Lesson-9

Capital Market in India. Primary and secondary markets and regulation of

capital markets

Objective:

After studying this lesson the student able to understand:

Concept and types of the Capital markets,

Capital market growth and development,
Regulation of Capital Market by Stock Exchange Board of India.

9.1 Introduction
9.2 Definition
9.3 Types of Capital Markets
9.4 Functions of Capital Market
9.5 Growth and Development of Capital Market
9.6 Regulation of Capital Market
9.7 Summary
9.8 Glossary
9.9 Model Questions
9.10 Further Readings

9.1 Introduction

Capital market is a part of Financial System of an economy. This market refers to institutional
arrangements for long term borrowing and lending of term funds. Capital market is a growing
component of the organized financial system in India. Basically financial system consists of two
markets i.e., Money Market and Capital Market. The money market comprises financial
instrument having a maturity period of one year or less than one year. It involves short term
transactions of capital. Capital market contains financial instruments of maturity period
exceeding one year. It involves long term capital transactions. Capital market instruments are
relatively less liquid in comparison to the money market instruments.

9.2 Definition
The capital market is basically used for the purpose of raising money. Companies of all kinds
require money for a variety of purposes i.e., Seed capital and working capital. Government may
raise money by selling treasury bills and bonds. Companies also raise money by selling shares
and debentures. This is the original issue market (primary capital market) in which there is a sale
from the issuer of the securities to the buyers of the securities. The capital market also includes a
secondary market in which owners of the securities can sell their securities to other financial
market traders or buyers. From a policy aspect, once the market has achieved a sufficient size
and attracted a sufficient number of active participants, the government central bank could out
open market purchases or sales of securities in the secondary market as part of its indirect
instruments of monetary policy.

Capital market in a broad sense encompasses all kinds of arrangements and financial institutions
involved in long term funding. Capital market commonly referred to the stock market in the
country. Capital market is the market for long term funds, just as money market is the market for
short term funds.

9.3 Types of Capital Markets

Capital markets which comprises two sub-markets namely primary market and secondary
market.

Primary Market:
The primary market is that part of the capital market that deals with the issuance of new
securities. Companies, governments or public sector institutions can obtain funding through the
sale of a new stock or bond issue. This is typically done through a syndicate of securities dealers.
In the case of a new stock issue, this sale is called an initial public offering (IPO). Dealers earn a
commission that is built into the price of the security offering, though it can be found in the
prospectus.
Primary or direct or new issues market deals in new financial claims or new securities. It is a
market in which newly issued capital, instruments are sold and purchased. Therefore, primary
market is also known as new issues market. Primary market mobilizes savings and thus it
supplies fresh capital to the business units. The main function of primary or new issues market is
to make arrangements for raising new capital by corporate enterprises. These enterprises may be
new or old. This involves attracting new investable resources in the corporate sector and their
allocation among alternative uses and users.

Secondary Market:
The secondary market is the financial market for trading of securities that have already been
issued in an initial private or public offering. Alternatively, secondary market can refer to the
market for any kind of used Securities. The market that exists in a new security just after the new
issue is often referred to as the aftermarket. Once a newly issued stock is listed on a stock
exchange, investors and speculators can easily trade on the Stock exchange, as market makers
provide bids and offers in the new stock.

In the secondary market, securities are sold by and transferred from one investor or speculator to
another. It is therefore important that the secondary market be highly liquid and transparent.
Before electronic means of communications, the only way to create this liquidity was for
investors and speculators to meet at a fixed place regularly. This is how stock exchanges
originated. Secondary marketing is vital to an efficient and modern capital market.

Fundamentally, secondary markets mesh the investor's preference for liquidity (i.e., the investor's
desire not to tie up his or her money for a long period of time, in case the investor needs it to deal
with unforeseen circumstances) with the capital user's preference to be able to use the capital for
an extended period of time. For example, a traditional loan allows the borrower to pay back the
loan, with interest, over a certain period. For the length of that period of time, the bulk of the
lender's investment is inaccessible to the lender, even in cases of emergencies.
Likewise, in an emergency, a partner in a traditional partnership is only able to access his or her
original investment if he or she finds another investor willing to buy out his or her interest in the
partnership. With a securitized loan or equity interest (such as bonds) or tradable stocks, the
investor can sell, relatively easily, his or her interest in the investment, particularly if the loan or
ownership equity has been broken into relatively small parts. This selling and buying of small
parts of a larger loan or ownership interest in a venture is called secondary market trading.

Under traditional lending and partnership arrangements, investors may be less likely to put their
money into long-term investments, and more likely to charge a higher interest rate (or demand a
greater share of the profits) if they do. With secondary markets, however, investors know that
they can recoup some of their investment quickly, if their own circumstances change.

9.4 Functions of Capital Market

Generally capital market plays an important role in mobilizing resources and diverting them into
productive channels. In other words, it facilitates and promotes the process of economic growth
in the country.

 Promotes Economic Growth: The capital market is the necessary condition for the
growth of the economy. Because it accelerates and smoothens the process of economic
growth. Various institutions of the capital market, like non-bank financial intermediaries,
allocate the resources rationally accordingly development needs of the country. As a
result there will be an expansion of trade and industry in both public and private sectors.
In turn this leads to promote the balanced growth in the economy.

 Encouragement to Saving: When there is a developed capital market in an economy,

banking and non banking institutions provide instruments which encourage people to
save more. In other words, capital market mobilizes savings from the households to the
producers who are the investors. It provides inter- mediation between savers and
investors on a long term basis. In less developed economies, in the absence of a capital
market, there are very little savings and those who save often invest their savings in
 unproductive and wasteful directions, which is in real estate and conspicuous
consumption.

 Transformation of Savings into Investment: Capital markets facilitate lending to the

businessmen and the government and encourage investment. In other words, capital
markets facilitate through banking and non banking financial institutions. For instance,
various financial assets such as securities, shares, bonds, etc., induce savers to lend to the
government or invest in industry. Therefore, due to development of financial institutions,
capital will be accumulated as a result rate of interest’s decreases and investment
increases.

 Funds Flow: Capital markets channelize the allocation of the funds from less profitable
to more profitable channels. As a result it leads optimum utilization of resources; it
enables surplus and idle funds to be used more effectively, efficiently and productively.

 Mediation between savers and investors: The capital market plays a role of link
between savers and investors. It mobilizes savings and diverts them into productive
investment. Therefore, capital market transfers the financial resources from surplus and
wasteful areas to deficit and productive areas. Consequently productivity and prosperity
of the country increases.

 Maintenance the stability in security prices: Capital market is inclined to stabilize the
values of stocks and securities and reduce the fluctuations in the prices to the minimum.
The processes of stabilization are facilitated by providing capital to the borrowers at a
lower interest rate and reduce the speculative and unproductive activities.
9.5 Growth and Development of Capital Market- Before and After Independence of Indian
Capital Market
Indian capital market has a vast growth potential. At present it has captured around 12 to 15
percent of household savings in mobilization for the corporate sector. But in developed countries
more than 25 percent of household savings are tapped by their capital markets.

Before Independence Capita After Independence Capital Market

Market
 Capital market in India  Constant Growth of Saving and Investment
was not properly  Growth of Special Financial Institutions. For
developed instance;
 Industrial securities 1. Industrial Finance Corporation of India
market was very much (IFCI, 1948)
hampered 2. State Finance Corporations (SFCs)
 Very few individual 3. Industrial Credit and Investment
investors Corporation of India (ICICI,1956)
 Many restrictions on the 4. Life Insurance Corporation (LIC, 1956)
institutional savers from 5. Industrial Development Bank of India
the government (IDBI, 1964)
 There were no 6. Unit Trust of India (UTI, 1964)
specialized issue houses  Commercial Banks also constituents of the
 There were no capital market.
specialized  New Institutions emerged: Many new financial
intermediaries and intermediaries have emerged which have
agencies to mobilize the accelerated growth and improved their
savings of the public efficiency at nationally and internationally. For
and channelize them to example;
investment 1. Merchant Banking
2. Leasing and Hire-Purchase Companies
3. Mutual Funds
4. Venture Capital and
 5. Other Institutions: for example
 Risk Capital and Technology
Corporation Ltd. (RCTC)
 Technology Development and
Information Company of India
(TDICI)
 Infrastructure Leasing and
Financial Services Ltd. (ILFS)
 Credit Rating Information
Services of India Ltd. (CRISIL)
 Stock Holding Corporation of
India Ltd. (SHCIL)
6. SEBI: In January 1992, Securities Exchange
Board of India (SEBI) has been set up as a statutory
body to regulate, supervise and improve the working of
capital market in India.

9.6 Structure of the Indian Capital Market

Capital market refers to all the facilities and the institutional arrangements for borrowing and
lending term funds that is medium term and long term funds. It does not deal in capital goods
but is concerned with the raising of money capital for purposes of investment.

Indian capital market has some important features that may favor more savings and
mobilization. Namely they are: rapid growth of mutual funds, growth of the merchant banking,
banks subsidiaries for financial services into the capital market, flotation of mega issues,
growing debt instruments, issue of debentures, avoidance of underwriting, increased
transparency through SEBI’s regulations, liberalization policy of the government, emerging new
financial instruments such as convertible bonds, foreign currency rates, zero coupon bonds,
discount bonds, warrants etc. A brief summary of the structure of Indian capital market is
illustrated in the following chart.
CAPITAL MARKET IN INDIA

9.7 Regulation of Capital Market

India’s stock exchanges functioning have shown many weaknesses, with long delays, lack of
transparency in procedures and vulnerability to price rigging and insider trading. Narasimham
Committee and other committees and groups were also pointed out all these shortcomings in the
functioning of stock markets in India. To counter these shortcomings and deficiencies and to
regulate the capital market, the Government of India set up the Securities Exchange Board of
India in 1988. Initially, SEB I was set up as a non statutory; body, but later SEBI was given
statutory body status by an Act of Parliament on April 4, 1992. SEBI was authorized to:
 To regulate all merchant banks on issue activity
 To lay guidelines and supervise and regulate the working of mutual funds and
 To oversee the working of stock exchanges in India
SEBI, in consultation with the Government has taken a number of steps to introduce improved
practices and greater transparency in the capital markets in the interest of the investing public
and the healthy development of the capital markets:

Main Functions of the SEBI

Regulating the business in stock exchanges and other securities markets;
Registering and regulating the working of stock brokers, sub brokers, share transfer
agents, bankers to an issue, trustees of trust deals, registers to an issue, merchant bankers,
underwriters, portfolio managers, and other intermediaries associated with the securities
markets;
Registering and regulating of collective investment schemes including mutual funds;
Promoting and regulating the working of self regulatory organizations;
Prohibiting fraudulent and unfair trade practices relating securities markets;
Promoting investor’s education and training of intermediaries of securities market;
Prohibiting insiders trading in securities; and
Regulating substantial acquisition of shares and takeover of companies

Strengthening of SEBI
SEBI statutory powers and functions were further strengthened through an Ordinance
promulgated on 25th January, 1995. The main features of the Ordinance are:
 To enable SEBI to respond speedily to market conditions and to reinforce its autonomy,
SEBI has been empowered to file complaints in courts and to notify its regulations
without prior approval of the Government;
 SEBI is now provided with regulatory powers over companies in the issuance of capital,
the transfer of securities and other related matters;
 SEBI is now empowered to impose monetary penalties on capital markets intermediaries
and other participants for a listed range of violations;
 SEBI is now given power to summon the attendance of and call for documents from all
categories of market intermediaries;
  SEBI has now the powers to issue directions to all intermediaries connected with
securities markets with a view to protect investors or secure the orderly development of
securities markets

SEBI Regulations
SEBI has introduced a number of new rules and regulations during 1995-1996, which have
improved market practice. The notified under SEBI Act rules and regulations were:
 Rules on Procedure for Holding Enquiry and Imposing Penalties by Adjucating Officer;
 Rules on Securities Appellate Tribunal (Procedure);
 Regulations on Prohibition of Fraudulent and Unfair Trade Practices relating to Securities
Markets;
 Regulations on Foreign Institutional Investors;
 Regulation on Payment of Fee ( Amendment)

These regulations prohibit manipulation of prices in the stock market, making misleading
statements to induce sale and purchase of securities and unfair trade practices relating to
securities. Therefore, these regulations would promote the orderly working of the securities
market.

9.8 Summary
In this lesson so far we have discussed the concept of capital market, types of capital market, its
functions, growth and development, composition, structure, regulations for the improvement etc.
after learning and reading the lesson the student could able to propose the suitable amendments
for the overcome of the capital market shortcomings in India.

9.9 Glossary
Financial System
Money Market
Capital Market
Stock Exchange Board of India
Short term Finance
Long term Finance

9.10 Model Questions

Short Answer Questions
1. Define the Capital Market
2. What are the features of Primary Market
3. What is the importance of Secondary Market
4. Write a brief note on functions of SEBI
5. Describe the constituents of Indian Capital Market
Essay type Questions
1. Distinguish between Money and Capital Market and explain the role of capital market in
financing
2. Critically evaluate the role of SEBI in regulation of Capital Market.
3. Describe in detail the structure of Capital Market

9.11 Further Readings:

L M Bhole (2016) Financial Markets and Institutions

A.V.Ranganadha Chary & R.R.Paul (2005): Banking and Financial System, Kalyani Publishers
Ruddar Datt & K.P.M. Sundharam (2007): Indian Economy, 55th Edition, S.Chand &
Company Ltd.
D.M. Mithani & E.Gordon (2003): Banking and Financial Systems, 5th Edition,
Himalaya Publishing House