Section 1 – financial markets

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 Objective
• To understand Financial System
• Constituents of Financial System
• Need to Regulate Financial System
• Types of Financial Markets
• Functions of Financial Markets
• Role of Financial Markets in Economic Growth
• Role of Financial Institutions
• Types of Financial Instruments
• Need of Financial Services

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 Savings

For the household sector, savings are surplus of income over consumption expenditure
 Expenditure includes both consumer non-durables as well as consumer durables.
 Would car and home loan instalment be part of consumption expenditure?
 Would purchase of gold by the household sector be classified as consumption
expenditure?
 Surpluses of the corporate sector, government sector and other institutions (such as
trusts/NGOs) also form part of the savings pool seeking investments.
 Savings, “if invested”, can grow due to returns earned from those investments.
 Savings which are not invested may reduce in “real” terms due to inflation.
 Savings => investments => growth of economy.

3
 Investments
What is Investment?
• An investment is an asset or item that
is purchased with the hope that it will
generate income or will appreciate
in value in the future.
• In an economic sense, an investment
is the purchase of goods that are not
consumed today but are used in the
future to create wealth.
• In finance, an investment is a
monetary asset purchased with the
idea that the asset will provide
income in the future or will be sold at
a higher price for a profit.

4
 Investments & Economic
Growth
“Economic growth without
investment in human
development is
unsustainable and
unethical” Amartya Sen

How would an individual saver;

• find various options for investing i.e., various business units requiring funds for
acquiring assets?
• evaluate various investment options on likely returns, safety and liquidity?
• How would an individual company requiring funds for setting up a factory go
about approaching individual savers?
• How would their needs be matched? e.g., saver wants to deploy funds for not
more than 3 years, but business unit needs funds for a project which requires
investment for 7 years.

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 Role of Financial System

Financial
Savings Investments
System

1.Collection of savings
2.Distribute the collected savings into various investments
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 What is Financial System

Need for a Sound Financial System

• Without financial system it is quite difficult and expensive to allocate resource and shift risks to its lowest
level (low economic development).
• It plays an important role in the economic development and it is divided into financial markets and
institutions.
• It gathers or pools money from people and businesses that have more than they need currently and
transmit those funds to those who can use them for either consumption or investment. The larger the
flow of funds and the more efficient their allocation is, the better the economic output and welfare of
the economy and society. A healthy economy is dependent on efficient transfers of resources from
people who are net savers (surplus) to firms and individuals who need capital. Without efficient transfers,
the economy simply could not function. Therefore, it is absolutely essential that our financial market
functions efficiently, not only quickly, but also at a minimal cost.

7
 Capital flow between Savers & Borrowers in economy

• Financial markets are where people buy and sell, win and lose, bargain and argue about the
price and the product/services.
• Financial institutions, as part of financial system, they also play an important role in economic
development by facilitating the flow of funds from surplus unit (savers) to the deficit
unit(borrowers).
• Economic elements or parties that are involved can be divided into households, business
organizations, and government.
• Business often needs capital to implement growth plans; government requires funds to finance
building projects; and households frequently want loans for example to purchase homes, cars and
so on.
• Fortunately, there are other individuals or households and firms with incomes greater than their
expenditures (surplus budget position).
• Therefore financial systems bring together people and organizations needing money with those
having surplus funds. In other words, the purpose of the financial system is to transfer funds from
savers to the borrowers in the most effective and efficient possible manner. And that job can be
done by direct financing or by indirect financing. Despite the method of transferring the resources
the objective is to bring the involving parties together at the lowest possible cost.
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 Value addition by the
financial sector
• Convenience
o Access : savers do not have to reach out to find the ultimate users of their
investments and vice-a-versa
o Divisibility : match the size needs of users of the funds ( ie the business
units) and savers by dividing a large investment into various size
denominations
o Tenure : “matching” the tenure requirements of business units and savers

• Lowering of risk through diversification

o Large pool of funds available to a financial institution allows it to invest
into various investments.
o For a saver, it is difficult to achieve the same level of diversification
o By dividing large and diversified investments into small denominations (eg
mutual fund units); benefits of diversification are shared by the individual
savers

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 Value addition by the
financial sector
• Expert management
o Trained, experienced and specialized managers
o Professionals who devote their full time to the investing activities
o Access to large information and data base

• Economies of scale
o Large pool of investible funds, hence financial institutions can drive a good
bargain
o Operating costs get spread over large investment base

• Boost to the economy

o Savers and users of the funds get encouraged leading to greater levels of
investments
o Greater levels of productive investments lead to higher growth of the
economy

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Regulating Financial System
Financial regulation is a form of regulation or supervision, which subjects
financial institutions to certain requirements, restrictions and guidelines,
aiming to maintain the integrity of the financial system. This may be handled
by either a goverment or non-government organization. Financial regulation
has also influenced the structure of banking sectors, by decreasing
borrowing costs and increasing the variety of financial products available.

The objectives of financial regulators are usually:

• market confidence – to maintain confidence in the financial system
• financial stability – contributing to the protection and enhancement of
stability of the financial system
• consumer protection – securing the appropriate degree of protection for
consumers.
• reduction of financial crime – reducing the extent to which it is possible
for a regulated business to be used for a purpose connected with
financial crime.
• regulating foreign participation in the
financial markets.

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Regulating Financial System
Regulators are the organizations entrusted with the task of implementing
such regulations and supervision of the financial sector
• Ministry of Finance
• Ministry of Corporate Affairs
• Reserve Bank of India (RBI)
• Securities and Exchange Board of India (SEBI)
• Insurance Regulatory and development Authority of India (IRDAI)
• Pension Fund Regulatory and Development Authority (PFRDA)

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Constituents of Financial
System
Financial
Markets

Financial Financial Financial

Services System Institutions

Financial
Instruments/
Products
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 Financial Markets

• A Financial market is a market for creation and exchange of financial assets.

• Financial markets act as a forum to facilitate financial transactions through the
creation, sale and transfer of financial securities. If you buy or sell financial assets,
you will participate in financial markets in some way or the other.
• Financial markets play a key role in the economy by stimulating growth, influencing
economic performance of the factors, affecting economic welfare.
• This is achieved by financial infrastructure, in which entities with funds allocate
those funds to those who have potentially more productive ways to invest those
funds.
• A sound financial market makes it a more efficient way to transfer funds.

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 Functions of Financial
markets
1) Financial Markets facilitate Price Discovery: The continual interaction among numerous
buyers and sellers who throng financial markets helps in establishing the prices of financial
assets. Well organized financial markets seem to be remarkably efficient in price discovery.
That is why economists say: “If you want to know what the value of a financial asset is, simply
look at its price in the financial market”.

2) Financial Markets provide liquidity to financial assets: Investors can readily sell their
financial assets through the mechanism of financial markets. In the absence of financial
markets which provide such liquidity, the motivation of investors to hold financial assets will be
considerably diminished. Thanks to negotiability and transferability of securities through the
financial markets, it is possible for companies and other entities to raise long term funds from
investors with short term and medium term horizons. While one investor is substituted by
another when a security is transacted, the company is assured of long term availability of
funds.

3) Financial Markets considerably reduce the cost of transacting: The two major costs
associated with transacting are search costs and information costs. Search costs comprise
explicit costs such as the expenses incurred on advertising when one wants to buy or sell an
asset and implicit costs such as the effort and time one has to put in to locate a customer.
Information costs refer to costs incurred in evaluating the investment merits of financial assets.

15
 Functions of Financial
markets
4) Mobilisation of Savings and their Channelization into more Productive Uses: Financial
market gives impetus to the savings of the people. This market takes the uselessly lying
finance in the form of cash to places where it is really needed. Many financial instruments are
made available for transferring finance from one side to the other side. The investors can
invest in any of these instruments according to their wish.

5) Diversification & Reduction in Risk: Financial markets provide a variety of financial products
/ instruments with varied of risk- return matrix. This provides the investor with the choice of the
right product to match his needs and thereby gives him the advantage of diversification and
reduced risk.

6) Easy transfer of financial asset: Financial markets facilitate ease in transferring financial
assets between investor and borrower. These markets also provide easy payment
mechanisms.

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 Classification

There are different ways of classifying financial markets.

• Type of financial claim: The Debt market is the financial market for fixed claims of debt
instruments and the Equity market is the financial market for residual claims or equity
instruments.

• Maturity of claims: The market for short-term financial claims is referred to as Money Market
and the market for long-term financial claims is called as Capital market. Since short-term
financial claims are invariably debt claims, the money market is the market for short-term
debt instruments. The capital market is the market for long-term instruments and equity
instruments.

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 Classification

There are different ways of classifying financial markets.

• Whether the claims represent new issues or outstanding issues: The market where issuers sell
new claims is referred to as the Primary market and the market where investors trade
outstanding securities is called the Secondary market.

• Timing of delivery: A Cash or Spot market is one where the delivery occurs immediately
and a Forward or Futures market is one where the delivery occurs at a pre-determined
time in future.

• Nature of its organizational structure: An Exchange-traded market is characterized by a

centralized organization with standard procedures. An Over-the counter market is a
decentralized market with customized procedures.
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 Role of Financial markets
in Economic Growth
• Mobilize savings for productive investments and facilitate capital inflows
• Financial Markets play an important role in promoting economic growth
• Strong Incentive for Investments
• Improved resource use and technological diffusion
• Collecting and Analysing information about investments
• Monitoring management and exerting corporate controls

Examples of Government, corporates, Investors and Individuals making optimum

use of financial markets to achieve economic growth

The Financial Market plays an important role in promoting economic growth. Thus,
by creating an efficient mechanism for transactions in long term financial
instruments, it provides a wide range of wealth creating opportunities for the
Government, Corporations, Private individuals, and other financial institutions..

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 Role of Financial markets in Economic Growth
• Financial Markets play an important role in promoting economic growth. It is
commonly argued in the economic literature that a well functioning financial
sector creates strong incentives for investment and also fosters trade and
business linkages thereby facilitating improved resource use and
technological diffusion. By mobilizing savings for productive investment and
facilitating capital inflows, financial markets stimulates investments.

• The financial sector also channels savings to more productive uses by

collecting and analysing information about investment opportunities. It has
also been argued that the financial system can enhance efficiency in the
corporate sector by monitoring management and exerting corporate
controls. Public as well as private sector operators make use of various
financial instruments to raise and invest short term funds which, if need be,
can be quickly liquidated to satisfy short-term needs.

• The Government, for instance, can borrow money from the general public to
finance long-term investment projects by issuing treasury notes or bonds. The
proceeds from the bonds issue can be used to build public hospitals,
construct roads, provide public transports, build airports, construct dams, or
build other social infrastructures. This entails national wealth creation for
economic growth.
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 Role of Financial markets in Economic Growth
• The Government can mobilize a huge amount of financial resources from the
Capital Market to finance long term development projects like the construction
of public markets, recreational centres, roads, develop efficient transport
system, build Schools, hospitals and provide many other services from which
they can generate a regular source of income.

• Corporate bonds can be issued by public companies to finance long-term

development projects like the construction of new plants, expansion of existing
plants, construction of new buildings, introduction of new technology, purchase
of new equipments, etc.
• Corporates can also issue equities to raise additional financial resources for long
term investment. The proceeds from equities could be use to purchase new
equipment, construct new factories, expand operations etc. All these activities;
the purchase of new equipments, expansion of existing plants, construction of
new buildings etc. entail wealth creation from the Capital Market by
corporates.
• Investors make money in the Capital Market through buying and selling of
financial securities. When investors buy debt instruments like government bonds
or corporate bonds, they receive an interest payment from the issuer of the
debt security plus the principal amount at the end of the loan period. The
amount of interest payable to an investor holding a debt security depends on
the interest rate agreed by the loan contract. Thus, investors create wealth in
the capital market by investing in debt securities.
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 Role of Financial markets in Economic Growth
• Suppose an individual invests in equities, The investor in this case becomes a
shareholder or part owner of the company that issues the shares. As a
shareholder, the investor is entitled to receive a share of the Company’s
annual profit which is distributed in the form of dividend. The amount of
dividend received by an investor depends on the number of shares he/she
holds as well as the dividend policy of the company. Sometimes the company
may decide not to pay dividend in cash but rather by issuing additional
shares to the existing shareholders. An investor may also decide to sell his/her
shares to make a capital gain. The receipt of dividend, bonus shares and
capital gains from selling shares all amount to wealth creation by the investor.

• The Financial Market plays an important role in promoting economic growth.

Thus, by creating an efficient mechanism for transactions in long term
financial instruments, it provides a wide range of wealth creating opportunities
for the Government, Corporations, Private individuals, and other financial
institutions.

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Section 2 – financial institutions

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 Financial Institution
• Financial institutions facilitate smooth working of the financial
system by making investors and borrowers meet.
• They mobilize the savings of investors either directly or
indirectly via financial markets, by making use of different
financial instruments as well as in the process using the services
of numerous financial services providers.
• They could be categorized into Regulatory, Intermediaries,
Non-intermediaries and Others.
• They offer services to organizations looking for advises on
different problems including restructuring to diversification
strategies.
• They offer complete array of services to the organizations who
want to raise funds from the markets and take care of
financial assets for example deposits, securities, loans, etc.

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 Categories of Financial
institutions
Some of the major categories of financial institutions
and their roles in the financial system are as follows;
•Non Banking
•Commercial
Finance
Banks
Companies
•Co-operative
•Development
Banks
Finance
•New Proposed Institutions
banks Banking Non Banking
Institutions Institutions

Insurance &
Housing
Mutual Funds
Finance
Companies
•Life •Public Sector
•General •Private Sector
•Re-insurance
•Health

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 Financial Institutions –
Under the Purview of RBI
• Commercial Banks
• Urban cooperative banks
• Newly proposed types of banks – payment banks,
small finance banks
• Non banking financial companies (NBFCs)
• Asset Reconstruction Companies (ARCs)
• Primary Dealers (PDs)

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 Define Commercial Banks

• Commercial banks accept deposits and provide security and convenience to their
customers.
• Part of the original purpose of banks was to offer customers safe keeping for their money.
• Commercial banks also make loans that individuals and businesses use to buy goods or
expand business operations, which in turn leads to more deposited funds that make their
way to banks.
Banks also serve often role as payment agents within a country and between nations. Not
only do banks issue debit cards that allow account holders to pay for goods with the swipe of
a card, they can also arrange wire transfers with other institutions. Banks essentially underwrite
financial transactions by lending their reputation and credibility to the transaction; a check
(cheque) is basically just a promissory note between two people, but without a bank's name
and information on that note, no merchant would accept it. As payment agents, banks
make commercial transactions much more convenient; it is not necessary to carry around
large amounts of physical currency when merchants will accept the checks, debit cards or
credit cards that banks provide.

If banks can lend money at a higher interest rate than they have to pay for funds and
operating costs, they make money.
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 Comm. Banks Functions

Commercial banks are further classified in India as Public Sector Banks, Private
Sector Banks, Foreign Banks in India and Regional Rural Banks.
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 Urban Co-operative
Banks
• Urban co-operative banks usually meet the needs of specific
types or groups of members pertaining to a certain trade,
profession, community or even locality.
• They are also called Primary Co-operative Banks (PCBs) by the
Reserve Bank.
• The Reserve Bank of India defines PCBs as ‘small-sized co-
operatively organised banking units which operate in
metropolitan, urban and semi-urban centres to cater mainly
to the needs of small borrowers, viz., owners of small scale
industrial units, retail traders, professionals and salaried
classes’.
• The RBI grants licenses to co-operative banks based on certain
entry point norms. The RBI has revised these norms in August
2000 prescribing 4 categories based on population criterion.

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 Urban Co-operative
Banks
According to these new norms UCBs should have;
• A minimum share capital of INR 4 crore and membership of at
least 3,000 if the population is over 10 lakh;
• A minimum share capital of INR 2 crore and membership of at
least 2,000 if the population is between 5 to 10 lakh;
• A minimum share capital of INR 1 crore and membership of at
least 1,500 for population of 1 to 5 lakh and;
• A minimum share capital of INR 25 lakh and membership of at
least 500 for population less than 1 lakh
New UCBs have to achieve the prescribed share capital and
membership before the license is issued. There is a two-tier
regulatory structure for UCBs.

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 Payment Banks
Payment banks are expected to reach customers mainly through their mobile
phones rather than traditional bank branches.

• They can’t offer loans but can raise deposits of up to Rs. 1 lakh, and pay
interest on these balances just like a savings bank account does.
• They can enable transfers and remittances through a mobile phone.
• They can offer services such as automatic payments of bills, and purchases in
cashless, cheque less transactions through a phone.
• They can issue debit cards and ATM cards usable on ATM networks of all
banks.
• They can transfer money directly to bank accounts at nearly no cost being a
part of the gateway that connects banks.
• They can provide forex cards to travellers, usable again as a debit or ATM
card all over India.
• They can offer forex services at charges lower than banks.
• They can also offer card acceptance mechanisms to third parties such as the
‘Apple Pay.’
• E.g. of payment banks in India – India Post, PayTm, Vodafone M-Pesa, Airtel M
Commerce Services, etc.
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 Small Finance Banks
• Small finance banks are allowed to take deposits from customers.
• As against payments banks, small finance banks are also allowed to lend
money to people.
• Most customers of small finance banks account for small and medium
enterprises and small businesses. These banks are able to provide secured
and legal loans to MSMEs and SMEs, bringing them under the ambit of the
financial system.
• Small finance banks provide banking products to the unserved and
undeserved sections of the country, which includes small and marginal
farmers, micro and small industries, and other organized sector entities, at an
affordable cost.

Small finance banks is another step to bring the unbanked under the ambit of the
banking system.

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 Define NBFCs
• A Non-Banking Financial Company (NBFC) is a company registered
under the Companies Act, 2013.

• They are engaged in the business of loans and advances, acquisition

of shares/stocks/bonds/debentures/securities issued by Government
or local authority or other marketable securities of a like nature,
leasing, hire-purchase, insurance business, chit business.

• It does not include any institution whose principal business is that of

agriculture activity, industrial activity, purchase or sale of any goods
(other than securities) or providing any services and
sale/purchase/construction of immovable property.

• A non-banking institution which is a company and has principal

business of receiving deposits under any scheme or arrangement in
one lump sum or in instalments by way of contributions or in any other
manner, is also a non-banking financial company (Residuary non-
banking company).
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 NBFCs vs. Banks

NBFCs lend and make investments and hence their activities are akin to
that of banks; however there are a few differences as given below:
i. NBFC cannot accept demand deposits;
ii. NBFCs do not form part of the payment and settlement system and
cannot issue cheques drawn on itself; and
iii. deposit insurance facility of Deposit Insurance and Credit Guarantee
Corporation is not available to depositors of NBFCs, unlike in case of
banks.

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 Types of NBFCs
Different types/ categories of NBFCs registered with
RBI are as follows;
NBFCs are categorized;
a) by the kind of activity they conduct
b) in terms of the type of liabilities into Deposit and
Non-Deposit accepting NBFCs,
c) non-deposit taking NBFCs by their size into
systemically important and other non-deposit holding
companies (NBFC-NDSI and NBFC-ND)

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 Types of NBFCs
Types of NBFCs registered with the RBI by nature of
activity
Asset
Finance
company

Others Inv.
company

Infra.
Loan
Debt NBFC Company
Fund

Infra.
SICI
Company Finance
Company
Micro
Finance
Institution

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NBFCs registered with the RBI by nature of activity
• Asset Finance Company (AFC): An AFC is a company which is a financial
institution carrying on as its principal business the financing of physical assets
supporting productive/economic activity, such as automobiles, tractors, lathe
machines, generator sets, earth moving and material handling equipments,
moving on own power and general purpose industrial machines. Principal
business for this purpose is defined as aggregate of financing real/physical
assets supporting economic activity and income arising therefrom is not less
than 60% of its total assets and total income respectively.

• Investment Company (IC): IC means any company which is a financial

institution carrying on as its principal business the acquisition of securities.
These include Primary dealers (PDs), who deal in underwriting and market
making for government securities.

• Loan Company (LC): LC means any company which is a financial institution

carrying on as its principal business the providing of finance whether by
making loans or advances or otherwise for any activity other than its own but
does not include an Asset Finance Company.

• Infrastructure Finance Company (IFC): IFC is a non-banking finance company

a) which deploys at least 75 per cent of its total assets in infrastructure loans,
b) has a minimum Net Owned Funds of ₹ 300 crore, c) has a minimum credit
rating of ‘A ‘or equivalent d) and a Capital to Risk Weighted Assets Ratio
(CRAR) of 15%. 37
NBFCs registered with the RBI by nature of activity
• Non-Banking Financial Company - Micro Finance Institution (NBFC-MFI):
NBFC-MFI is a non-deposit taking NBFC having not less than 85% of its assets in
the nature of qualifying assets which satisfy the following criteria:
a) loan disbursed by an NBFC-MFI to a borrower with a rural household
annual income not exceeding ₹1,00,000 or urban and semi-urban
household income not exceeding ₹ 1,60,000;
b) loan amount does not exceed ₹ 50,000 in the first cycle and ₹ 1,00,000 in
subsequent cycles;
c) total indebtedness of the borrower does not exceed ₹ 1,00,000;
d) tenure of the loan not to be less than 24 months for loan amount in excess
of ₹ 15,000 with prepayment without penalty;
e) loan to be extended without collateral;
f) aggregate amount of loans, given for income generation, is not less than
50 per cent of the total loans given by the MFIs;
g) loan is repayable on weekly, fortnightly or monthly instalments at the
choice of the borrower

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NBFCs registered with the RBI by nature of activity
• Systemically Important Core Investment Company (CIC-ND-SI): CIC-ND-SI is an
NBFC carrying on the business of acquisition of shares and securities which
satisfies the following conditions:-
a) it holds not less than 90% of its Total Assets in the form of investment in equity
shares, preference shares, debt or loans in group companies;
b) its investments in the equity shares (including instruments compulsorily
convertible into equity shares within a period not exceeding 10 years from
the date of issue) in group companies constitutes not less than 60% of its Total
Assets;
c) it does not trade in its investments in shares, debt or loans in group
companies except through block sale for the purpose of dilution or
disinvestment;
d) it does not carry on any other financial activity referred to in Section 45I(c)
and 45I(f) of the RBI act, 1934 except investment in bank deposits, money
market instruments, government securities, loans to and investments in debt
issuances of group companies or guarantees issued on behalf of group
companies.
e) Its asset size is ₹ 100 crore or above and
f) It accepts public funds

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NBFCs registered with the RBI by nature of activity
• Infrastructure Debt Fund - Non-Banking Financial Company (IDF-NBFC): IDF-
NBFC is a company registered as NBFC to facilitate the flow of long term debt
into infrastructure projects. IDF-NBFC raise resources through issue of Rupee or
Dollar denominated bonds of minimum 5 year maturity. Only Infrastructure
Finance Companies (IFC) can sponsor IDF-NBFCs.

40
NBFCs registered with the RBI by nature of activity
• Non-Banking Financial Company – Factors (NBFC-Factors): NBFC-Factor is a
non-deposit taking NBFC engaged in the principal business of factoring. The
financial assets in the factoring business should constitute at least 50 percent
of its total assets and its income derived from factoring business should not be
less than 50 percent of its gross income.

• Mortgage Guarantee Companies (MGC) - MGC are financial institutions for

which at least 90% of the business turnover is mortgage guarantee business or
at least 90% of the gross income is from mortgage guarantee business and net
owned fund is ₹ 100 crore.

• NBFC- Non-Operative Financial Holding Company (NOFHC) is financial

institution through which promoter / promoter groups will be permitted to set
up a new bank .It’s a wholly-owned Non-Operative Financial Holding
Company (NOFHC) which will hold the bank as well as all other financial
services companies regulated by RBI or other financial sector regulators, to
the extent permissible under the applicable regulatory prescriptions.

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 Types of NBFCs
Types of NBFCs registered with RBI by type of liabilities
and size
• Deposit Taking NBFCs
• Non- deposit taking, further classified by size;
o Systematically Important: NBFCs whose asset size is of ₹ 500 cr or more as
per last audited balance sheet are considered as systemically important
NBFCs. The rationale for such classification is that the activities of such
NBFCs will have a bearing on the financial stability of the overall
economy.
o Non- Systematic Investment NBFC-ND with assets size of less than 500Cr :
NBFC’s with assets of less than Rs. 500 crores are exempted from the
requirement of maintaining Capital To Risk Asset Ratio (CRAR) and
complying with credit concentration norms.

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 NBFCs
Methods of financing for purchasing assets
• Loans
• Hire purchase – purchasing in instalments
• Leasing – lease rental is the consideration for the
right to use a product ; the product is not sold.
o In case of operating lease, lessor ( i.e., the entity which offers lease) has
the obligation to maintain the product.
o In case of financial lease, no such obligation on the lessor. Lessor typically
sells the product to the lessee at a residual value at the end of the tenure
of the lease contract

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 Loan V/s Lease V/s Hire
Purchase
Loan Lease Hire Purchase

Passes immediately to the Transfers to the hirer at

Title/ownership of asset Remains with the lessor
borrower end of HP contract

Interest expenses are tax

deductible. In India,
Complete lease rentals Only interest component
Tax treatment home loan principal
are tax deductible. is tax deductible.
repayments are also tax
deductible.

Borrower must pay some

Upfront payment by Lessor may collect 1 or 2 Owner may collect 1 or 2
amount as lender doesn’t
borrower/hirer/lessee lease rentals upfront instalments upfront
finance 100%

Higher as it is for the full Lower as it is for the part Higher than lease of loan
Installment payment
value of the asset value of the asset as HP charges are higher

Claimed by the hirer

Claimed by borrower as Claimed by the lessor as though not the owner
Tax depreciation
he is the owner he is the owner (ownership passes to him
after expiry of HP)

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 NBFCs - Regulation
Are all NBFCs regulated by RBI? No.

• stock exchanges, investment banking, stock

broking, mutual funds , venture capital funds
register with SEBI
• Housing Finance companies are regulated by
National Housing Bank
• Insurance companies regulated by IRDA.

Refer to the frequently asked questions 1 to 4 on NBFCs , updation as on 15th April,2015 (dated
May,06 2015 in the main menu on FAQs) on the website of the RBI, Consumer Education and
Protection section, subsection “For Common Person”

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Asset Reconstruction Companies (ARCs)
Asset reconstruction
Banks Company (ARC)
Bad Loan
NPA

Borrower

An ARC is in the business on acquiring Non Performing Assets/ Loans which are not being
repaid by borrowers even after repeated notices/efforts of the Bank/financial institution.

So the Banks & an Asset reconstruction company get into an agreement whereby the
ARC agrees to take over the NPAs from the Banks Balance sheet at a certain amount
(Lower than the book value, of course) & then try to recover these amounts from the
Borrowers or if the borrowers are corporates then they can even offer them attractive
settlement terms for their loans.

For e.g., if there is a Rs. 40 cr NPA which an ARC purchased for 30 crores it can go back
to the borrower & offer them to settle the loan at 35 crores this way both parties benefit
from the arrangement.
46
 ARCs
• Non performing assets of a bank or an NBFC are those lending
assets on which the borrowers are not paying back their dues
within stipulated time period.

• ARCs acquire “non performing assets” in bulk on attractive

terms, work on them and generate incomes

• Usually ARCs issue “security receipts” to other investors who

share with the ARC the returns from the assets acquired.

• They get the benefit of the SARFAESI Act (The Securitization

and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002); which allows them to take
possession of the secured assets of the defaulting borrower
without court or tribunal intervention.

47
 Primary Dealers (PDs)

• Primary dealers are registered entities with the RBI who have the license to
purchase and sell government securities.
• They are entities who buys government securities directly from the RBI (the RBI
issues government securities on behalf of the government), aiming to resell
them to other buyers. In this way, the Primary Dealers create a market for
government securities.
• The Primary Dealers system in the government securities market was
introduced by the RBI in 1995.

The PDs are thus created to promote transactions in government securities

market. A facilitating arrangement is essential for selling of government securities
as government is the single largest borrower in the market who borrows through
the issue of its securities – treasury bills and bonds.

48
 Primary Dealers (PDs)
• Central government and state governments periodically borrow funds to meet their
expenses.

• For amounts borrowed by the central government for a period less than 1 year, the
government issues “ T- bills” ( Treasury bills) and Cash Management Bills (CMBs).

• T bills have maturities of 91 days, 182 days and 364 days. CMBs are for less than 91 days.

• For borrowings beyond one year, the lenders get “G-Sec”, also called Gilt ( or Gilt edged
security).

• Likewise state governments issue state government securities.

• RBI offers these securities periodically through auctions and also buys them back from the
market when governments have excess liquidity.

• Role of the primary dealers is to help RBI distribute T bills and government securities. They
participate in the auctions along with the banks and thereafter sell these securities to
various investors.

• PDs are allowed to be active participants in the money markets.

49
 Government Securities
• A Government security is a tradable instrument issued by the Central
Government or the State Governments.

• It acknowledges the Government’s debt obligation.

• Such securities are short term (usually called treasury bills, with original
maturities of less than one year) or long term (usually called
Government bonds or dated securities with original maturity of one
year or more).

• In India, the Central Government issues both, treasury bills and bonds
or dated securities while the State Governments issue only bonds or
dated securities, which are called the State Development Loans
(SDLs).

• Government securities carry practically no risk of default and, hence,

are called risk-free gilt-edged instruments.
50
 Government Securities
• Treasury Bills: Treasury bills or T-bills, which are money market instruments, are
short term debt instruments issued by the Government of India and are
presently issued in three tenors, namely, 91 days, 182 days and 364 days.
Treasury bills are zero coupon securities and pay no interest. They are issued at
a discount and redeemed at the face value at maturity. For example, a 91
day Treasury bill of Rs.100/- (face value) may be issued at say Rs. 98.20, that is,
at a discount of say, Rs.1.80 and would be redeemed at the face value of
Rs.100/-. The return to the investors is the difference between the maturity
value or the face value (that is Rs.100) and the issue price

• Cash Management Bills: Government of India, in consultation with the Reserve

Bank of India, has decided to issue a new short-term instrument, known as
Cash Management Bills (CMBs), to meet the temporary mismatches in the
cash flow of the Government. The CMBs have the generic character of T-bills
but are issued for maturities less than 91 days. Like T-bills, they are also issued
at a discount and redeemed at face value at maturity. The tenure, notified
amount and date of issue of the CMBs depends upon the temporary cash
requirement of the Government.

• G-secs: Government paper with tenor beyond one year is known as dated
security.
51
 FI- Under the purview of
• Exchanges
SEBI
• Member brokers and sub-brokers
• Depositories
• Depository participants
• Mutual funds
• Alternative Investment Funds (AIFs)
• Foreign Institutional Investors (FIIs)
• Custodial agencies
• Portfolio management companies
• Investment bankers
• Investment advisors
• Distributors for mutual funds and other investment products
• Registrars and transfer agents
• Debenture trustees
• Self regulated organizations (SROs) such as Association of Mutual
Funds of India (AMFI) 52
Development Finance Institutions
DFIs were started by the government to give sector-specific loans to various
sectors- industry, agriculture, housing, infrastructure, export finance etc. The
first DFI was the Industrial Financial Corporation of India (IFC) that was
launched in 1948.
Later several of them were converted into banks as industry got opportunity
to avail funds from the capital market (equity and debt) with the
development of the capital market.

Thus, DFIs are financial agencies that provide medium and long-term
financial assistance and engaged in promotion and development of industry,
agriculture and other key sectors.

Objectives of Development banks are as follows:

• To serve as an agent of development in various sectors and international
trade
• To accelerate economic growth
• To allocate resources to high priority areas
• To foster rapid industrialization
• To finance housing, small scale industries, infrastructure and social utilities

Universal banking: One stop shop of financial products & services –

everything from term finance, working capital, project advisory services etc.
Encompassing commercial banking and investment banking, including
investment in equities and project finance.
53
 Some DFIs
• Industrial Finance Corporation of India Ltd. (IFCI)
• Industrial Development Bank of India (IDBI)
• Industrial Investment Bank of India Ltd. (IIBI)
• Small Industrial Development Bank of India (SIDBI)
• Export Import Bank of India (EXIM)
• National Bank For Agriculture & Rural Development
(NABARD)

54
Financial Institutions with
Development Perspective
• Clearing Corporation of India Limited (CCIL)
o Set up by major banks and financial institutions with support of the RBI
o Manage risks in settlements of transactions in debt, money and forex
markets
o acts as a central counterparty in various segments of the financial
markets regulated by the RBI viz. the government securities segment,
collateralised borrowing and lending obligations (CBLO) - a money
market instrument, USD-INR and forex forward segments.
• Credit rating agencies
o 6 agencies viz. CRISIL, CARE, ICRA, Fitch, Brickworks ratings and SME rating
agency are registered with SEBI
o Primary role is to give credit rating to various debt issuances, this helps
investors to understand the credit risks associated with various debt
issuances
• Credit Information Bureau of India limited (CIBIL)
o Was set up by SBI,HDFC, D&B and TransUnion International
o Primary role is to provide credit related information about the individual
borrowers to lenders and credit card companies
• Discount and Finance House of India limited (DFHIL)
o Was set up by the RBI, Public sector banks and financial institutions
o Primary role is to make market and provide liquidity in the Money Market 55
Financial Institutions with
Development Perspective
• STCI Finance Ltd. (formerly known as Securities Trading Corporation of
India limited (STCI) – is a NBFC – ND – SI
o Was set up by the RBI, public sector banks and financial institutions
o Primary role is to create active secondary market in the government
securities
• National Housing bank (NHB)
o Central Government set up NHB under the national Housing bank Act of
1987
o It is the apex housing finance institution to function as the principal
agency for the registration and promotion of various housing finance
institutions
• EXIM bank
o Central government set it up in 1981
o Primary role is to finance, facilitate and promote foreign trade in India

56
Financial Institutions with
Development Perspective
• National Bank for Agriculture and Rural Development
(NABARD)
o Was set up by the Central government and the RBI in 1981
o Primary role is to be the apex institution in the field of credit for agriculture
and other economic activities in rural India.
• Small Industries Development bank of India (SIDBI) and
18 State Finance Corporations (SFCs)
o Primary role to provide financial assistance to the Micro, Small and
Medium Enterprises
• The Deposit Insurance and Credit Guarantee
Corporation (DICGC)
o Set up by RBI to provide insurance of deposits and guaranteeing credit
facilities
• Small savings schemes of the Central government
o Operated through the post offices and public sector banks and promoted
through National Savings Organisation 57
Financial Institutions with
Development Perspective
• ECGC Ltd. (Formerly Export Credit Guarantee
Corporation of India Ltd.)
o Main objective is to promote exports from the country by providing Credit
Risk Insurance and related services for exports
o Provides a range of credit risk insurance covers to exporters against loss in
export of goods and services
o Offers Export Credit Insurance covers to banks and financial institutions to
enable exporters to obtain better facilities from them
o Provides Overseas Investment Insurance to Indian companies investing in
joint ventures abroad in the form of equity or loan

58
 Mutual Funds

A mutual fund is a pool of money from numerous investors who wish to save or
make money just like you. Investing in a mutual fund can be a lot easier than
buying and selling individual stocks and bonds on your own. Investors can sell
their shares when they want.

• Professional Management
• Fund Ownership
• Mutual Funds are Diversified
https://www.investopedia.com/terms/m/mutualfund.asp
59
•
Mutual Funds
Alternative Investment Funds:
An alternative investment is an asset that is not one of the conventional
investment types, such as stocks, bonds and cash. Most alternative
investment assets are held by institutional investors or accredited, high-
net-worth individuals because of the complex natures and limited
regulations of the investments. Alternative investments include strategies
like private equity, hedge funds, managed futures, real estate,
commodities and derivatives contracts.
https://www.investopedia.com/terms/a/alternative_investment.asp

• Portfolio Management Services:

Portfolio management Services popularly known as PMS are specialized
investment vehicle for lump sum investments. The portfolio manager
invests the money in shares and other securities and manages the
portfolio on behalf of the client. One can invest fresh money in PMS and
the portfolio managers will construct a portfolio by deploying that money.
Also one can transfer his existing share portfolio to the PMS provider, in this
case the portfolio manager will revamp the portfolio in sync with his
investment philosophy and strategy.
http://www.iciciprupms.com/index
60
 Insurance

• A promise of compensation for specific potential future losses in exchange for

a periodic payment.
• Insurance is designed to protect the financial well-being of an
individual, company or other entity in the case of unexpected loss.
• Some forms of insurance are required by law, while others are optional.
• Agreeing to the terms of an insurance policy creates a contract between
the insured and the insurer.
• In exchange for payments from the insured (called premiums), the
insurer agrees to pay the policy holder a sum of money upon the occurrence of
a specific event.
• Insurance works on the principle of Utmost Good Faith.
• Insurance companies are regulated by Insurance Regulatory and Development
Authority (IRDA)

61
 Types of Insurance

• Life Insurance: Life Insurance is a contract providing for payment of a sum of

money to the person assured or, following him to the person entitled to receive the
same, on the happening of a certain event. It is a good method to protect your
family financially, in case of death, by providing funds for the loss of income.

• General Insurance: Insurance other than ‘Life Insurance’ falls under the category of
General Insurance. General Insurance comprises of insurance of property against
fire, burglary etc. personal insurance such as Accident and Health Insurance, and
liability insurance which covers legal liabilities. There are also other covers such as
Errors and Omissions insurance for professionals, credit insurance etc.

• Health Insurance: Health insurance is a type of insurance coverage that covers the
cost of an insured individual's medical and surgical expenses. Depending on the
type of health insurance coverage, either the insured pays costs out-of-pocket and
is then reimbursed, or the insurer makes payments directly to the provider.
In health insurance terminology, the "provider" is a clinic, hospital, doctor,
laboratory, health care practitioner, or pharmacy. The "insured" is the owner of the
health insurance policy; the person with the health insurance coverage.

62
 Insurance
• Reinsurance companies: Insurance companies “sell” their insurance covers to large
overseas reinsurers as a measure of risk management.

• Insurance agents: Entities (individuals as well as companies) which sell insurance products
of only one insurance company in a category.

• Insurance brokers: Organizations which are allowed by IRDAI to sell insurance products of
more than one insurance company in a category.

Pension Funds:
• National Pension System: Voluntary, defined contribution retirement savings scheme
• Institutions under the purview of Pension Fund Regulatory and Development Authority
(PFRDA)
• NPS Trust
• Central Record Keeping Agency (CRA)
• Pension Funds
• Trustee Bank
• Custodian
• Aggregators
• Points of presence
• Government Nodal Office

63
Section 3 – Financial Instruments

64
 Financial Instruments

• This is an important component of financial system.

• The products which are traded in a financial market are financial assets,
securities or other type of financial instruments.
• There is a wide range of securities in the markets since the needs of investors
and credit seekers are different.
• They indicate a claim on the settlement of principal down the road or
payment of a regular amount by means of interest or dividend.

E.g., Equity shares, debentures, bonds, etc.

65
 Capital Markets

Capital market refers to a type of financial market, where individuals and institutions are
trading in financial securities. Public and private institutions or organisations usually list their
securities for selling among investors and for raising their funds. This kind of a market is made
for both primary and secondary market. In this market, long term maturity instruments are
listed, which have a period of more than one year.

• Capital market is classified into two categories, first one is Primary market and second is
Secondary market.
• In primary market, the all new shares are traded in market and , on the other hand, in the
secondary market, the existing securities are traded.
• The institutions of capital market facilitate foreign exchange loans, underwriting,
consultancy, rupee loans, etc.
• Capital market provides equity finance and long term debt to government or corporate.
66
 Capital Market
Instruments
Bonds
Shares Other
Derivatives

Capital
Debentures Market
Instruments

Options
Fixed
Deposits Futures

67
 Capital Market Instruments
• Shares: A unit of ownership interest in a corporation or financial asset. While
owning shares in a business does not mean that the shareholder has direct
control over the business's day-to-day operations, being a shareholder does
entitle the possessor to an equal distribution in any profits, if any are declared
in the form of dividends. The two main types of shares are common shares
and preferred shares.

• Bonds: A debt investment in which an investor loans money to an entity

(corporate or governmental) that borrows the funds for a defined period of
time at a fixed interest rate. Bonds are used by companies, municipalities,
states and governments to finance a variety of projects and activities. Bonds
are commonly referred to as fixed-income securities and are one of the three
main asset classes, along with stocks and cash equivalents.

• Derivatives: A security whose price is dependent upon or derived from one or

more underlying assets. The derivative itself is merely a contract between two
or more parties. Its value is determined by fluctuations in the underlying asset.
The most common underlying assets include stocks, bonds, commodities,
currencies, interest rates and market indexes. Most derivatives are
characterized by high leverage.
68
 Capital Market Instruments
• Options: A financial derivative that represents a contract sold by one party
(option writer) to another party (option holder). The contract offers the buyer
the right, but not the obligation, to buy (call) or sell (put) a security or other
financial asset at an agreed-upon price (the strike price) during a certain
period of time or on a specific date (exercise date).
Call options give the option to buy at certain price, so the buyer would want
the stock to go up. Put options give the option to sell at a certain price, so the
buyer would want the stock to go down.

• Futures: A financial contract obligating the buyer to purchase an asset (or the
seller to sell an asset), such as a physical commodity or a financial instrument,
at a predetermined future date and price. Futures contracts detail the quality
and quantity of the underlying asset; they are standardized to facilitate
trading on a futures exchange. Some futures contracts may call for physical
delivery of the asset, while others are settled in cash. The futures markets are
characterized by the ability to use very high leverage relative to stock
markets.

69
 Capital Market Instruments
• Debentures: Debenture is an instrument which is used by the Corporations and
Government for getting a loan from public and it is given under the
company’s Stamp Act. Corporations and Government can secure their
debenture on company assets which it issues as long term loans. In
Debentures, companies are required to announce a fixed return at the time
of issuance. Therefore, holders know that, how much amount they will get in
future by issuer. Debentures have various advantages for holders and issuers. It
implies that holders know that how much amount they will get in future,
therefore they do not worry about their payment and, in general, debentures
are freely transferable by their holder to others. Therefore, holders have a right
to transfer their shares to anyone before their redemption.

• Fixed Deposit: Fixed Deposit is that kind of bank account, where an amount is
deposited for a specified period of time. All Commercial banks offer their
customers with the facility of opening a fixed deposit in their bank. If the
account holder wishes to withdraw any amount of money from fixed deposit
account, then he will have to close the fixed deposit account. The main
purpose of account holders to open this account, is to earn interest money
from their actual money, which is given by the banks during a specified period
of time.

70
 Foreign Exchange Market
• Forex is one of the most biggest investment markets in the world and
it is a huge platform for investors for their investment.
• There are various forms of currencies included for trading on
international level.
• The investors invest their money on the value of currencies
fluctuation because of variation in the economic position of
countries and entire world economy.
• We are dealing with different currencies of countries. We are not
dealing with only one currency at one time, we have to deal with a
couple of currencies at one time, for example USD/INR.

A price of one currency expressed in terms of the currency of another

country is called as the exchange rate. For example, the ratio INR/USD is
53.9, which implies that one unit of US Dollar can buy or equals 53.9
Rupees of India. In that case, the US Dollar is a base currency and the
Indian Rupee is quote currency.

71
 Gold ETF
• Gold ETF is one of the most popular ETFs as it does not get
influenced due to stock fluctuations or inflation.

• Gold ETF fund is a fiscal instrument which works as a mutual

fund and whose prices are depending upon the market price
of gold. When the market price of gold increases, gold ETF
prices also increase.

• The services of Gold ETF fund transfers is available in few stock

exchanges, such as Mumbai, Paris, Zurich and New York.

• Gold ETF fund provides a variety of advantages to their

holders, such as Low cost, Tax advantage, Gold purity, there is
no need to worry about safety, Issue of selling gold bars and
also beneficial in short term investments.
72
 Money Market
Money Markets are generally considered to be the
more active place, where government and other
securities of very smaller time duration are traded.
India has a very active money market, where a host
of instruments are traded.
Here you have government banks, mutual funds and
various other large domestic institutions like insurance
companies also participating.

73
 Money Market
Instruments
• Money Market Instruments provide the tools by which one can
operate in the money market.
• Money market instrument meets short term requirements of the
borrowers and provides liquidity to the lenders.
• The most common money market instruments are:

74
 Money Market
Instruments
• Treasury Bills (T-Bills): Treasury Bills are one of the safest money market
instruments as they are issued by Central Government. They are zero-risk
instruments, and hence returns are not that attractive. T-Bills are circulated by
both primary as well as the secondary markets. They come with the maturities
of 3-month, 6-month and 1-year. The Central Government issues T-Bills at a
price less than their face value and the difference between the buy price and
the maturity value is the interest earned by the buyer of the instrument. The
buy value of the T-Bill is determined by the bidding process through auctions.
At present, the Government of India issues three types of treasury bills through
auctions, namely, 91-day, 182-day and 364-day.

• Certificate of Deposits (CDs): Certificate of Deposit (CD) is a negotiable

money market instrument and issued in dematerialised form or as a Promissory
Note against funds deposited at a bank or other eligible financial institution
for a specified time period. Guidelines for issue of CDs are presently governed
by various directives issued by the Reserve Bank of India (RBI), as amended
from time to time.

75
 Money Market
Instruments
• CDs can be issued by
(i) scheduled commercial banks {excluding Regional Rural Banks and Local
Area Banks}; and
(ii) select All-India Financial Institutions (FIs) that have been permitted by RBI
to raise short-term resources within the umbrella limit fixed by RBI.

The maturity period of CDs issued by banks should not be less than 7 days
and not more than one year, from the date of issue.
The FIs can issue CDs for a period not less than 1 year and not exceeding 3
years from the date of issue.

76
 Money Market
Instruments
• Commercial Papers (CPs): Commercial Paper is the short term unsecured
promissory note issued by corporates and financial institutions at a discounted
value on face value. They come with fixed maturity period ranging from 7 day
to 364 days. These are issued for the purpose of financing of accounts
receivables, inventories and meeting short term liabilities. The return on
commercial papers is higher as compared to T-Bills so is the risk as they are
less secure in comparison to these bills. It is easy to find buyers for the firms with
high credit ratings. These securities are actively traded in secondary market.

• Repurchase Agreements (Repo): Repurchase Agreements which are also

called as Repo or Reverse Repo are short term loans that buyers and sellers
agree upon for selling and repurchasing. Repo or Reverse Repo transactions
can be done only between the parties approved by RBI and allowed only
between RBI-approved securities such as state and central government
securities, T-Bills, PSU bonds and corporate bonds. They are usually used for
overnight borrowing. Repurchase agreements are sold by sellers with a
promise of purchasing them back at a given price and on a given date in
future. On the flip side, the buyer will also purchase the securities and other
instruments with a promise of selling them back to the seller.
77
 Money Market
Instruments
• Banker's Acceptance: Banker's Acceptance is like a short term investment
plan created by non-financial firm, backed by a guarantee from the bank. It's
like a bill of exchange stating a buyer's promise to pay to the seller a certain
specified amount at a certain date. And, the bank guarantees that the buyer
will pay the seller at a future date. Firm with strong credit rating can draw such
bill. These securities come with the maturities between 30 and 180 days and
the most common term for these instruments is 90 days. Companies use these
negotiable time drafts to finance imports, exports and other trade.

78
 Money Market
Instruments
Commercial bills: Commercial bill is a short term, negotiable and self liquidating
instrument with low risk. It enhances the liability to make payment on affixed date
when goods are bought on credit. The commercial bills are issued by the seller
(drawer) on the buyer (drawee) for the value of goods delivered by him. These
bills are of 30 days, 60 days or 90 days maturity.

If the seller is in need of funds, he may draw a bill and send it to the buyer for
seller is in need of funds, he may draw a bill and send it to the buyer for
acceptance. The buyer accepts the bill and promises to make payment on the
due date. He may also approach his bank to accept the bill.

The bank charges a commission for the acceptance of the bill and promises to
make the payment if the buyer defaults. Once this process in accomplished, the
seller can sell it in the market. This way a commercial bill becomes a marketable
investment. Usually, the seller will go to the bank for discounting the bill. The bank
will pay him after deducting the interest for the remaining period of the bill and
service charges from the face value of the bill. The interest rate is called the
discount rate on the bills.

79
 Call/ Notice & Term
Money Market
• Call Money, Notice Money and Term Money
markets are sub-markets of the Indian Money
Market.
• These refer to the markets for very short term funds.
o Call Money refers to the borrowing or lending of funds for 1 day.
o Notice Money refers to the borrowing and lending of funds for 2-14 days.
o Term money refers to borrowing and lending of funds for a period of more
than 14 days.

80
Section 4 – Financial Services

81
 Financial Services
• Financial services consist of services provided by Asset Management and Liability
Management Companies.

• They help to get the necessary funds and also make sure that they are efficiently
deployed.

• They assist to determine the financing combination and extend their professional
services up to the stage of servicing of lenders.

• They help with borrowing, selling and purchasing securities, lending and investing,
making and allowing payments and settlements and taking care of risk exposures
in financial markets. These range from the leasing companies, mutual fund houses,
merchant bankers, portfolio managers, bill discounting and acceptance houses.

• The financial services sector offers a number of professional services like credit
rating, venture capital financing, mutual funds, merchant banking, depository
services, book building, etc.

• Financial institutions and financial markets help in the working of the financial
system by means of financial instruments. To be able to carry out the jobs given,
they need several services of financial nature. Therefore, Financial services are
considered as the 4th major component of the financial system.
82
 Functions of Financial
services
• Facilitating transactions (exchange of goods and
services) in the economy.
• Mobilizing savings (for which the outlets would
otherwise be much more limited).
• Allocating capital funds (notably to finance
productive investment).
• Monitoring managers (so that the funds allocated
will be spent as envisaged).
• Transforming risk (reducing it through aggregation
and enabling it to be carried by those more willing
to bear it).

83
 Types of Financial
Services
Investment Investment
Distributors
Banking Advisory

Merchant Credit Custodial

Banking Rating services

Factoring Forfaiting Leasing

Hire Housing
Purchase Finance
84
 Types of Financial
Services
• Investment Bankers: An investment banker serves as a facilitator between a
company and investors when the company wants to issue Stocks or bonds.
The investment banker assists with pricing financial instruments so as to
maximize revenue and with navigating regulatory requirements. Often, when
a company holds its IPO, an investment bank will buy all or much of that
company’s shares directly from the company. Subsequently, as proxy for the
company holding the IPO, the investment bank will sell the shares on the
market.

• Distributors: Distribute various investment products such as mutual funds, IPOs

to the savers (commonly called investors). They earn commission from the
mutual funds, IPO issuers, however, they do not provide any investment
advice.

• Investment Advisor: Their role is to provide investment advice to the investors.

They earn fee from the investors. They are not allowed to distribute investment
products and earn commission from the mutual funds and other investment
product companies or from the issuing companies of the IPOs.

85
 Types of Financial
Services
• Merchant banking: Merchant banking is basically a service banking,
concerned with providing non-fund based services of arranging funds rather
than providing them. The merchant banker merely acts as an intermediary. Its
main job is to transfer capital from those who own it to those who need it.
Today, merchant banker acts as an institution which understands the
requirements of the promoters on the one hand and financial institutions,
banks, stock exchange and money markets on the other.

• Credit rating: Credit rating means giving an expert opinion by a rating agency
on the relative willingness and ability of the issuer of a debt instrument to meet
the financial obligations in time and in full. It measures the relative risk of an
issuer’s ability and willingness to repay both interest and principal over the
period of the rated instrument. It is a judgement about a firm’s financial and
business prospects. In short, credit rating means assessing the creditworthiness
of a company by an independent organisation.

86
 Types of Financial
services
• Custodial services: In simple words, the services
provided by a custodian are known as custodial
services .
o Custodian is an institution or a person who is handed over securities by the
security owners for safe custody.
o Custodian is a caretaker of a public property or securities. Custodians are
intermediaries between companies and clients (i.e. security holders) and
institutions (financial institutions and mutual funds).
o There is an arrangement and agreement between custodian and real
owners of securities or properties to act as custodians of those who hand
over it.
o The duty of a custodian is to keep the securities or documents under safe
custody.
o The work of custodian is very risky and costly in nature. For rendering these
services, he gets a remuneration called custodial charges.
Thus custodial service is the service of keeping the securities safe for and on
behalf of somebody else for a remuneration called custodial charges.

87
 Types of Financial
•
Services
Factoring: Factoring is an arrangement under which the factor purchases the
account receivables (arising out of credit sale of goods/services) and makes
immediate cash payment to the supplier or creditor. Thus, it is an arrangement in
which the account receivables of a firm (client) are purchased by a financial
institution or banker. Thus, the factor provides finance to the client (supplier) in
respect of account receivables. The factor undertakes the responsibility of
collecting the account receivables. The financial institution (factor) undertakes the
risk. For this type of service as well as for the interest, the factor charges a fee for
the intervening period. This fee or charge is called factorage.

• Forfaiting: Forfaiting is a form of financing of receivables relating to international

trade. It is a non-recourse purchase by a banker or any other financial institution of
receivables arising from export of goods and services. The exporter surrenders his
right to the forfaiter to receive future payment from the buyer to whom goods
have been supplied. Forfaiting is a technique that helps the exporter sells his goods
on credit and yet receives the cash well before the due date. In short, forfaiting is a
technique by which a forfaitor (financing agency) discounts an export bill and pay
ready cash to the exporter. The exporter need not bother about collection of
export bill. He can just concentrate on export trade.

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 Types of Financial
Services
• Leasing: Leasing is a process by which a firm can obtain the use of a certain fixed
assets for which it must pay a series of contractual, periodic, tax deductible
payments. The lessee is the receiver of the services or the assets under the lease
contract and the lessor is the owner of the assets. The relationship between the
tenant and the landlord is called a tenancy, and can be for a fixed or an indefinite
period of time (called the term of the lease). The consideration for the lease is
called rent.
Lease can be defined as the following ways:
 A contract by which one party (lessor) gives to another (lessee) the use and
possession of equipment for a specified time and for fixed payments.
 The document in which this contract is written.
 A great way companies can conserve capital.
 An easy way vendors can increase sales.

A lease transaction is a commercial arrangement whereby an equipment owner or

Manufacturer conveys to the equipment user the right to use the equipment in return
for a rental. In other words, lease is a contract between the owner of an asset (the
lessor) and its user (the lessee) for the right to use the asset during a specified period in
return for a mutually agreed periodic payment (the lease rentals). The important
feature of a lease contract is separation of the ownership of the asset from its usage.
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 Types of Financial
Services
• Hire Purchase: Hire purchase is a type of instalment credit under which the hire
purchaser, called the hirer, agrees to take the goods on hire at a stated rental,
which is inclusive of the repayment of principal as well as interest, with an option to
purchase. Under this transaction, the hire purchaser acquires the property (goods)
immediately on signing the hire purchase agreement but the ownership or title of
the same is transferred only when the last instalment is paid.

The hire purchase system is regulated by the Hire Purchase Act 1972. This Act
defines a hire purchase as “An agreement under which goods are let on hire and
under which the hirer has an option to purchase them in accordance with the
terms of the agreement and includes an agreement under which:
 The owner delivers possession of goods thereof to a person on condition that
such person pays the agreed amount in periodic instalments.
 The property in the goods is to pass to such person on the payment of the last
of such instalments, and
 Such person has a right to terminate the agreement at any time before the
property so passes”.

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 Types of Financial
Services
• Housing Finance: Housing finance is a business of financial
intermediation wherein the money raised through various sources
such as Public Deposits (which are subject to the regulatory
stipulations of NHB), institutional borrowings from banks, refinance
from NHB and their own capital, is lent to borrowers for purchasing a
house. These intermediaries lend money by accepting mortgage by
deposit of title deeds of the residential property.

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