security. The bank can ask for the payment
of the loan when their want.
iii) Discounting Bills of Exchange: It is very famous type of
lending in the modern bank. In this at the time of requirement of
money the bank can discount the bill. The commission is
deducted and the bank will pay the present price of the bill to
the holder. These bills give liquid asset to the bank which can be
changed into cash so it is profitable investment for the bank.
The central bank can also re-discount the discounted bill for the
commercial banks when they require money. These bills are
safe and secured bills as when the bill matures the bank can
secure the payment by the party which will accept the bill.
iv) Money at Call: In this the bank will give loans for very small
period i.e. of 7 days to the borrowers like dealers or brokers in
the stock market against the collateral securities like stock or
equity shares, debentures, etc., given by them. The payment of
such is made after the short time period so they are known as
money at call or call money.
v) Term Loans: These are also known as participation loans or
consortium finance. These loans are given by banks to the
traders, industrialists and also to agriculturists in return of
collateral securities. These term loans are for 1 to 10 years.
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142 MBA Third Semester (IFS&FM) MDU
They help in providing intermediate or working capital funds to
the borrowers. The term loans are also provided by two or more
banks against same security.
vi) Consumer Credit: The banks also provide loan to the
households of a small amount for buying the durable consumer
goods like television sets, refrigerators, etc. They are also
require for the personal needs like payment of hospital bills etc.
the loan is given in lumpsum amount and the payment by the
borrower is done in instalment for small time period. It is also
provided for bearing expenses like marriage, funeral, etc.
vii) Miscellaneous Advances: It is another form of bank advances.
There are packing credits provided to exporters for a small-time
period, export bills purchased/discounted, import finance-
advances against import bills, financial help to the self-
employed, loan to the public sector, loan to the cooperative
sector and loans to the weaker sections of the community at
discount rates.
3) Creation of Credit: The main function of the bank is to create
credit. The banks gives money to the traders and manufacturers. The
banks also help in creating money. The bank deposits is referred to
as the money for the bank and they are as good as cash because they
can be used for purchasing the goods and services and for paying
debts. The banks credits the amount required by the borrower as the
loan and the borrower withdraw the required amount from the
cheque. By the help of this there is creation of deposit which will
lead to creation of credit. Sayers says ―banks are not merely
purveyors of money, but also in an important sense, manufacturers
of money‖.
i) Investment of Funds: Apart from granting loans and credits,
banks also invest their surplus fund in government securities in
order to yield interest from it. There are several provisions that
bind commercial banks to necessarily buy the government
securities because this fund ensures the liquidity in banks and
protect them from the threat of loss in near future.
ii) Promote the Use of Cheques: All the commercial banks
provide cheque leaf to its customers for free or against a
nominal cost. Banks also encourage the use of cheques among
customers because it is an easier task for the banks to facilitate
the transactions done through cheques than cash. The cheque is
found to be the best and most widespread credit instrument
among all others of money market.
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Commercial & Development Banks (Unit 3) 143
iii) Financing Internal and Foreign Trade: Banks provide
financial assistance to entrepreneurs by discounting and re-
discounting of their bills. This service helps the entrepreneurs
to get the payment when it is needed the most; this in turn
assist the businesses of entrepreneurs. Banks also provide
short-term credits to entrepreneurs by mortgaging their
commercial papers.
iv) Purchase and Sale of Foreign Exchange: Purchasing and
selling of currencies is itself a business, i.e., people do it to
make more money by taking advantages of changing rates of
exchange. Some of the banks also perform this function to
facilitate the needs of its customers.
4) Remittance of Funds: The commercial banks have the branches in
various part of the country which help in transferring funds from
one place to another by the help of bank drafts, mail transfers or
telegraphic transfers on small nominal commission charges.
The postal money orders or other instruments has helped in giving
the economical way of transferring money and has also helped the
various business.

3.1.5. Secondary Functions

Secondary banking functions of the commercial banks include the
following:
1) Agency Functions/Services: Agency functions are those functions
performed by bank against which bank charge their customers with
a particular commission. Following are some of such services or
functions performed by bank:
i) Fund Transfer: Banks facilitate the customers‘ needs of
transferring amount to any other account at any other place.
Banks render this service against a commission, which depends
on the amount to be transferred. The tool used by bank for this
is referred to as ‗Bank Draft‘.
ii) Collecting Customers’ Funds: The funds of a customer are
owed by any other bank. The bank collects his fund from that
bank‘s account and deposits it in its own account. For example,
clearance procedure of cheques.
iii) Purchase and Sale of Shares and Securities for its
Customers: The bank also acts as depository participant and
plays a role of intermediary in the process of buying and selling
of shares and securities of private and government companies.
For example, Demat accounts.
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144 MBA Third Semester (IFS&FM) MDU
iv) Collecting Dividends on the Shares of the Customers: The
shares and other securities purchased by the customers yield
certain interest or dividend. Banks credit these amounts to the
accounts of customers.
v) Payment of Premiums: The insurances purchased by
customers generally require premium after a regular interval of
time. Customers may instruct their banks to do timely payments
of premium on their behalf. Similarly, they can instruct for other
payments too.
vi) Bank acts as the Trustee and the Executor: Bank also renders
the service of keeping the ‗wills‘ of its customers safe. It may
also be authorised to take the actions as written in the will, after
the death of its customer.
vii) Income-Tax Consultant: Banks also act as income tax
consultant for its customers by providing them valuable
suggestions of tax savings. If customer asks the bank to prepare
the income tax statement for him, bank does this favour but
charges a certain fee.
viii) Acts as Correspondent: Banks, against a certain fee, also act
as a representative, agent, or correspondent of the customer in
the processes like buying tickets, obtaining passports, making
payments, etc.
2) Other Functions: Following are several other functions performed
by bank:
i) Locker Facility: Banks also offer the service of lockers to its
customers, which provide safe custody to their valuable items
such as, important documents, expensive metals, etc. The
facility of locker is given to the customers against a fixed annual
rent and few other terms and conditions.
ii) Issuing of Traveller’s Cheques: Traveller‘s cheque is an
instrument issued by banks to its customers. It is basically an
instrument that can be used in place of or can be exchanged
with cash while travelling to different countries. This instrument
reduces the risk of theft of money as it can be used only after
endorsement by the signature of holder.
iii) Giving Information about its Customers: Banks have the
access to financial details of their customers, which they can
share with other parties. For example, banks help businessmen
in knowing the credibility and financial position of parties who
are associated with businessmen in credit transactions, i.e.,
*
retailers who purchase in bulk on credit. *
Commercial & Development Banks (Unit 3) 145
iv) Collection of Statistics: Banks also gather updated information
and data related to economy, money, trade and commerce
sector, banking, etc., and communicate it with the help of
booklets, flyers, pamphlets, etc. This information educates the
customers about the economic and business environment and
trend, which helps them in several ways, e.g., businessmen can
use this information during formulation of their policies.
v) Underwriting of Company Debentures: People often hesitate
to buy the debentures issued by private companies. Whereas,
debenture underwritten by banks, i.e., signed by bank gets sold
easily among the people. For underwriting the debentures of
private companies, banks charge certain commission from them.
vi) Accepting Bills of Exchange on behalf of Customers: Banks
also accept the bills of exchange or promissory note of their
reliable customers. Any exchange bill which signifies the
acceptance of bank on it becomes discountable throughout the
money market. Hence, customers get benefitted by this service
of the bank.
vii) Giving Advice on Financial Matters: Banks are very
important part of the economy and they are well versed with the
economic environment of the country. Hence, it can provide
valuable suggestions to its customers regarding financial
concerns.
3) Fulfilment of Socio-Economic Objectives: Banks, especially
public sector and nationalised banks, facilitates the execution and
fulfilment of national policy objectives of the country such as,
elimination of poverty, decentralisation of wealth, eradication of
unemployment, etc. Banks do special arrangements and formulate
special schemes for achieving socio-economic objectives such as,
providing soft loans and loans with lesser rate of interests to
farmers, persons associated with handicrafts and other small-scale
businesses, artisans, etc.

3.1.6. Advantages of Commercial Banks

There are a number of advantages from commercial banks in the present
social milieu, some of which are as following:
1) Financial Assistance: Financial support provided by the
commercial banks is the biggest advantage of having them in the
system. Such support may be for the short-term like cash credit,
overdraft, loans and advances, discounting of bills of exchange, etc.,
or for long term like term loan, venture capital, etc.
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146 MBA Third Semester (IFS&FM) MDU
2) Agency Services: Commercial banks offer various agency services
at reasonable rates (fees or commission) in a swift and dependable
manner. Trade and industries stand to gain by taking the advantages
of such services.
3) Attractive Rates of Interest: The rate of interest and other services
offered by commercial banks to their depositors is quite attractive,
which encourages the household savings to be brought to banks.
Such funds are used for onward lending and investment by
commercial banks.
Thus, the commercial banks indirectly inspire households to
inculcate the habit of thrift and savings, which ultimately find its
way to the bank, and made available to entrepreneurs for productive
purposes.
4) General Utility Services: General utility services offered by
commercial banks include acting as referee, accepting bills of
exchange, providing locker facilities, etc. business organizations as
well as individual bank customers are beneficiaries of such services.
5) Provides Documentary Proof: Cheques can be used for
withdrawal of money, and / or making payments to third parties. As
the withdrawal of money is on demand, there is no need for the
business organizations to maintain huge cash balances with them.
Similarly, large payments need not be made in cash. Another
advantage of making payment through cheque is that it acts as a
documentary evidence of the transaction, i.e. having made the
payment.
6) Smooth Functioning of Foreign Trade: Transactions involved in
foreign trade cannot be accomplished smoothly without availing the
services (which include dealing – receipt and payment- in foreign
exchange, providing credit/guarantee, etc.) of a bank.
Most of the commercial banks have separate divisions dealing
exclusively in foreign exchange matters.

3.1.7. Disadvantages of Commercial Banks

The disadvantages of commercial banks are as follows:
1) Insufficient Growth: The growth of commercial bank in terms of
population is insufficient in India even though the commercial bank
is widespread throughout the country. It can be seen in the rural
areas where there are 50% of the bank branches but the population
of rural areas is only about 75% of the overall population of the
country.
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Commercial & Development Banks (Unit 3) 147
2) Regional Imbalances: There are only few states in the country
where there is proper availability of well-developed banking
services like Assam, Bihar, Arunachal Pradesh and Madhya Pradesh
,which has less banks in comparison to the other states of the
country. Hence, there is presence of regional imbalances in the
coverage of the bank offices. The various states such as
Maharashtra, West Bengal and Tamil Nadu, are being well banked
but are not included in the population per bank office as it is larger
than the average for these states.
3) Increasing OverDues: The commercial banks are having the issue
of bad debts, doubtful debts and over dues due to rise in the
advances and loans to unemployed and lower section of the
commercial bank.
The process of recycling of funds by the commercial bank is
adversely affected because the loans for advances of more than 50%
are not recovered by the banks.
4) Lower Efficiency: As per the passage of time,the quality of
services provided by the commercial bank has declined. It is
because of disruptive behaviour of employees and lack of proper
accountability system.
There arises the difficulty of proper management and control
especially among the branches present in the remote areas. Hence,
the efficiency of the commercial banks is affected to a large extent.
5) Declining Trends in Profitability: The profitability ratio of return
on investment and return on equity has decreased whereas the
absolute profits of the banks have increased.
There are factors which are responsible for decreasing the
profitability trend:
i) The rise in Statutory Liquidity Ratio and Cash Reserve Ratio,
ii) The continuous rise in importance of social goals,
iii) The increase in rate of industrial sickness,
iv) The speedy increase in the branch expansion,
v) The adverse deposit mix of banks, and
vi) The increase in occurrence of financial disintermediation.
6) Lack of Expert: The public sector banks lack expertise in the field
of merchant banking and agricultural financing even though they
enter into these sectors. Hence, they are required to be trained by the
experts and acquire the knowledge about these areas.
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148 MBA Third Semester (IFS&FM) MDU

3.2. TYPES OF COMMERCIAL BANKS

The organizational set-up of commercial banks in India has been shown
in the following chart:
Structure of
Commercial Banks

Public Private Regional Foreign

Sector Sector Rural Banks
Bank Bank Banks

State Bank of Other

India and its Nationalized
Associate Banks
Banks
Figure 3.1: Structure of Commercial Banks
3.2.1. Public Sector Banks
Public sector banks are the backbone of the commercial banking framework
in India. Majority of their shareholding lies with the Government of India.
They can be broadly classified into two categories:
1) State Bank of India Group; and
2) Other Nationalized Banks.
3.2.1.1. State Bank of India Group
The history of State Bank of India may be traced back to the pre-
independence era, when in the year 1921 three Presidency Banks, viz.
Bank of Bengal, Bank of Bombay, and Bank of Madras were
amalgamated to form the Imperial Bank. This was followed by its
nationalization in 1955 through the enactment of State Bank of India,
1955 and birth of State Bank of India on July 1, 1955. This was a
milestone in the nationalization process, which took the final shape in
the year 1959 and 1969 with the nationalization of other major
commercial banks. The primary objective of the nationalization of banks
was making banking facilities available to masses, especially covering
the people residing in rural and semi-urban areas, which were hitherto
deprived of the same.
Other objectives of the nationalization were as under:
1) Reforming the system of agricultural finance and ensuring smooth
flow of credit to agriculture sector;
2) Facilitating the implementation of RBI credit policies; and
3) Enabling the Government in tracking its broad economic policies.
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Commercial & Development Banks (Unit 3) 149
3.2.1.2. Other Nationalized Banks
Subsequent to the nationalization of Imperial Bank in 1955, which saw
the SBI coming into existence, nationalization of SBI subsidiaries took
place in 1959. However, the nationalization of major 14 banks in 1969
may be termed as the watershed event, the architect of which was our
late Prime Minister Mrs. Indira Gandhi. The ownership pattern of those
banks changed overnight from ‗Private‘ to ‗Public‘.

The next phase of nationalization process took place in 1980, when

seven more banks, having deposit-base over `200 crore, were
nationalized. Now at this stage, the Government of India owned almost
80% business of the banking sector. It is interesting to know that
consequent upon the nationalization, the business of public sector banks
grew manifolds (approximately 800% in deposits and 11,000% in
advances).

A summary of history of nationalization process in India is as following:

1955: Nationalization of State Bank of India;
1959: Nationalization of SBI subsidiaries;
1969: Nationalization of 14 major banks; and
1980: Nationalization of Seven banks.

The number of nationalized banks remained at 20 for a long time.

However, the merger of a nationalized bank viz. New Bank of India
with another nationalized bank viz. Punjab National Bank in 1993, (an
isolated case of merger of one nationalized bank with another
nationalized bank), led to a reduction in the number of nationalized
banks from 20 to 19.

3.2.2. Private Sector Banks

Private sector banks are those banks in which majority of stake are held
by private individuals. Eg. ICICI Bank, etc. Subsequent to the
nationalization of 14 major banks in 1969, business houses were not
allowed to set-up banks; in other words, no bank was allowed to be set
up in the private sector.

However, as a aftermath of the Narasimhan Committee report, entry of

new private sector banks was permitted, with certain riders pertaining to
capital adequacy and other requirements (especially use of technology),
by RBI in the year 2003. One of the objectives behind allowing entry of
new generation private sector banks was to bring about an element of
competition amongst public sector banks, as the quality of services
provided by them had declined considerably.
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150 MBA Third Semester (IFS&FM) MDU
Difference between Public Sector Bank and Private Sector Bank
Public Sector Banks Private Sector Banks
1) A minimum of 51% shares of all Majority shares of private sector banks,
the PSBs (including SBI, its both old (e.g. South Indian Bank,
associates, and other nationalized Karnataka Bank, Jammu & Kashmir
banks) are held by Government of Bank, etc.), and new (e.g. HDFC Bank,
India. . ICICI Bank, AXIS Bank, Kotak Mahindra
Bank, etc.) are held by the general public.
2) Their balance sheet size is large, The size of their balance sheet is small,
and their capital adequacy level is and they can be set-up with a lower level
high. of capital base.
3) The branch network of PSBs is The branch network of private sector
widespread covering a large chunk banks (including those in rural areas) is
of even rural areas. They have limited; especially the new generation
comparatively a deeper penetration private sector banks have their presence
and geographical presence in mostly in urban centres.
remote regions of the country.
4) A higher number of staff is The number of personnel is comparatively
employed by PSBs. They are also much less. Trade Unions of private sector
known to have the presence of banks are not that organized and
well-organized Trade Unions. powerful.
5) PSBs focus more on fund-based Besides the traditional banking, i.e. loans
business, i.e. loans and advances, and advances, they engage themselves
and as such the major chunk of into the fee-based businesses, e.g. loan
their income comes therefrom. syndication, equipment leasing, credit
Nonetheless, of late a good number cards, mutual funds, insurance, etc. Their
of PSBs have ventured into the income from fee-based / commissions are,
business of credit cards, mutual therefore, more.
funds, etc.
6) Use of technology by PSBs is Private sector banks, especially the new
generally at a lower level. generation private sector banks, are tech-
However, now they are trying to savvy. They are able to grow faster with
catch up with their peers in private lesser resources by using state-of-the-art
sector. technology.
7) The intervention and control With the RBI‘s policy of deregulation
exercised by the Government of being implemented at a fast pace during
India is more, although the same is the last few years, the private sector banks
declining slowly. As a result, PSBs have more freedom in deciding their
have limited freedom in deciding business models / other policies.
their business models / other
policies.
8) NPAs tend to be at a higher level. NPAs tend to be at a much lower level.
9) The word ‗Limited‘ is not used at The word ‗Limited‘ is used at the end of a
the end of a public sector bank‘s private sector bank‘s name.
name.

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Commercial & Development Banks (Unit 3) 151

3.2.3. Regional Rural Banks

Regional Rural Banks were established under the provisions of the RRB
Act, 1976 with a view to extend appropriate banking services
(particularly the credit facility) in rural areas of the country. Their entry
into the rural scenario was the outcome of the recommendations of
‗Narasimham Working Group‘, which had strongly favoured including
rural areas into economic mainstream.
RRBs were expected to be the key agents for taking the banking
services to the rural masses, particularly in the remote rural areas, who
at that time had no access to the banking services. They were basically
intended to extend institutional credit to the weaker sections of the
society called ―target group‖, which were hitherto deprived of any such
facility. RRBs have an appropriate combination of qualities possessed
by cooperative banks (local feel and better understanding of rural
challenges) and commercial banks (business organization and the
deposit mobilization skills).
Functions/Role of Regional Rural Banks in Rural India
1) Granting loans and advances to the individuals from weaker section
of the society belonging to the rural background, particularly to the
small and marginal farmers, agricultural labourers, artisans and
small entrepreneurs, engaged in the occupations like agriculture,
small trade /commerce/industry and similar productive activities;
2) Extending financial support in the form of loans and advances to
various cooperative societies such as marketing societies,
agricultural processing societies, cooperative farming societies, pri-
mary agricultural credit societies, farmers service societies for
agricultural purposes, etc.;
3) Ensuring the provision of banking services to the rural masses,
especially covering the unbanked rural areas;
4) Mobilization of household rural savings through the acceptance of
deposits and lending to the rural population for undertaking
productive activities at the local level;
5) Creating an additional source of credit from the urban money
market to the rural areas through refinances;
6) Generation of job prospects in rural areas; and
7) Reduction in the cost of credit supply in rural areas.

3.2.4. Foreign Banks

Banks, having their origin in foreign countries with their head offices
situated outside India, are known as foreign banks. They were earlier
referred to as ‗Exchange Banks‘.
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152 MBA Third Semester (IFS&FM) MDU
Some of the prominent foreign banks currently operating in India are as
under:
1) Standard Chartered Bank (Standchart): in operation since 1858;
2) Citibank: in operation since 1902;
3) Hong Kong and Shanghai Banking Corporation (HSBC): in
operation since 1953.
However, consequent upon policy initiatives taken by the Government and
Reserve Bank in late 1980, a large number of foreign banks opened their
branches in India. As on date, almost all the international banks have their
presence on Indian soil in one form or the other (representative office or
full-fledged branch). Indian banking system also stands to gain from their
presence, as they bring latest technology and banking practices with them.
In fact, domestic banks have learnt a lot from them and have been able to
improve their performance, especially in the area of customer service. A
large number of customers are attracted towards the foreign banks because
of the efficient and prompt services provided by such banks. As per the new
guidelines issued by the RBI, foreign banks operating in India are allowed
to set-up local subsidiaries.

3.2.5. Difference between Central Bank and

Commercial Bank
Basis of Central Bank Commercial Bank
Difference
1) Meaning A central bank is the bank which A commercial bank is such a bank
controls the monetary system of which offers banking services to
the country. public.
2) Deals with The central bank is the banker to The commercial bank is the banker
banks and government. Hence, it to the public. Therefore, it deals
deals with banks and government. with general public.
3) Governing It is governed under the Reserve It is governed under the Banking
Statute Bank of India, 1934. Regulation Act, 1949.
4) Motives The objective behind the The objective behind the existence
or existence of central bank is of commercial bank is to earn profit.
Objectives economic development and
welfare of the public.
5) Authority Since the central bank controls the The commercial banks do not have
monetary system of the country, it any monetary authority.
is considered as the apex monetary
authority with great powers.
6) Source of It has the authority to issue The functions like issue of currency
Supply for currency and hence it supply are not performed by any
Money money in the economy. commercial bank.
7) Number There is only one central bank in There could be any number of
of Banks the country. In India, Reserve commercial banks in a country. For
Bank of India is the central bank. example, Bank of Baroda, State Bank
of India, Axis Bank, ICICI Bank, etc.
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Commercial & Development Banks (Unit 3) 153

3.3. REGIONAL RURAL BANKS (RRBS)

3.3.1. Meaning of Regional Rural Banks (RRBs)
There is a huge portion of India which comes under the rural areas. But
unfortunately, this rural region is backward and it has a very little access
to the banking facilities of the country. Hence, Regional Rural Banks
were established to promote the access of rural areas in banking sectors.
Initially, these banks were established with the aim to provide financial
assistance to the weaker section of the society i.e., ‗the target group‘.
The RRB is considered as the institution which brings together the local
familiarity and rural issues. In order words, RRBs unite the rural issues
of the business and cooperatives of the rural areas with ability to mobile
the deposits possessed by the commercial banks.

3.3.2. History of Regional Rural Banks

In the year 1975, the Narasimham Committee conceptualised the
creation of RRBs. This committee suggested the establishment of RRBs
as a new set of regionally oriented rural banks. This committee also
suggested to meet the needs of funds in rural areas, RRBs will be more
suitable than any other commercial or cooperative bank.
Hence, as per the recommendations of this committee, 5 RRBs were
established on 2nd October 1975 under the ordinance passed by the
government on 26th September 1975. Later, this ordinance was replaced
with the Regional Rural Bank Act, 1976.

3.3.3. Features of Regional Rural Banks

The features of regional rural banks are given as follows:
1) Sponsorship: Any scheduled commercial bank must sponsor the
regional rural banks. For example, Allahabad UP Gramin Bank is
sponsored by Allahabad Bank and Baroda UP Gramin Bank is
sponsored by Bank of Baroda, etc.
2) Jurisdiction: For the efficient functioning of the banks, the
operational areas of the RRBs cover one or two districts. While
keeping in mind the financial and operational efficiency of the bank,
the number of branches of each RRB may vary from 50 to 60.
Further, each branch of the RRBs must cover the population
approximately twenty thousand. However, all these conditions may
change from time to time as per the guidelines of the RBI.
3) Management: The management of RRBs is done by the board
members. In the board, there must be 8 directors (3 directors
*
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154 MBA Third Semester (IFS&FM) MDU
government and other 3 nominated by central government) and 1
Chairman who is the officer of the sponsored bank. Generally,
RRBs are sponsored by such commercial banks which are the
leading bank of the district. Further, in some areas, the private
banks or state cooperative banks are also allowed to sponsor RRB.
The sponsored bank must offer assistance to RRB for its initial
five years.
4) Share Capital: The capital structure of the RRB must have
authorised share capital `1 Crore and issued capital `25 lakhs. The
contribution of this capital must be among Central Government,
State Government, and Sponsored Bank and this capital must be in
the ratio of 50:15:35 respectively.
5) Functions: The basic function of RRBs is to offer loans and
advances to the target groups, like, small farmers, cooperative
societies, agricultural labours, cooperative farming society (for
agriculture), small businessmen, etc. This function of offering loan
must be performed within their operational areas. The RRBs also
expand their banking facilities by collecting cheques, issuing
drafts, etc.
6) Rate of Interest: The RRBs charges the same rate of interest as the
PACS (Primary Agricultural Credit Society). Further, in order to
promote saving habit among the rural people, RRBs are also
allowed to offer 0.50% more interest on deposits than any other
commercial bank.

3.3.4. Objectives of RRBs

The objectives of RRBs are as follows:
1) To offer loans and advances to the target groups, like small farmers,
cooperative societies, agricultural labours, small businessmen,
weaker sections of the society, etc.
2) To encourage various productive activities in rural areas, such as
industry, trade, commerce, etc.
3) To control the unstructured flow of credit in the rural areas and
provide sufficient and easy loan to the people belonging to poor and
backward classes.
4) To motivate rural entrepreneurs.
5) To boost employment opportunities in the rural areas.
6) To meet the social responsibilities and to settle the objective of rural
business.
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Commercial & Development Banks (Unit 3) 155

3.3.5. Functions of RRBs

The functions of the regional rural banks are mentioned below:
1) The primary function of RRBs is to provide loans to socially weaker
section, agricultural labours, small farmers, artist, etc., who are
engaged in workers related to agriculture, small trade and
commerce, etc.
2) The RRBs provide support to different cooperative society, like
agricultural processing societies, marketing societies, cooperative
farming societies, farmers service societies, primary agricultural
credit societies, etc.
3) The RRBs ensures that whether banking provisions are extended to
rural people or not. It also covers such areas or groups which are
unbanked.
4) The RRBs also function in areas to mobilise the savings of rural
people through accepting their deposits and advancing loans to
people where money will be used in productive areas.
5) With the help of refinancing, it also creates an additional source of
fund from urban to rural money market.
6) Since, the RRBs provide loans on easy terms and on lower rate of
interest. Therefore, it helps the rural areas to reduce the cost of
credit supply.

3.4. DEVELOPMENT BANKS

3.4.1. Meaning of Development Banks

Development Banks are specialised and multipurpose financial
institutions which offer long-term assistance to the institutes engaged in
providing services in critical areas of economy. Such sectors are small
scale industries, export houses, agricultural development and industrial
development. Development banks act as financial agencies which offer
medium to short-term funds and also provide advisory services for the
balance growth in the country. These institutes are involved in key areas
of economy such as agriculture and such. Such institutes help in faster
growth of the economy.

3.4.2. Features of Development Banks

The main features of development banks are as follows:
1) These banks are not engaged in regular banking activities such as
accepting deposits.
2) Such banks also provide working capital assistance.
3) Development banks also provide other assistance to the industries as
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156 MBA Third Semester (IFS&FM) MDU
4) Such banks also subscribe to the instruments issued by other
companies by offering guarantees and underwriting services.
5) These banks also offer other services such as planning and strategic
advises.
6) Such institutes may also offer managerial, technical and economic
assistance in the form of carrying out surveys and studies.
7) Such banks engage with both private and public banks.
8) The main purpose of such institutes is to promote development and
help industrialization.
9) Such institutes help in increasing the economic growth rate.

3.4.3. Objectives of Development Banks

Following are the main objectives entrusted to development banks:
1) Such banks act as a growth catalyst for different sectors ranging
from agriculture to industry.
2) Increasing the growth rate for the economy.
3) Dividing the resources appropriately to aid critical domains.
4) To help the process of fast industrial growth and offer employment
opportunities.
5) To aid the process of developing entrepreneurial skills.
6) To help promoting rural area development.
Additionally, these banks also play key roles as below:
1) Planning and promoting industries in the areas which are lagging.
2) To coordinate between various institutes engaged in the process.
3) Offering promotional activities such as finding new ideas, carrying
out feasibility analysis and offering technical and other expertise.

3.4.4. Functions of Development Banks

Following are the main functions and working of development banks:
1) Catalysts: The development banks are required to act as activators
for the purpose of providing accelerated growth rate. This is
important for the purpose of ensuring sustainable growth.
2) Entrepreneurial Cult: These banks help in increasing
entrepreneurial traits. It helps in providing assistance in the form of
technical and managerial assistance.
3) Socio-Economic Objectives: Such banks help in attaining the
objective of achieving socio-economic growth. It helps in equitable
distribution of wealth and increasing self-reliance.
4) Balanced Development: These institute help in ensuring balanced
development as these are entrusted with the task of providing funds
*
and assistance to critical areas of economy. *
Commercial & Development Banks (Unit 3) 157
5) Optimal Utilisation: These banks help in utilizing the national
resources in a more balanced way. It also helps in the development
of infrastructure sector as well.
6) Financial Functions: Development banks perform various financial
functions such as providing loans and financial assistance. It also
aids other processes such as issue of equity shares and debentures
by subscribing to them, providing loan guarantees and offering
strategic advisory services.

3.5. NON-BANKING FINANCIAL

COMPANIES (NBFCS)/NON-BANKING
FINANCIAL INSTITUTIONS (NBFIS)

3.5.1. Meaning and Definition of NBFCs/NBFIs

Non-Banking Financial Institution refers to those financial institutions
which provides various banking services but does not have any banking
license. These are registered under the Companies Act, 1956. These are
controlled by the Reserve Bank of India.

According to the Reserve Bank (Amendment Act) 1997, ―A Non-

banking Finance Company (NBFC) means:
1) A financial institution which is a company;
2) A non-banking institution which is a company and which has as its
principal business the receiving of deposits under any scheme or
arrangement or in any other manner or lending in any manner;
3) Such other non-banking institution or class of such institutions, as
the Bank may with the previous approval of the Central
Government specify.
The definition given by Reserve Bank (Amendment Act), 1997 does not
include the financial institutions which does agricultural operations as
their main business.
The NBFC includes those companies which does the work as stated in
the above definition and also the foreign companies which comes under
Section 591 of the Companies Act. The company which does the
following activities is not an NBFC:
1) Agricultural activity
2) Industrial operation
3) The purchase or sale of any goods except securities or also
providing any kind of services.
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158 MBA Third Semester (IFS&FM) MDU
4) The purchase, construction or sale of immovable property and also
no part of income of the institution is taken from the financing of
purchase, construction or sale of immovable property by other
persons.
The company for working as NBFC needs to register with RBI.
Also, the Non-Banking Financial Institution (NBFI) are those financial
institutions which does not have banking license and cannot take
deposits from the public. Thus, NBFI helps in various other services like
collective and individual type of investment, risk pooling, financial
consulting, brokering, money transmission and check cashing. NBFI
also provides consumer credit with the licensed banks. The non-banking
financial institutions also gives services which are not provided by the
banks and also act as the competition for the banks and are also expert
in certain sectors and groups.

3.5.2. Features of NBFCs

The various features of NBFCs are as follows:
1) The non-banking financial companies need to registered with the
Reserve Bank of India. The companies which are not registered
cannot do the financial activities.
2) The NBFCs has constant communication and direct relation with the
customers.
3) The NBFCs has the better understanding of the need and demand of
the customers.
4) The NBFCs has various branches in the country so they are present
everywhere.
5) The NBFCs involves very low cost operations.

3.5.3. Functions and Working of NBFCs

The various functions and working of the NBFCs are as follows:
1) Financial Intermediation: The transfer of funds from savers to the
investors is one of the important function of non-bank financial
institution. It is efficient and less costly for small businesses and
small savers.
i) It gives financial assistance to the small business which cannot
sell stocks and bonds due to high transaction costs.
ii) It also helps the small savers by allocating funds and expanding
the investments.
2) Economic Basis of Financial Intermediation: The fund can be
handled more efficiently and effectively in financial intermediaries
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Commercial & Development Banks (Unit 3) 159
as compared to the individual wealth owners as the financial
intermediation depends on:
i) Law of Large Numbers: The financial institutions work on the
statistical law of large numbers. The law states that all the
creditors will not withdraw the funds. There will be some which
will withdraw the cash while other will deposit the cash in these
institutions.
The financial intermediaries get the regular interest payments on
loans and investments done by them. The financial
intermediaries by the help of these factors maintains certain
amount of cash and while the rest is either given as loan or is
invested.
ii) Economies of Scale: The big size of the asset portfolios helps
the financial institutions to attain economies of scale in portfolio
management. The various economics are as follows:
a) The risk can be reduced due to portfolio diversification.
b) The appointment of efficient and experienced managers.
c) The low administrative cost of large loans.
d) The low cost of establishment, information and transactions.
iii) Inducement to Save: The non-bank financial institution is
significant for promoting saving in the country. These financial
institutions provide the different type of financial assets for
storing the savings value of the public. They also provide expert
financial services to the savers.
These financial assets are more beneficial than the tangible
assets like physical capital, inventories of goods, etc. They can
be easily stored as they can be easily liquid and has less risk.
There is positive ratio between saving and income of both
financial institutions and financial assets.
iv) Mobilization of Saving: The mobilisation of saving can be
done when the saving is in the form of currency, bank deposits,
post office savings deposits, life insurance policies, bills, bond's
equity shares, etc. It gives the better system for mobilising the
savings.
v) Investment of Funds: The basic aim of NBFI is to earn profit
by investing in mobilisation of savings. These institutions have
different type of investment policies. For example, savings and
loan associations, mutual saving banks invest in mortgages,
while insurance companies invest in bonds and securities.
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160 MBA Third Semester (IFS&FM) MDU

3.5.4. Services Rendered by NBFCs

There are different kinds of financial services provided to the clients.
The different types of services which are under on-banking financial
services are as follows:
1) Mobilisation of Savings: The NBFCs has the positive impact on
certain deposits segments. These companies help in increasing the
savings among the public. They provide different methods for catering
the needs of different customers by providing different interest rate.
The 98% of deposits is given at the interest rate above 13%.
2) Provision of Easy, Simple, and Adequate Credit: The NBFCs
provide the credit on the time of requirement. It is available for
everyone. The procedure and formalities are easy in it. They give
loans for personal expense like marriage religious activities, etc.
3) Acting as Financial Supermarket: NBFCs gives different types of
services which makes it a financial supermarket for the customers.
They provide services with diversification of the activity which reduces
the risk of NBFCs. The different services provided by NBFCs are
mutual funds, specialist forex operations, counselling, merchant
banking, etc., which are different from the traditional services.
4) Channelising Funds for Productive Purposes: NBFCs helps in
mobilising the small savings of the public and help in increasing the
production. The industrialists can do production with less capital as
the machinery and equipment given by leasing companies.
5) Increasing Saving in Public: NBFCs help in increasing saving in
the public by receiving deposits from the public in different ways.
They help in mobilising saving by the issue of debentures, unit
certificates, saving certificates, chits, subscriptions, etc.
6) Providing Housing Finance: NBFCs provides different types of
housing loans to the public on simple terms and conditions. The
housing facility is very important for the public to survive.
7) Increasing the Standard of Living: NBFCs helps in increasing the
standard of living by providing loan to public for purchasing
consumer durable goods on instalment basis. The efficient transport
facilities helps in the movement of goods from one place to another
and also increase the availability of different goods which has
increase the standard of living of the people.
8) Promoting Economic Development: NBFCs helps in increasing
the economic development by increasing the growth of the financial
market and providing different choices to the investors. These
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Commercial & Development Banks (Unit 3) 161
NBFCs by the help of diversification provides good return on
savings while reducing risk. They keep the capital market active and
busy which help in enhancing the stability of business in the
economy and also increase the growth of an enterprises.
They are interested in price stability rather than speculative
activities. Hence, it has the positive effect on the stock market
which also lead to the economic development of the country.
9) Rendering Investment Advice: NBFCs also provides advices for
doing and controlling the investments. They also provide protection
to the small investors by giving diversified investment opportunity.
They provide service to the investors by giving options of various
securities which provide maximum return.

3.5.5. Types of NBFCs

The various types of NBFCs are as follows:
1) Equipment Leasing Company (ELC): As by the name the
companies which are involved in the leasing of the equipment or
financing of such activity is known as equipment leasing
company.
2) Hire-Purchase Finance Company (HPFC): The company which
are involved in the hire-purchase business or in the financing of
hire-purchase is known as hire-purchase finance company.
3) Housing Finance Company (HFC): The company whose principal
business is to provide finance for the acquisition or construction of
house which includes the acquisition or development of plots of
lands is known as housing finance company.
4) Investment Company (IC): The company which are involved in
acquisition of securities is known as investment company.
5) Loan Company (LC): Loan company is the company whose
principal business is to provide loan and advances. The equipment
leasing company or a hire-purchase finance company or a housing
finance company are not the part of loan company.
6) Miscellaneous Non-Banking Company (MNBC): The MNBC
includes the following types of business:
i) The company involved in handling, doing or controlling as a
promoter, foreman or agent of any type of transaction or
arrangement by the help of the company enters into an
agreement with specific number of subscribers in which all of
them should subscribe same number of instalments in the
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162 MBA Third Semester (IFS&FM) MDU
specific period. These subscribers will estimated by lot or by
auction or by tender or in the way to be given in the agreement
which is eligible for prize amount.
ii) The company which is doing different type of chit or kuri which
not the same from the business which is given above.
Undertaking or doing the other kind of business which is same
to the business given above.
7) Nidhis or Mutual Benefit Finance Company (MBFC): MBFC are
the company which is reported by the Central Government under
Section 620A of the Companies Act 1956. These have `1 as the
nominal shares.
It gets deposits from its member and give loan only to the members
in mortgage of some tangible securities. The loans are provided for
personal expenses like marriages, repair if houses, etc. These types
of loans are not given by commercial banks.
It is one of the oldest type of non-financial companies. The main
objective of Nidhis to take deposit from their members and to get
loans at a favourable rate of interest. It helps in increasing the
saving habit among the people.
These are generally well-managed and work on the principle of
complete mutuality of interest. As these promote the saving
habits in the middle and lower class of society so the government
also provides deduction under Section 620A of the Companies
Act.
8) Residuary Non-Banking Company (RNBC): RNBC is the
company which gets deposits according to various schemes or
arrangement in one lumpsum or in instalments by the help of
contribution or subscriptions or by sale of units or certificates or
other instruments or in any other form as stated in the definition of
non-banking financial companies (Reserve Bank) Directions, 1977
or as the case may be, the Miscellaneous non-banking companies
(Reserve Bank) Directions, 1977 is not an insurance company.
9) Non-Banking Non-Financial Company (NBNFC): NBNFC is
the industrial concern which is defined in Industrial
Development Bank of India Act, 1964 or the company whose
main work is the agricultural operation or trading in goods and
services or construction/sale of real estate and which is not
classified as financial or miscellaneous or residuary non-banking
company.
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Commercial & Development Banks (Unit 3) 163

3.5.6. Structure of NBFCs

The structures of NBFCs are presented in diagrammatic form:
Non-Banking
Financial Sector

Non-Banking
Financial Company

Non-Registered with RBI, Exemptions from RBI in all

Registered and regulated regulations (including
but RBI issues directions on
by RBI requirement of registration)
the deposit taking activity

— Loan company — Insurance Company

— Mutual benefit finance
— Investment Company — Stock exchange, Stock
Company (notification)
— Equipment issuing — Mutual benefit company
Bankers, Merchant
Company Bankers
(protected) Nidhi
— HP Finance Company — House Finance Company
— Miscellaneous Non-
— Residuary Non-banking — Micro-finance Company
banking Company
Company

3.5.7. Importance of NBFCs

The importance of NBFCs are as follows:
1) Greater Reach: NBFCs are present in every part of the country.
These institutions are present in the remote area of the country
which expand their reach in the country.
These are able to reach the financial requirement of large number of
customers which does not get the services of the banking
institutions.
2) Flexibility in Tapping Resources: The NBFCs are present
everywhere which let them use the new and different types of
resources of the economy. The different type of financial sources
keep on changing.
3) Retail Services to Small and Medium Business: The NBFCs
provides loans and funds to the small and medium units on easy
terms and conditions which is not possible in other banking
institutions.
4) Important Component of Financial Market: NBFCs help in
providing financial services to the people present in the distant and
remote areas of the countries. It is very important part of financial
market.
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164 MBA Third Semester (IFS&FM) MDU

3.5.8. Difference between Banks and NBFCs

Basis of Banks NBFCs
Differences
1) Meaning Bank are those financial NBFCs are the financial
institutions which takes bank institutions which does not
deposits as the way of making accept liabilities as way of
payment in settling the debt. making payment in settling
the debt.
2) Types of The banks are of same type The NBFCs are the
Group which means they are heterogeneous in the financial
homogeneous in the business. structure of the economy.
3) Credit The banks provide short-term NBFCs provides the short,
Term credit in the money market. medium and long-term credit
in financial market.
4) Functions The commercial banks are The NBFCs are basically
basically involved in involved in the mobilising
expanding credit. saving for investment.
5) Influence of The credit creation of The rate of interest affects the
Interest commercial bank is estimated operations and mobilisation
Rate by the available surplus of saving in the NBFCs.
revenue and the cash revenue
ratio. The rate of interest is not
very important for this.
6) Cost of There is no interest paid on the NBFCs pay high interest for
Funds demand deposits which leads attracting more funds.
to raising funds.
7) Purpose The public deposits money in The public deposits saving in
commercial bank for safety, NBFCs for investing their
convenience and for liquidation. savings for earning more profit.
8) Processing The credit creation in the There is longer time period in
Time banks uses less time as the NBFCs according to the
banks are basically interested income turnover.
in the payment turnover.

3.6. EXPORT IMPORT (EXIM) BANK

OF INDIA
3.6.1. Introduction
The Export and Import Bank of India is also known as the EXIM Bank.
It was set up on 1st of January,1982. The bank took over the tasks which
were earlier undertaken by the international finance wing of the IDBI. It
provides assistance to importers and exporters. Its other function is to
act as the apex financing body for international trade. The EXIM Bank
offers refinancing facility to various institutes such as commercial
* *
Commercial & Development Banks (Unit 3) 165
banks. The EXIM Bank was set up by an Act of Parliament and its main
purpose was to offer financing for the purpose of promoting foreign
trade. It also co-ordinates the activities of various financial institutions
engaged in this sector.
The EXIM Bank is fully owned by the Government of India. The bank is
managed by a Board of Directors which consists of the representatives of
the Government, Reserve Bank of India and Export Credit Guarantee
Corporation of India and many other financial institutions. The main
purpose of the bank is to promote globalization in India. It also aims to
develop connections between different organizations.

3.6.2. Objectives of EXIM Bank

Following are the main objectives of EXIM Bank:
1) The bank aims to provide comprehensive services to Indian project
exporters.
2) It helps in increasing the scope of export contracts which are funded
by international bodies such as Asian Development Bank, the World
Bank, European Bank for Reconstruction and Development and
African Development Bank.
3) It offers lines of credit to foreign financial institutions as well as to
foreign governments. This also helps in boosting India‘s foreign trade.
4) The bank helps in reducing credit risk for Indian foreign traders by
offering lines of credit.
5) The bank provides a wide range of facilities for people interested in
making capital investments. The bank uses its Overseas Investment
Finance Program. The facilities consist of providing direct equity
participation and non-funded services such as letters of credit.
6) The bank also runs The Rural Initiative Programme under which it
endeavours to connect Indian rural businesses with global markets.
7) The bank has also launched the Export Marketing Services (EMS)
program for the purpose of aiding small and medium scale
businesses.
8) The bank aids its programs by providing mentoring facilities as
well. It also offers advisory and value added information services.

3.6.3. Functions and Working of EXIM Bank

The functions and working of the EXIM Bank includes:
1) The bank offers financing services for foreign trade of India and
other third world countries.
2) Offers financing for the import and export of various machinery and
equipment‘s on lease basis.
3) Financing of joint ventures abroad.
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166 MBA Third Semester (IFS&FM) MDU
4) Offering loans to Indian entrepreneurs for supplying capital for their
joint ventures abroad.
5) Perform several merchant banking activities such as underwriting of
bonds, debentures, stocks and shares of businesses involved in
foreign trade.
6) Offers technical, financial and administrative guidance to the
businesses involved in export and import.

3.6.4. Facilitative Role of EXIM Bank in Financing

Exports
Export-Import (EXIM) Bank of India was established in 1st Jan. 1982
with the objective of providing financial support to exporters and
importers, and functioning as the apex financial institution for
coordinating the working of institutions engaged in financing export and
import of goods and services with a view to promoting the country‘s
international trade. It plays an important role in facilitating foreign trade
in our country, as may be seen from the following:
1) Funded Assistance: Funded assistance programs of the EXIM bank
are designed for Indian exporters to make them competitive and
their successful operation in global markets. This program provides
extending three types of credit facilities as following:
i) Loans to Indian Companies
a) Deferred Payment Exports: This type of facility is meant
for the Indian exporters engaged in the export of authorised
goods and services, under which they are empowered to
extend deferred credit to their overseas buyers. Indian
consultants, technology, and certain other services are
covered under this scheme. Commercial banks play a
significant role in ‗deferred payment exports‘, directly as
well as under ‗risk syndication arrangements‘.
b) Pre-Shipment Credit: Pre-shipment credit, also referred to
as packing credit, is made available to the exporters
engaged in execution of export contracts involving cyclic
payment from their overseas buyers, for a period not
exceeding six months. This facility is also available for
meeting rupee mobilisation expenses for the export of
construction/turnkey projects.
c) Term Loans for Export Production: Under this type of
facility, term loans/deferred payment guarantees are made
available, in collaboration with International Finance
Corporation, to 100% Export Oriented Units (EOU) in free
*
trade zones (FTZ), and computer software exporters. *
Commercial & Development Banks (Unit 3) 167
d) Overseas Investment Finance: Overseas investment
finance is provided to Indian companies intending to set-up
in joint ventures abroad, for the purpose of contributing
their share in the venture.
e) Finance for Export Marketing: This program is one of the
constituents of a World Bank Loan, which is extended to
Indian exporters for marketing of their products and setting
a position for themselves in overseas market.
ii) Loans to Foreign Governments, Companies and financial
Institutions
a) Overseas Buyer's Credit: Overseas Buyers‘ Credit is made
available to foreign entities for facilitating the import of
eligible goods and services. This facility is extended on
deferred payment basis.
b) Lines of Credit: Lines of credit are provided to Foreign
Governments, Foreign Financial Institutions (FIIs), and
overseas Government agencies for onward lending in
their respective countries for importing goods and
services from India.
c) Re-lending Facility to Banks Overseas: Overseas banks
are eligible for this type of finance for the purpose of
extending term finance to their clients spread all over world
for importing goods and services from India.
iii) Loans to Commercial Banks in India
a) Export Bills Rediscounting: Under this scheme, domestic
Scheduled Commercial Banks, which are duly authorised to
deal in foreign exchange business, are eligible to rediscount
their export bills (post-shipment credit), for an unexpired
usage period not exceeding 90 days, with EXIM Bank.
b) Refinance of Export Credit: This facility is also available
for the domestic Scheduled Commercial Banks, which are
duly authorised to deal in foreign exchange business. Under
this scheme, they can avail 100% refinance in respect of
referred payment loans granted by them for export of goods
and services from India.
2) Non-Funded Assistance: Non-fund based facilities are those
facilities extended by banks/FIs to their customers, wherein
immediate outflow of funds is not involved. Some examples of non-
fund based facilities are various forms of guarantees (advance
*
payment, performance guarantee, retention guarantee, guarantee for *
168 MBA Third Semester (IFS&FM) MDU
raising funds from overseas market, etc.), letters of credit, etc. They
are off-balance sheet items in the nature of contingent liabilities
which may or may not devolve. EXIM Bank provides non-funded
support, through Indian commercial banks, by issuing guarantees
such as letters of credit on behalf of Indian exporters and contractors
in favour of overseas importers, employees, and banks.
Of late, the EXIM bank has been very proactive in encouraging Indian
participation in the projects funded by various multilateral agencies,
e.g. the World Bank, Asian Development Bank, African Development
Bank, etc. With the objective of promoting Indian exports, EXIM
banks have recently come out with following three schemes:
i) Production Equipment Finance Program: This program
offers provision of rupee term loans to Export Oriented Units
(EOUs), with certain qualifications, for acquiring necessary
equipment.
ii) Export Marketing Finance: This kind of finance facilitates
Indian manufacturers in engaging in export marketing activities
on the basis of well-designed long-term plans meant for the
markets of developed countries.
iii) Export Vendor Development Finance: Export Vendor
Development Finance offers organised financial packages
especially developed for Indian manufacturers/exporters/traders
for the purpose of preparing and executing tactical vendor
development plans.

In addition to the above roles, the EXIM Bank plays yet another
important role by engaging itself in the areas of merchant banking and
development banking, which are the backbones of financing
promotional activities and undertaking counselling services.

3.6.5. EXIM Bank Finance

In line with the objective of setting up EXIM Bank, i.e. to give a boost to
India‘s export promotion efforts, it extends following export credit facilities
to Indian companies, Indian commercial banks, and overseas entities:
1) For Indian Companies Executing Contracts Overseas
i) Pre-Shipment Credit: Pre-shipment credit, also referred to as
the packing credit, is made available by the EXIM Bank to the
exporters, through their bankers, for the activities before the
shipment of goods, i.e. purchase of raw material, manufacturing,
and keeping the finished goods ready for shipment. It is
provided in Indian as well as foreign currency.
* *
Commercial & Development Banks (Unit 3) 169
ii) Supplier’s Credit: Supplier‘s credit, which is available at post-
shipment stage in respect of eligible goods, enables Indian
exporters to offer term-credit accommodation to the overseas
counterparties (importers).
iii) Project Exporters: Indian exporters engaged in the export of
projects are required to incur miscellaneous expenditures during
the execution of such project contracts, e.g. costs of
mobilisation of materials, personnel and equipment, etc. EXIM
Bank provides finance for meeting such Rupee denominated
expenditures.
iv) Exporters of Consultancy and Technological Services: This
is a unique credit facility made available by the EXIM Bank to
the Indian exporters engaged in the business of exporting
consultancy and technological services, with a view to enabling
them to extend term loans to the overseas importers from their
end.
v) Guarantee Facilities: Guarantee facilities are made available
by the EXIM Bank to Indian exporters/importers, so as to
support them in executing export contracts and import
transactions.
2) For Commercial Banks: Commercial banks, as part of their
normal banking business, discount the genuine export bills of their
customers (including their MSME customers), with usance period
not exceeding 90 days. Such bills may be re-discounted by the
commercial banks under the scheme offered by the EXIM Bank. In
addition to the above, EXIM Bank also provide refinance facility in
respect of supplier‘s credit to the commercial banks, which in turn
enables them to pass on the same to their customers engaged in the
export of eligible goods and services. These exporters are now in a
position to extend credit to their overseas buyers/importers for a
period of 180 days.

Other Facilities for Indian Companies

In terms of the Foreign Trade Policy of Indian Government, some of
the contracts, though executed by Indian companies within India,
are treated as deemed exports. Further, there are secured contracts
under international competitive bidding, the payment in respect of
which are received in foreign currency. With a view to ensuring that
the companies engaged in the execution of such contracts do not
face cash-flow deficits, EXIM Bank offers credit facilities under the
scheme ‗Finance for Deemed Export‘.
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170 MBA Third Semester (IFS&FM) MDU
3) For Overseas Entities: Overseas entities are entitled to avail ‗Buyer‘s
Credit‘ facility provided by EXIM Bank, which is available for import
of eligible goods from India on deferred payment basis. A list of
eligible goods is mentioned in the ‗Exim Policy‘ of the Government of
India, and includes capital goods, plant and machinery, industrial
manufactures, consumer durables, etc.

3.7. RESERVE BANK OF INDIA (RBI)

AS A CENTRAL BANK

3.7.1. Introduction
Reserve Bank of India (RBI) regulates, manages and controls the banks
from the period when they are opened till the period when they are
closed. There is no regularity in the regulation of all the banks and its
applicability is based on the constitution of the institution. It means that
the applicability is based on the fact that whether it is a statutory
corporation, banking company or cooperative society.
In order to safeguard the monetary stability of the banks and to
smoothly regulate the credit system, RBI compels the scheduled banks
to certain amount as reserve with the banks rather than dealing directly
with the regulation of the banking system under the Reserve Bank of
India Act, 1934. In case any special event, direct discount is provided by
the RBI act which is important for the purpose of regulating credit in the
interests of trade, industry and agriculture.

3.7.2. Meaning of Reserve Bank of India

Reserve Bank of India looks after the working and functioning of
money market in India. The central bank introduce liquidity in banking
system whenever required, especially when there is lack of money and
also have the contract of the same in the different conditions.
The Reserve Bank was formed in 1st April, 1935 under the provision of
Reserve Bank of India Act and is known as Central Bank of the country. It
was started with the paid-up capital of `5 crore. It was established for
currency management and credit control. Earlier currency management was
done by Government of India and credit control by Imperial Bank of India.
The Reserve Bank was nationalised after independence of the country in
1949. The reasons for nationalisation are as follows:
1) It was seen that various central banks of the countries all over the
world were now nationalised after the end of Second World War.
The Bank of England was also nationalised in 1946.
* *
Commercial & Development Banks (Unit 3) 171
2) Due to the inflationary tendencies, which started along with the
Second World War in 1939. The Reserve Bank was nationalised for
controlling these tendencies effectively as it was made credit and
currency management.
3) The nationalisation of the Reserve Bank of India was important and
effective tool for economic development of the country as the
country has started working according to the planned economic
programme after independence.

The Reserve Bank of India has started its working in accordance with
the provisions of the Reserve Bank of India Act, 1934 and this act is
changed on the regular time period.

3.7.3. Features of Reserve Bank of India

The features of RBI are as follows:
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 the 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 in good quality.

3.7.4. Subsidiaries of RBI

The various subsidiaries of RBI are as follows:
1) Deposit Insurance and Credit Guarantee Corporation of India
(DICGC),
2) National Housing Bank (NHB),
3) National Bank for Agriculture and Rural Development (NABARD)
and
4) Bharatiya Reserve Bank Note Mudran Private Limited
(BRBNMPL).

3.7.5. Purpose/Objectives of Reserve Bank of India

The various objectives of RBI are as follows:
1) For controlling the monetary and credit system of the country.
2) For balancing the internal and external value of rupee.
3) To have equal and organised development of bank in the country.
4) Its objective is to make growth in the organised money market of
the country.
5) RBI is for proper arrangement of agriculture finance of the country.
6) RBI helps in the availability of industrial finance of the country.
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172 MBA Third Semester (IFS&FM) MDU
7) RBI helps in maintaining the public debts.
8) RBI helps in maintaining the monetary relation with other countries
and international financial institutions.
9) RBI helps in the centralisation of cash reserves of all commercial
bank in India.
10) RBI helps in building balance relation with the demand and supply
of currency.

3.7.6. Structure/Organisation of Reserve Bank of

India
The organisation of RBI is given as follows:
1) Central Board: The Central Board of Director has the power of
general superintendence and direction given to the bank. The basic
organisational structure of Central Board is given in figure 3.2:
Governor

Deputy Deputy Deputy Deputy

Governor Governor Governor Governor

Executive Executive Executive Executive

Director Director Director Director

Chief Manager

Chief Accountant

Figure 3.2: Organization of the Reserve Bank of India

The organisation consists of Governor, only four Deputy Governors

and fifteen Directors. All appointments are done by the Central
Government. The Governors and Deputy Governors are appointed
for five years or according to the terms fixed by Central
Government. The re-appointment of Governors and Deputy
Governors is done by the Central Government. There is Committee
of the Central Board which includes Governor, Deputy Governors,
Directors representing or resident in the area in which the meeting is
held, the Director representing the government and other Directors
as may be present at the place at the relevant time and these
committee are given certain functions delegated by the board.
2) Local Board: There are four Local Boards for regional areas in the
country which are Western, Eastern, Northern and Southern. The
headquarters of these local boards are at Mumbai, Kolkata, New
*
Delhi and Chennai. The members of these local boards are *
Commercial & Development Banks (Unit 3) 173
appointed by Central Government. It performs the work of
providing information to the Central Board on various matters and
also doing duties which are delegated by Central Board.

3.7.7. Departments of RBI

There are sixteen departments of the Reserve Bank of India. These are:
1) Issue Department: This department undertakes the job of issuing
paper currency and therefore it also makes arrangement for the
distribution of paper currency. It maintains regular accounts of the
notes printed at Nasik Press. Its branches are at Bangalore, Mumbai,
Kolkata, Hyderabad, Kanpur, Chennai, Nagpur, New Delhi and
Patna.
2) Banking Department: This department performs two primary
functions, one of dealing with Government transactions and floating
of loans on behalf of the Central and State Governments and
arranging remittances of government funds from one place to another
and the other regarding the maintenance of cash reserves of scheduled
banks, extending financial assistance to them, whenever required and
functioning as the clearing house for the scheduled banks.
3) Banking Development: This department is concerned with the
expansion of banking facilities in the rural and semi-urban areas. It
also imparts training to the scheduled banks.
4) Banking Operations: This department undertakes periodical
inspections of the scheduled banks, analyzes their balance sheets,
issues licenses for opening of new banks, considers requests for
opening new branches, examines the requests of scheduled banks
for increasing the paid-up capital, examines the possibilities for the
amalgamation of existing banks and tenders advice to the scheduled
banks in their day-to-day functioning.
5) Agricultural Credit: This department studies the problems
connected with agricultural credit, conducts research on rural credit
problems, formulates rural credit policy of the Reserve Bank, grants
rural credit to State Governments and State Cooperative Banks and
publishes reports on agricultural credit.
6) Exchange Control: This department regulates and controls the sale
and purchase of foreign exchange.
7) Industrial Finance: This department extends financial assistance to
small scale and medium scale industries and also tenders advice to
various industrial financial corporations for their day-to-day
working.
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174 MBA Third Semester (IFS&FM) MDU
8) Non-Banking Companies: The headquarters of this department is
at Kolkata and it is chiefly concerned with the supervision of the
non-banking companies and financial institutions in the country.
9) Legal Department: This department tenders advice to the various
departments of the Bank on legal matters, prepares directives and
communiqués of the Bank and gives advice to the Bank on the
proper implementation of legal matters relating to banking in the
country.
10) Research and Statistics: This department undertakes research on
problems in the areas of money, credit, finance, production, etc.,
collects statistics about the various sectors of the economy and
publishes them; and tenders advice to the Government for the
solution of various economic problems and in the formulation of its
economic and financial policies.
11) Department of Planning and Reorganization: The department
formulates new plans and reorganizes existing policies so as to
make them more effective.
12) Economic Department: This department formulates banking
policies for better implementation of economic policies of the
Government.
13) Inspection Department: This department undertakes inspection of
various offices of the commercial banks.
14) Department of Accounts and Expenditure: This department
maintains proper records of all receipts and expenditures of the
Reserve Bank of India.
15) RBI Services Board: The Board deals with the selection of new
employees for different posts in the Reserve Bank of India.
16) Department of Supervision: This department was set up on 22
December, 1993, for conducting proper supervision of commercial
banks.

3.7.8. Functions and Working of Reserve Bank of

India
Reserve Bank of India is regarded as the Central Bank of India. So, RBI
performs the role of central bank of India. The various functions of the
central bank are the same all over the world but the scope and the type
of policy is different from country to country. These policies depend on
growth and arrangement of the economy, objective of the government
and the present economic conditions.
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Commercial & Development Banks (Unit 3) 175
Functions and Working of Reserve Bank of India

Monetary Functions Non-Monetary Functions

─ Issue of Bank
Notes
─ Banker to
Supervisory Promotional
Government
Functions Functions
─ Banker‘s Bank
─ Lender of the ─ Provide Licence
─ Established the Bill
Last Resort ─ Coverage of Bank
Market Scheme
─ Custodian of Operations
─ Development of
Foreign ─ Liquidation of Weak
Specialised
Exchange Banks
Financial
Reserves ─ Branch Expansion
Institutions
─ Credit Control ─ Issue Directions on ─ Promote Regional
Credit Control
Rural Banks
─ Training of Bank
─ Establishment of
Personnel
Export Import
─ Restrict Loans and
Bank of India
Advances
─ Promotes Research
─ Collect and Supply
Information
─ Spreading Banking
Habits
─ Corporate Governance
─ KYC Norms
─ Transparency Norms
─ Risk Management
─ Audit and Inspection
3.7.9. Monetary Functions
Following are the central banking or monetary functions of RBI:
1) Issue of Bank Notes: Reserve Bank of India has the complete control
over the currency management and credit control of India due to which
the Reserve Bank of India has the right to issue bank notes of all
denominations except one rupee notes which are issued only by
Government of India. The bank has framed a separate department for
issue of notes known as ―Issue Department‖. The bank issues the notes
as according to the ―Minimum Reserve System‖.
The Reserve Bank has done the proper planning and controlling for
the holding and distribution of currency. The issue departments are
present in seventeen important cities of the countries and will also
circulate the currency all around the country.
2) Banker to Government: The Reserve Bank of India works as the
Banker to Government. The RBI receives money and also does the
payment on behalf of Union and State Government of India. It does
various operations like exchange, remittance, managing public debt,
etc. on behalf of the government. It gives ways and means advances
to the government for 90 days. It helps in providing all the monetary
*
and banking advices to the government. *
176 MBA Third Semester (IFS&FM) MDU
3) Banker’s Bank: The following ways by which Reserve Bank act as
the banker bank are as follows:
i) According to the Reserve Bank of India Act the bank needs to
maintain certain amount of cash reserve with the central bank. It
is done so because at the time of requirement of cash, the bank
can ask for financial help from Reserve Bank and so the
Reserve Bank is known as lender of the last resort. The
Banking Regulation Act, 1949 has given guidelines for
maintaining cash reserve like schedule bank need to maintain
the cash reserve of 5% at the demand liabilities and 2% at the
time liabilities. There are some changes according to the
Reserve Bank (Amendment) Act, 1956 in which cash reserve
ratio was increased to 20% of demand liabilities and 8% of time
deposits. There was some difficulty in classifying the deposits
and there were some changes in Banking Regulation Act in
September 1972 in which has changed the provision of reserve
to 3% of deposits and it can be increased to 15% as required by
the Reserve Bank.
ii) The Reserve Bank gives financial help to the scheduled banks
through discounting the eligible bills and by the loans and
advances in mortgage of approved securities.
iii) In the Banking Regulation Act, 1949 and the various changes
done in this has given importance to supervision and control
over the banking system. These powers include licensing of
banks and their branch expansion; liquidity of assets of the
banks; management and methods of working of the banks;
amalgamation, re-construction and liquidation of banks;
inspection of banks; etc.
4) Lender of the Last Resort: The Central Bank provides helps to the
commercial bank at the time of emergency. The commercial banks
cannot always help each other. It is only the Central Bank which
provides help to one and more banks at the same time. At the time
of depression, general public keeps the cash with themselves than
the Central Bank being the lender of last resort provides helps to
Commercial Banks by giving loans or by buying the securities. The
Central Bank is directly or indirectly responsible for fulfilling the
demands of funds by commercial bank at the time of emergency
because of this, the central bank is known as lender of last resort.
5) Custodian of Foreign Exchange Reserves: The central bank holds
the foreign exchange reserve so that the external value of the rupee
can be maintained. India is also the part of International Monetary
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Commercial & Development Banks (Unit 3) 177
Fund so the Central Bank needs to maintain the fixed exchange rate
with all the other member countries. Hence, the foreign exchange is
bought and sold to and from authorised person at the fixed rate
according to the government.
6) Credit Control: The credit control is a significant technique used
by the Reserve Bank of India. It is used for controlling the demand
and supply of money in the economy. The need of credit control are
as follows:
i) For increasing the growth of priority sector. The priority sector
refers to the sectors in the economy which are set by the
government as the priority sector.
ii) To monitor the credit channelization so that the credit is given
only for certain work.
iii) To control the inflation and deflation scenario.
iv) To increase the growth of economy by ensuring the appropriate
flow of bank credit to various sectors.
The Reserve Bank also acts as the credit controller. There are
various methods for controlling credit creation by commercial banks
which are as follows:
i) The bank rate or market operations can be changed by the
Reserve Bank. The Reserve Bank of India can also instruct any
specific bank or the whole banking system not to give loan to
particular person or group on the mortgage of certain securities
as given by the Banking Regulation Act, 1949.
ii) The selective controls of credit are being used since 1956 by the
Reserve Bank for controlling credit.
iii) The Reserve Bank of India has the right to issue licence for
doing the banking business in India and licence can also be
cancelled if some conditions are not followed by these
businesses.
iv) The Reserve Bank has the right to give permission to the bank
to open new branch.
v) The Reserve Bank of India has the right to call for information
in the form of weekly report on the assets and liabilities of the
bank. This also helps in controlling the credit creation in banks.
vi) The Reserve Bank has the right to inspect the books of accounts
of any commercial bank.

3.7.10. Non-Monetary Functions

Following are the non-monetary functions of RBI:
1) Supervisory Functions, and
2) Promotional Functions.
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178 MBA Third Semester (IFS&FM) MDU
3.7.10.1. Supervisory Functions
There are several supervisory functions of the Reserve Bank which
helps in improving and establishing a better banking system in India.
These functions are licensing and establishment, branch expansion,
liquidity of assets, management of working capital, amalgamation, re-
construction and liquidation of commercial and co-operative banks.
The Reserve Bank regularly checks the banks and asks for information
which is important for efficient performance of supervisory functions.
The different types of supervisory functions are:
1) Provide Licence: For doing the business, banking function requires
the licence from the Reserve Bank of India. The Reserve Bank
checks certain conditions before granting loan like the business is in
position for paying claims of the deposits and the working of the
business is done in the manner which is not harmful for the
depositors‘ interest.
2) Coverage of Bank Operations: The Banking Regulation Act has
given guidelines for maintaining minimum paid-up capital, reserves,
cash reserve and other liquid assets according to the geographical
requirement of business operation for maintaining the sound
financial position of banking. The Reserve Bank attainment of the
requirement mentioned in the guidelines of Banking Regulation Act.
3) Liquidation of Weak Banks: The liquidation of weak bank or the
merger with the stronger bank helps in increasing the growth of
commercial banking structure in country as given by RBI. The
Reserve Bank has the right to check, examine and does the required
work for enhancing the operational efficiency of the banks. The
Central Bank can also call for closing of the business.
4) Branch Expansion: Reserve Bank of India gives the permission to
the commercial bank for opening new branches. However, the RBI
can instruct the bank to open branches in small town and urban area
for improving geographical coverage of the banks.
5) Issue Directions on Credit Control: The sectorial distribution of
bank credit can be improved by enhancing the functional coverage
of banks especially in areas like agriculture, small-scale industries,
self-employed persons, small borrowers, etc. The RBI gives
directions to the commercial banks by the help of various credit
control measures available with the RBI.
6) Training of Bank Personnel: The RBI has set up various training
institutes like Bankers Training College (Mumbai), the National
Institute of Bank Management (Mumbai), the Cooperative Bankers
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Commercial & Development Banks (Unit 3) 179
Training College (Pune), the College of Agricultural Banking
(Pune), Staff Training College (Chennai) and Zonal Training
Centres for Staff at Mumbai, Kolkata, Chennai and New Delhi for
providing proper education and training of various banking
personnel present all over the country.
7) Restrict Loans and Advances: The RBI controls the loan and
advances given by the banks and has framed certain guidelines for
the guarantee given by banks on behalf of company, firm and
association of person or individual. Due to change brought from
February 1, 1964, the RBI has the right to appoint and remove the
executive personnel of the commercial banks.
8) Collect and Supply Information: The Reserve Bank of India has
the right to call for information according to the credit facilities
given by bank and other financial institutions and also provide
information on application in a consolidated form to the banks.
9) Spreading Banking Habits: The RBI has developed a Deposit
Insurance Corporation in 1962 for increasing the trust in the public
towards the bank and to increase the banking habits in the country
mainly among the lower section of society. The scheme has also
moved to co-operative and regional rural banks. The amount
required for insurance cover has also increased from time to time.
By 1st July, 1980 it was `30,000 for every bank.
The Reserve Bank of India can exercise better control over
commercial banks as with the nationalisation there are 20 major
commercial banks in India (14 in July 1969 and 6 in April 1980).
The development of regional rural banks has led to the growth in
the banking system of India. It has also expand the bank both
functionally and geographically as it become easy for RBI to
control the growth of the banks.
10) Corporate Governance: The RBI has the right to manage the
appointment of the chairman and directors of banks in India. The
RBI can also appoint the additional directors of banks.
11) KYC Norms: The RBI has started a new guideline which is known
as ―Know Your Customers‖ for the banks. The banks need to assure
that all the KYC norms are filled before opening the bank account.
It will help in avoiding the use of banks for criminal activity and
saving from money laundering activity.
12) Transparency Norms: The banks need to inform the customers
about all the charges imposed on them for every kind of service
*
given by the bank. *
180 MBA Third Semester (IFS&FM) MDU
13) Risk Management: The RBI provides the ways by which the risk
can be reduced in the banks and by the help of Basel norms the risk
management guidelines is given by the RBI to the banks.
14) Audit and Inspection: The audit and inspection is done by RBI by
the help of off-site and on-site monitoring system. The on-site
inspection method is known as ―CAMELS‖ which stands for
Capital adequacy, Asset quality, Management, Earning, Liquidity
and System and control.

3.7.10.2. Promotional Functions

The Reserve Bank of India was established in 1935 for developing the
money market and commercial banking system in India. It is known as
central bank of the country. The Reserve Bank of India is not only
engaged in monetary activity but also in the development and promotion
work of the banks. RBI along with controlling the credit, currency
management and price stabilising also work as the promoter of financial
institutions which is needed for specific financial requirement of the
developing economy.

Earlier, India was the backward country but after the independence the
country had grown as well-organised and a planned economy. This led
to the development of Reserve Bank of India for attaining the efficient
monetary and credit policy and also for taking various steps for
increasing the growth of various sectors of the economy according to
the rules and regulations framed by the government.

Promotional Steps Taken by the RBI

The various steps taken by RBI for promotional activity are as follows:
1) Established the Bill Market Scheme: The Bill Market Scheme
was established in 1952.
2) Development of Specialised Financial Institutions: There are
various specialised financial institutions set up which are
Industrial Finance Corporation of India (IFCI), State Financial
Corporation (SFCs), Industrial Development Bank of India
(IDBI), Unit Trust of India (UTI), Deposit Insurance and Credit
Guarantee Corporation of India (DICGC), and National Bank for
Agriculture and Rural Development (NABARD), etc. The RBI
may be directly or indirectly being involved in setting of these
financial institutions.
3) Promote Regional Rural Banks: It has also led to increase in the
number of Regional Rural Bank by the help of commercial banks
for developing banking system in the rural areas.
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Commercial & Development Banks (Unit 3) 181
4) Promote National Housing Bank: The National Housing Bank
was established in 1988. It was wholly-owned subsidiary for
arranging resources for housing. It provides assistance to the
industries which are involved in providing housing finance and also
helps the industries which are involved in providing supplies for
building materials and for the low-cost construction.
5) Establishment of Export-Import Bank of India: The
establishment of Export-Import Bank of India has provided
financial assistance to the exporter and has also helped the various
commercial banks in growing the foreign trade of the country by
opening their branches in foreign countries.
6) Promotes Research: Various kinds of research in the field of
banking are promoted by Reserve Bank of India.

3.7.11. Role of Reserve Bank of India in Indian

Economy
The Central Bank of the country has to act as a banker to the
Government, and in that capacity it supports/facilitates various
economic activities. The RBI plays an important role in the country‘s
economic development as following.
1) Promotion of Commercial Banking: For the economic
development of a country, a robust banking system is one of the
crucial pre-requisites. Reserve Bank of India, the central bank of our
country, has taken (and continues to take) a number of concrete
measures to reinforce the banking system. RBI has been sufficiently
empowered by two important statutes, viz. Banking Regulation Act,
1949, and RBI Act, 1934, to supervise and monitor/control the
activities of various categories of banks, i.e. commercial banks,
cooperative banks, urban cooperative banks, Regional Rural Banks,
Local Area Banks, etc. RBI uses these powers in following manner:
i) To improve the operational efficiency of the banking sector as a
whole, and remove the weak banks through the process of
liquidation and amalgamation;
ii) To ensure that the banking services reach to each and every
individual residing in any corner of the country-whether urban,
semi-urban or rural area; and
iii) To encourage the flow of credit to priority sectors of the
economy, viz. agriculture and allied activities, Small Scale
Industries (SSIs), exports, etc.
Reserve Bank of India has been taking necessary steps for imparting
*
training in various fields of banking and finance. It had set up *
182 MBA Third Semester (IFS&FM) MDU
training establishments like College of Agricultural Banking (CAB)
at Pune, Bankers Training College (BTC) at Mumbai, Indira Gandhi
Institute of Development Research (IGIDR) at Mumbai, National
Institute of Bank Management (NIBM) at Pune, etc.
2) Promotion of Rural Credit: Faulty rural credit framework,
poor/non-availability of finance for agricultural and allied activities,
and rural small scale industries, etc. are some of the reasons lagging
behind of the agriculture sector. Reserve Bank had taken note of the
problem faced by the rural economy and agriculture sector, and
necessary steps have been taken from time to time to reform rural
credit framework and ensuring appropriate institutional finance for
agriculture, allied activities and other activities of rural economy.
With a view to improving flow of credit towards rural sectors,
following steps were taken by the RBI:
i) A new department, viz. Agricultural Credit Department (ACD)
was established within RBI to ensure proper expansion and
coordination of rural credit;
ii) Right from the beginning itself, the RBI had taken requisite
steps to empower the rural cooperative credit system, so that the
credit requirements of rural folks are considered;
iii) With a view to ensuring provision for medium-term and long-
term loans to the state cooperative banks, two specific funds,
viz. the National Agriculture Credit (long-term operations) Fund
and the National Agricultural Credit (stabilization) Fund were
created in the year 1956;
iv) Regional Rural Banks (RRBs) were set up under the provisions
of RRB Act, 1976 for promoting banking facilities (including
flow of credit) to rural and semi-urban centres;
v) Some of the commercial banks were nationalised with the main
focus on expansion of bank finance to rural sectors;
vi) An apex institution for agriculture finance, viz. The National
Bank for Agriculture and Rural Development (NABARD) was
set up in 1982; and
vii) The RBI had facilitated creation of a number of warehouses in
the country.
As an outcome of the above measures, the institutional finance
framework has been strengthened over a period of time. With the
help of institutional finance, the agricultural output has been
showing an increasing trend for the past many years. The work done
by RBI in this regard is commendable, and perhaps it is the only
*
central bank in the world who have achieved such a level. *
Commercial & Development Banks (Unit 3) 183
3) Promotion of Co-operative Credit: Reserve Bank of India has also
been entrusted with the job of encouraging and promoting the co-
operative credit movement. With a view to reinforcing the country‘s
cooperative credit framework, the RBI has been taking steps from
time to time on the basis of recommendations made by Rural Credit
Survey Committee. It is through the cooperative credit institutions,
that RBI extends credit facilities to agriculturists. RBI has played a
crucial role the advancement of cooperative credit movement in India.
4) Promotion of Industrial Finance: Industrial development of a
country can take place only if uninterrupted flow of long-term
finance to various industries is ensured. RBI had established in the
year 1957 a separate department, Industrial Finance Department
(IFD), with the sole purpose of providing financial and
organisational support to the institutions engaged in the business of
extending long-term finance to industries. RBI has also played a key
role in setting up financial institutions for providing long-term and
medium-term finance to industries; some of such institutions are:
Industrial Development Bank of India, Industrial Finance
Corporation of India, State Finance Corporations, State Industrial
Development Corporations and the Industrial Credit and Investment
Corporation of India. Yet another initiative taken by the RBI for
ensuring flow of finance to industrial sector relates to development
of domestic capital market, which offers an additional venue for the
industries to tap for their long-term and medium-term financial
requirements.
5) Promotion of Export Credit: Since long, the export sector has
been gaining importance in overall economic development of a
country, especially the developing countries‘. The promotion of
exports is getting more focused. Appropriate level of continuous
finance is an important aspect in the promotion of export sector.
With this objective, the RBI had introduced a number of export
credit schemes-both pre-shipment and post-shipment. Some of the
important measures taken by RBI in this regard are as following:
i) It introduced the Export Bills Credit Scheme and the Pre-
shipment Credit Scheme;
ii) It has instructed commercial banks to charge concessional rates
of interest on different categories of export credits extended by
them; and
iii) It set up an apex institution (Exim Bank) for the promotion of
foreign trades, viz. exports and import by granting exporters and
importers financial support. RBI on its part provide refinance to
Exim Bank on specified terms and conditions.
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184 MBA Third Semester (IFS&FM) MDU
6) Regulation of Credit: Reserve Bank of India has a number of
instruments for the regulation (cost, quantum, and purpose) of
credit, which are liberally used. Some of such instruments are Bank
rates, Repo Rate, requirements in respect of Cash Reserve Ratio
(CRR) and Statutory Liquidity Ratio (SLR), directions issued with
regard to priority sector lending, etc.
Credit is a scarce commodity in our country, and by regulating it,
the RBI has been able to achieve following:
i) Overall economic development of the country;
ii) Keeping an eye on inflation, and curbing the inflationary forces;
iii) Ensuring that the scarce credit is not diverted for speculation;
iv) Making available institutional finance for productive purposes
only, in tune with the Government‘s priorities plans; and
v) Inspiring the masses to inculcate the saving habits.
7) Credit to Weaker Sections: In synch with the Government‘s
policies, the RBI has taken various steps from time to time to ensure
that sufficient credit is provided by the commercial banks to the
weaker sections of the society at concessional rates of interest. One
such step was introduction of the ―Differential Rate of Interest
Scheme‖ in 1972, which offer provision of cheap credit to the
economically and socially backward people engaged in productive
activities. The commercial banks issued directives by RBI to extend
credit to the unprevailed people under the self-employment schemes
of Government.
8) Development of Bill Market: Reserve Bank of India launched a
scheme, viz. ―Bill Market Scheme‖ in 1952 for providing credit
facilities to commercial banks against their demand promissory
notes. However, as the scheme did not insist for genuine trade bills
pertaining to sale/dispatch of goods, the scheme was revised, and a
new scheme, viz. ―New Bill Market Scheme‖ was introduced,
which only covers the genuine trade bills pertaining to sale/dispatch
of goods. This scheme proved to be instrumental in developing bills
market in India, which in turn enhanced the liquidity in the market.
9) Exchange Controls: Under the provisions of RBI Act, 1934, RBI
has been entrusted, inter-alia, with the responsibility of maintaining
the stability of external value of ‗Indian Rupee‘ despite adverse
circumstances and unfavourable pressure and anxiety on many
occasions. Foreign exchange management has also been carried out
by the RBI efficiently.
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Commercial & Development Banks (Unit 3) 185
The performance of RBI as a forex manager, banker to the
Government/banks, and as an engine of overall economic development
of the country, has been more than satisfactory despite all the limitations
it had to encounter from time to time. The financial framework of the
country has been created and developed by RBI in consistency with the
social and economic objectives and priorities set up by the Government.
Its promotional and developmental role has taken the country‘s
economy to new heights.

3.7.12. Recent Monetary Policy of RBI

The Reserve Bank of India (RBI) is about to announce its recent
monetary policy:
1) Rate Decision: The MPC voted to keep the repo rate on hold at 6.25%
today. Cash Reserve Ratio (CRR) was also kept unchanged. However,
RBI reduced the width of the policy corridor from 100 bps to 50 bps,
by increasing the Reverse Repo rate to 6.00% from 5.75% and reduced
Marginal Standing Facility (MSF) from 6.75% to 6.50%, in order to
keep the effective policy rate closer to the repo rate.
2) Liquidity Management: RBI expects systemic liquidity to moderate
over the next three to four quarters. RBI also stated that it will maintain
systemic liquidity using a combination of issuing Market Stabilization
Scheme (MSS) bonds, longer tenor variable reverse repos and open
market operations (OMO). On the Standing Deposit Facility (SDF),
RBI is still awaiting clarity from the Government.
3) Inflation: RBI raised the Consumer Price Index (CPI) projection to
average 4.5% in the first half and 5% in the second half of the year.
4) Demonetisation Impact: This is the second RBI monetary policy
announcement since demonetisation. In the last monetary policy
announcement, RBI did not clarify the impact of demonetisation on
growth in India. It is crucial to find out the real consequences of
removing 86% of currency notes by value from circulation. Data
points about the total deposits acquired by banks during the 50-day
period and the number of new currency notes pushed back into the
banking system should be given out.
5) Growth: Gross Value Added (GVA) is projected to strengthen to
7.40% in 2017-18 from 6.70% in 2016-17 with risks evenly balanced.
6) Forward Guidance: The RBI maintained its neutral policy stance
with a commitment to lowering inflation to 4% on a durable basis.
On liquidity, it stated that it ―is committed to reverting system
liquidity to a position closer to neutrality, consistent with the stance
of monetary policy...‖ by employing a mix of instruments.
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186 MBA Third Semester (IFS&FM) MDU

3.7.13. RBI’s Regulatory Environment

Prudential regulation and supervision have formed a critical component
of the financial sector reform programme since its inception and India
has endeavored to international prudential norms and practices. These
norms have been progressively tightened over the years, particularly
against the backdrop of the Asian crisis. Bank exposures to sensitive
sectors such as equity and real estate have been curtailed. The Banking
Regulation Act 1949 prevents connected lending (i.e., lending by banks
to directors or companies in whom Directors are interested):
1) Periodical inspection of banks has been the main instrument of
supervision, though recently there has been a move toward
supplementary ‗on-site inspections‘ with ‗off-site surveillance‘.
2) The system of ‗Annual Financial Inspection‘ was introduced in 1992,
in place of the earlier system of Annual Financial Review/Financial
Inspections. The inspection objectives and procedures, have been
redefined to evaluate the bank‘s safety and soundness; to appraise the
quality of the Board and management; to ensure compliance with
banking laws and regulation; to provide an appraisal of soundness of
the bank‘s assets; to analyze the financial factors which determine
bank‘s solvency and to identify areas where corrective action is
needed to strengthen the institution and improve its performance.
Inspections based upon the new guidelines have started since 1997.
3) A high powered Board for Financial Supervision (BFS), comprising
the Governor of RBI as Chairman, one of the Deputy Governors as
Vice-Chairman and four Directors of the Central Board of RBI as
members was constituted in 1994, with the mandate to exercise the
powers of supervision and inspection in relation to the banking
companies, financial institutions and non-banking companies.
4) A supervisory strategy comprising on-site inspection, off-site
monitoring and control systems internal to the banks, based on the
CAMELS (capital adequacy, asset quality, management, earnings,
liquidity and systems and controls) methodology for banks have
been instituted. The RBI has instituted a mechanism for critical
analysis of the balance sheet by the banks themselves and the
presentation of such analysis before their boards to provide an
internal assessment of the health of the bank. The analysis, which is
also made available to the RBI, forms a supplement to the system of
off-site monitoring of banks.
5) Keeping in line with the merging regulatory and supervisory
standards at international level, the RBI has initiated certain macro
level monitoring techniques to assess the true health of the
*
supervised institutions. *
Commercial & Development Banks (Unit 3) 187
6) The format of balance sheets of commercial banks have now been
prescribed by the RBI with disclosure standards on vital
performance and growth indicators, provisions, net NPAs, staff
productivity, etc., appended as ‗Notes of Accounts‘.
7) To bring about greater transparency in banks‘ published accounts,
the RBI has also directed the banks to disclosure date on movement
of non-performing assets (NPAs) and provisions as well as lending
to sensitive sectors. These proposed additional disclosure norms
would bring the disclosure standards almost on par with the
international best practice.

3.7.14. Achievements of Reserve Bank of India

Following are the main achievements of the Reserve Bank of India:
1) It has very successfully regulated credit to meet the requirements of
trade, industry and agriculture.
2) As a partner to the government it has been admirably managing the
public debt.
3) It has developed and promoted sound banking practices in the
country. This has inspired public confidence in the banking system.
4) The Reserve Bank has successfully promoted the institutionalization
of savings by:
i) Promoting banking habits,
ii) Extending banking facilities all over the country, and
iii) Establishing specialized financial agencies.
5) It has achieved appreciable success in promoting co-operative credit
and rural credit.
6) It has achieved great success in the field of industrial credit by
promoting a number of institutions for providing medium and long-
term credit.
7) The Reserve Bank has succeeded in providing credit facilities to
exporters by extending concessional credit, refinance facilities and
guarantee to commercial banks. It has been instrumental in setting
up the Export-Import Bank for providing credit and other facilities
to exporters.
8) As a guardian of the banking system the Reserve Bank has been
providing deposit insurance and credit guarantee facilities to the
banks through DICGC.
9) The Reserve Bank has played a crucial role in promoting social
banking in the country.
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188 MBA Third Semester (IFS&FM) MDU
10) The Reserve Bank has also been successful to a large extent in
developing bill culture in the country.
11) The Reserve Bank has been rendering a very useful service in
providing information and data on the different sectors of the
economy through its publications.
12) The Reserve Bank has been successfully providing clearing house
facilities through its 15 branches and 2 offices and the State Bank of
India.
13) The management and control of foreign exchange by the Reserve
Bank has been admirable.
14) The Reserve Bank has set up a number of training centres and
colleges to impart training to the staff of co-operative banks,
commercial banks, regional rural banks, NABARD, etc., and thus
are contributing in a big way to the development of human
resources in the sphere of banking.
15) Through its department of information technology the Reserve Bank
has modernized its functioning by introducing advanced computer
technology for inter-office communication and Internet technology
for information collecting and sharing. It has also encouraged
computerization of the branches of commercial banks.

3.8. MONETARY POLICY/CREDIT

CONTROL METHODS OF RBI

3.8.1. Introduction
Monetary policy is defined as the policy of Central Bank where the cost,
availability and use of money are controlled by using monetary methods
so as to attain predetermined objectives. It uses various instruments to
determine the level of aggregate demand for goods and services or to
analyse the trends in the economic sectors.

Credit Control is the most significant tool of monetary policy. Reserve

Bank of India uses this tool to control the demand and supply of money
in the economy.

To maintain the stability in the market the Central Bank regulates the
commercial banks with their credit flow in the economy. This helps the
banks to manage the inflationary conditions, promote economic growth
and improve the level of national income.
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Commercial & Development Banks (Unit 3) 189

3.8.2. Methods/Instruments of Credit Control of RBI

The instruments of credit control can be categorised into:
Credit Control Methods of RBI

Quantitative Qualitative/Selective Credit

1) Bank rate Controls
2) Open market operations 1) Credit Rationing
3) Variations in the reserve requirements 2) Margin requirement
4) Repo rate 3) Publicity
5) Liquidity adjustment facility 4) Regulation of consumer credit
5) Moral Suasion
6) 6) Direct Action

3.8.3. Bank Rate

Bank rate is the oldest monetary policy instrument and is also known as
the Discount Rate. It is the rate at which the RBI discounts or
rediscounts the eligible bills. Broadly speaking, it refers to a minimum
rate that central bank uses to provide financial accommodation to
commercial banks as lender of the last resort in the discharge of its
functions. Both the credit availability and credit cost are affected by the
bank rate policy.

Benefits of Bank Rate

1) Helpful in Re-Discounting Bills of Exchange and Commercial
Paper: The standard rate at which the RBI is prepared to buy or re-
discount bills of exchange or other commercial papers eligible for
purchase under the provisions of the Act of RBI. Thus the RBI, re-
discounts the first class bills in the hands of commercial banks to
provide them with liquidity in case of need.
2) Acts as a Signal of Central Bank’s Long-Term Outlook: This
rate is subjected to change from time to time in accordance with the
economic stability and its credibility of the nation. The bank rate
signals the Central Bank‘s long-term outlook on interest rates. If the
bank rate moves up, long-term interest rates also tend to move up,
and vice versa.
3) Provide Stability: It is the rate at which bills are discounted and re-
discounted by the banks with the Central Bank. During inflation, the
bank rate is increased and during deflation, bank rate is decreased.
So it provides economic stability during the inflation or deflation.
4) Oldest and Suitable Method: Bank rate policy is the oldest and
suitable method of credit control that operates through in bank rate
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190 MBA Third Semester (IFS&FM) MDU
made by the Central Bank. Bank rate is defined as the official
minimum rate at which the Central Bank re-discounts approved bills
of exchange.

3.8.4. Open Market Operations by RBI

The process of buying and selling of various assets by the RBI is known
as Open Market Operations. Such assets include foreign exchange,
government securities, company‘s stocks and gold. The main function
of such operations is to affect the economy by either augmenting or
reducing the money supply.

Benefits of Open Market Operations

1) Stimulate Bank Rate: Bank rate policies may be made more
effective with the use of Open Market Operations. For example,
decreasing bank rate during depression phase along with the buying
of securities may affect the economy in a better way.
2) Support Government Credit: Open market operations may help in
boosting government credit. The central bank can help in stabilizing
stabilising the price of sovereign securities through purchase of
securities when their prices are low and vice-versa. It can also create
better conditions for issuing or converting government loans. For
example, floatation of new loans may be facilitated through
purchase of securities.
3) Impacting Wages and Internal Prices: The balance of payment
may be influenced by regulating the movement of gold. The sale of
securities may lead to favourable balance of payment and balance of
trade, if it causes deflation. This also facilitates inflow of foreign
exchange and gold.
4) Fulfilling Seasonal Demands: Open Market Operations helps to
nullify the impact of seasonal demands for contraction and
expansion of credit. The securities should be purchased during the
busy phase while these may be sold during the relaxed period.

3.8.5. Variations in the Reserve Requirement

Variation in reserve requirement is another important tool used by the
reserve bank for controlling credit in the country. The credit creation
capacity of the banks may be influenced by the change in ratio.

Following are the two main types of this ratio:

1) CRR (Cash Reserve Ratio)
2) SLR (Statutory Liquidity Ratio)
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Commercial & Development Banks (Unit 3) 191
3.8.5.1. CRR (Cash Reserve Ratio)
This ratio is also known as CRR. Cash Reserve Ratio implies that a
commercial bank is required to keep a certain portion of its total
deposits with Reserve Bank. This portion is known as Cash Reserve.
The central bank generally keeps this ratio in the range of 3 percent to
15 percent of the aggregate time and demand liabilities.

Advantages of Maintaining CRR

1) To ensure liquidity and solvency position of scheduled commercial
banks.
2) To monitor and regulate the flow of credit given by commercial
banks
3) To ensure a stable flow of credit in the economy.
4) When RBI increases CRR the SCB restrict the flow of credit to the
public which sucks the money from the general public.
5) When RBI decreases CRR the SCB grant more credit loans and
other facilities to the general public which increase the flow of
money in the hands of many.

3.8.5.2. SLR (Statutory Liquidity Ratio)

This ratio implies that a commercial bank needs to keep a certain
portion of its total deposits with itself in the form of liquid assets. It is
defined as a certain percentage of total time and demand liabilities. This
tool is used for influencing the velocity of credit money in the economy.
It can be increased or decreased by RBI.
Reserve bank may increase this ratio to curtail credit volume generated
by commercial banks. The regulation of credit volume further impacts
the velocity of lending money in the economy.
Advantages of Statutory Liquidity Ratio
1) Helps in identifying limits that are not likely to increase the odds of
the bank failing, the government helps to protect both consumers
and the economy in general
2) Helps to protect any investments that government agencies have in
those financial institutions.
3) Helps to protect the interests of consumers, as well as provides the
government with one more way to help move the economy in the
most desirable direction possible.
4) SLR helps in maintaining the expansion of Bank Credit.
5) SLR helps in solvency of commercial bank.
6) SLR helps in boost growth of Indian economy
7) RBI uses as a tool which helps in controlling inflation rate.
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192 MBA Third Semester (IFS&FM) MDU

3.8.6. Repo Rate and Reverse Repo Rate

When the commercial banks have any shortage of funds then Reserve
Bank provides financial help in terms of loan. The rate at which banks
borrow rupees from RBI is called repo rate. Any reduction in the repo
rate will help commercial banks to lending money at a lower rate. On
the other hand, if repo rate increase then borrowing from RBI become
more expensive.

The rate at which the Reserve Bank of India (RBI) borrows money from
commercial banks is called reverse repo rate. Commercial banks are
very comfortable to lend money to RBI because their money are in safe
hands with a good interest. If reverse repo rate is increased, then in
encourage to transfer more funds to RBI due to this attractive interest
rates. It can cause the money to be drawn out of the banking system.

Advantages of Repo Rate

1) Increase in turnover in the money market.
2) Repos increase the volumes in the debt market
3) Under a repo transaction the seller of the security is the borrower
and the buyer is the lender of money.
4) Central banks can use repo as an integral part of their open market
operations.
5) For institutions and corporate entities, repos provide a source of
relatively inexpensive finance.
6) Central banks can use repo and reverse repo as an integral part of
their open market operations with the objective of
injecting/withdrawing liquidity into and from the market and also to
reduce volatility in short term in particular in call money rates.

3.8.7. Liquidity Adjustment Facility

This credit control tool is used in monetary policy which allows
commercial banks to borrow money through repurchase agreements.
This arrangement allows banks to respond to liquidity pressures and is
used by governments to assure basic stability in the financial markets.

3.8.8. Selective Credit Controls (Qualitative)

Method
The qualitative instruments are explained below:
1) Credit Rationing: It is the instrument used by the commercial
banks to maintain and regulate the rationale for providing credit to
the public. It focuses on restraining the amount of loans and
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Commercial & Development Banks (Unit 3) 193
advances approved by banks. Sometimes, it limits the loans and
advances of a particular category. Credit rationing may also be used
by Central Bank to limit discounts on short-term bills.
2) Margin Requirement: The difference between the market value
and maximum loan value of a particular security is called margin.
Flow of credit can be controlled by altering the marginal
requirement of a loan. For example, if a person deposits its
property worth `1,00,000 as a security, then he will receive a loan
amount of `85,000 only by the bank. Therefore, the margin created
will be `15,000, which makes marginal requirement of 15%.
Likewise, as the credit limit increases, the marginal requirement
decreases.
3) Publicity: Publicity is also used as an instrument for credit control.
It is mainly used by the RBI to review the prevailing market
conditions and direct the commercial banks to follow the
recommendations in order to control market fluctuations.
4) Regulation of Consumer Credit: The regulation of consumer
credit helps the Central Bank to prevent the market from inflation
and deflation of economy. For example, in case of consumer
durables with high prices having excess demand, the Central Bank
can increase down payment, and reduce the number of repayment
instalments to reduce the consumer credit.
On the contrary, in case of deflation due to deficit demand of certain
commodities, Central Bank can decrease down payment and
increase the number of repayment instalments to increase the
consumer credit.
5) Moral Suasion: Persuasion and request combine to form ‗moral
suasion‘. Central Bank uses this tool of credit control over
commercial banks by way of persuasion and request. In case of
inflationary situation, the commercial banks avoid giving loans for
provisional and non-essential purposes on the persuasion and
request of Central Bank.
On the contrary, in dealing with deflation, commercial banks extend
their credit on the approval of the Central Bank. Hence, the
objectives of monetary policy can be successfully achieved by
commercial banks with the help of moral suasion of Central Bank.
6) Direct Action: The Central Bank reserves the right to take any
action against commercial banks which violate the guidelines of
Banking Regulation Act. It maintains the follow-up of guidelines
and directions of central bank.
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3.9. EXERCISE

3.9.1. Short Answer Type Questions

1) Define the term ‗Bank‘
2) What is commercial bank?
3) What do you mean by regional rural banks?
4) Define public sector bank.
5) What is foreign banks?
6) What do you mean by development banks?
7) Discuss the features of NBFCs.
8) What is EXIM?
9) What is RBI?
10) Define repo rate and reserve repo rate.
11) Discuss the features of RBI.
12) What is monetary policy?
13) What is bank rate?

3.9.2. Long Answer Type Questions

1) What are commercial banks? Discuss its types.
2) Describe the features functions of commercial banks in detail.
3) Elaborate the role and functions of regional rural banks.
4) Discuss the advantages and disadvantages of commercial banks in detail.
5) Elaborate the features, objectives and functions of regional rural banks.
6) Elaborate the features, objectives and functions of development banks.
7) What is NBFCs? Explain the functions and importance of NBFCs.
8) Discuss the Services Rendered by NBFCs.
9) Distinguish between banks and NBFCs.
10) Explain the objectives and functions of EXIM.
11) What is RBI? Discuss their features and objectives of RBI.
12) Describe main functions and working of RBI.
13) Discuss the organisation of Reserve Bank of India.
14) Explain the role of RBI in Indian Economy in detail.
15) Elaborate the monetary and non-monetary functions of Reserve bank of
India/ Central Bank.
16) Discuss the credit control measures of RBI.
17) Describe the recent monetary policy of RBI.

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LICI & Microfinance (Unit-4) 195

UNIT 4 LICI & Microfinance

4.1. INSURANCE

4.1.1. Concept of Insurance

Insurance is a financial tool or a contract which is designed to minimize or
completely eliminate risk of loss to life and property. It is a tool for risk
management and is used as a hedge against the risk of incurring a potential
loss. Insurance helps in spreading the losses and risks over a number of
people, making it collective. The process allows people to take up a certain
amount of small loss in lieu to be compensated for a bigger uncertain loss.
This concept works with the scheme of economic co-operation.
Insurance can be defined as a tool which involves the payment of a
sum of money in the form of a premium by the insured in lieu of the
insurer agreeing to bear the risk of a given contingency.
Insurance involves a legal contract. The party which offers to bear the
risk is called insurer while the party paying the premium is known as
insured. The amount of money paid by the insured is known as
premium. The other terms associated with the contract are Assured and
underwriter. The document which spells out the terms and conditions of
the contract is known as the policy.
As per Insurance Act, “The undertaking by one person to indemnify
another person against loss or liability for loss in respect of a certain risk
or peril to which the object of the insurance may be exposed, or to pay a
sum of money or other thing of value upon the happening of a certain
event and includes life insurance”.

4.1.2. Features of Insurance Services

The main features of insurance services are difficult in case of life,
marine, fire and general insurance which are as follows:
1) Risk Sharing: The main purpose of the insurance is to share the
financial loss happened to a person. Such loss is caused by an
unforeseen event and it may involve the destruction of property or
even death. Different types of insurance deal with different subject
matters. For example, marine insurance deals with losses caused by
the sea or in the connection to sea.
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196 MBA Third Semester (IFS&FM) MDU
2) Risk Assessment: The evaluation of risk is an important part of the
insurance process. It involves the calculation of the premium
amount. If the probability of the insured event happening is high,
then the premium will also be higher. There are various methods for
determining the risk and probability of loss at the time of insurance.
3) Cooperation: The process of insurance requires cooperation from
the large number of people who agree to share the risk probability.
Such act should be voluntary and may not be forced upon them.
4) Payment at the Time of Contingency: The insurer promises to
compensate the insured person at the time of their loss through a
stated contingent incident. The compensation is only payable when
the loss occurs due to the incident covered under the contract of
insurance. However, in the case of life insurance, the insured sum
may be paid at the time of death or at the time of policy expiration,
whichever is earlier.
5) Quantum of Compensation: The actual loss incurred determines
the amount of compensation payable. However, such amount cannot
exceed the amount set at the time of taking out the policy. Overall,
the amount of compensation is the insured money or the amount of
actual loss, whichever is lower. The insured person is required to
prove the occurrence of the incident and extent of loss.

4.1.3. Need of Insurance Services

The need of insurance service are as follows:
1) Social Security Tool: Insurance is an important device to bring the
sense of security among the people. Every person has the right to have
basic amenities such as food, shelter and clothing. They also need
security against unfortunate events such as layoffs, diseases and death.
2) Uncertainty: The main aim of insurance contract is to minimize the
extent of uncertainty faced by people. The contract of insurance
does not protect the asset from any hazard but it compensates for the
loss caused. Such compensation is known as claim payment.
3) Economic Development: The contract of insurance also leads to
economic development as people utilize their savings for the
purpose of making premium payments. Thus, insurance helps in the
process of saving and mobilization of such savings. It is helpful for
lower-income and middle income families. These savings help in
the process of economic development.
4) General Purposes of Insurance: Insurance is popular and
beneficial due to the following reasons:
i) Protection or safety as provided by the help of term insurances.
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LICI & Microfinance (Unit-4) 197
ii) Marriage or education of the child as provided by the help of
children plans.
iii) Fast growth of money and offering of risk coverage as provided
by the help of unit linked plans.
iv) Savings and security offered by the help of endowment type
plans.
v) Savings, security and liquidity of funds as provided by the help
of money back plans.

4.1.4. Principles of Insurance

Following are the main principles governing insurance:
Principles of Insurance

Principle of Uberrimae Fidei

Principle of Insurable Interest
Principle of Indemnity
Principle of Subrogation
Principle of Causa Proxima or
Nearest Cause Principle of Contribution

1) Principle of Uberrimae Fidei (Utmost Good Faith): Under this

principle, the insurance contract is required to be signed by both
insured and the insurer in an absolute good faith or trust. This means
that the insured person is duty bound to disclose and surrender the
complete and true information to the insurer with regard to the subject
matter of insurance. If it is found that a material statement related to
the subject matter of insurance was omitted, hidden, falsified or
presented in the wrong manner by the insured then the insurer‟s
liability becomes void, i.e., it is legally revoked or cancelled. This
principle is applied to all kinds of insurance contracts.
2) Principle of Insurable Interest: This principle means that the person
getting insured must have insurable interest in the object which is being
insured. The existence of insurable interest is deemed when the
physical existence of the product gives the person some gain and the
object‟s non-existence may have caused some loss to that person. In
other words, the insured person should be liable to suffer some sort of
financial loss on account of damage caused to the insured product.
3) Principle of Indemnity: Indemnity means making good of a loss or
a damage. Under this principle, an insurance contract is meant to
provide protection against unforeseen financial losses. The
insurance contracts are not meant to generate any profit. Their sole
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198 MBA Third Semester (IFS&FM) MDU
4) Principle of Subrogation: Subrogation means the substitution of
one creditor for another. The principle of subrogation suggests upon
payment of the compensation to the insured, the insurer obtains the
ownership rights of the property which was the subject matter of
insurance. Principle of subrogation is the logical extension as well
as the alternative definition of principle of indemnity and therefore
is applicable to all contracts which are subject to indemnity.
5) Principle of Causa Proxima or Nearest Cause: Principle of Causa
Proxima states that if the loss is caused by more than one causes
then the cause which is the closest should be considered for the
purpose of determining the liability of the insurer. The same
principle should be followed to see whether the insurer is liable at
all or not.
6) Principle of Contribution: This principle is an offshoot of the
principle of indemnity. It suggests that if the insured has taken out
more than one policy for the same subject matter then the
compensation claimed from all such sources may not be higher than
the loss sustained. If one insurer pays full compensation to the
insured then such insurer has the right to claim proportionate
contribution from other insurers.

4.1.5. Functions of Insurance Services

Following are the main functions of insurance:
Functions of Insurance Services

Primary Functions
Secondary Functions
─ Provide Protection
─ Prevention of Loss
─ Collective Bearing of Risk
─ Small Capital to Cover Larger Risks
─ Assessment of Risk
─ Contributes towards Economic
─ Provide Certainty Prosperity
─ Means of Savings and Investment
─ Source of Foreign Exchange
─ Risk Free Trade

1) Primary Functions: Following are the main functions of insurance

contracts:
i) Provide Protection: The main aim of the insurance contract is to
offer security against unforeseen risky events and accidents. While
insurance cannot stop such incidents from happening, it can
mitigate the loss by providing insurance. Thus, the contract of
*
insurance is a hedge against economic loss caused by an event. *
LICI & Microfinance (Unit-4) 199
ii) Collective Bearing of Risk: Insurance is a tool which lets
people share the risk. Under this concept, the risk of losses is
spread over a large number of people, so that per capita risk is
small in value. Such people contribute through the payment of
premium and such premium is then used to compensate people
who suffer the losses covered under such insurance scheme.
iii) Assessment of Risk: The contract of insurance also seeks to
determine the volume of risk by analyzing the various factors
related to it. Such assessment is also useful for determining the
amount of premium to be paid.
iv) Provide Certainty: Insurance seeks to replace uncertainty by
providing some element of certainty. The insurance is method in
which the uncertain risk can be changed into certain.
2) Secondary Functions: Following are the secondary functions of
insurance contract:
i) Prevention of Loss: Insurance makes people aware about the
chances of an unfortunate event. It also prompts them to take
effective measures against such events. Payment of premium
requires them to save a part of their income. Such savings also
promote economic growth in the society.
ii) Small Capital to Cover Larger Risks: Insurance reduces the
risk element for people as they are required to pay only small
amount as premium to be protected against bigger and more
uncertain risk elements.
iii) Contributes towards Economic Prosperity: Insurance may be
used as a method for savings, which may then be mobilized for
investment purpose. This helps in improving the economic
environment in the society as there are various industries which
provides fund to sick industries.
iv) Means of Savings and Investment: Insurance may use for
encouraging savings. These savings may then be mobilized for
the purpose of investment, which encourages the process of
industrialization. Investing in insurance products may also be
used for the purpose of availing several income tax exemptions.
v) Source of Foreign Exchange: Insurance may be carried out
internationally and thus may be used for the purpose of earning
foreign exchange.
vi) Risk Free Trade: Insurance helps in the growth of business
especially international business by reducing the risk involved
in such trades. Various types of policies such as marine
insurance may be used for this purpose.
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200 MBA Third Semester (IFS&FM) MDU

4.1.6. Significance of Insurance

Insurance plays an important role in modern business scenario.
Following are the main significance of insurance to the business world:
1) Protection against Risk of Loss: The main function of insurance is
to provide protection from unanticipated losses. Such protection
provides a degree of freedom to businesspeople and lets them take
reasonable risks, leading to the growth of business and commerce.
2) Distribution of Risk: The insurance contract transfers the risk to
insurance provider, who in turn distributes this risk over a large
number of individuals. Whenever a loss is suffered by the insured,
the impact of such loss is borne by such contributing members. It
results in minimal burden on any individual. It helps in minimizing
the risk burden and proper working of the business.
3) Capability of Facing Cut Throat Competition: Modern
businesses have to face massive competition. The sharing of risk
through insurance allows the businesses to work in the efficient
manner. It increases their ability to take risks.
4) Specialization of Labour: Insurance allows the businessperson
to devote their attention to more important business concerns
rather than worrying about various risks. This helps in achieving
the specialization of labour as the burden of risk is transferred to
the insurance company which is more specialized in undertaking
such burden.
5) Optimum Utilization of Capital: Investment in an insurance
policy allows a business to devote its capital for productive business
purposes. Without insurance, the business will need to provide for
contingency, which is not a productive use of business funds.
6) Formation of Capital: The insurance companies offer protection
against losses. At the same time, they also mobilize savings from
numerous people and such savings are invested to the industry. It
helps in overall economic development of the society.
7) Advancement of Loans: Life insurance may be used as collateral
for obtaining a loan. Similarly, if the business is ensured then its
creditworthiness is enhanced. This makes it easier for the business
to obtain loans and credit advances.
8) Mobilization of Small Savings: Insurance helps in raising
savings made by people. These small savings are aggregated and
invested to industrial sector which helps in the industrial
development of the country.
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LICI & Microfinance (Unit-4) 201
9) Social Security: Insurance is a form of social security. It helps in
providing a sense of security to the society. It may also be used for
saving for retirements and old age. Insurance is useful in the case of
untimely death of the breadwinner of the family.

4.1.7. Type/Classification of Insurance

Following are the main types of insurance policies:

Type/Classification of Insurance

Life Insurance
General Insurance
Term Policy
Fire Insurance
Whole Life Policy
Marine Insurance
Endowment Policy
Money- Back Policy Motor Insurance
Annuity Accident Insurance
Unit Linked Insurance Credit Insurance
Policy (ULIP) Public Liability Insurance
Property/Casualty Insurance
Fidelity Insurance
Burglary Insurance
Workmen Compensation Insurance
Unemployment Insurance
National Health Insurance
Cash Transit Insurance
Employment Liability Insurance

1) Life Insurance: Under this type of contract, the insured person pays
a specific amount of money as premium payment. In return, they
receive a sum of money either at the time of death of the person
whose life is assured or at the end of the term of life insurance,
whichever is earlier.
Life insurance may be of following types:
i) Term Policy: Term Insurance is defined as “a policy in life
insurance may be defined as a contract that furnishes life
insurance protection for a limited numbers of years, the face
value of the policy being payable only if death occurs during the
stipulated term, and nothing being paid in case of survival”.
ii) Whole Life Policy: Under this type of policy, the insurance
amount is only in the event of death of the insured or assured.
The premium is required to be paid throughout the life tenure of
the policy.
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202 MBA Third Semester (IFS&FM) MDU
iii) Endowment Policy: This type of policy provides for the
payment of the sum assured in the event of the death of the
insured person or at the expiry of the term of insurance,
whichever is earlier. The premium is only required to be paid
for the fixed time period mentioned in the policy.
iv) Money Back Policy: Such types of policies offer periodical
payments during the term of the insurance policy. However, this
is done only if the insured person is still alive. In the case of
insured person‟s death, the claim money becomes payable.
v) Annuity: This policy involves the payment of periodic money
in lieu of the purchase price of the policy for a specified period
of time.
vi) Unit Linked Insurance Policy (ULIP): A Unit Linked
Insurance Plan (ULIP) is a type of life insurance policy which
provides both protection and investment opportunity. The
protection is offered by the insurance cover while saving is done
through the investment of premium money by the insurance
company on behalf of the insured. The former is called Death
Benefit while the latter is termed as Maturity Benefit.
2) General Insurance: This is a type of contract of indemnity. Under
this contract, the insurer promises to pay a certain sum of money to
the insured for the actual amount of loss sustained by them.
However, no payment is required to be made, if there is no loss
occurred to the insured.
Following are the main types of general insurance:
i) Fire Insurance: This type of contract allows for the
compensation for loss occurred due to fire.
ii) Marine Insurance: This insurance seeks to provide
compensation for the losses sustained due to marine transport.
iii) Motor Insurance: The losses incurred due to theft of the
automobile or any accident or damage. Such insurance policies
may be third-party as well where the compensation may be paid
to the third party.
iv) Accident Insurance: This type of contract seeks to compensate
for any loss incurred due to physical injury or property damage
caused due to accident.
v) Credit Insurance: Credit insurance is designed to repay a loan
either completely or partly upon the occurrence of certain
contingency such as the borrower‟s death, layoff etc.
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LICI & Microfinance (Unit-4) 203
vi) Public Liability Insurance: Public liability insurance offers
protection to the insured for any damage occurred to a third
party‟s property.
vii) Fidelity Insurance: This is the special type of insurance
available for businesses especially finance businesses.
viii) Burglary Insurance: This type of insurance compensates for
losses arising from burglary and theft.
ix) Unemployment Insurance: This insurance pays a defined sum
of money to the insured person during their unemployment
tenure, for helping them retain their basic level of sustenance.
x) National Health Insurance: This insurance forms a part of
Indian National Social Security Scheme. This aims to provide
basic health coverage to people especially the people below
poverty line.
xi) Cash Transit Insurance: This type of insurance provides
protection against theft and other such losses during the transit.
xii) Employment Liability Insurance: Such insurance helps the
employers with regards to their statutory payments required to
be paid to their employees.

4.2. INSURANCE COMPANIES IN

INDIA
Insurance is the contract between the company known as insurer and the
customers known as insured. It is a financial service which is very
common in India. The insurance is done for giving financial help at the
time of sudden tragic events like death. The insurance requires proper
planning and execution.

The insurance in India is divided into life and general insurance. The
general insurance also covers health insurance. The plans and policies
are the products of insurance. Premium is known as the payment given
by the customers and terms of plans is the time period for which
insurance is done. There are different types of insurance according to
the nature ranging from term insurance to unit linked plan.

The insurance industry of India has 52 insurance companies in which 24

are life insurance companies while 28 are general insurance companies.
Life Insurance Corporation (LIC) is the only public sector company in
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204 MBA Third Semester (IFS&FM) MDU
life insurance business. There are six public sector companies in the
field of general insurance. There is also one national re-insurer which is
known as General Insurance Corporation by India. There are other
shareholders in India Insurance company like agents, individual,
brokers, surveyors and third party administrators servicing health
insurance claims.

In the 28 general insurance companies there are five private sector

companies does the work of underwriting the policies in health, personal
accident and travel insurance segments like Star Health and Allied
Insurance Company Ltd, Apollo Munich Health Insurance Company
Ltd, Max Bupa Health Insurance Company Ltd, Religare Health
Insurance Company Ltd and Cigna TTK Health Insurance Company
Ltd. Export Credit Guarantee Corporation of India for Credit Insurance
and Agriculture Insurance Company Ltd are the main public insurance
companies which does the crop insurance.

The various insurance companies in India are as follows:

1) Life Insurance Company in Public Sector: The main life
insurance company in the public sector is known as Life Insurance
Corporation of India (LIC).
2) General Insurance Companies in Public Sector: There is only
one public sector general insurance company known as General
Insurance Corporation of India (GIC). It is divided into the
followings subsidiaries:
i) National Insurance Company Limited,
ii) New India Assurance Company Limited,
iii) Oriental Insurance Company Limited, and
iv) United India Insurance Company Limited.

4.3. LIFE INSURANCE CORPORATION

OF INDIA (LICI)

4.3.1. Introduction
Life Insurance business in India has started from 1818. Before 1956,
the insurance business was combined and the powers were distributed.
There was various companies of different ages, sizes and arrangement
of organisation. There are various companies which are for life
insurance business and while others are mainly for general insurance
but they also do business in life insurance. There were also many
provident societies.
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LICI & Microfinance (Unit-4) 205
There was nationalisation of the life insurance companies and was
formed into one known as Life Insurance Corporation of India (LIC) in
1956. The business of life insurance is in the hands of the LIC. The post
and telegraph departments provides life insurance to its employees but
this is very less as compared to volume of business with LIC.

4.3.2. Features of LIC

The features of LIC are as follows:
1) Saving Institution: Life insurance encourages savings among the
public in the country. There is deduction given in the income tax
law for the LIC policies. The overall insurance business in the
country has also increased due to public, becoming more conscious
about the insurance in the country.
The changes needed for the growth of the business are as follows:
i) There should be improvement in the organisational and
operational productivity of the LIC.
ii) The various different types of insurance covers should be
introduced.
iii) The service of LIC should also be given in rural areas.
iv) The importance of life insurance should be informed to the
public.
v) The general price level should be fixed for all the insurance
companies so that there is no fraud with the insuring public.
2) Term Financing Institution: LIC also work as the large-term
financing institution in the country. There is large flow of annual net
accrual of investible funds from life insurance business and net
income from its vast investment is also big.
3) Investment Institutions: The LIC invest their funds in the
government securities. The LIC has to invest 50% of its funds
according to the law in the form of premium income in government
and other approved securities.
The LIC also invest in shares, debentures and loans of private company.
LIC is important in the formation of underwriting of new issue.
4) Stabiliser in Share Market: The LIC works as the downward
stabiliser for the share market. The regular flow of funds allows LIC
to buy the shares if the market price is low. Thus, the LIC will not
sell the share when the market is increasing. It is because of on-
going burden for investing in new funds and also because of
disadvantage of capital gains tax.
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206 MBA Third Semester (IFS&FM) MDU

4.3.3. Objectives of LIC

The objectives of LIC are as follows:
1) To increase the life insurance protection among the general public at
low price.
2) To increase the return on the savings of the people by insurance-
linked saving schemes.
3) The funds should be invested in such manner that the profit for both
the policyholders and the nation can be increased.
4) LIC should work as trustee of the policyholders and should protect
the individual and collective interests.
5) There should be prompt change and innovation for meeting the
requirement of the public for the life insurance.
6) There should be maximum involvement of the employees so that
there is effective and well-informed services be available to the
insured public.
7) It should increase the feeling of pride and job satisfaction among all
the agents and employees by committed service for attaining the
corporate objective in stipulated time.

4.3.4. Role of LIC

The various roles of LIC are as follows:
1) It does long-term investments in government securities, public
sector industry, cooperative sectors, private sector and joint sector
concerns.
2) The new issue of shares, bonds and debentures are underwritten.
3) The distribution of loans for the industrial development.
4) It gives the financial support in making and transferring of
electricity, agriculture and industry, development of road, housing
use, water supply schemes, etc.
5) There is subscription of shares, bonds and debentures.
6) It provides financial help to increase the industrial growth of the
country.
7) The planning of ways for increasing the funds from the public
especially from the rural areas and using these funds in the capital
market.

4.3.5. Functions of LIC

The main functions of LIC are as follows:
1) Mobilise Savings: The LIC mobilises the saving of policyholders
and give them to the public and private sectors types of industries.
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LICI & Microfinance (Unit-4) 207
2) Provide Finance: The main aim of LIC is to give financial
assistance to industries. The LIC also play an important role in the
capital market by underwriting and subscribing to industrial
securities. It helps in giving long-term and medium-term type of
direct loans. The cumulative assistance and disbursement of LIC
was `1,298.1 crore and `977.7 crore respectively till 31 March,
1985. From the total assistance, the 55% was registered as direct
loan while the leftover are in the form of underwriting and direct
subscriptions to shares and debentures.
3) Make Investment: The total investment of LIC was `10,804 crore on
31st March, 1985. The public sector has 79.5% of the total investment,
11% to private sector and 9.5% to the co-operative sector. While 13%
of total fund was given to the projects in the backward areas. The LIC
did a record business of `12,404 crore attaining the highest ever
growth rate of 36.2% in 32 years of its business in 1987-1988. It
earned a profit of `952.65 crore and increased the bonus rate to
`77.50 per `1,000 sum obtain in the overall life policies.
4) Deployment of Funds in Money Market Instruments: The funds
are temporarily invested in the short-term money market
instruments like Call/Notice Deposits, Certificate Deposits,
Government of India Treasury Bills, Short-term fixed deposits with
the banks and commercial papers issued by corporates which are
anticipated investments.
5) Investment in Small and Medium-Scale Industries: The LIC
provides financial help to the small-scale and medium-scale
industries by buying the shares and bonds of State Financial
Corporations.
6) Assistance to Corporate Sector: LIC gives financial help to
corporate sector in different forms like loans, underwriting direction
subscription, firm allotment and rights issues, equity/preference
shares, debentures, bonds, short-term loans, unsecured short-term
deposits according to the Section 27A of the Insurance Act. LIC
also provide help to the corporate sector for starting new units for
expansion, diversification and modernisation of existing units and
for adjusting equipment and rehabilitation and for other work which
includes helping in increasing the cash reserve of the company.
7) Resources Support to Financial Institutions: LIC along with
corporate sector also give help to the industrial corporate sector in
the indirect manner. It increases the financial support by the help of
financial institutions like IFCI, SFCs, etc. in the form of term loans
and also by subscribing their shares and debentures.
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208 MBA Third Semester (IFS&FM) MDU

4.3.6. Procedure of Taking Life Insurance Policy

In reference to the rules and regulations of LIC, following procedure is
obeyed to acquire a life insuance policy:
1) Proposal Form: Similar to that of other contracts, establishment of
proposal is the foremost step to enter into a contract of life
insurance. Thus, one can obtain a printed proposal form from any
branch of LIC without incurring any cost. This form is comprised of
various questions which needs to be answered with accurate
information in complete manner. Generally, the following
information is collected from a proposal:
i) Name, address, and occupation,
ii) Date of birth,
iii) Suggested insurance scheme or plan,
iv) Purpose, i.e., protection to family, old age provisions, etc., and
v) Particulars of previous insurance, if any.
At the ending portion of a proposed form, a para of declaration is
given which explains that the furnished information is accurate,
thorough and guenuine as per the knowledge of applicant, who is
funishing the information. Thus, he has to authenticate such
declaration by putting his signature.
2) Personal Statement: Together with a proposal form, the personal
statement is also issued with it. This form is supplementary to the
proposal form, where proposer is asked to disclose his entire
medical history and the medical history of his family members.
Whether the proposal will be accepted or rejected by LIC is
completely based on the information furnished by the proposer, in
the proposal form and in the personal statement. LIC is entitled to
repudiate the proposal, if the applicant is found guilty for furnishing
false and wrong data or for hiding required informaion.
3) Medical Examination: Once the proposal and personal statements
are submitted with LIC, it will give instructions to applicant
(proposal assured) to go through a complete medical examination.
Such medical examination is only perfomed by the authorised
doctors. More specifically, these doctors are on the Official panel of
LIC. Nothing is charged from the proposer for such medical
examination. After examination, the report is directly sent to LIC.
4) Proof of Age: In proposal form, the date of birth column must be
filled with accurate date and it must be proved through required
proof documents of age such as through a document of leaving
certificate, high school marksheet, or through a copy of affidavit of
court etc. Accurate age of a proposer is significant to know because
it is a base for deciding the premium of a contract.
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LICI & Microfinance (Unit-4) 209
5) Reviewing Stage/Scrutiny of Reports: Subsequently, the
acceptance and rejection of a proposal completely depends on the
LIC officers because only the officers are entitled to take decisions
after examining the information of proposal form, personal
statement, medical reports, agent‟s remarks, and a certificate of
proof of age.
6) Acceptance of the Proposal: The LIC officer can accept the
proposal, if he agrees with the information furnished by the
proposer. On acceptance, he is also responsible to sent an intimation
notice to the proposer. On the other hand, LIC officer can reject the
proposal, if he is not satisfied with the furnished information and he
can convey the same to the proposer by sending a initimation notice
to the proposer.
7) Payment of Premium: Acquisition of LIC contract gets complete on
payment of first premium made by the proposer. Such payment is
considered to be complete on the date, when the proposer is receiving
receipt for the same. There may be situations under which the first
premium amount is paid right at the beginning together with the
submission of proposal form. Under, such case the LIC contract is
deemed to be acquired on the date, the proposer is receiving receipt of
the payment. After acceptance of contract, LIC is bound to manage
the risk of proposer from the date on which the payment gets
completed. Subsequent to the first premium, the proposer has to make
payments of additional premiums for the approved time period.
8) Issue of Insurance Policy: When the acquisition of insurance
policy gets complete, a written agreement is created known as
insurance policy. This document is specifying the required details
like, the name, address, occupation, age of the proposer, policy
number, type of amount and term of policy, and the other terms and
conditions of the insurance contract.

4.3.7. Investment Pattern of LIC

LIC is also considered as a investment institution because of the
following reasons:
1) The investment policies created by LIC are based on considerate
factors that affects the cardinal principles of safety to the principal
amount.
2) Through a contract with LIC, a proposer is making diversified
investment as such contract is a form of securities.
3) Pooled money by LIC, is used for helping the other organisations of
different kinds.
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210 MBA Third Semester (IFS&FM) MDU
4) The various products of LIC are subject to mature after a definite
period as similar to the maturity of securities.
5) LIC is offering its products for the growth of all regions which are
underdeveloped.

LIC is binding with the principles of Corporation Acts and it offers

investment policies for the benefits of policyholders and for the greater
welfare of entire nation.

Till the present time, the arrangement of making investment through

LIC is regulated through the Section 27A of Insurance Act 1938. In
reference to the provisions of Corporation Acts, LIC needs to invest its
controlled funds in the securities of Central and State government and in
the other securities which are authorised in this Act, the proportion shall
be 50% of controlled fund. While the 35% of the fund shall be invested
in authorised investments and the final residual proportion of 15% shall
be invested in those investments which are not authorised. These
proportions of controlled funds are decided by the investment
committee of LIC.

The controlled fund is comprising of all funds obtained through the

business of LIC and the amount of capital which is to be redeemed
through the business of LIC. Investment of pooled money by LIC is
undertaken in the following manner:
1) An investment amount in marketable securities of Central
government should not be less than 25% of controlled fund.
2) An investment amount in marketable securities of central and state
government together with the government guaranteed marketable
securities should not be less than 50% of controlled fund.
3) An investment amount in socially-oriented sector comprising of
public sector, co-operatives, houses built by policyholders, OYH
schemes should not be less than 75% of controlled fund.

The balance 25% of controlled fund must be distributed in such

manner as may be specified by the government:
i) Nearly 8% of controlled fund are to be allocated to the loans
provided against the policies upto the surrender values;
ii) Nearly 2% of controlled fund can be invested in immovable
properties; and
iii) Nearly 10% of controlled fund can be invested in private
corporate sector.
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LICI & Microfinance (Unit-4) 211

4.3.8. Criticisms of Investment Policy

The following are the known criticisms of investment policy:
1) Wrong Assumptions for Investment: There are many people who
criticise the investment policy of LIC because they normally assume
that LIC is making investment for the advantage of big industrial
units by making investment more primarily in the approved
securities and thus avoiding to make any investment in public sector
or in priority sector which needs suitable attention.
2) Actual Benefit of Investment to the Large Industrial Units: The
second factor due to which investment policies are criticised is that
the actual benefit of the investment is taken by the large and big
industrial units because these policies provide them assistance in the
name of security. The investment to such units are supported by LIC
because these units provide constant return with less risk. The
persons who criticize such assumption are of the opinion that LIC
should invest its controlled fund in small scale sector as it is useful
for this sector to generate more employment and increase the level
of production.
Development in small scale sector ultimately leads to the
development of entire economy. Therefore, while investing the
controlled fund, LIC needs to consider the national priorities
instead of less risk and constant returns. In addition to this,
investment in small scale sector is also fruitful as in the case of
large scale sector.
3) Less Returns on Investment: Making investment in LIC insurance
policies is very much similar to the investment in government
securities, where the returns on investment are less. In addition to
this, the cost of acquiring and maintenance of LIC policies are also
high. Thus, the policy holders are incurring heavy expenditure on
payment of premium, even though their life expectancy has been
increased. On the other hand, in respect of LIC, it covers huge
expenditures on different operations performed by it. Thus,
maximum portion of surplus fund is spend on meeting the
operational expenditures and less portion of fund is left for the
distribution of bonus among the policy holders.
4) Requirement of Amendments: Even in present time, LIC is
structuring its investment policies in reference to the provisions
specified in Act 1938, which are no more useful in the present time.
Thus, this Act is required to be modified and it must be revised as
per the interest of policy holders.
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212 MBA Third Semester (IFS&FM) MDU

4.4. UNIT TRUST OF INDIA (UTI)

4.4.1. Introduction
The unit trust helps the small and medium investors to make
investments in those stocks in which they cannot invest earlier. The
small denomination of units of trust is chosen by the small investors and
the trusts invest this money in the shares of profitable company. All the
income and capital gains from these investment is shared with the unit
holders and the investors gets the high return, low-risk combination
from indirect holding of equities and other assets. The Government of
India has established an investment trust for increasing the area of
investment in equity capital of companies by large and growing number
of small and medium investors. The Unit Trust of India was established
by the Government of India from the Unit Trust in India Act. 1963. This
trust was basically set in February,1964.

4.4.2. Objectives of UTI

The various objectives of UTI are as follows:
1) The UTI helps in encouraging saving in the middle and low income
group.
2) It helps unit holders to share the profits of growing industries in the
country.
3) The units are sold to large number of investors.
4) The UTI helps in investing the money raised from the sale of units
and capital in various corporate and industrial securities.
5) The UTI helps in paying dividend to the unit holders.

4.4.3. Functions and Working of UTI

The functions and working of UTI are as follows:
1) The UTI does the mobilising of saving by the sale of units.
2) The savings should be mobilised in corporate securities like shares
and debentures etc.
3) It also helps in increasing the profit of the unit holders and country
both.
4) It also helps in underwriting the issue of shares and debentures.

4.4.4. Operational Policies and Practices of UTI

UTI is performing the following operations:
1) It enables the lower and middle-class people to maintain the habit
of savings.
2) It enables the investors to sell units in any part of the nation.
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LICI & Microfinance (Unit-4) 213
3) It channelizes the pooled savings into productive use in the form of
industrial finance.
4) It enables the investors to obtain higher returns on investments
due to success rate of industrialization in the nation.
5) Investors can readily sell their units at any time, whenever they find
suitable. Thus, liquidity of units has been increased.
6) It enables the investors to make investment with less risk of
uncertainty.
7) On making investment in UTI, the lower and middle-class investors
are entitled for all probable benefits that are provided to the large
and rich investors.
8) It enables the investors to obtain high and secure returns on their
savings.

4.4.5. Achievements of UTI

Following are the important achievements of UTI:
1) Savings Mobilizer: One can easily observe the growth of UTI as it
acts as a savings mobilizer and as an institutional financier.
2) Boon to Small Investors: Invstment in UTI is useful for both to
the small investors and to the capital market. For example, if a
small investor makes investment in UTI then he is entitled to
receive dividend which is normally fair and constant. In addition
to this, investor‟s investment is more safe and liquid in nature
because UTI enables him to sell his units at any time whenever
he like to do so.
3) Dominant Role: In capital market, UTI is the sole largest purchaser
of industrial securities. Thus, it has a dominant role over the others
organisations.
4) Big Underwriter: UTI is a largest underwriter which issues new
shares and debentures in the market. It is offering such securities at
nominal rates to encourage the habit of savings. Normally, these
securities are issued in the month of July on annual basis. On
estimation, there are more than one crore clients of UTI, out of
which 85% of clients are small investors.
5) Network of Agents: UTI has a network of authorised agents and
registered brokers to facilitate the investors to sell their units in the
entire nation. Normally, the appointed brokers and agents are the ex-
servicemen and war widows. UTI assists all types of investors by
selling the units of small denominations in reference to the different
schemes structured by it.
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214 MBA Third Semester (IFS&FM) MDU
6) CRISIL: The Credit Rating Information Services of India Ltd
(CRISIL), has been established through the combined efforts of UTI
and ICICI. This organisation has been set up in the interest of
individual and institutional investors because its main purpose is to
offer an objective assessment of credit quality in respect of debt
liabilities of the companies. This body also facilitates the investors
to make decisions in respect of investment and savings.

4.5. SMALL INDUSTRIES

DEVELOPMENT BANK OF INDIA
(SIDBI)

4.5.1. Introduction
SIDBI is a development bank dedicated for the betterment of small-
scale industries. It was incorporated in 1990 and is undertaken by
Central Government of India. Providing financial assistance and worthy
factors of production in order to improve and encourage the small-scale
industries is the main objective behind the establishment of SIDBI.
SIDBI is the chief financial institution for providing finances,
encouraging and improving the small-scale industries. It is responsible
for directing all those commercial banks and financial institutions which
provide financial assistance to small-level businessmen. The objective
of SIDBI is to make MSME sector capable of generating employment,
contributing the growth of economy, and in bringing evenness in
industrial development in different regions.

4.5.2. Objectives of SIDBI

Small Industries Development Bank of India (SIDBI) was established
on 2nd April 1990 as an apex Development Financial Institution (DFI)
for the promotion, financing and development of the Micro, Small and
Medium Enterprise (MSME) sector as well as for co-ordination of
functions of institutions engaged in similar activities. Its objectives may
be summarised as following:
1) To extend short term credit in the form of working capital finance
to the entrepreneurs engaged in MSME sector for meeting their
various expenses on daily basis, e.g. purchase of raw material,
payment of wages/salaries, electricity/water charges, etc. Long-
term credits are also provided in the form of term loans for
creation of fixed assets, e.g. plants, machineries, equipment, land,
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building, etc.; *
LICI & Microfinance (Unit-4) 215
2) To take appropriate measures for technological advancement and
modernisation of prevailing MSME units;
3) To enlarge ways and means of marketing the merchandises
manufactured by MSME units;
4) To support and encourage the MSME industries having potential of
generating employment opportunities for the people residing in
semi-urban areas with a view to curbing their migration to
urban/metropolitan areas;
5) To provide refinance facilities to the banks and other financial
institutions lending to the MSME units;
6) To extend discounting/rediscounting facilities in respect of the bills
representing genuine transactions of sales of machineries
manufactured by MSME units;
7) To offer seed capital and soft loan support under various
Government schemes, such as National Equity Fund, Mahila
Udyam Nidhi, Mahila Vikas Nidhi, and other seed capital schemes;
8) To provide direct support and refinance facilities to the primary
lending institutions for onward financing the export of products
manufactured by MSME units;
9) To offer services of factoring, leasing, etc. to MSME units;
10) To provide financial assistance to State Small Industries
Corporations (SSICs) for the procurement of rare/limited raw
materials for MSME units, and marketing of their products; and
To extend financial help to National Small Industries Corporation
(NSIC) for providing necessary finance to MSME units in
undertaking leasing, hire purchase and marketing activities.

4.5.3. Organisation Chart

Small Industries Development Bank of India is headed by Board of
Directors along with Chairman & Managing Director. The Bank has
defined hierarchy in place to enable effective decision making through
focus on single set of organisational objectives.
SIDBI has floated several other entities for related activities,
including:
1) SIDBI Venture Capital Limited (SVCL) for providing Venture
Capital (VC) assistance to MSMEs;
2) Micro Units Development & Refinance Agency (MUDRA) for
„funding the unfunded‟ micro enterprises in the country;
3) Receivable Exchange of India Ltd. (RXIL) to enable faster
realisation of receivables by MSMEs;
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216 MBA Third Semester (IFS&FM) MDU
4) SMERA Ratings Limited (SMERA) for credit rating of MSMEs,
renamed as Acuite Ratings & Research Limited;
5) India SME Technology Services Ltd (ISTSL) for technology
advisory and consultancy services; and
6) India SME Asset Reconstruction Company Ltd. (ISARC) for
speedier resolution of Non-Performing Assets (NPA) in the MSME
sector. Organisation Chart

Board of
Directors

Chairman &
Managing
Director

Deputy
Managing
Directors

Operations &
Services

New Delhi Lucknow Mumbai

Office Office Office

Subsidiaries &
Associates Offices & Branches
Organisation

SIDBI Venture Capital Ltd.

Regional Offices(g)
SIDBI Trustee Company Ltd.
Branches / RROS(77)
Micro Units Development & Refinance Agency
Swavalamban academic
Ltd.
Centre(1)
Receivables Exchange of India Ltd.
Credit Guarantee Fund Trust for MSES.
India SME Technology Services Ltd.
Acuite Ratings & Research Ltd.
India SME Asset Reconstruction Company Ltd.
Figure 4.1: SIDBI Organisational Chart
[Adapted from www.sidbi.in]

SIDBI supports the Government of India in its initiatives and work as a

nodal agency for some of the schemes related to development of
MSMEs, such as Make in India and Startup India.
* *
LICI & Microfinance (Unit-4) 217

4.5.4. Functions and Working of SIDBI

The main functions and working performed by SIDBI are as following:
1) Re-Financing: SIDBI refinances the credits and loans granted by
financial institutions to small-scale industries. It also assists
financial institutions by providing them finance and other resources
so that they can sufficiently help the small-scale industries to grow
and develop.
2) Discounting and Re-Discounting: SIDBI also serves the function
of discounting and re-discounting of bills of the small scale
industrial units. Bills can either be of purchases made by any small-
scale unit or by the purchases of products produced by any small-
scale unit.
3) Direct Assistance: Other than the re-financing of loans granted by
credit institutions, SIDBI also extend direct assistance to the small-
scale industrial sector for exporting of goods.
4) Soft Loans and Seed Capital: There are various schemes of
SIDBI, by which it provides soft loans, i.e., loans which can be
availed on very lenient terms and conditions. Some of them are
Mahila Vikas Nidhi, National Equity Fund, Mahila Udyam Nidhi,
etc. In the same way, through the specific credit agencies, SIDBI
also provides schemes of seed capital.
5) Support to SSIDCs: The two most important difficulties that are
often faced by the companies of small-scale sector are procuring the
scarce resources, and marketing and selling of the finished goods.
The financial assistance needed to carry out these two activities is
given by SIDBI, not directly but through one of its agencies, named
as State Level Small Industries Development Corporations
(SSIDC).
6) Other Services: Alongwith all the aforementioned functions,
SIDBI also assist the small-scale industrial units in services such as
factoring, leasing, etc.
7) Help to NSIC: National Small Industries Corporation (NSIC) is a body
that helps small-scale industrial units in making hire-purchases, leasing,
marketing activities, etc. The SIDBI assists NSIC financially, so that
the latter can perform its functions effectively.
8) Technological Upgradation: In the era of globalisation, technology
and its regular updation is becoming a necessity for all the sectors
and same applies to small-scale industrial sector. This is the reason
why SIDBI took a step ahead in order to renovate the small-scale
industrial units by instituting advanced technology in their
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operations. *
218 MBA Third Semester (IFS&FM) MDU

4.5.5. Schemes for Promotion of Small Business

At present, various schemes offered by SIDBI for the promotion and
encouragement of MSME sector are as following:
1) National Equity Fund Scheme: Under this scheme, equity support
is made available to small entrepreneurs intending to set up project
in tiny Sectors.
2) Technology Development & Modernisation Fund Scheme: This
scheme envisages financial support to the existing MSME units for
the technological advancement and modernisation.
3) Single Window Scheme: Under this scheme, all long-term (in the
form of term loan) as well as short-term (in the form of working
capital) financial support is provided to the MSME units through a
single agency.
4) Composite Loan Scheme: Composite Loan Scheme is extended for
the acquisition of equipment, working capital, and construction of
work sheds to artisans, village and cottage industries in tiny sector.
5) Mahila Udyam Nidhi (MUN) Scheme: This scheme is specifically
designed for providing equity assistance to women entrepreneurs for
initiating new projects in tiny Sector.
6) Scheme for Financing Activities Relating to Marketing of Products
Manufactured by MSME Units: This scheme envisages extending
financial support to MSME units for marketing related activities
(including research projects) like marketing research, R&D, product
upgradation, participation in trade fairs and exhibitions, advertising
branding, setting up/development of distribution networks including
show rooms, retail outlets, warehousing facilities, etc.
7) Equipment Finance Scheme: This scheme is designed to extend
financial support to MSME units for the acquisition of machinery
including diesel generator sets for general purpose, i.e. not for any
specific project.
8) Venture Capital Scheme: Venture Capital Scheme has been
introduced with the objective of encouraging MSME ventures/sub-
contracting units to go for capital equipment and latest technology
with a view to enhancing their export competencies/import
substitution including cost of Total Quality Management (TQM)
and for acquiring ISO-9000 certification and expansion of capacity.
9) ISO 9000 Scheme: This scheme provides financial support to
MSME units for meeting various expenses to be incurred in
connection with securing ISO 9000 certification. Such expenses
may relate to consultancy, documentation, audit, certification fee,
*
equipment and calibrating instruments; and *
LICI & Microfinance (Unit-4) 219
10) Micro Credit Scheme: This scheme is meant for the well managed
voluntary agencies (fulfilling certain eligibility criteria) for meeting
their requirements. The eligibility criteria are as following:
i) Should be in existence for a minimum period of five years;
ii) Should have a good past record; and
iii) Should have a robust network and experience of small savings-
cum-credit programmes with Self Help Groups (SHGs) individuals.
New Schemes
1) To enhance the export capabilities of SSI units.
2) Scheme for Marketing Assistance.
3) Infrastructure Development Scheme.
4) Scheme for acquisition of ISO 9000 certification.
5) Factoring Services and
6) Bills Re-discounting Scheme against inland supply bills of SSIs.

4.5.6. Benefits of SIDBI

SIDBI schemes benefited in the following manner:
1) Custom-made: Various schemes of SIDBI are designed in such a
way that at least one of them fulfil the requirements of individual
business entity. However, if the requirements of a business
organisation do not fall under any of the existing schemes, SIDBI
takes the responsibility to facilitate finding an appropriate solution
for fulfilling the specific need of that business organisation.
2) Dedicated Size: Various financial facilities offered by SIDBI are
tailor made in accordance with the size of the business and level of
the requirement. There is no “one size fits all” type of approach.
3) Attractive Interest Rates: SIDBI has tie-up arrangements with
numerous banks and financial institutions spread over throughout
the globe (e.g. World Bank, Japan International Cooperation
Agency, etc.), and therefore can afford to offer financial support at a
very competitive interest rates.
4) Assistance: The support extended by SIDBI is not confined to
provide financial facilities; it offers valuable advice and also other
forms of assistant. Its services are provided through a personalised
relationship manager, who helps the entrepreneurs in taking
appropriate decisions and offers other support till the loan is
finalised.
5) Security Free: Financial accommodation may be made available to
entrepreneurs up to ₹100 lakh without any tangible security such as
*
clean loan. *
220 MBA Third Semester (IFS&FM) MDU
6) Capital Growth: In case of need, an entrepreneur can approach
SIDBI and seek financial support for the purpose of expanding
the capital base, without compromising the ownership pattern of
the company.
7) Equity and Venture Funding: Equity capital requirement of
MSME entrepreneurs is fulfilled by a wholly owned subsidiary of
SIDBI, viz. SIDBI Venture Capital Limited.
8) Subsidies: A number of SIDBI schemes provide financial support on
easy terms and conditions with subsidised interest rates. SIDBI has a
team of professionals with thorough knowledge and understanding of
various subjects and schemes offered by it, and they are willing to
help MSME entrepreneurs in taking decisions regarding most
appropriate scheme to suit their business requirements.

4.6. NABARD
4.6.1. Introduction
National Bank for Agriculture and Rural Development (NABARD) was
set up pursuant to the recommendations made by the Committee to
Review Arrangements for Institutional Credit for Agriculture and Rural
Development (CRAFICARD). It was set up on July 12, 1982. The main
purpose of NABARD was to promote cohesive rural growth and to
ensure the provision of production as well as investment credit required
for rural and agricultural growth. NABARD is a top development bank
and has the mandate to facilitate credit flow for the purpose of
promoting and developing agriculture, village and cottage industry and
small scale industry. It also ensures the growth of handicrafts industry.
Following are the main tasks entrusted to NABARD:
1) Offering refinance for the purpose of extending credit to rural area
enterprise.
2) Develop and promote institutional development.
3) Carrying out proper evaluation, monitoring and inspection of the
client banks.
Apart from these, the bank also performs the following tasks:
1) It helps in coordinating the activities of several rural credit
institutions.
2) Extending support to the Reserve Bank of India, the government
and other stakeholders in the process of rural growth process.
3) Providing research and training functions for various participants
such as banks and cooperatives working for rural development.
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LICI & Microfinance (Unit-4) 221
4) Assisting state government in achieving their targets for providing
aid to various institutions.
5) Carrying out the role of being a facilitator for banks and Regional
Rural Banks.

4.6.2. Objectives of NABARD

Following are the main purposes of NABARD:
1) The National Bank will serve as an apex body for the matters related to
the policy and planning for extending credit for promoting agriculture,
cottage industry, small-scale industries and rural crafts sector.
2) The bank will also have the responsibility to provide refinancing for
institutional credit, ranging from short-term to long-term in diverse
sectors.
3) The bank will also be responsible for providing direct lending as
directed by the central government.
4) Aid state governments in meeting their target for extending assistance
to various institutions engaged in rural-sector development.
5) Provide services to regulate co-operative banks and Regional Rural
banks and maintain close links with Reserve Bank of India.

4.6.3. Functions and Working of NABARD

The functions and working of NABARD have been divided into three
categories:
Functions and Working of NABARD

Credit Development Regulatory

Distribution Functions Functions
– Short-Term Credit
– Medium-Term Credit
– Long-Term Credit
– Facilities for Changes and Re-Arrangement
– Refinancing of Industries in Rural Areas

1) Credit Distribution: This bank offers financing solutions to the

following institutions:
i) Short-Term Credit: The firm offers short duration credit
facilities to various institutes such as Regional Rural Banks,
State Cooperative Banks and other RBI approved institutions
for the following intents:
a) Seasonal agricultural operations.
b) Marketing of various agricultural products.
c) Marketing and dispersion of products such as fertilisers and
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herbicides. *
222 MBA Third Semester (IFS&FM) MDU
d) Other activities pertaining to rural development or
agricultural development.
e) Real commercial activities.
f) Facilitate production and trade of handicrafts, products from
small-scale industries and artisans.
ii) Medium-Term Credit: The NABARD offers medium-term
credit to various approved institutions such as LDBs, RRBs and
SCBs. Such credit may range from a few months to a couple of
years. The bank extends medium-term loans for investment
schemes for agricultural and rural development schemes.
iii) Long-Term Credit: The NABARD offers long-term credit
facilities to RRBs, SCBs and State Land Development Banks. It
may also extend such services to other approved institutions.
iv) Facilities for Changes and Re-Arrangement: The NABARD
extends refinance facilities to various institutes such as RRBs
and SCBs. It can also provide aid in the times of political
upheavel or natural calamity. However, such refinancing facility
is only extended for 7 years or less.
v) Refinancing of Industries in Rural Areas: The NABARD
offers refinancing provisions for small industries, rural
industries and cottage industries.
2) Development Functions: The NABARD carries out the following
development functions:
i) Coordinating the institutions offering rural credit.
ii) Work towards improving the capacity and efficiency of credit
delivery system.
iii) Work towards developing solutions for problems faced by
villages and agricultural system.
iv) Works as an area of government, RBI and other such
organisations for improving the rural improvement programs.
v) Represent the government as well as RBI for keeping a watch
on agricultural sector.
vi) Offer research and training to the human resources of various
institutions such as RRBs, LDBs and SCBs. It also works
towards enhancing research activities in different areas.
vii) It also provides training facilities through its banker rural
development institute and national bank staff colleges at
Lucknow, Bolpur and Mangalore, and College of Agriculture
Banking (CAB) at Pune. The training is imparted to people
*
working in the field of rural banking and development sector. *
LICI & Microfinance (Unit-4) 223
viii) Disseminating information related to rural development and
banking.
ix) Aid state governments in subscribing to the shares of state
cooperative banks.
x) Offering direct credit for agricultural and rural development
upon getting approval from the central government.
xi) Create a credit fund for the purpose of providing funds to the
entrepreneurs engaged in rural and agricultural sector.
xii) Such aid is provided on interest-free basis and is recovered
through yearly installments after the repayment of the loan.
3) Regulatory Functions: Following are the main functions of
NABARD:
i) The Banking Regulation Act, 1949 allows NABARD to carry
out inspection of RRBs and other cooperative banks (excluding
primary cooperative banks).
ii) RRBs and other cooperative banks are required to get
NABARD approval for seeking RBI permission for the purpose
of opening new branches.
iii) RRBs and other cooperative banks are bound to file returns and
other documents with NABARD as well as to RBI, pursuant to
the provisions of the Banking Regulation Act, 1949.

4.6.4. Organisation and Structure of NABARD

NABARD's affairs are governed by a Board of Directors. The Board of
Directors are appointed by the Government of India in accordance with
NABARD Act. The Board consists of a Chairman, Managing Director,
two directors having expertise in rural economics and developments,
three directors with the background of having experience in the working
of cooperative banks, three directors from the Board of RBI, three
directors nominated by the Government of India, and two directors
nominated by State Governments.
All the directors are appointed by the Central Government. Consequent
upon the transfer of the agriculture credit functions of RBI and refinance
functions of the Agricultural Refinance and Development Corporation
(ARDC), NABARD came into existence on 12 July 1982. It was set up
with the initial capital of `100 crore, which was held in equal proportion
by the Government of India and RBI. However, there were revisions in
its share capital structure, and as on March 31, 2019 the same stood at
`12,580 crore. With further revision in the composition of share capital
of NABARD, as on date it stands fully owned by the Government of
India. It is authorised to accept deposits for more than one year from
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224 MBA Third Semester (IFS&FM) MDU
Central Government, State Governments, Local Governments, and
Scheduled Commercial Banks. Its borrowing powers are inclusive of raising
foreign currency loans from any bank or institution in India or abroad.

4.6.5. Major Activities of NABARD

NABARD is the apex financial institution for the agriculture and rural
development. Its major activities are as following:
1) Offer and Provide Production Credit: It offers short-term
refinance facilities for various activities relating to
production/procurement/marketing of agricultural and other rural
produces, some of which are explained in the following points:
i) Seasonal Agricultural Operations (SAOs): SAOs include the
activities, which are integral part of nurturing different crops,
and are seasonal in nature.
ii) Weavers Financing: Refinancing facilities are extended by
NABARD to Scheduled Commercial Banks (SCBs) and District
Cooperative Central Banks (DCCBs) for the purpose of further
financing of the production/procurement/marketing activities of
Primary Weavers‟ Co-operative Societies (PWCS) and
Apex/Regional Weavers‟ societies.
iii) Financing of other than Seasonal Agricultural Operations
(OSAOs): NABARD extends refinance facilities to Regional
Rural Banks (RRBs) for financing of production/marketing of
activities other than those relating to Seasonal Agricultural
Operations (OSAOs), such as the activities undertaken by
artisans (including handloom weavers) and village/ tiny sector
industries. It also provides finance to persons belonging to
weaker sections of the society, engaged in trade/service.
iv) Refinance for Marketing of Crops: State Cooperative Banks
can avail short-term refinance facility from NABARD for
onward financing to farmers for marketing of their crops. The
objective of such facility is to empower the farmers to:
a) Carry-on their production programs, and
b) Get lucrative price for their harvest.
v) Refinance for Procurement, Stocking and Distribution of
Chemical Fertilizers: Procurement, stocking, and distribution
of chemical fertilizers is yet another area for which refinance
facility is provided by NABARD to the State Cooperative
Banks for extending financial support to:
a) Apex societies (at wholesale level) and
b) Farmers (at retail level). Such kind of financial support is
*
provided for 120 days. *
LICI & Microfinance (Unit-4) 225
2) Investment Credit: Keeping in view its mission, which is to
“Promote sustainable and equitable agriculture and rural
development through participative financial and non-financial
interventions, innovations, technology and institutional development
for securing prosperity”, NABARD extends investment credit
(medium as well as long-term refinance) to the institutions and
agencies engaged in agriculture financing. The underlying objective
in this regard is to ensure an accelerated private capital formation
for the promotion of viable and fair agriculture and rural prosperity
with refinance as the tool. The salient features of such facility
offered by NABARD are as following:
i) Eligible Institutions: Following is the list of institutions, which
are entitled for availing refinance of investment credit:
a) State Co-operative Agriculture and Rural Development
Banks (SCARDBs);
b) Regional Rural Banks (RRBs);
c) State Co-operative Banks (SCBs);
d) Scheduled Commercial Banks (SCBs);
e) State Agricultural Development Finance Companies
(ADFCs); and
f) Primary Urban Co-operative Banks.
ii) Purposes: Refinance of investment credit is made available by
NABARD for following purposes:
a) Farm Sector: For the investment in agriculture and allied
activities, e.g. minor irrigation, farm mechanisation, land
development, soil conservation, dairy farming, sheep
rearing, poultry, piggery, plantation/horticulture, forestry,
fishery, storage and market yards, bio-gas and other
alternate sources of energy, sericulture, apiculture, animals
and animal-driven carts, agro-processing, agro-service
centres, etc.
b) Non-Farm Sector: For the investment in the activities
relating to rural economy, such as the activities of artisans,
small-scale industries, tiny sector, village and cottage
industries, handicrafts, handlooms, power looms, etc.
iii) Loan Period: Investment credits are made available for a long
period (with a limit of 15 years).
iv) Refinance Channel: Under this channel (Automatic Refinance
Facility), refinance is made available automatically without any
prior sanction. It is available for project-based lending up to a
ceiling of ₹20 lakh.
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226 MBA Third Semester (IFS&FM) MDU
v) Refinance Criteria: Appraisal of investment credit refinance is
undertaken on the basis of following parameters:
a) Feasibility report (technical) of the project;
b) Viability report (financial) and bankability of the project; and
c) Organisational framework in place for credit supervision.
vi) Beneficiaries: The beneficiaries of investment credit are
individuals, proprietary/partnership concerns, companies, State-
owned corporations, co-operative societies, etc., who avail the
facility through SCARDBs/SCBs/CBs/RRBs/ADFCs/ PUCBs,
for whom refinance is made available by NABARD.
vii) Margin Money: One of the conditions, for providing
investment credit stipulated by NABARD, relates to
beneficiary‟s contribution in the project cost in the form of
margin money. This stipulation is put with a view to ensure the
active involvement in the proposed project. The level of such
margin money ranges between 5% and 25% of the project cost
depending up on the type of the investment and the
creditworthiness of the borrower.
viii) Special Focus: With a broader perspective of ensuring
elimination of regional as well as sectoral imbalances,
NABARD has a policy of focusing on giving preference to the
requirements of less developed areas as far as the allocation of
resources, quality of refinance, etc. are concerned. In line with
the above perspective, it has been the attempt of NABARD to
make additional efforts through refinance on more liberal
terms and other reassuring measures for the reinforcement of
the rural credit delivery system prevailing in North Eastern
region of the country.

4.7. MICROFINANCE

4.7.1. Meaning and Definition of Microfinance

Microfinance is a form of banking and other financial services (savings
and checking accounts, small credit facilities, micro-insurance,
remittance, etc.), which is provided to the individuals and small
entrepreneurs, who do not have the ability to approach the traditional
banking. The individuals and business entities covered under the
microfinance are generally from the weaker and downtrodden section of
society with very low income level. The targeted group under
microfinance are not able to get bank finance as they do not have
requisite collaterals to offer.
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LICI & Microfinance (Unit-4) 227
Microloans are generally extended to the masses living in under-
developed or developing countries and who are engaged in different
professions, e.g. carpentry, fishing, plumbing, transportation, etc. Over a
period of time, the microfinance has evolved from the basic definition as
stated above, and has taken the shape of a movement whose objective is
“to develop a world in which as many poor and near-poor households as
possible have permanent access to an appropriate range of high quality
financial services, including not just credit but also savings, insurance
and fund transfers”. The promotors of microfinance sector are of the
opinion and belief that microfinance has the potential to take out the
poor people out of poverty.
There are two basic models/approaches for the delivery of financial
service to the targeted group, viz. (i) relationship-based approach for
individuals and entrepreneurs, and (ii) group-based approach, wherein
several individuals/entrepreneurs come together to form a group and
take the delivery of various financial services as a group.

4.7.2. Nature of Microfinance

Microfinance is characterized by following traits:
1) Microfinance is essentially a component of rural finance;
2) It is not confined to banking services, but it may be used as a tool
for overall development of individuals/community;
3) The credit facilities extended under microfinance are basically for
meeting working capital requirements;
4) A formal appraisal of borrowers and investments is lacking. On the
other hand, the hallmark of microfinance is an informal approach;
5) The beneficiaries/clients do not approach the Microfinance
Institutions (MFIs) for availing the services, instead the MFIs
approach the clients;
6) The procedures followed in delivery of financial services (savings,
loans) are very simple without any complications;
7) Interest rate charged by MFIs lies between what is charged by a
banks and the one charged by a money lender;
8) End-use of funds is not ensured by the lenders; loan availed from a
MFI may be used for any purpose without any restriction;
9) Similarly, repayment of loan may be made from the income
generated business for which the loan was taken or from any other
source;
10) There is no large-scale diversification of financial products; the
number of loans and savings products are well within the
manageable limits;
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228 MBA Third Semester (IFS&FM) MDU
11) Collateral securities are not insisted upon either from the individuals
or the group;
12) Depending upon the repayment history, the fresh loans may be
extended to poor borrowers;
13) It incentivizes the self-employment by offering opportunities for the
same; and
14) The emphasis and objective of microfinance is focused on service
rather than on the profit.

4.7.3. Need for Microfinance

Microfinance plays an important role as may be seen from the
following:
1) Helps to Provide Credit to Rural Poor: Institutional support to the
rural sectors for meeting their financial needs is almost non-existent.
As a result, they are totally dependent upon various non-institutional
agencies in this regard. In this backdrop, the microfinance
institutions (MFIs) play an important role by acting as an engine of
growth and development of rural folks and make their life
economically and socially better.
2) Helps in Poverty Alleviation: Microfinance offers employment
opportunities to the poor individuals/groups. It also facilitates and
encourages them to develop their entrepreneurial skills, which
ultimately inspires them to engage in self-employment. Once
employed, their income level tends to improve, which finally
cumulates in the form of overall poverty reduction in the rural areas.
3) Helps to get Women Empowered: Under the group-based model,
most of the Self Help Groups (SHGs) are created by women. They
are empowered enough to have an easy access to various financial
resources, which is a step in the right direction for their financial
security. In short, microfinance makes the poor women folks
sufficiently empowered from the social and economic angle.
4) Helps in Economic Growth: Financial strength is the one of the
most vital stimulants behind the stable and consistent economic
development. In the context of rural economy, microfinance
encourages and facilitates production of goods and services in rural
areas, which is one of the contributing factors in improving the GDP
level and economic development of the country.
5) Helps to Mobilize the Savings: With the inculcation of banking
habits, sooner or later the rural people start developing and
appreciating the habit of savings. Even the poorest of the poor
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LICI & Microfinance (Unit-4) 229
people start realising the significance of savings. The financial
resources created through savings and the microcredit availed from the
MFIs help them to engage in businesses, thereby improving their lots.
6) Helps in Development of Skills: MFIs play an active role in
identifying and developing the value of entrepreneurship amongst the
rural people. Self Help Groups formed by the rural folks (men/women)
with the support of MFIs, encourages its members to start innovative
business units either individually or jointly with others. With the
appropriate trainings in the respective fields, they develop leadership
qualities, and excel in the business undertaken by them.
7) It Provide Mutual Help and Cooperation: Microfinance
encourages to develop the quality and habit of cooperation and
mutual support amongst members of SHGs. Such an attitude goes a
long way in promoting mutual economic interests and achieving the
objective of socio-economic development.
8) It Helps in Social Welfare: With the availability of opportunity for
employment (including self-employment), the overall income level
amongst the rural masses tends to increase. And with the increasing
level of income, people can afford to have better education,
healthcare, family welfare, improved standard of living, etc. In
wider perspective, microfinance brings about remarkable
improvement in the area of social welfare.

4.7.4. Types of Microfinance Products

Following types of microfinance products are made available by MFIs
to their customers.
1) Micro Credit: Micro credit is a loan of very small amount, which is
extended by the registered MFIs to their borrowers (i) having no
regular income in the form of salary or any other source, and (ii) who
are not in a position to offer collateral security. Majority of such
recipients are illiterate, and therefore unable to complete paperwork
required to get conventional loans. At present, the consumer credit,
which is made available to salaried employees on the basis of
„automated credit scoring‟ is out of the definition of microcredit.
2) Micro Savings: Micro savings form a part of microfinance. It is
like a savings account specifically designed as an incentive for
saving money, to those with lower incomes, without any
requirement regarding maintenance of minimum balance. The
members of Self Help Groups are encouraged to save very small
amount of money in a group fund created for this purpose. They are
*
allowed to borrow out of this group fund in case of any contingency, *
230 MBA Third Semester (IFS&FM) MDU
including emergencies relating to household, medical, children‟s
school fees, etc. SHGs having proven record of managing their
group fund efficiently and are allowed to borrow money from a
local bank to start a small business or to invest in farm activities.
Local banks allow borrowing up to ₹ 4.00 for every rupee of the
group fund.
3) Micro Insurance: Under the concept of micro insurance, insurance
is broken down into much smaller, i.e. insuring small items such as
insurance of one-time event, properties, health, disability, or
working possibilities. It pays only for the insurance actually
required, and is designed to help more people buy insurance
coverage who were previously unable to afford it. The coverage of
micro insurance keep on widening, as each MFI try to innovate new
schemes and terms of providing insurance coverage.
4) Micro Leasing: Micro leasing is just like a regular leasing business.
Under this kind of service, the small entrepreneurs, who are
financially not in a position to buy equipment, machineries, or
vehicles, can have them on lease. Generally there is no minimum
cap with regard to the cost of equipment, etc. to be taken on lease.
5) Money Transfer: This is yet another service extended by MFIs to
their customers, under which they may transfer funds to their friends
and family staying in other parts of the country or abroad.
Individuals are allowed to transfer funds without having an account
with them by a number of commercial banks as well as by MFIs,
through international money transfer systems like Western Union,
MoneyGram, and Anelik. Small money transfers taking place day in
and day out around the world makes their volume a sizeable one.
Money transfer service by MFIs is not only a service provided to
their customers, it also offers a business opportunity for them.

4.7.5. Advantages of Microfinance

Its advantages are as follows:
1) Economies of scale is the biggest strength of MFIs, which has made
it possible to provide various financial services to the people from
poor financial backgrounds, who were otherwise financially
excluded hitherto. That factor (economies of scale) has also ensured
that MFIs remain financially viable;
2) Microfinance facilitates economic growth and development by
offering an opportunity for the people to set up a various stream of
regular income. This in turn results in an increase in their disposable
*
income and subsequent economic development and growth; *
LICI & Microfinance (Unit-4) 231
3) As most of the microfinance programs are dependent upon peer
pressure and peer support, the culture of community building and
mutual responsibility is encouraged and developed amongst the
participants;
4) Majority of the microfinance programs are self-funding. As they do
not need any financial support, some of them operate successfully
even as for-profit banks. As regards charities, the best option is to
make one time investment and forget, instead of keeping on
investing endlessly;
5) From MFIs people start learning how to save/deposit money, how to
take loan, how to buy insurance, and how to look forward for a
better future. Besides living their lives on a day-to-day basis in the
present, they also start dreaming about a better future, life style,
improving their standard of living, education of their children,
etcetera. They also realise that the sacrifices made by them today
will not go a waste and ultimately bring dividends in the times to
come. This is what the capitalism is all about. The development
agencies have been playing a crucial role in spreading awareness
regarding capitalism on a smaller scale through the medium of
microfinance; and
6) Microfinance acts as a booster for the upliftment of women folks,
especially those hailing from rural areas. Most of the SHGs are
promoted by women and majority of micro-borrowers are women,
who establish and run home businesses. It is a general observation
that women tend to behave in a more responsible manner than men,
as they prefer to spend their earnings on food, medicines, children‟s
education, and improving their standard of life, rather than on
alcohol and gambling. Microfinance has empowered the women to
have control over their own lives, which they have used for the
benefit of their families including their men.

4.7.6. Disadvantages of Microfinance

The microfinance suffers from following deficiencies:
1) Excessive emphasis on microfinance is likely to result in lower
priority of spending in other equally important areas, such as
public health, education, and other welfare measures;
2) It has been reported that some of the MFIs are charging exorbitant
rate of interest from their borrowers;
3) Some studies undertaken on micro-credit programs have disclosed
that many a time women folks of a family act merely as collection
*
agents on behalf of their men folks (husbands and sons). The men *
232 MBA Third Semester (IFS&FM) MDU
folks are reported to have spent borrowed money on their
consumption, whereas the women folks are taking the
responsibility of credit risk;
4) Some of the borrowers are reported to have diverted funds taken
as a loan to elsewhere (mostly for household expenses), instead of
making capital investment for creation of an asset with a view to
having a regular source of income;
5) Most of the beneficiaries of microfinance are women; involvement
of men is comparatively very poor. As a result the desired
transformation of communities has not taken place, because for the
community transformation, participation of both-men and women-
is a precondition. As the communities are made of equal parts of
men and women, without the involvement both parts, development
of a community is limited; and
6) Services under microfinance are provided at a very small scale.
In theory, a small business started with the financial support of MFI
has the potential of growing into a big business, but in practice it
happens very rarely. The fact is that such business is not capable of
supporting a household fully, although they may be of some help, to
some extent. This may perhaps be the reason behind the indifferent
attitude of men folks toward microfinance.

4.8. FINANCIAL INCLUSION

4.8.1. Introduction
Financial inclusion is defined as a process of providing financial service
to the vulnerable sections of an economy, namely the weaker sections and
the low income groups. But, it must be assured that the provided service
shall be sufficient and on time as whenever the requirements are arising.
According to Committee on Financial Inclusion has defined financial
inclusion as “the process of ensuring access to financial services and
timely and adequate credit where needed by vulnerable groups such as
weaker sections and low income groups at an affordable cost”.
In other words, financial inclusion is referred to as a process of
delivering banking services to the weaker sections of society at an
affordable price. In open and efficiently running economy, limitless
access to public goods and services is an essential condition. Because
the banking services are the public goods thus it is important to provide
banking and payment services to each and every person in the economy
without any priorties. Normally, this is the prime objective of creating
public policies.
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LICI & Microfinance (Unit-4) 233

4.8.2. Process of Financial Inclusion

The following three steps are taken in financial inclusion:
1) Access to the financial products and services should be offered to
each and every person.
2) The financial products and services should be sufficient enough for
distribution purpose without any discrimination. While, the
distribution must be arranged in fair and equitable manner.
3) An individual provided with financial products and services must be
assisted through credit counselling in respect of following reasons:
i) To avoid decrease in incomes,
ii) To re-frame the debt policy for avoiding the liability of debt,
and
iii) To enhance the skills of individual in respect of money-
management.

4.8.3. Benefits of Financial Inclusion

Following are the salient benefits of financial inclusion:
1) Financial inclusion is one of the significant method to pool savings
from the weaker sections of our society. Further, the accumulated
savings is channelized into the formal financial intermediation system.
2) The banks can maintain uniformity in both liquidity risks and asset-
liability because more deposits are acceptable at affordable cost.
3) This method is useful for securing the transfer payments like
NREGA is making use of „Electronic Benefit Transfer‟ (EBT)
method for transferring the wages or salaries into the bank accounts
of beneficiaries.
4) Through this method, the weaker sections of an economy can be
encouraged for savings and to make investments. In addition to this,
they are also allowed for acquiring credit facility.
5) Through this method, the low income group people can safeguard
themselves from decrease in income and it enables them to
overcome with the financial difficulties arising at the time of
sickness or loss of employment.

4.8.4. Various Initiatives Undertaken for Financial

Inclusion
Banks are taking the following initiatives for meeting the objectives of
financial inclusion:
1) In order to provide credit facilities to the farmers, NABARD has come
up with SHG-bank linkage programme in 1992 and Kisan Credit Cards
(KCCs) in late 1998. Both the policies are authorised by the RBI. As
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234 MBA Third Semester (IFS&FM) MDU
per the SHG-bank linkage programme, the banks are directed to offer
required resources to the farmers and the Non-Government Organisa-
tions (NGOs) are directed to act as agencies for organising the poors,
creating their abilities and supporting the process of strengthening
them. Later in 1998, all SHGs that were involved in promotion of
savings were allowed to open savings accounts.
2) Later in April 2005, financial inclusion has become a clear open
policy and subsequently in November 2005, the banks were
recommended to provide banking facilities to all SHGs without any
restriction of low or minimum balances. Thus, thereafter such SHGs
are allowed to open accounts through a easiest procedure of Know-
Your-Customer (KYC). In addition to this, banks were also directed
to expand such facility to major section of the society. Under the
procedure of KYC, it is very convenient to open account in a bank,
specially for those accounts holding the balances not more than
`50,000 and for the accounts allowed for the credit limits not more
than `1,00,000 in a year.
3) Later in January 2006, RBI has allowed the banks to avail the
service of NGOs/SHGs, MFIs (other than NBFCs) and other civil-
society organisations. As all these organisations are directed to
facilitate the banks as intermediaries in respect of offering financial
and banking services to the weaker sections of the society. These
organisations are acting as intermediaries under the Business
Facilitator (BF) and Business Correspondent (BC) models.

Banks are availing the service of business facilitator in respect of

the following reasons:
i) In order to find out the borrowers and the auxiliary activities;
ii) For collecting the applications of loans for initial process, where
authentication of primary information/data is required.
iii) To promote the importance of savings and the other products of
bank, and to suggest and teach required things on management
of money and on debt counselling.
iv) To accept applications from clients for the processing of
applications.
v) For the development and advancement of self-help groups or the
joint-liability groups;
vi) For conducting the thorough post-sanction examination.
vii) For inspection and for providing guidelines to the self-help
groups or to the joint-liability groups or to the credit groups or
to the others; and
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LICI & Microfinance (Unit-4) 235
viii)To complement the recovery of loans or the other credit
instruments.
4) The C. Rangarajan Committee has suggested the following funds
for financial inclusion:
i) Financial Inclusion Fund (FIF): This fund is useful for
facilitating the development and promotional activities of
financial inclusion.
ii) Financial Inclusion Technology Fund (FITF): This fund is
useful for increasing investment in Information Communication
Technology (ICT) in respect of promotional activities of
financial inclusion.

4.9. EXERCISE

4.9.1. Short Answer Type Questions

1) What is insurance?
2) State any two objectives of LIC.
3) What is SIDBI?
4) Give any two operational policies and practices of UTI.
5) Define microfinance.
6) What is micro credit?
7) What do you understand by micro insurance?
8) What do you mean by financial inclusion?

4.9.2. Long Answer Type Questions

1) Explain the features of insurance services.
2) Explain the functions and principles of insurance.
3) Discuss the types and significance of insurance.
4) Discuss the operational policies and procedure of taking life insurance
policy.
5) Describe the objectives and functions of SIDBI.
6) What do you understand by NABARD? Explain the objectives and
functions and workings of NABARD.
7) Explain the nature and need of microfinance.
8) Discuss the participants and products in microfinance.
9) What are the advantages and disadvantages of microfinance?
10) Discuss the process and benefits of financial inclusion.
11) Illustrate the various initiatives undertaken for financial inclusion.

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236 MBA Third Semester (IFS&FM) MDU

MODEL PAPER
MBA-THIRD SEMESTER EXAMINATION

INDIAN FINANCIAL SYSTEM AND FINANCIAL

MARKETS

Time: 3 Hours Max. Marks: 80

Note: The question paper will have Two Sections. Section-A shall
comprise 8 short questions carrying 2 marks each which are
compulsory. Answer to each question should not exceed 50 words
normally. Section-B shall comprise 8 questions (Two questions from
each Unit). The students will be required to attempt Four questions
(One from each Unit.) All questions will carry equal marks.

SECTION-A

1) Short answer type questions:

a) List the components of Indian financial system.
b) What is money market?
c) What is capital market?
d) What do you mean by depository system?
e) What do you mean by regional rural banks?
f) What do you mean by development banks?
g) What is SIDBI?
h) What do you mean by financial inclusion?

SECTION-B
Unit-I
2) Financial markets and financial institutions play an important role in
financial system”. Do you agree? Justify your answer.

3) Discuss the money market segments or instrument in detail.

Unit-II
4) What is new issue market? Explain the function of new issue market.

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Model Paper 237

5) What is stock exchange? Explain the functions and stock exchanges

of India.

Unit-III

6) What are commercial banks? Discuss its types.

7) What is RBI? Discuss their features and objectives of RBI.

Unit-IV

8) Describe the objectives and functions of SIDBI.

9) What do you understand by NABARD? Explain the objectives and

functions of NABARD.

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238 MBA Third Semester (IFS&FM) MDU

Index
A F
All-or-None Order (AON), 102 Factoring, 26
B Financial Assets, 24
Financial broadening, 17
Bank Guarantees, 28
Financial deepening, 17
Bank Rate, 189
Financial Inclusion, 233
Banker’s Bank, 176
Financial Intermediaries, 94
Bill Discounting, 27
Financial System, 13
Bill of Exchange, 46
Fixed Deposits, 140
Bombay Stock Exchange (BSE), 105
Fixed Offers Method, 83
Bonus Shares, 81
Follow on Public Offer (FPO), 75
Book Building, 125
Foreign Banks, 151
Book-Building, 84
Foreign Currency Convertible Bond
BSE Training Institute, 107
(FCCB), 135
BSEWEBX.com, 107
Forfaiting, 26
C Fund/Asset Based Financial
Call Money/Term Money, 45 Services, 26
Capital Market, 23, 60 Futures, 135
Capital Market Instruments, 24
Cash Reserve Ratio, 191
G
Global Depositary Receipts
Central Board, 172
(GDR’s), 135
Certificates of Deposits (CDs), 52
Good-Till-Canceled (GTC) Order,
Commercial Banks, 138
102
Commercial papers, 50
Commercial Papers (CPs), 50 H
Consumer Credit, 142 Hire Purchase, 26
Consumer Credit / Consumer Housing Finance, 27
Finance, 27 Housing Finance Company (HFC),
Credit Control, 188 161
Credit Rating, 28
Credit Rationing, 192 I
Current Account, 140 Immediate-or-Cancel (IOC), 103
Custodians, 117 Indian Financial Institutions, 21
Indian Financial Markets, 22
D Indian Financial Services, 26
Day Order, 102 Indigenous Bankers, 42
Debenture, 64 IndoNext, 107
Depository, 115 Initial Public Offer (IPO):, 73
Derivative, 64 Insurance, 195, 204
Development Banking, 155 Inter Corporate Deposits (ICDs), 55
Distribution, 68 Intermediaries, 21
Domestic Hedge Fund, 136 Investment Company (IC), 161
E L
Equipment Leasing Company (ELC), Lease Financing, 26
161 Lender of the Last Resort, 176
Equity Shares, 64 Letters of Credit, 28
Exchange Traded Funds, 136 Life Insurance Corporation of India
EXIM Bank, 164 (LICI), 205
Limit Order, 102
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Index 239
Liquidity Adjustment Facility, 192 Prospectus, 88
Loan Company (LC), 161 Public Issue, 72
Local Board, 172 Public Sector Banks, 148
M R
Margin Requirement, 193 Recurring Deposits, 140
Market Intermediaries, 125 Regional Rural Banks, 151
Market Order, 101 Regulation of Consumer Credit, 193
Micro Credit, 230 Repo Rate, 192
Micro Insurance, 231 Reserve Bank of India, 170
Micro Savings, 230 Reverse Repo Rate, 192
Microfinance, 227 Rights Issue, 76
Miscellaneous Non-Banking RRBs, 153
Company (MNBC), 161 S
Monetary policy, 188
Savings Bank Account, 140
Money at Call, 141
SEBI, 122
Money Market, 23, 36
Rules and Regulations, 130
Money Market Instruments, 24
secondary market, 92
Money Market Mutual Funds, 54
Secured Premium Notes (SPNs), 65
Money Transfer, 231
Securitization of Debt, 28
Monty Lenders, 42
SIDBI, 215
Mortgage Backed Securities, 136
Statutory Liquidity Ratio, 191
Mutual Fund, 95
Stock Broker, 94
N Stock Exchange, 92
NABARD, 221 Stop Limit Order, 102
National Stock Exchange (NSE), 108 Stop Order, 102
NBFCs/NBFIs, 157 Supervisory Functions, 178
New Issue Market, 67 Surveillance, 107
Nidhis or Mutual Benefit Finance Sweat Equity, 64
Company (MBFC), 162 T
Non Intermediaries, 22
Tender Method/Offer, 81
Non-Banking Non-Financial
Term Loans, 141
Company (NBNFC), 162
The BSE On-line Trading (BOLT),
O 107
Offer for Sale, 79 Tracking Stocks, 135
Off-shore Hedge Fund, 136 Transfer Function, 63
Open Market Operations, 190 Treasury-Bills (T-Bills), 49
Options, 135 U
Organised Money Market, 41
Underwriting, 68
Organized Markets, 22
Unorganised Money Market, 42
Origination, 68
Unorganized Markets, 22
OTCEI, 111
Unregulated Non-Bank Financial
Overdraft Facilities, 141
Intermediaries, 42
P UTI, 213
Preference Share, 64 V
Preferential Allotment, 78
Variations in the Reserve
Private Placement, 77
Requirement, 190
Private Sector Banks, 149
Venture Capital, 27
Promoters’ Contribution, 124
Promotional Function, 180 W
Proposal, 209 Warrant, 65
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240 MBA Third Semester (IFS&FM) MDU

Bibliography
 Bharti V Pathak, Indian Financial System, Pearson
 M Y Khan, Financial Services, Tata McGraw Hill
 L M Bhole, Financial Institutions and Markets, Tata McGraw Hill
 Anthony Saunders, Financial Markets and Institutions, Tata Mc Graw Hill
 S Gurusamy, Financial Marketes and Institutions, Vinay Nicole Publication
 Nalini Prava Tripathi, Financial Institutions and Services, Prentice Hall
 K. Sasidhran, Alex K Mathews, Financial Services and System, Tata Mc-
Graw-Hill
 Dr. S Gurusamy, Essentials of Financial Services 2nd Edition, TMH
 Clifford Gomez, Financial Markets, Institutions and Financial Services,
Prentice-Hall of India
 Meera Sharma, Management of Financial Institutions, Prentice-Hall of
India
 Preeti Singh, Dynamics of Indian Financial System Markets, Institutions
and Services, Ane Books
 Nalini Prava Tripathy, Financial Services, Prentice Hall of India

Selected Sites
 www.books.google.co.in
 www.managementparadise.com
 www.scribd.com
 www.wisegeek.com
 www.enotes.com
 www.ehow.com
 www.managementstudyguide.com
 www.wikipedia.org
 www.slideshare.net
 www.citeman.com
 www.investorwords.com

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