TOPIC – Financial System. Its Role in economic development. Recent developments in FS.

SUBJECT- Management of Financial Institutions

Submitted To Submitted By Ms. Pooja Sharma Amandeep Kaur Roll no-12 Class-MBA 2nd (A) Session -2011-12

The economic development of any country depends upon the existence of a well organized financial system. Financial System plays a very crucial role in the functioning of the economy because it allows transfer of resources from savers to investors(S2I).

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Financial System is a broader term which brings under its fold the financial markets and financial institutions which support the system. Financial System provide the intermediation between savers and investors and promotes faster economic development.

FS = FI + FM + FI + FS

The Financial System is set of Financial Institutions, Financial Markets, Financial Instruments & Financial Services which help in the formation of capital and meet the short term and long term financial needs of households and corporate houses.

The major assets traded in the Financial System are money or monetary assets. So, the responsibility of Financial System is to mobilize the savings in the form of money and invest them in to productive venture.

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Financial Markets

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Financial Institutions Financial Institutions are the intermediaries who act as mobilizers and depositories of savings and as providers of credit/finance. FI is a mixture of Banking financial institutions(BFI) & Non-Banking financial institutions(NBFI).

Financial Market is a Place/mechanism where funds/savings are transferred from surplus units to deficit units. These markets can be broadly classified into Capital & Money Market.

Capital Market deals with those financial assets which have

maturity period of more than one year . Money Market deals with short term financial assets which have

maturity period of less than one year.

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Financial Instruments

The commodities that are traded in a financial market are financial assets/securities/instruments.

FI = CMI + MMI + FA

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Financial Instrument (continue……….

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Financial ServicesFinancial services are activities ,benefits and satisfactions, connected with sale of money, that offer to users and customers, financial related values. Within financial services industry the main sectors are banks ,financial institutions and non- banking financial companies. These services are regulated by SEBI, RBI, IRDA, Govt. of India, DBI(Dept. of Banking & Insurance). Kinds of Financial Services

(Asset based & fee based)

Economic development is partially dependent on the financial system to help mediate the transfer of money to areas of the economy that need it most. The financial system has a number of key functions, which help facilitate these shifts in money that are important for sustainable economic growth.

1.Savings The financial system allows you to place your excess money into a savings account in a bank of your choice. Keeping your money in a bank safeguards your savings, and the bank pays you interest based on the amount you keep in your account.

2.Loans Money in deposit accounts, like savings accounts, is used to provide loans for a wide range of projects to people and businesses. Mortgages, car loans and student loans are financed largely by deposits in banks, savings institutions and credit unions.

3.Investments The financial system also facilitates the transfer of money from investors to businesses. When businesses raise capital, they sell stock to investors. Investors give their money to the company in exchange for ownership in the company.

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4.Government Expenditure Governments may finance programs or deficit spending through the financial system by issuing bonds to raise money. Investors may buy government bonds to own a part of government debt, and collect interest payments from the government. In turn, the government has the money it needs to continue to function.

5.Resource allocation: Because of the cost of obtaining information, individual savers are not in a position to evaluate whether particular borrowers or projects are worthwhile. The institutions and professionals of the financial system develop expertise which enables them to better decide who receives loans.

6.Business Growth Businesses may expand their operations or finance growth by issuing debt instruments called bonds. Bonds are bought and sold through the financial system. Bond markets allow businesses to access investor capital to finance their growth, while bond investors have an opportunity to profit from helping finance business expansion.

7. Savings mobilization:  Savings mobilization is the most fundamental function of capital markets. Individual savers typically cannot fund borrower needs completely. Financial markets pool the savings of households and make the funds available for investment. The scale of this exercise lowers transaction costs. Borrowers go directly to financial markets rather than individual savers, which is clearly more cost efficient.

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The recent development in financial system are due to the recent developments in financial markets and financial institutions. These recent developments are discussed below :

1.Recent developments or reforms in Capital market 2. Recent developments or reforms in Money market 3. Recent developments or reforms in Commercial banks.

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1.Establishment of SEBI: The Securities and Exchange Board of India(SEBI) was established in 1988. It got a legal status in 1992. SEBI was primarily set up to regulate the activities of the merchant banks, to control the operations of mutual funds, to work as a promoter of the stock exchange activities and to act as a regulatory authority of new issue activities of companies. The SEBI was set up with the fundamental objective, "to protect the interest of investors in securities market and for matters connected therewith or incidental thereto."

2. Establishment of Creditors Rating Agencies:T hree creditors rating agencies viz. The Credit Rating Information Services of India Limited (CRISIL - 1988), the Investment Information and Credit Rating Agency of India Limited (ICRA –1991) and Credit Analysis and Research Limited (CARE) were set up in order to assess the financial health of different financial institutions and agencies related to the stock market activities. It is a guide for the investors also in evaluating the risk of their investments.

3. Growing Merchant Banking Activities: Many Indian and foreign commercial banks haves set up their merchant banking divisions in the last few years. These divisions provide financial services such as underwriting facilities, issue organizing, consultancy services, etc. It has proved as a helping hand to factors related to the capital market.

4. Growing of Electronic Transactions: Due to technological development in the last few years. The physical transaction with more paper work is reduced. Now paperless transactions are increasing at a rapid rate. It saves money, time and energy of investors. Thus it has made investing safer and hassle free encouraging more people to join the capital market.

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Reforms In Capital Market (Continue……………….5. Investor's Protection: Under the purview of the SEBI the Central Government of India has set up the

Investors Education and Protection Fund (IEPF) in 2001. It works in educating and guiding investors. It tries to protect the interest of the small investors from frauds and malpractices in the capital market.

6. Growing Stock Exchanges: The numbers of Stock Exchanges in India are increasing. Initially the BSE was the main exchange, but now after the setting up of the NSE and the OTCEI, stock exchanges have spread across the country. Recently a new Inter-connected Stock Exchange of India has joined the existing stock exchanges.

7.Growing Mutual Fund Industry: The growing of mutual funds in India has certainly helped the capital market to grow. Public sector banks, foreign banks, financial institutions and joint mutual funds between the Indian and foreign firms have launched many new funds. A big diversification in terms of schemes, maturity, etc. has taken place in mutual funds in India. It has given a wide choice for the common investors to enter the capital market

8. Growth of Derivative Transactions: Since June 2000, the NSE has introduced the derivatives trading in the equities. In November 2001 it also introduced the future and options transactions. These innovative products have given variety for the investment leading to the expansion of the capital market.

9. Commodity Trading: Along with the trading of ordinary securities, the trading in commodities is also recently encouraged. The Multi Commodity Exchange (MCX) is set up. The volume of such transactions is growing at a splendid rate.

Apart from these reforms the setting up of Clearing Corporation of India Limited (CCIL), Venture Funds, etc. have resulted into the tremendous growth of Indian capital market

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Narayanan Vaghul working group and Narasimham Committee was also set up. As per the recommendations of these study groups and with the financial sector reforms initiated in the early 1990s, the government has adopted following major reforms in the Indian money market.

1.Deregulation of the Interest Rate : In recent period the government has adopted an interest rate policy of liberal nature. It lifted the ceiling rates of the call money market, short-term deposits, bills rediscounting, etc.

2.Money Market Mutual Fund (MMMFs) : In order to provide additional short-term investment revenue, the RBI encouraged and established the Money Market Mutual Funds (MMMFs) in April 1992. MMMFs are allowed to sell units to corporate and individuals. Financial institutions such as the IDBI and the UTI have set up such funds.

3. Establishment of the DFI : The Discount and Finance House of India (DFHI) was set up in April 1988 to impart liquidity in the money market. It was set up jointly by the RBI, Public sector Banks and Financial Institutions.

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Reforms In Money Market (Continue………4.Electronic Transactions : In order to impart transparency and efficiency in the

money market transaction the electronic dealing system has been started. It covers all deals in the money market. Similarly it is useful for the RBI to watchdog the money market.

5. Establishment of the CCIL : The Clearing Corporation of India limited (CCIL) was set up in April 2001. The CCIL clears all transactions in government securities, and repose reported on the Negotiated Dealing System

6. Development of New Market Instruments : The government has consistently tried to introduce new short-term investment instruments. Examples: Treasury Bills of various duration, Commercial papers, Certificates of Deposits, MMMFs, etc. have been introduced in the Indian Money Market.

These are major reforms undertaken in the money market in India. Apart from these, the stamp duty reforms, floating rate bonds, etc. are some other prominent reforms in the money market in India.

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1.Reduced CRR and SLR: The Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) are gradually reduced during the economic reforms period in India. By Law in India the CRR remains between 3-15% of the Net Demand and Time Liabilities. It is reduced from the earlier high level of 15% plus incremental CRR of 10% to current 4% level. Similarly, the SLR Is also reduced from early 38.5% to current minimum of 25% level. This has left more loanable funds with commercial banks, solving the liquidity problem.

2. Deregulation of Interest Rate: During the economics reforms period, interest rates of commercial banks were deregulated. Banks now enjoy freedom of fixing the lower and upper limit of interest on deposits. Interest rate slabs are reduced from Rs.20 Lakhs to just Rs. 2 Lakhs. Interest rates on the bank loans above Rs.2 lakhs are full decontrolled. These measures have resulted in more freedom to commercial banks in interest rate regime.

3.Computerisation – an agreement for computerisation was signed with trade unions. Bank computerisation has been taking at fast pace.

4. Branch licensing - branch licensing has been liberalised. Domestic banks satisfying capital adequacy are free to start new branches. Except rural branches, banks can close down loss making unviable branches.

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Reforms In Commercial Banks (Continue…………5. Operational Autonomy: During the reforms period commercial banks enjoyed the

operational freedom. If a bank satisfies the Capital Adequacy Ratio then it gets freedom in opening new branches, upgrading the extension counters, closing down existing branches and they get liberal lending norms.

6. Banking Diversification: The Indian banking sector was well diversified, during the economic reforms period. Many of the banks have stared new services and new products. Some of them have established subsidiaries in merchant banking, mutual funds, insurance, venture capital, etc which has led to diversified sources of income of them.

7. New Generation Banks: During the reforms period many new generation banks have successfully emerged on the financial horizon. Banks such as ICICI Bank, HDFC Bank, UTI Bank have given a big challenge to the public sector banks leading to a greater degree of competition.

8. Improved Profitability and Efficiency: During the reform period, the productivity and efficiency of many commercial banks has improved. It has happened due to the reduced Non-performing loans, increased use of technology, more computerization and some other relevant measures adopted by the government.

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