Chapter-3: Banking Sectors
CHAPTER-5
BANKING SECTORS
“There is a law in life: When one door closes to us, another one opens”
Outline of the Chapter
5.1
5.2
5.3
5.4
5.5
5.6
5.7
5.8
5.9
Objective
Introduction
Recent Developments in Banking Industry
Banking Sectors
Corporate Banking
Retail Banking
International Banking
Rural Banking
Non-Banking Financial Intermediaries
5.1
Objectives
After going through this chapter we will be able to:

Understand the recent developments taking place in banking industry.

Describe the various sectors of banking:
5.2

Corporate banking

Retail banking

International banking

Rural banking
Introduction
Modern banking in India has traversed a, long way since independence. If one
traces the evolutionary path that the banks have taken, one turning point was the
nationalization of 14 leading banks in 1969 to bring them under social control. This
forced banks to operate under a highly regulated environment wherein they had to
comply with quantitative restrictions on credit flows, follow administrated interest
rate structures, divert funds to the priority sector and curtail liquidity by setting
aside their assets under statutory reserve ratios. All these translated into banks
being plagued with low productivity, inefficiency and mounting bad debts. The
second turning point came with the reform measures initiated by the Reserve Bank
of India following the Narasimham Committee recommendations in 1991.
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5.3
Recent Developments in Banking Industry
The financial sector reforms introduced strict prudential norms for higher
operational efficiency and improved productivity and profitability. They also
ushered in healthy competition by allowing new banks in the private sector. These
banks brought about a paradigm shift in service standards in terms of choices of
services offered, the speed of delivery, the superior technology employed by them
and their market orientation. The public sector banks had no option, but to get out
of their lethargic and inefficient state and gear them selves to face the onslaught of
their competitors.
Liberalization and deregulation of the financial sector , the use of technology and
the changing nature of customers who are time quality and price conscious as well
as demanding in a number of other ways has ushered in a new area in the Banking
sector. Banks can no longer afford to be insulated from these changes. The
traditional face of banking which concentrated on deposits and loans now has to
cater to a whole range of services-personal loans for education, housing or
automobiles, equipment financing, remittances from abroad, international letters of
credit, loan syndication and insurance.
5.4
Banking Sectors
The spectrum of needs and requirements of individuals, organizations and sectors
of the economy is very diverse. Banks have come up with a whole range of
banking products and services to suit the requirement of their clients. Banking
sectors include corporate banking, retail banking, international banking and rural
banking.
5.5
Corporate Banking
Corporate banking typically serves the financial needs of large corporate housesboth domestic and multinational- public sectors and governments. However,
traditionally banks had primarily been focusing on production based activities and
financed working capital requirements as well as term loans to corporate due to
the following reasons:
From the beginning till the pre-reform era, business houses were heavily
dependent on banks for their financial needs. The capital markets were not well
developed, joint venture norms had not been liberalized, mergers And acquition
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were not the preferred route and numerous restrictions were placed on
finance from overseas markets.
raising
The banking institutions too showed a preference for providing credit to the
corporate. This way their paper work was markedly reduced as the numbers of
clients were less. Not only the workload was eased but also the risk involved was
considerably less as corporate borrowings were made against collaterals after
verifying their capacity for repayment.
The government had also earmarked priority sectors, and as such banks had to
comply with the targets allotted to them.
After liberalization many corporate could not face the competition and went into
the red. Economic downturn and recessionary environment resulted in poor
performance of many borrowers. As a direct consequence of all these, the NPAs of
banks started mounting. However, according to the RBI annual report of 2005-06,
the credit demand by the corporate sector has turned robust on the back of strong
industrial performance. Furthermore, banks are expected to have greater financing
opportunities in the area of project finance, especially in the infrastructure sector,
given the conversion of two major financial institutions (FIs) into banks. Banks
have been focusing mainly on syndication of debt to ensure wider participation
in project finance and wholesale lending segment.

Features
Corporate banking serves the needs of corporate, those having a legal
entity. They offer business current accounts, make commercial loans,
participate syndicated lending and are active in inter-bank markets to
borrow/lend from/to other banks. Many banks offer structured products,
capital market services
and corporate solutions. Corporate banking
involves comparatively fewer borrowers, and the account size is usually
large and sometimes it can turn into billions of dollars.

Services

Corporate banking services include

Working capital and term loans, overdrafts, bill discounting,
Project financing

Cash management both short-term holdings of cash as well as
funds held for longer periods
Financing of exports and imports including export credit

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Arrangements

Project finance

Transmission and receipt of money

(vi) Handling foreign currency and
changes in Value
hedging against
In recent times, there has been a marked shift from corporate to
retail banking. The major reason for avoiding corporate accounts is
the mounting non-performing corporate accounts. Difficulty in
pricing the services and high risks involved are some of the other
reasons for overlooking corporate accounts. However, this is a very
lucrative segment provided care is taken in identifying and focusing
on selected business segments and catering to their requirements,
e.g; for the SME segment, credit is paramount whereas for big
corporate, customized solutions are needed. Systematic account
planning process can help to identify the profitable customers, and
pricing of services can help the bank to get rid of asset quality
problem. Most developed nations banks have separate corporate
bank divisions which help them to avoid the pit falls of one-sizefits-all policies.
5.6
RETAIL BANKING
Retail banking encompasses deposit and asset linked products as well as other
financial services offered to numerous personal banking customers and small
businessmen. It tends to be domestic rather than international. Retail banking is
largely intra bank: The bank itself accepts deposits and makes many small loans.
Products offered by retail banking include credit cards, educational loans, housing
loans, consumption loans for consumer durables like refrigerators, washing
machines, music systems, convenience/flexi deposit accounts, and so on.

Characteristics of Retail Banking

Large number of small customers: Retail banking is
characterized by the existence of a large number of small customers,
who consume personal banking and small business services. The
essential prerequisite of retail banking is its orientation towards the
consumer whether it is in size, price, delivery channels or product
profile.
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

Multiple products: A basket of products including flexi deposits,
cards, insurance, medical expenses, auto loans are offered to the
consumers. Besides these, there are a number of value added
services like de-mat accounts, issue of free ATM cards, portfolio
management, payment of water, electricity and telephone bills.

Multiple delivery channels: To increase penetration and access
banks are not limiting themselves to branches but are making
extensive use of internet, call centre, kiosks, etc.
Origin of Retail Banking
Origin of retail banking in India can be traced to a number of
developments.

Financial sector reforms and liberalization: Before opening up
of the economy during the decade of the nineties, corporate banking
had been the preferred goal for bankers, However, after the reforms
it no longer remained so, Corporate could now go in for external
commercial borrowing (ECB) from any internationally recognized
bank, export credit agency, international capital market or supplier of
equipment, They could also opt for mergers and acquitions. So banks
had to look for other avenues than the corporate sector for growth
and expansion.

Spreading of risk: Another consequence of liberalization was
industrial recession, economic downturn, industrial sickness which
resulted in failure of many big corporate. Mounting non-performing
assets made banks more cautious about lending to business houses,
and diverting their funds into the retail segment, as retail banking has
the advantage of minimizing the risk and maximizing the returns.
The returns from retail sectors are 3 to 4 per cent as compared to 1 to
2 per cent from the corporate segment.

Growth in banking technology and automation of banking
processes: Technology has opened up new vistas for the banking
industry and redefined its nature, scope and extent. State-of-the art
electronic technology has helped to increase penetration through
ATMs without opening more branches. Internet has made possible
banking to be done from home. Tele-banking and phone banking are
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some other new technologies which have revolutionized banking.

5.7
Changing profile of customers: An ever-increasing middle class,
with more disposable income, higher education and a desire for
higher standard of living have fuelled the demand for retail banking
services. More and more people seemed to have embraced the credit
culture, and are demanding consumer goods, holidays, education and
a host of other value added banking services.
INTERNATIONAL BANKING
International banking is a logical extension of domestic banking. It dates back to the 13th century.
More recently there has been a rapid increase in the scale of international banking from about mid
1975, when the main banks of western countries established an extensive network of global operations.


Characteristics of International- Banking

Banking activities are carried across different geographical borders: When
branches and subsidiaries are carrying out operations in different countries, then
question is to which supervisory authority will have jurisdiction over these arise.
Effective coordination can be achieved only if there is good communication between
countries, and global compliance standards are in place.

Risks in international banking are both pecuniary as well as political: Apart from
the financial risks inherent in all business, fluctuating rates of currencies of different
countries can also pose problems giving rise to the need for hedging and other
measures. Political instability like coups or fall of governments, changing economic
and fiscal policies can all become a major cause of concern.

Non-interest income is substantially more than interest income: Income from,
fund based activities like commission on bills, guarantees, letters of credit, syndication
fees, loan processing and counseling fees, etc. are more than the interest earned from
lending operations.
International Banking Services: Some services offered under International banking
including remittances, export credit and international letter of credit and bank guarantee are
explained as follows:

Remittance: Remittance is a facility by which the bank makes funds available from a
customer at one place to him or anyone authorized by him, at another place within
India and abroad. International remittances can be inward or outward.
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

International inward remittance: There is a huge pool of Indians working abroad
who regularly send money back home. There are numerous inter-bank transactions
between corporate and countries. International inward remittances ensure quick and
safe delivery of funds from exchange houses and banks to beneficiaries to India.
Remittances can be transferred easily and swiftly in any of the following ways:

Transfer through SWIFT- Most branches of al leading
banks like SBI, ICICI, HDFC, UTI, etc. are directly
connected to the globe via SWIFT. The SWIFT message is a
highly secure, fast and efficient method of fund transfer.

Transfer through telex- If SWIFT facilities are not
available from any place, then one can remit funds through
texted telex messages.

Demand drafts- These can also be used to send money into
India from abroad.
International outward remittances. When any person, firm, organization
or resident in India desires to transfer funds to any place outside India, it
gives rise foreign outward remittances.
Banks that have been named as authorized dealers are delegated powers to
affect outward remittances on behalf of their constituents, subject to certain
conditions and completion of formalities as enumerated in the exchange
control manual as amended up to date.

Pre-Shipment and Post-shipment Credit for Exports
Before the goods are exported, exporters need finance for purchasing,
manufacturing, transporting, etc. of goods, i.e; pre-shipment finance. After
exports of goods and before payment is realized, exporters again need
finance to tide them over that period. This is termed as post-shipment
finance. All this is arranged by commercial banks as part of their
international banking operations.

International Letter of Credit
A letter of credit is a commercial instrument of assured payment through which the
buyer’s bank undertakes to make payment to the seller on production of documents
stipulated in the credit. Under this facility the buyer’s bank gives commitment of
payment to the seller through this bank. International letter of credit facilitates global
commerce through the banking channel. These letters are by and large
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irrevocable. The letter of credit specifies conditions regarding proof of
dispatch of goods or services by sellers, submission of all relevant
documents, and stipulation as to payment being made on presentment of
documents or at some future date, and so on.


Main parties to international letter of credit:

Applicant (the buyer/importer)

Issuing bank (the applicant's bank who lends his name on
credit)

Advising bank (bank to whom L/C is sent after authentication
for transmission to seller or beneficiary)

Negotiating bank (the bank to whom beneficiary presents his
documents for negotiation)

Reimbursing bank (the third bank which pays negotiating
bank at the request of issuing bank)

Confirming bank (bank which undertakes the responsibilities
of payment in case of failure of issuing bank to make
payment)
Bank Guarantee
Bank guarantee includes both a finance guarantee as well as performance
guarantee. Under finance guarantee, the bank guarantees the beneficiary
(the person name in the guarantee to receive the guaranteed sum), certain
amount on behalf of its customer who has commercial relationship with the
beneficiary. Under performance guarantee, the bank guarantees
performance of a contract of goods/services supplied under a contract by its
customer.
5.8
RURAL BANKING
Even though nearly 68 per cent of India’s population lives in villages yet India’s banking
penetration remains low. The geographic reach of banking is uneven. Till 1955 when the
State Bank of India came into being only Rs. 5 crore of rural credit, accounting for hardly
0.9 per cent of total credit requirement was provided by banks. As a result, neither there was
effective machinery for mobilization of rural savings, nor could the poor farmers and
agricultural labourers get out of the clutches of rich landlords and moneylenders.
The SBI tried to address this problemby setting a target of opening 400 branches in five years
in the district and sub-district level. A nother turning point came when fourteen banks were
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nationalized in 1969. The liberalized branch licensing policy of the RBI provided further
impetus to opening of more branches in rural areas. In spite of all these measures, the
problem of rural finance remained. In fact, the populist government policies which allowed
cheapwer credit to the needy without proper controls led to defaults in repayment, which
were later written off for political as well as administrative reasons. Consequently, the trends
over the years have clearly shown that the banking system in India finds a more profitable
business in the urban regions as compared to the rural ones.
The failure of the formal delivery channels in bridging the credit gap helped to spawn the
well-organized informal delivery channels lihe moneylenders and chit funds. This
dependence has been said to be as high as 78 per cent according to a pricewaterhouse
Coopers study. The reasons cited for this include better delivery mechanisms offered by
them, ease in purchase and greater flexibility in repayment. The commercial banks
in their attempt to serve these two disparate areas suffered from liquidity
constraints, asymmetric information, and high transaction costs which decreased
their efficiency and profitability.

Multi-agency Approach to Rural Credit
Before nationalization cooperative system was the only agency for
dispensing rural credit. In order to address the need of the rural sector,
numerous attempts made including setting up of regional rural banks,
schemes for micro-finance, setting up of self-help groups, primary credit
societies and other cooperative banks and local area banks. As RRBs were
set up as specialized rural financial in institutions for developing the rural
community. It was hoped that the RRBs by combining the feel and
familiarity of rural problems, characteristic of cooperatives with the
professionalism and large resource base of commercial banks, shall go a
long way in providing credit to this hither to neglected area. It was envisaged
that the RRBs would mobilize local savings and meet the entire credit needs
of all medium and small cultivators. They would implement programmes of
supervised credit, set up and maintain godowns, supply inputs and
agricultural equipment, provide assistance in marketing and generally help in
the overall development 'of the villages in their area.
Since, in most states cooperative banking structure is behest by weaknesses
so a multi-agency approach to rural credit has been in operation for quite
sometime. Along with rural banks other methods of extending credit
facilities in the .countryside include setting up of more branches of
commercial banks, financing of credit societies, providing micro-credit
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through SHGs and NGOs which at times raise fears of overlapping. But
fears about overlapping and duplication of banking facilities are not entirely
true. The large credit gap both quantitative and qualitative that exists in rural
areas necessitates the coexistence of all the credit agencies albeit with proper
coordination. RRBs are preferred over commercial banks for purveying
direct finance to farmers owing to their low cost structure and rural ethos. In
any case, in view of the formidable problems of personnel and management,
it is not possible for commercial banks to cover the rural area adequately.
However, they pre important for extending refinancing facility to rural
banks. Commercial banks also play a supporting role in relation to
cooperatives. The expansion of commercial banks branches in rural areas
should be regulated and monitored, so that the commercial banks as well as
rural banks support the role of cooperatives which are the primary credit
institutions in rural area. Where cooperatives have failed to make
development loans, but are in a position to look after short-term needs,
commercial banks should lend only for the developmental purposes by
entering into special arrangements with the cooperators.
It was hoped that through these formal and semi-formal channels, the rural
households will have access to credit. The role of micro-credit and self-help
groups in delivering credit to the rural sectors is being examined
hereinafter.

RBI recommendations for supply of rural credit: The
recommendations of the RBI to examine issues relating to rural credit
include the business facilitator model and the business correspondent
model. It is hoped that these models would provide a whole range of
financial services encompassing savings, credit and remittance,
insurance' and pension products in rural areas.

Business facilitator model: This model proposed that banks could
use a wide array of civil society organizations and others for
supporting them by undertaking non-financial services. These would
include NGOs, farmers clubs, functional cooperatives, IT enabled
rural outlets of corporate, postal agents, insurance agents, well
functioning panchayats, and so on.

Business correspondent model: This model proposed using
institutional agents/other external entities for supporting the banks
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for extending financial services. They would function as "pass
through" agencies to provide credit related services such as disbursal
of small value credit, recovery of principal/collection of interest and
sale of micro-insurance/mutual fund products/pension products, etc.
NGOs micro-finance institutions registered NBFCs with significant
rural presence, IT enabled rural outlets or corporates and post offices
may function as the business correspondents.

RBI recommendations for supply of rural credit: The
recommendations of the RBI to examine ·issues relating to rural
credit include the business facilitator Model and the business
correspondent model. It is hoped that these models would provide a
whole range of financial services encompassing savings, credit and
remittance, insurance and pension products in rural areas.

Business facilitator model: This model proposed that banks could
use a wide array of civil society organizations and others for
supporting 'them by undertaking non-financial services. These would
'include NGOs, .farmers' clubs, functional cooperatives, IT enabled
rural outlets of corporates, postal agents, insurance agents, well
functioning panchayats, and so on.

Business correspondent model: This model proposed using
institutional agents/other external entities for supporting the banks for
extending financial services. They would function as "pass through"
agencies to provide credit related services such as disbursal of small
value credit, recovery of principal/collection of interest and sale of
micro-insurance/mutual fund products/pension products, etc. NGOs
micro-finance institutions registered NBFCs with significant rural
presence, IT enabled rural outlets or corporates and post offices may
function as the business correspondents.

Micro-credit: In spite of the phenomenal outreach of formal credit
institutions, the rural poor still depend upon the informal sources of
credit. Two major causes for this are the large number of small
borrowers with small and frequent needs. Also the ability of these
borrowers to provide collateral is very limited. Besides, the long and
cumbersome bank procedures and their risk perception have also been
limiting factors. Micro-credit has emerged as the most suitable and
practical alternative to conventional banking in reaching the hitherto
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untapped poor population.

Micro-credit or microfinance means providing very poor families with
very small loans to help them engage in productive activities or grow
their tiny businesses. Over time, the concept of micro-credit been
broadened to include a whole range of financial and non-financial
services like credit, equity and institution building support, savings,
insurance, etc. Micro-finance institution is an organization that
provides financial services to people with limited income who have
difficulty in accessing the formal banking sector. The objectives of
micro-finance is to provide appropriate financial services to significant
numbers of low-income, economically active people in order to
finance micro-enterprises and non-farm income generating activities
including agro-allied activities and ultimately improve their condition
as well as that of local economies.

As per RBI micro-finance is the provision of thrift, credit and other
financial services and products of very small amount to the poor in
rural, semi-urban and urban areas for enabling them to raise their
income levels, and improve their living standard. Micro credit
institutions are those that provide these facilities. The micro-finance
approach has emerged as an important development in banking for
channelizing credit for poverty alleviation directly and effectively. The
micro-credit extended by banks to individual borrowers directly or
through any agency is regarded as a part of banks priority sector loans.
The RBI has made the following recommendations:


Institutions such as NABARD and SIDBI may provide bulk
lending support to start-up MFIs and funds of state/central
development/finance corporations.

Micro-credit portfolio of the regulated MFIs may be made
eligible for .direct finance from NABARD.

The MFIs may be rated to help banks/financial institutions to
decide about engaging them as their agents and funding them.

Accounting standards for SHGs and NGOs may be developed,
codified and standardized by NABARD.
Self-help groups (SHGs): SHGs have been launched to combat the,
problem of growing poverty at the grass roots level. Small, cohesive
and participative groups of the poor are formed who regularly pool
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their savings to make small interest bearing loans to its members. In
the process, they lean the nuances of financial discipline. Initially
bank credit is not a primary objective. It is only after the group
stabilizes and gains ability to undertake productive activity and bear
risk that micro-credit comes into play.
The SHG bank linkage programme (launched in 1992) has proved to
be the major supplementary credit delivery system with a wide
acceptance by banks, NGOs and various government departments. It
encourages the rural poor to build their capacity to manage their own
finances, and then negotiate bank credit on commercial terms. In
India there are three models of SHG bank linkages, namely:
Model 1 SHGs formed and financed by bank
Model 2 SHGs formed by NGOs and formal organizations, but
directly financed by the banks
Model 3 SHGs financed by banks using NGOs and other agencies as
financial intermediaries
Norms to be observed by SHGs. certain norms have to be observed in the
formation of SHGs. To become a member, a person has to be below
the poverty line. 'Only one member of a family can become a member
and that person cannot become a member of more than one SHG.
There is no limit of maximum number of members for irrigation
projects, but for other groups the numbers of members- can be
between 10 and 20. Members of SHGs are supposed to meet
regularly, that is, once a week or once a fortnight. However,
registration is optional and left to the discretion of the members.
5.9
NON-BANKING FINANCIAL INTERMEDIARIES
As already observed financial intermediaries are institutions that serve as
“middleman” in the transfer of funds from savers (millions of households) to those
who invest in real assets such as houses, equipment, factories, etc. These funds can
be channeled from surplus units either directly, e.g; through stocks, bonds or other
debt instruments, or indirectly through
financial intermediaries who hold these primary claims as investments, obtain
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funds from them by issuing secondary claims on themselves like safe deposits,
insurance policies, mutual funds,- etc., and sell them to the surplus units (savers).
Banks are the biggest financial intermediaries. Many non-banking institutions like
UTI, LIC, GIC also act as intermediaries, and when they do so they ate known as
non-banking financial intermediaries (NBFI). Some non-intermediaries,
e.g., IDBI, IFC, NABARD have been set up by the government, they are
called non-banking statutory financial organizations (NBSFO). The
Indian financial system also comprises a large number of privately owned,
decentralized and relatively small-sized financial intermediaries which are
either primarily engaged on fund based activities, while the others
primarily provide financial services. For convenience the former are called
non-banking financial companies (NBFSCs).
Non-banking financial companies represent a heterogeneous group of institutions
engaged in hire purchase, housing finance, lease finance, investors, etc. The
number of such companies runs into thousands but only a small proportion of them
report to/file return with the RBI. Four types of institutions categorized in terms of
their primary business activity and under the regulatory purview of the Reserve
Bank are: equipment leasing companies, hire purchase companies, loan companies
and investment companies. The residuary non-banking companies (RNBCs) have
been classified as a separate category as their business does not confirm to any of
the other defined classes of NBFC business. Besides, there are other NBFCs, viz.,
miscellaneous non-banking companies (chit funds), mutual benefit finance
companies (nidhis and potential nidhis) and housing finance companies which are
either partially regulated by the Reserve Bank or are outside the purview of the
Reserve Bank.
There is a considerable overlap in the functioning of these institutions-both
mobilize savings and facilitate financing of different activities. However, the
difference lies in fact that banks accept deposits which are repayable on demand
(i.e., they have cheque facility), their deposits liabilities constitute a major part of
money supply and banks also create credit.
NBFls play an important dual role in the financial system.
They complement the role of commercial banks by filling gaps in their range of
services. At the same time, they also compete with banks and force them to be
more efficient and responsive to the needs of customers. They have helped to
bridge the credit gaps in several sectors wherein the banks were unable to do so.
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Their role in delivering credit to the unorganized sector including farms and small
borrowers at the local level on a sustained basis is widely recognized. They
provide a diversified range of functions to individuals, corporate and institutions
clients. The NBFls are very effective as they have the ability to take quicker
decisions, assume greater risks and customize their services. This is because Fls
have access to private information such as loan application deposit history,
incomes, assets, liabilities and credit history. They are also able to monitor the
borrower's activities better and so are better equipped to make more rational loan
decisions. They provide the lender information, diversification and financial
expertise. They benefit the borrower by reducing transaction costs through
broadening the rate of instrument, denomination and maturities that deficit
spenders can issue.

Insurance Companies
Insurance companies are one of the major types of financial intermediaries,
and they collect large amounts of premiums from the investors and
channelize funds to the government’s other sectors.
Previously the
insurance companies were very active in the fields of life, health, and
general insurance both poverty liability and property casualty. Now, they
have begun to operate the pension schemes and mutual funds also.
The institutions providing insurance services have gone through three
distinctive phases. Before independence, there were a large number of
insurance companies (total 352 comprising 245 life insurance companies
and 107 general insurance companies), and all of them were in the private
sector and truly competitive. Life insurance was nationalized in 1952 by
passing of the LIC Act, 1956 and General Insurance was nationalized in
1972 after passing of General Insurance Services (Nationalization) Act,
1972.
Nationalization transformed the competitive private insurance industry into
monopolistic and oligopolistic state or public sector insurance industry in
India.
The insurance regulatory and development body (IRDA) which became a
statutory body in April 2000 opened up the insurance sector to let some
Indian and foreign private companies to enter the insurance business. At
present, there are a total of 24 companies-7 general insurance companies, 11
life insurance companies in the private sector, LIC, GIC and its 4
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subsidiaries carrying on life and general insurance business in India. In
addition, there is post office life insurance business also. The major
distinction between the life and general insurance is that in the life
insurance companies liability is fixed and certain as well as fairly longterm-sometimes even 30, 40 or even 50 years. As a result liquidity is not a
problem for them. In case of general insurance companies, their liabilities
are mostly short-term and unpredictable because their claims are uncertain,
their amount is variable and ascertainable only sometimes after the
happening of the event (accident, fire, etc.). As a result, liquidity is a major
consideration in their investment policy.
The assets of these companies are also different. For LIC government
securities, mortgage and housing loans, loans to electricity boards and
power companies, loans for water supply and sewerage, other
infrastructural loans, industrial securities and term loans to companies are
important assets. The GIC invests in corporate securities, government
securities, and mortgage and housing loans. Dues from subsidiaries, special
deposits with the government; loans to banks are its other major
investments.
Both life insurance companies and general insurance companies are
powerful players in the market and their decisions have a significant impact
on the financial markets in India. LIC and GIC have now diversified their
activities significantly in areas like mutual funds, pension schemes, housing
finance, venture capital, and so on. In fact, the financial resources of the
postal life insurance business have accumulated to a substantial size.

Mutual Funds
Mutual funds are pure intermediaries, and perform the basic function of
buying and selling securities on behalf of its unit holders. The savings of
their members are collected and invested in a diversified portfolio of
financial assets. The investors in the mutual fund are given share in its total
funds, which is proportionate to their investments and which is evidenced
by the unit certificates.
However, unlike the shareholders of the company, the shareholders in
mutual funds do not have any voting rights. Mutual funds or units may be
either growth oriented or income oriented or both income and growth
oriented. In addition, they may offer many other financial services such as
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Chapter-3: Banking Sectors
insurance, share exchange, housing and bank loans to their customers.
Mutual funds distribute the income to its members on a pro-rata basis.
Small investors invariably do not possess adequate time, knowledge,
expertise, experience and resources for directly accessing highly profitable
avenues in capital and money markets. The portfolio investment and
management by specialists in the trust help the small investors to obtain
'high return-low risk' combination. These experienced professionals not
only judicially take investment decisions but continuously monitor,
supervise and analyze investments, so that the investors keep enjoying a
high and secure return on their savings. Since, mutual funds portfolios are
diversified, some people maintain that though there is reduction of risk,
returns from them are average. Mutual funds may not be a channel for
getting rich quickly but they provide long-term growth avenues. At present,
individuals enjoy the additional benefit of not attracting any tax on the
income from mutual funds, and if they are sold after one year, then no
capital gain has to be paid.
Mutual funds include the Unit Trust of India which was the first one to be
set up in 1964, and still occupies the top most and dominating position in the
market. From 1964 till nearly 1986, the UTI had a monopoly of the mutual
fund business. During 19871992, public sector banks and financial
institutions (Fls) set up their mutual funds and since 1992, the entry of
private sector mutual funds and foreign participation was allowed. Other
mutual funds have been set up by the merchant banking nationalized
subsidiaries of some banks (like SBI, PNB, Canara Bank, Bank of India,
etc.), insurance companies (LIC and GIC mutual funds) as well as private
sector corporate like Birla, Prudential, ICICI, etc. and overseas mutual fund
companies. The total number of mutual funds was 23 and 38 in 1997 and
200~, respectively. While 11 of them (including UTI) are in the public
sector, the others belong to the private sector. Together they have floated
more than 400 investment schemes/plans. However, among the public sector
mutual funds, UTI still has a predominant or monopolistic position in the
mutual fund sector.
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