Raising Institutional Finance
(To familiarize learner with the Major financial
Institutions which provide short term or long term
financial resources and other technical support to
establish a business.)
UNIT 1
Indian Financial System-Introduction
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Financial System- Meaning & its components, Financial
Institutions, Financial Markets, Financial Instruments, Financial
Services
Types of Markets- Money Markets, Capital Markets, Foreign
Exchange Markets
Financial Intermediations
Types of Financial Institutions & the regulators
Financial System
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An institutional framework existing in a country to
enable financial transactions
Three main parts
◦ Financial assets (loans, deposits, bonds,
equities, etc.)
◦ Financial institutions (banks, mutual funds,
insurance companies, etc.)
◦ Financial markets (money market, capital
market, forex market, etc.)
Regulation is another aspect of the financial system (RBI,
SEBI, IRDA)
Financial assets/instruments
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Enable channelizing funds from surplus units to deficit
units
There are instruments for savers such as deposits,
equities, mutual fund units, etc.
There are instruments for borrowers such as loans,
overdrafts, etc.
Like businesses, governments too raise funds through
issuing of bonds, Treasury bills, etc.
Instruments like PPF, KVP, etc. are available to savers
who wish to lend money to the government
Financial Institutions
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Includes institutions and mechanisms which
◦ Affect generation of savings by the community
◦ Mobilisation of savings
◦ Effective distribution of savings
Institutions are banks, insurance companies, mutual
funds- promote/mobilize savings
Individual investors, industrial and trading companiesborrowers
Financial Markets
Segments & Functions of Financial Markets
Figure Flow of Funds Through the Financial System
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Financial Markets
Importance of Financial Markets
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Financial markets are critical for producing an efficient
allocation of capital, which contributes to higher
production and efficiency for the overall economy, as
well as economic security for the citizenry as a whole
Financial markets also improve the lot of individual
participants by providing investment returns to lendersavers and profit and/or use opportunities to borrowerspenders
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How We Study Financial Markets

Features
1. Case studies
2. Applications and Numerical Examples
3. Special Interest Boxes
4. Following the Financial News boxes
5. Reading the Economics Times/Financial Times Etc
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Reading the Financial Page
Stock Prices
Daily Stock Transactions
 Points
 A day’s Transactions
 Prices
 Dividend yield
 The price-earning ratio…
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Exploring the Web
Web Exercise
The World Wide Web is an enormous resource for
present and historical information
 Reading the electronic pages
 Reading the online FT.com/Economics times
 Company websites and online financial
publications
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Exploring the Web: Exercises
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http://www.indiainfoline.com/
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http://www.forecasts.org/data/index.htm
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http://http://in.finance.yahoo.com/
Easy-to-use company level and industry-level information

Pick any company and look up the closing stock price
for that company one week ago, and for yesterday.
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Exploring the Web
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Exploring the Web
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Exploring the Web
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Financial Markets
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Money Market- for short-term funds (less than a year)
◦ Organized (Banks)
◦ Unorganised (money lenders, chit funds, etc.)
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Capital Market- for long-term funds
◦ Primary Issues Market
◦ Stock Market
◦ Bond Market
Foreign Exchange Market
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Organized Money Market
Call money market
 Bill Market
◦ Treasury bills
◦ Commercial bills
 Bank loans (short-term)
 Organized money market comprises RBI, banks
(commercial and co-operative)
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Purpose of the money market
•
Banks borrow in the money market to:
– Fill the gaps or temporary mismatch of funds
– To meet the CRR and SLR mandatory requirements
as stipulated by the central bank
– To meet sudden demand for funds arising out of large
outflows (like advance tax payments)
•
Call money market serves the role of equilibrating the
short-term liquidity position of the banks
Call money market (1)
•
•
•
Is an integral part of the Indian money market where
day-to-day surplus funds (mostly of banks) are traded.
The loans are of short-term duration (1 to 14 days).
Money lent for one day is called ‘call money’; if it
exceeds 1 day but is less than 15 days it is called ‘notice
money’. Money lent for more than 15 days is ‘term
money’
The borrowing is exclusively limited to banks, who are
temporarily short of funds.
Call money market (2)
Call loans are generally made on a clean basis- i.e. no
collateral is required
 The main function of the call money market is to
redistribute the pool of day-to-day surplus funds of
banks among other banks in temporary deficit of funds
 The call market helps banks economies, their cash and
yet improve their liquidity
 It is a highly competitive and sensitive market
 It acts as a good indicator of the liquidity position

Call Money Market Participants
•
•
•
Those who can both borrow and lend in the market –
RBI ,banks and primary dealers
Once upon a time, selected financial institutions viz.,
IDBI, UTI, Mutual funds were allowed in the call money
market only on the lender’s side
These were phased out and call money market is now a
pure inter-bank market (since August 2005)
Bill Market

Treasury Bill market- Also called the T-Bill market
◦ These bills are short-term liabilities (91-day, 182-day,
364-day) of the Government of India
◦ It is an IOU (I owe you) of the government, a promise
to pay the stated amount after expiry of the stated
period from the date of issue
◦ They are issued at discount to the face value and at
the end of maturity the face value is paid
◦ The rate of discount and the corresponding issue
price are determined at each auction
◦ RBI auctions 91-day T-Bills on a weekly basis, 182-day
T-Bills and 364-day T-Bills on a fortnightly basis on
behalf of the central government
Money Market Instruments (1)
Money market instruments are those which have
maturity period of less than one year.
 The most active part of the money market is the
market for overnight call and term money between
banks and institutions and repo transactions
 Call money/repo are very short-term money market
products

Money Market Instruments(2)
Certificates of Deposit
 Commercial Paper
 Inter-bank participation certificates
 Inter-bank term money
 Treasury Bills
 Bill rediscounting
 Call/notice/term money
 Market Repo
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Certificates of Deposit
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CDs are short-term borrowings and are freely
transferable by endorsement and delivery.
Introduced in 1989
Maturity of not less than 7 days and maximum up to a
year. FIs are allowed to issue CDs for a period between
1 year and up to 3 years
Subject to payment of stamp duty under the Indian
Stamp Act, 1899
Issued to individuals, corporations, trusts, funds and
associations
They are issued at a discount rate freely determined by
the market/investors
Commercial Papers
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Short-term borrowings by corporate, financial institutions, primary
dealers from the money market
Can be issued in the physical form (Promissory Note)
or demat form
Introduced in 1990
When issued in physical form are negotiable by endorsement and
delivery and hence, highly flexible
Issued subject to minimum of Rs. 5 lacs and in the multiple of Rs. 5
lacs after that
Maturity is 7 days to 1 year
Unsecured and backed by credit rating of the issuing company
Issued at discount to the face value
Market Repos
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Repo (repurchase agreement) instruments enable
collateralized short-term borrowing through the selling
of debt instruments
A security is sold with an agreement to repurchase it at
a pre-determined date and rate
Reverse repo is a mirror image of repo and reflects the
acquisition of a security with a simultaneous
commitment to resell
Average daily turnover of repo transactions (other than
the Reserve Bank) increased from Rs.11,311 crore
during April 2001 to Rs. 1,00,000 crore (Approx)in June
2010
Indigenous bankers
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Individual bankers like Shroffs, Seths, Sahukars, Mahajans,
etc. combine trading and other business with money
lending.
Vary in size from petty lenders to substantial shroffs
Act as money changers and finance internal trade
through hundis (internal bills of exchange)
Indigenous banking is usually family owned business
employing own working capital
At one point it was estimated that IBs met about 90%
of the financial requirements of rural India
RBI and indigenous bankers (1)
Methods employed by the indigenous bankers are
traditional with vernacular system of accounting.
 RBI suggested that bankers give up their trading and
commission business and switch over to the western
system of accounting.
 It also suggested that these bankers should develop the
deposit side of their business
 Some of them should play the role of discount houses
(buy and sell bills of exchange)
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RBI and indigenous bankers (2)
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IB should have their accounts audited by certified
chartered accountants
Submit their accounts to RBI periodically
As against these obligations the RBI promised to
provide them with privileges offered to commercial
banks including
◦ Being entitled to borrow from and rediscount bills
with RBI
The IBs declined to accept the restrictions as well as
compensation from the RBI
Therefore, the IBs remain out of RBI’s purview
The Indian Capital Market (1)
•
•
•
Market for long-term capital. Demand comes from the
industrial, service sector and government
Supply comes from individuals, corporates, banks,
financial institutions, etc.
Can be classified into:
– Gilt-edged market
– Industrial securities market (new issues and stock
market)
Industrial Securities Market
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Refers to the market for shares and debentures of old
and new companies
New Issues Market- also known as the primary marketrefers to raising of new capital in the form of shares and
debentures
Stock Market- also known as the secondary market.
Deals with securities already issued by companies
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The equity or stock market is the market where stock,
representing ownership in a company, are traded.
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Buyers of common stock are owners of the firm
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Common stock has no finite life or maturity date
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Advantage of common stock is potential high income
since return is not fixed or limited

Disadvantage is that debt payments must be made
before equity payments can be made

The stock exchange is the main ‘secondary’ market for
shares in corporations.
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Primary Markets
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Definition: initial sale of securities from the issuing
corporation to the investors

Participants: investment bankers
Commercial Banks
◦ underwrite securities
 Securities Houses
◦ distributor
◦ market makers
◦ brokers

Primary Markets

Primary market can be illustrated as
Seasoned New Issues
Sale of New Securities
&
Using
Investment Bankers
IPOs
Who form Syndicates
to sell the securities
Primary Markets
Functions of Investment Bankers

Investment Banker: firm specializing in the sale of new
securities to the public, typically by underwriting the
issue
◦ Specialists in advice, design, and sales
◦ Intermediaries between issuer and investor

Advising issuer on terms, key features and timing of
offering, etc, i.e. to design a security structure
◦ advisor
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Buying securities from issuer
◦ Underwriting, Risk of selling to investors assumed from issuer

Distributing issue to public
◦ Distributor, Coordinates marketing by helping issuer register securities,
issue prospectus, and sell securities
Secondary Markets

Definition: where already issued/existing financial assets
are traded.
◦ Auction markets involve bidding in a specific physical
location, where brokers represent investors for a fee and
others trade for their own account
◦ Negotiated markets consist of decentralized dealer
network

Functions
◦ Providing security values and required returns
◦ Providing liquidity
Organization of Secondary Markets
Intermediaries (1)

Brokers
agents – do not hold securities on their own account
 Dealers/Market-makers
principals - do trade and hold securities on their own
account, required to quote two-way prices for selected
securities
 computerization
Organization of Secondary Markets
Intermediaries (2)
Brokers
 A broker acts on behalf of an investor who wishes to
execute orders.
 Broker functions:
◦ Receives, transmits and executes orders
◦ Brings together buyers and sellers
◦ Negotiates prices
 In return, the broker receives a commission.
Organization of Secondary Markets
Intermediaries (3)
Dealers as market makers
 The dealer holds in inventory the financial asset traded.
 To execute orders for own account in order to provide
liquidity.
 To make a market by standing ready to buy and sell
securities at specifies price.
 Dealer functions:
◦ Takes a position (long or short) in the asset
◦ Provides opportunity to trade immediately
◦ Offers price information

Dealer profit is the bid-ask spread.
Organization of Secondary Markets
Short Sales
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Long the position –first you buy, then you sell because
you believe the price is likely to rise.
Short the position – first you sell, then you buy, you
think the price of a security will decline.
Have to borrow a stock from a third part
Sell it
Replace it later, hopefully when the price has declined
The Foreign Exchange Market

The foreign exchange market is where international currencies trade and
exchange rates are set.

Although most people know little about this market, it has a daily volume
around $1 trillion!
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FII- An investor or investment fund that is from or registered in a country
outside of the one in which it is currently investing. Institutional
investors include hedge funds, insurance companies, pension funds and
mutual funds.
FDI-An investment abroad, usually where the company being invested in is
controlled by the foreign corporation.
An example of FDI is an American company taking a majority stake in a
company in China
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Foreign Exchange Market
Figure 1.3 Exchange Rate of the U.S. Dollar
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Foreign Exchange Market
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Foreign exchange trading refers to trading of one
country’s money for that of another country.
The need for such trade arises because of:
◦ Tourism
◦ The buying and selling of goods internationally
◦ Investment across international boundaries.
Foreign Exchange Market
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
Foreign exchange market refers to large commercial
banks in financial centers such as New York, London and
Tokyo, Hongkong, Shanghai, Mumbai trading foreigncurrency denominated deposits with each other.
Spot market: where currencies are traded for current
delivery
Financial Institutions
Function of Financial Intermediaries (1)
•
Engage in process of indirect finance
e.g. transfer of funds from savers to investors,
•
More important source of finance than securities
markets
 The transformation role involves: providing
maturity intermediation, reducing risk, reducing
costs of contracting and information processing,
and providing a payment mechanism
•
Needed because of transactions costs and
asymmetric information
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Financial Institutions
Function of Financial Intermediaries (2)

Transactions Costs
1. FIs make profits by reducing transactions costs (e.g.
provide with liquidity services and risk sharing)
2. Reduce transactions costs by developing expertise
and taking advantage of economies of scale
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Financial Intermediaries in India
Unorganized sector
Organized Sector
Money
Lenders
Capital Market
Intermediaries
Traders and
Landlords
Money Market
Intermediaries
Development
Banks
IRBI
Insurance co.
NBFC
Gov. (PF,NSC
Etc)
Agl Financing
Institutions
Indigenous
Bankers
UTI
Exim
Bank
Gov.
(T Bills)
RBI
Commercial
Banks
Co-op
Banks
Post
Offices
The India Banking Scenario - A Comparison
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Only one Indian Bank in the top 100 Banks in the world
India's best and brightest, the SBI, is roughly one-tenth the size of the world's
biggest bank - Citigroup
Six Chinese banks feature among the top 25 Asian banks while India has only
two representatives - SBI and ICICI Bank.
Similarly, SBI's consolidated pre-tax profit is $1.9 billion against Citigroup's $29
billion, Bank of America's $25 billion and HSBC's $21 billion
The one area where Indian banks are able to compete with their global peers
is their return on assets (RoA). Among big Indian banks, ICICI Bank, PNB,
Canara Bank and HDFC Bank have a return on assets of over 1 per cent
return, while SBI's return on assets is 0.89 per cent. Among Indian banks,
HDFC Bank has the highest return on assets -- 1.71 per cent.
This is lower than that of Citigroup (1.97 per cent) but much better than the
RoA of HSBC (1.40 per cent). Our banks are small but efficient. However, if
the economy has to grow at over 8 per cent, they must build the scale. India
Inc has already announced over Rs 650,000 crore (Rs 6,500 billion) of
investment plans. Without the scale, local banks can't possibly support this
growth story
Regulatory Mechanism
RESERVE BANK OF INDIA

The central bank of the country is the Reserve Bank of India (RBI).
It was established in April 1935 with a share capital of Rs. 5 crores
on the basis of the recommendations of the Hilton Young
Commission. The share capital was divided into shares of Rs. 100
each fully paid which was entirely owned by private shareholders in
the begining. The Government held shares of nominal value of Rs.
2,20,000.
The Reserve Bank of India Act, 1934 was commenced on April 1, 1935. The Act, 1934
(II of 1934) provides the statutory basis of the functioning of the Bank.
The Bank was constituted for the need of following:

To regulate the issue of banknotes

To maintain reserves with a view to securing monetary stability and

To operate the credit and currency system of the country to its advantage.
RBI’s Major Functions

Supervisory & Regulatory

Promotional & Developmental

Refinance Activities
RBI’s Major Functions
SUPERVISORY & REGULATORY
ISSUANCE
OF
CURRENCY
NOTES
CREDIT
CONTROL
EXCHANGE
CONTROL
TRANSFER
OF FUNDS
RBI’s Major Functions
PROMOTIONAL & DEVELOPMENTAL
Banker to
Government
Banker to
Bankers
Finance
Agriculture
Industry
Exports
Training
RBI’s Major Functions
REFINANCE ACTIVITIES
LENDER OF LAST RESORT
REFINANCE OPERATIONS
Regulatory Mechanism
Need For The Regulation Of Stock
Market :
A stock market is the hallmark of any
capitalist economy. Growth of the industry
requires long-term funds, and it is the saving
of the people, which comes to the stock
market for use as a long-term capital. Thus
development of industry- and thereby of the
economy necessitates the development of the
stock market. And any desirable growth calls
for regulations in the right direction.
Monitoring Stock Market :
There are three main regulatory bodies for
monitoring stock market:
1.
Reserve bank of India
2.
Ministry of Company Affairs
3.
Securities and exchange Board of India (SEBI)
(SEBI is the main regulator of security market)
In late 80’s , the government set up a body called
Securities and Exchange Board of India for
regulating the stock market. SEBI was established
as statuary body on April 12, 1992 in accordance
with the provision of the SEBI Act 1992. However,
SEBI has received more power from the
government recently and its regulating the entire
capital market operation now. )

Objectives Of SEBI :
The SEBI came into being to promote orderly and healthy development of the securities
markets and to provide adequate investor protection.
Headquartered in Mumbai, SEBI’s function is to ensure a conductive environment for
growth in capital market.
The Three objectives of SEBI as per SEBI Act 1992 are :
Protect the interest of the investors in securities.
Promote the development of the securities market
Regulation of securities markets

The SEBI has been entrusted with both the regulatory and developmental
functions. The objectives of SEBI are as follows:
a.
Investor protection, so that there is a steady flow of savings into the Capital
Market.
b.
Ensuring the fair practices by the issuers of securities, namely , companies so
that they can raise resources at least cost.
c.
Promotion of efficient services by brokers, merchant bankers and other
intermediaries so that they become competitive and professional.
Function Of SEBI :

The main Function of SEBI is to
achieve all Objectives.

SEBI has power to issue Direction for
the protection of interest of investor.

Matter related to issue and transfer
of securities and non payment of
dividend.

Can take various actions like
debarring, cancellation of registration
etc.
Role of SEBI :
It is an independently constituted board with regulatory power over stock
exchange, all intermediaries of securities market, matter relating to IPO, mutual
fund etc.
Although SEBI is an autonomous body, there is government control in the sense of
having nominees from the ministry on its board.
The regulatory powers given to SEBI are also subjected to government directives
and overrule. The power to prosecute and fine defaulters is also denied.
HOW SEBI REGULATES NEW ISSUE
SEBI has been given wide powers for protecting the interest of investors in the
securities market as well as for orderly development and regulation of securities
market by such measures it thinks appropriates under provisions of the SEBI Act
1992.
To regulate primary issue market, SEBI has come up with detailed guidelines
known as SEBI ( Disclosure and investor protection) guideline 2000. These guide
lines are issued U/s 11 of SEBI Act 1992.
^These guidelines are detailed guidelines in every aspect of pre-public issue and
post- public issues of securities.
HOW SEBI REGULATES INTERMEDIARIES
All Intermediaries associated with the securities market have to be registered with
SEBI.
It has made separate regulations for regulating these entities. These intermediaries
have to stick to code of conduct as specified in these regulations and support by
the requirements of the regulations.
If the intermediaries fail to stick the regulatory requirements, SEBI initiates
disciplinary action against the violators as per SEBI Act and relevant regulation,
SEBI may suspend their registration, impose monetary penalty, warning in case of
small default. Generally, SEBI warns intermediaries for minor violation and takes
severe action like suspension of registration, monetary penalty, or even registration
cancellation in case of serious violation. SEBI can also launch prosecution in serious
violation.