COURSE 1

ACCUMULATING WEALTH
FOR CLIENTS

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 Overview of the Financial
Landscape, Markets, Economy, 1
and Regulations in India

CONTENT AREAS

Phases of the Indian Financial Sector

The Indian Financial System

Regulatory Framework in the Indian Financial System

Increasing Digitization

Growth in the Financial Services Industry

LEARNING OBJECTIVES
By the end of this lesson, you should be able to:

1 | Understand the Indian financial system.

2 | Understand the banking structure in India.

3 | Discuss the regulations in the Indian financial sector.

4 | Understand the trends in the Indian financial sector.

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KEY TERMS

Key terms appear in bold text in the chapter.

assets under management non-banking financial companies

capital markets payments banks

commercial banks Pension Fund Regulatory and Development

Authority
depository participants
public sector banks
financial intermediary
Reserve Bank of India
Insurance Regulatory and Development
Authority Securities and Exchange Board of India

nationalization small finance banks

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INTRODUCTION
India is one of the most vibrant major economies in the world, having transformed itself from an agriculture-based
economy to a fast-moving, services-focused economy. Its services sector currently accounts for nearly 55 per cent
of India’s gross domestic product (GDP). It has emerged as the fastest- growing major economy in the world in
recent years, and is expected to be one of the top three economic powers of the world over the next 10–15 years,
thanks to a young working population, political stability, globalization, encouraging regulations, urbanization,
government policies, and a culture of innovation and invention.
India has a well-diversified financial sector comprising of commercial banks, insurance companies, mutual funds,
pension funds, non-banking financial companies (NBFC), co-operatives, and other smaller financial entities
providing nearly 20 per cent of India’s GDP. The Indian financial landscape is still dominated by the banking industry,
which alone accounts for 60 per cent of the entire financial services industry.
The Indian economy has gone through a sea change and made monumental strides toward global standing, backed
by massive regulatory changes since the economy was opened up to the international market forces during the
liberalization period of 1991. The Indian economy, especially the financial services sector, is now held as an example
across the world.
Your understanding of the Indian economy in the current scenario, and projections for the future, will be incomplete
without knowing its history. Therefore, we begin this lesson with a brief journey through the modern Indian financial
system. We discuss the major changes that occurred after the liberalization phase of 1991–92. We also discuss the
various regulatory markets that regulate India’s financial system. Finally, you will learn about key trends in the
Indian financial system, which will also likely affect your clients’ investment decisions.

PHASES OF THE INDIAN FINANCIAL SECTOR

The Indian financial sector’s history can be divided into two distinct phases:
• Pre-independence
• Post-independence

PRE-INDEPENDENCE PHASE
The Bank of Hindustan was the first modern bank in India, established in 1770, but it did not survive long. Several
other banks were subsequently established by the East India Company to facilitate trade and finance in India. The
creation of three banks—the Bank of Bengal/Calcutta (1806), Bank of Bombay (1840), and Bank of Madras (1843),
collectively known as Presidency Banks—was an important milestones in the modern banking history of India. These
three banks were amalgamated to form the Imperial Bank of India in 1921, which acted as the central bank of India
until the eventual establishment of today’s central bank: Reserve Bank of India (RBI). Some other still active banks
established between 1865 and 1913 include Allahabad Bank, Punjab National Bank of India, Canara Bank, Indian
Bank, Bank of Baroda, Central Bank of India, and Bank of Mysore.
In the insurance sector, the first company, formed in 1818, was Oriental Life Insurance Company in Calcutta. Several
foreign and Indian companies were also operating during the pre-Independence era, including Albert Life Assurance,
Royal Insurance, Liverpool and London Globe Insurance, Bombay Mutual, and Empire of India. In 1912, the Indian
Life Assurance Companies Act was passed, which was the first statutory measure to regulate the Indian market.
The Bombay Stock Exchange (formerly known as the Native Share & Stock Brokers Association) is the oldest stock
exchange in Asia, formally established in 1875.

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POST-INDEPENDENCE PHASE
The post-independence phase can be further categorized under three stages:
• Pre-nationalization period
• Nationalization period
• Liberalization period

PRE-NATIONALIZATION PERIOD (1947 TO 1969)

At the time of independence, the India’s banks were fully under private ownership. These private owners, who were
driven strictly by profit motives, did not consider providing banking facilities to the rural population or to small
business organizations. Growth in the banking sector was very slow, and many banks experienced periodic failures.
To resolve these issues and streamline the Indian banking system, the Banking Regulation Act was passed in 1949,
RBI was vested with extensive power for the supervision of banking in India as the central banking authority.
In 1955, Imperial Bank of India was nationalized and formed into State Bank of India, which was intended to act as
the principal agent of RBI and handle the banking transactions of the country’s central and state governments.
There were a large number of Insurance companies operating in India during this period. In 1956, all these
companies were nationalized and Life Insurance Corporation of India (LIC) was formed with the absorption of
154 Indian and 16 non-Indian insurers, along with 75 provident societies.
In 1963, the first mutual fund company was formed in India by RBI under the name of Unit Trust of India (UTI). UTI
launched the first mutual fund scheme in India in 1964, named the Unit Scheme.

NATIONALIZATION PERIOD (1969 TO 1991)

To spread the banking system across the country, especially in the rural and semi urban areas, several banks in
India were nationalized by the Indian government in 1960, 1969, and 1980. After the nationalization period, almost
92% of the deposits in the country were managed by the nationalized banks. These banks were quantitative targets
for the expansion of their branch network and for the percentage of credit they had to extend to certain sectors
and groups in the economy. Therefore, the majority of rural and unbanked populations came under the banking
system. Many banks remained unprofitable and inefficient due to their poor lending strategies and lack of internal
governance under the government’s ownership.
In 1987, the first non-UTI public sector mutual funds were set up, which included SBI Mutual Fund (in June) and
Canbank Mutual Fund (in December). They were followed by LIC Mutual Fund, Punjab National Bank Mutual Fund,
and Indian Bank Mutual Fund in 1989; Bank of India and GIC Mutual Fund in 1990; and Bank of Baroda Mutual Fund
in 1992. However, these companies also failed to strike the desired impact in the Indian financial market.
Reforms in the financial sector were initiated in 1991, which were intended to open the economy to the global
markets and curb the inefficiencies of nationalized and government-owned financial institutions.

LIBERALIZATION PERIOD
In 1991, the Narasimham committee was formed, under the chairmanship of M. Narasimham, to reform India’s
banking practices. In the early 1990s, banking licences were granted to several private banks, including UTI Bank
(now Axis Bank), ICICI Bank, and HDFC Bank. Years later, in 2015, approval was granted “in-principle” by RBI to
11 applicants to set up payments banks and to 10 applicants to set up small finance banks.
The Insurance segment was also liberalized and opened to private companies during this period. In 1993, a
committee was set up by the Indian government under the chairmanship of R.N. Malhotra, the former governor
of RBI, to advise and recommend on reforms in the insurance sector. As per the recommendations of the
Malhotra committee, the Insurance Regulatory and Development Authority (IRDA) was constituted in 1999
as an autonomous body to regulate and develop the insurance industry. The insurance sector was finally opened

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to private companies in 2000, with the maximum permissible foreign participation at 26%. Several insurance
companies looking to take advantage of the opportunity were set up. Currently, there are 24 life insurance
companies and 34 general insurance companies operating in India.
The mutual fund sector was also opened up to the private sector in 1993, as a part of the financial liberalization
process. Several private mutual fund companies entered the market, with Kothari Pioneer (now merged with
Franklin Templeton) as the first company to be registered, in July 1993. Since then, many new private entities have
entered the mutual fund industry. Currently, there are 44 mutual fund companies operating in India.
The National Stock Exchange was incorporated in 1992 and commenced operations as a stock exchange in 1994. It
grew very quickly, to become the 11th largest stock exchange in the world.

THE INDIAN FINANCIAL SYSTEM

The financial markets enable efficient transfer and allocation of financial resources from savers to borrowers for
productive activities in the economy. Both savers and borrowers can be individuals or business organizations.
Without an efficient financial system in place, these surplus funds cannot be mobilized to the borrowers or
investors, who then use the excess funds. This process of mobilization of excess funds from the savers to the
investors is known as capital formation. To enable the overall growth of the country’s economy, an efficient financial
system is required.
The Indian financial system, as shown in Figure 1.1, comprises four major components: financial intermediary,
financial markets, financial instruments, and financial services. These four elements of the financial system are
closely related and complementary. They play a significant role in the mobilization and allocation of funds.

Figure 1.1 | India’s Financial System

Indian Financial System

Financial Financial Financial Financial

Intermediary Market Instruments Services

Non
Regulatory Unorganised Organised Cash Loans
Regulatory

RBI Banks Money Capital Savings

Shares
Lenders Market Account

NBFC’s Chit Funds Money Investment

SEBI Mutual Funds
Market Banking

Mutual Indigenous Cash

IRDA Funds Bonds,etc Management,
Bankers
etc

Insurance
PFRDA Companies

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BANKING STRUCTURE IN INDIA

In India, banks are classified under four major categories:
• RBI, the central bank
• Specialized banks
• Commercial banks
• Co-operative banks

The various components of the Indian banking structure are illustrated in Figure 1.2.

Figure 1.2 | India’s Banking Structure

Reserve Bank

Scheduled Non Scheduled Banks

Banks

Commercial Co-operative Specialized Banks

Banks Banks
Urban Co-operative Banks

State Co-operative Banks

District Co-operative Banks

Public Sector Private Sector Foreign Payments Small Finance

Banks Banks Banks Banks Banks

SBI

Nationalized Banks

Regional Rural
Banks

RESERVE BANK OF INDIA

RBI is the centre of the Indian banking system; in fact, it is the nerve centre of the Indian financial system. RBI is
the banker to the central government, state governments, and all banks. It is the regulator for the banking sector,
responsible for setting the monetary policies and maintaining the financial stability of the country.

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SPECIALIZED BANKS
Banks that cater to the requirements of, and provide support for, setting up activities only for specific purposes
are known as specialized banks. Specialized banks include National Bank for Agriculture and Rural Development
(NABARD), Small Industries Development Bank of India (SIDBI), and Export Import Bank of India (EXIM Bank).
For example, NABARD helps provide financing specifically and only to the agricultural and rural sector. SIDBI was
formed to support and provide loans to small-scale business units and enterprises. EXIM Bank provides assistance
specifically, and only, to importers and exporters.

COMMERCIAL BANKS
The primary function of commercial banks is to accept deposits from the public and grant loans. The primary
motive of a commercial bank is profitability. The Banking Regulation Act of 1949 defines a banking company as a
company that transacts the business of banking in India. Banking is defined as accepting, for the purpose of lending
or investment, deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque,
draft, order, or otherwise. Scheduled banks are defined as banks included in the Second Schedule of the Reserve
Bank of India Act of 1934. These banks must adhere to additional requirements, as required by RBI, and are therefore
considered safer banks for your clients.
Commercial banks are further classified under six categories:
• Public sector banks (PBS)
• Private sector banks
• Foreign banks
• Local area banks
• Payments banks
• Small finance banks

PUBLIC SECTOR BANKS

These banks are considered to be in the “public sector” because the government holds more than 51% of these
banks’ shares. In India, more than 70% of total banking transactions are carried out at these institutions. PSBs can
be further subdivided into three classes:
• State Bank of India: This is the largest bank in India with over 20,000 branches and 500 million clients. Note
that, although this bank, together with its subsidiaries, is often referred to as a nationalized bank, it is actually a
public sector undertaking, rather than one of the nationalized banks of India.

DID YOU KNOW?

On April 1, 2017, the State Bank of India became one of the 50 largest banks in the world after
merging with five associate banks:
• State Bank of Bikaner & Jaipur
• State Bank of Hyderabad
• State Bank of Mysore
• State Bank of Patiala
• State Bank of Travancore

• Nationalized Banks: The Indian government is the largest shareholder of nationalized banks and controls their
management. Currently, there are 19 nationalized banks in India, which have been taken over and are directly

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controlled by the Indian Government. Some nationalized banks include Allahabad Bank, Canara Bank, Central
Bank of India, Punjab National Bank, and Bank of Baroda.
• Regional Rural Banks (RRB): These banks were established to cater to and to boost the rural economy of India,
and they are sponsored by other public sector banks. The central government of India holds a 50% share in
these banks, the respective state governments hold a 15% share, and the sponsoring nationalized bank holds
a 35% share. These banks do not offer all products available at other commercial banks, and their area of
operation is restricted to 3–4 districts in a single state. RRBs perform three main functions:
Providing banking facilities to rural and semi-urban areas
Carrying out specific government operations (e.g., disbursement of wages of MGNREGA workers, distribution
of pensions)
Providing para-banking facilities (e.g., locker facilities, debit cards, credit cards)
Although RRBs were established to provide basic banking and financial services to rural India, they can also open
branches for operation in urban areas. Some RRBs include Uttar Bihar Gramin Bank, Dena Gujarat Gramin Bank,
Odisha Gramya Bank, Baroda Rajasthan Ksethriya Gramin Bank, and Allahabad UP Gramin Bank.

PRIVATE SECTOR BANKS

Most shares in a private bank are held by individuals, groups of people, or private companies. Most private banks are
known for their technology-driven infrastructure, superior service, innovative products, and aggressive marketing
strategies. They have recently become widely popular, especially among younger clients. Some private sector banks
include ICICI Bank, Axis Bank, and HDFC Bank.

FOREIGN BANKS
Foreign banks have their headquarters in a foreign country and operate in India as branches or representative
offices of foreign entities. These banks generally have fewer branches compared to Indian banks, and their branches
are usually located in metropolitan cities or state capitals. These banks are known for superior technology-driven
operations and innovative products, and their services are offered only to select groups of wealthy clients. Some
foreign banks operating in India include HSBC, Standard Chartered Bank, Citibank, Deutsche Bank, and DBS Bank.

LOCAL AREA BANKS

Local area banks are similar to RRBs in that they also operate only in a restricted geographical area. However,
unlike RRBs, they offer normal banking services to their clients. Local area banks were established to mobilize local
savings and utilize them in the form of loans within their local areas. Currently, there are only four local area banks
operating in India: Coastal Local Area Bank Ltd., Capital Local Area Bank Ltd., Krishna Bhima Samruddhi Local Area
Bank Ltd., and Subhadra Local Area Bank Ltd.

PAYMENTS BANKS
In 2015, RBI gave approval “in principle” for 11 entities to set up payments banks, with the intention to provide
banking services to migrant labour workforces, low income households, small businesses, other unorganized sector
entities, and other users. The scope of activities of payments bank includes the following services:
• Payment banks accept demand deposits from clients, with the restriction to hold a maximum balance of
₹100,000 per individual client.
• They can issue automated banking machine (ATM) cards and debit cards; however, they cannot issue credit
cards.
• Payment banks can provide payments and remittance services through various channels.
• They may act as business correspondents for other banks.
• Simple financial products, such as mutual fund units and insurance products, are available at a payments bank.

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Payments bank are restricted to undertake any lending activity, including issuance of credit cards. They can keep
their demand deposit balances in certain eligible government securities or Treasury bills (T-bills) with maturity up to
one year, and fixed deposits with other scheduled commercial banks.
Some payments banks operating in India include Fino Payments Bank Ltd., Airtel Payments Bank Ltd., India Post
Payments Bank Ltd., and Paytm Payments Bank Ltd.

SMALL FINANCE BANKS

RBI enabled small finance banks to operate in India to increase banking penetration in India’s unbanked areas. The
scope of small finance banks includes the following services:
• Local area banks accept deposits and lend money to clients, like any commercial bank.
• At least 50% of the bank’s total loans should constitute ₹2.5 million in loans and advances.
• Of all credit extended to clients, 75% should be reserved for priority sectors identified by RBI.
• At least 25% of new branches should be opened in unbanked rural areas.
• Small finance banks may offer financial services such as distribution of mutual fund units, insurance products,
and pension products with approval from RBI.

Small finance banks operating in India include Equitas Small Finance Bank, Ujjivan Small Finance Bank, Janalakshmi
Small Finance Bank, and Suryodaya Small Finance Bank.
Table 1.1 compares the objectives, eligible promoters, and scope of activities of payments banks against those of
small finance banks.

Table 1.1 | Comparison of Payments Banks and Small Finance Banks

Payments Banks Small Finance

Banks Objective

Provide small savings accounts, as well as payments Financial inclusion and supply of credit to small
and remittance services, to migrant labour workforces business units and farmers through high-technology
and low-income households. and low-cost operations.

Eligible Promoters

Individuals or professionals with necessary experience Resident individuals or professionals with 10 years of
and eligibility, existing NBFCs, corporate banking experience in banking and finance, companies and
correspondents, mobile companies, supermarket societies owned and controlled by residents, existing
chains, real estate co-operatives, and corporate NBFCs, microfinance institutions, and local area banks
entities. owned and controlled by residents.

Scope of Activities

Accept deposits, but the client’s account balance Basic services of accepting deposits and lending funds.
should not exceed ₹100,000.

Cannot extend loans or issue credit cards, but can issue No restrictions in the area of operations.
ATM and debit cards.

Can distribute low-risk simple financial products, such At least 50% of all loans constituting ₹2.5 million in
as mutual funds and insurance products. loans and advances.

Non-resident Indians not allowed to open accounts. No restriction on business with non-resident Indians.

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CO-OPERATIVE BANKS
Co-operative banks in India play a major role in the financial inclusion and increased banking penetration in rural
and urban lower-income group populations. Co-operative banks are registered under the Co-operative Societies Act
of 1965. Their banking-related activities are regulated and supervised by RBI or the National Bank for Agriculture
and Rural Development according to RBI guidelines (in the case of state or district level co-operative banks).
However, matters such as governance, audit, registration, and liquidation are managed by the respective state’s
Registrar of Co-operative Societies for co-operative banks operating within the geographical borders of a single-
state, or by Central Registrar of Co-operative Societies for co-operative banks operating in multiple states. The
management of these banks, as well as their organizational set up, is based on the co-operative principles of self-
help and mutual-help.
Co-operative banks can be broadly classified under three categories:
• Primary Co-operative Banks (or Urban Co-operative Banks)—Just like any other commercial bank, urban co-
operative banks offer basic services and financial products such as loans, banking, deposits, mutual funds, and
insurance. They may operate within a single state or have a presence in multiple states.
• State Co-operative Banks—These banks operate at the apex level in states. They are generally established by the
respective state government to develop the co-operative movement within the state.
• District Central Co-operative Banks—These banks operate at the district level. They often have multiple branches
within their district boundary.

Several other co-operative societies accept deposit and disburse loans from their members, operating at the local
or village level. These co-operative societies, known as primary agricultural credit societies, are outside the purview
of the Banking Regulation Act of 1949, and are therefore not regulated by RBI. The sole responsibility of governance
and supervision for these credit societies remains with the respective state’s Registrar of Co-operative Society.

DID YOU KNOW?

Net Interest Margin and Bank Profitability

Net interest margin (NIM) is the difference between interest income and interest expenses, expressed in
percentage terms, using the following equation:
Spread = Interest Income – Interest Expenses
NIM = Spread ÷ Average Assets
NIM is expressed as a percentage and ranges from 2% to 3% in banks, depending on their interest cost
and interest income. Therefore, NIM is affected by interest earned by the bank from loans, advances,
investments, and interest spent on deposits and other borrowings.
A bank’s NIM improves when the bank reduces the cost of deposits and borrowings, or when it increases
the stream of income from loans and investments.
Non-interest income is the other major contributor to bank profitability. It comes from services rendered
and other non-banking activities, such as gold sales, Demat accounts, issues of bank guarantees, and
letters of credit. Banks can increase their profitability by increasing their non-interest income.

FINANCIAL INTERMEDIARIES
Financial intermediaries are institutions that facilitate the transfer of capital from entities with a cash-surplus to
those that are cash-deficient. They mobilize the savings of households or businesses and allocate them to more
productive activities. They also provide advisory services related to raising funds from the market, mergers and
acquisitions, and corporate restructuring.

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The classic example of a financial intermediary is a bank that consolidates deposits and transforms the funds into
loans. The role of a financial intermediary is credit creation and administering the payments mechanism.
In India, financial intermediaries can be broadly divided into two broad classes: banks and non-banking institutions.
The second of the two classes—non-banking financial intermediaries (NBFI)—includes insurance companies, mutual
funds, investment companies, pensions, equity funds, and NBFCs. Some of these entities are briefly described as
follows:
• Asset management companies (AMC): An AMC is a company that pools the investors’ money and invests in
securities according to the client’s stated financial objectives. Since they have access to large pool of funds,
AMCs can diversify their investments in various instruments, thereby reducing investment risk. Diversifying
assets follows the old adage of “not keeping all of one’s eggs in one basket”. AMCs earn income by charging
service charges or management fees to their clients.
• Depository participants (DPs): In India, shares and securities are normally held in electronic form in an account
known as a Demat account, which can include shares, bonds, mutual funds, and other securities. The term
Demat is derived from the longer term “dematerialized”. In India, two central depositories hold all details about
the shareholders. These central depositories can be accessed through DPs, which act as intermediaries between
the investors and the central depositories. Demat accounts are opened with a DP, who may be a broker, a bank,
or any other financial institution authorised to open a Demat account.
• Insurance companies: Insurance companies provide coverage or compensation in case of loss, damage, injury,
or death caused to the insured, provided that the insured has taken out an insurance policy and has paid all
required insurance premiums. Insurance companies calculate the risk, or chance of the event occurring, and
determine the appropriate premium. They also provide insurance plans combined with the concept of saving
and investment, such as endowment plans and unit-linked insurance plans.
• NBFCs: Although NBFCs lend money to individuals and businesses, much like banks do, there are specific
differences between an NBFC and a bank:
An NBFC cannot accept a demand of any deposits, other than those authorized by RBI.
An NBFC is not part of the payment and settlement system, and it cannot issue cheques drawn on itself.
The deposit insurance provided by the Deposit Insurance and Credit Guarantee Corporation, which provides
insurance to clients of banks, is not available to depositors of NBFCs.

FINANCIAL MARKETS
A financial market is a place where savers and borrowers transact with each other through financial intermediaries.
In other words, it is a place where financial products are bought and sold through intermediaries. Financial markets
play an important role in the development of an economy. They help businesses raise the much needed finance
to be able to run their business with a reasonable amount of cost, time, and effort. Financial markets are freely
accessible by everyone. Therefore, the price of each financial instrument is determined solely by the forces of supply
and demand, without outside intervention. This allows for a fair trading ground for all investors and capital seekers,
irrespective of their size. Financial markets also provide liquidity to investors who plan to invest in the market for
only a short time.
As shown in Figure 1.3, financial markets can be structured into two broad components: capital markets and money
markets.

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Figure 1.3 | The Structure of Financial Markets

Financial
Markets

Capital Money
Market Market

Corporate Govt
Long Term Organized
Securities Securities
Loan Market Market
Market Market

Unorganized
Primary
Market
Market

Secondary
Market

CAPITAL MARKETS
Capital markets deal with financial products that have maturity periods longer than one year, whereas money
markets refer to financial instruments with shorter (less than 1 year) maturity periods.
Capital markets can be classified into three major segments: corporate (primary and secondary), government
securities, and long-term loan markets.
• Corporate securities market: In this market, corporate securities are traded, including equity shares, preference
shares, and debentures. This market can again be divided into a primary and a secondary market:
Primary market: The primary corporate securities market is where corporate securities are issued for the first
time and are purchased by the investors directly from the issuer of the instrument.
Secondary market: The secondary corporate securities market is where corporate securities are traded freely
among investors. The stock exchanges are classic examples of secondary markets. In India, the Bombay Stock
Exchange and the National Stock Exchange are the two prominent secondary markets.
• Government securities market: Government securities are bought and sold in this market, also known as a gilt
market. Buyers of government securities include institutional investors, insurance companies, banks, pension
funds, and provident funds.
• Long-term loan market: This market features long-term loans issued to corporate clients by banks or other
financial institutions.

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MONEY MARKETS
Money markets can be broadly classified into two segments: unorganized and organized markets.
• Unorganized market: This market comprises local money lenders, indigenous bankers, chit funds, and others.
• Organized market: This market is regulated and controlled by various regulatory bodies, including RBI and the
Securities and Exchange Board of India (SEBI). Securities traded in this market include T-bills issued by the
government, commercial papers issued by corporate entities, and certificates of deposit issued by financial
institutions.

FINANCIAL INSTRUMENTS
Another important constituent of the financial system is the financial instruments segment. Financial instruments
are contracts that can be traded between the interested parties for immediate cash or a right to receive cash at
some future date. Financial instruments available and actively traded in India include equity shares, derivatives,
mutual funds, T-bills, certificates of deposits, and commercial papers:
• Equity shares: These shares represent ownership in a company and are traded in the stock exchanges. Equities
have a potential to generate very high returns, although there is also a substantial underlying risk.
• Derivatives: These instruments are financial contracts that derive their value from the performance of the
underlying assets or group of assets such as equities, commodities, foreign currency, or interest rates. The most
popular derivatives in India are futures and options.
• Mutual funds: AMCs create these funds as vehicles for large numbers of investors to pool and invest their
resources in the capital markets. The funds are created by a team of professional fund managers, according to a
stated investment objective.
• T-bills: These securities are issued by the central government, and are therefore considered the safest
instrument. T-bills are issued with a maturity period of 14 days, 91 days, 182 days, or 364 days.
• Certificate of deposits: These securities are issued by banks and other financial institutions and are available for a
tenure of three months to five years.
• Commercial papers: These securities are promissory notes issued by corporate entities with a maturity period of
one to 270 days.

FINANCIAL SERVICES
The efficiency of a financial system depends largely on the quality and variety of financial services provided by
financial intermediaries. Financial services refer to all services provided by financial intermediaries. In India, the
most prevalent financial services include merchant banking services, credit card services, and financial advisory
services.

REGULATORY FRAMEWORK IN THE INDIAN FINANCIAL SYSTEM

The Indian financial system is highly regulated, with various independent regulators monitoring and controlling
financial markets such as banking, insurance, pension funds, and equity markets. These regulators provide
permissions to operate, and issue operational guidelines on every aspects of functioning, to the organizations in the
respective fields. They also seek periodical reports from these organizations in pre-determined formats. The most
prominent regulators in the Indian financial system are RBI, SEBI, IRDA, and the Pension Fund Regulatory and
Development Authority (PFRDA).

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RESERVE BANK OF INDIA

RBI is the most prominent of all regulators in the Indian financial system. RBI was established on April 1, 1935
in accordance with the provisions of the Reserve Bank of India Act of 1934. RBI was nationalized in 1949 and it is
currently fully owned by the Government of India. RBI is the sole regulatory authority of all the banks operating in
India. The most prevalent functions of RBI are briefly described below.

ISSUE OF CURRENCY NOTES

RBI issues the country’s currency notes and coins, as per the requirement of India’s economy. It also exchanges
or destroys currency and coins that are not fit for circulation to ensure that the proper quantity of good quality
currency notes and coins are in circulation.

CONTROLLING THE MONETARY POLICY

The money supply in the economy must be controlled with utmost care. The supply of money in the economy
is controlled by RBI using a process known as monetary policy. The policy aims to apply various tools to ensure
inflation remains controlled and economic growth continues.
RBI carefully monitors the economic position of the country and decides whether the money supply should be
increased or decreased. RBI uses various tools such as increasing or decreasing repo rates, which refers to the rates
at which the banks borrow money from RBI. Whenever the banks experience a shortage of funds, they can borrow
from RBI. When RBI reduces the repo rate, the banks borrow at lower rates, and can pass on a lower rate for lending
funds to clients. When loans are available at low rates, clients tend to increase their borrowing from banks and
spend more money on goods and services. This, in turn, increases the economic activity in the country. Conversely,
when repo rates increase, borrowing from RBI becomes more expensive, which makes loans from banks more
expensive and results in clients to borrowing less and spending less.

REGULATOR AND SUPERVISOR OF THE FINANCIAL SYSTEM

RBI prescribes the guidelines for the operations of India’s banking and financial systems. To determine these
guidelines, several factors are considered. Some factors include maintaining public confidence, protecting depositor
interests, and providing cost effective banking services to the public.

BANKER TO OTHER BANKS

All banks have to maintain an account with RBI. This enables statutory reserve requirements and maintenance
of transaction balances. It also helps to enable smooth, swift, and seamless clearing and settlement of interbank
obligations. RBI acts as a lender of the last resort for the banks in the country. It can come to the rescue of a bank that is
solvent but faces temporary liquidity problems by supplying it with much needed liquidity when no one else is willing to
extend credit to that bank. This facility is provided by RBI to protect the interests of the bank’s depositors and to prevent
the bank from the possibility of failure, which could result in serious financial instability for the country’s economy.

BANKER TO THE GOVERNMENT

RBI is the banker to the central and state governments. As a banker, RBI receives and makes payments on behalf
of the central and state governments. Much like any client’s bank account with a commercial bank, the accounts
of these governments are maintained with RBI. All government income, including income taxes and goods and
services taxes, are deposited in the various government accounts. Similarly, all payments that the central and
state governments have to make are issued from these accounts. RBI also acts as an advisor to the government on
financial and banking matters.

MANAGER OF FOREIGN EXCHANGE OF INDIA

Just like the supply of Indian currency is controlled by RBI, India’s foreign exchange market is also controlled and
managed by RBI. It provides the operational guidelines to the dealers in foreign currency and regulates India’s

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foreign exchange market. RBI holds India’s reserves of international currencies and administers the country’s
exchange control system.
Although RBI is the primary regulator in the Indian financial system, not all financial institutions are required to
register with RBI. Subject to certain conditions, various NBFCs are exempt, including housing finance companies,
merchant banking companies, stock exchanges, companies engaged in the business of stockbroking or sub-broking,
venture capital fund companies, nidhi companies, insurance companies, and chit fund companies. These entities are
exempt from the requirement of registration under Section 45-IA of the Reserve Bank of India Act of 1934.
Figure 1.4 shows the regulatory authority of various types of NBFCs.

Figure 1.4 | Regulatory Authority of Non-Banking Financial Companies

Overview of Regulators of Non-Banking Companies

Companies
(Registered under Section 3 of the Companies Act 1956)

NBFCs Regulated by
Other Regulators
NBFCs registered with RBI* Non Banking Non Financial
Companies

Regulation, Supervision, Authority for

Type of Financial Institutions Regulation, Supervision, Regulation, Supervision
Surveillance & Enforcement and Surveillance
under RBI Surveillance & Enforcement
under the Companies Act 1956.
Housing Finance Institutions National Housing Bank
Regulator :
Ministry of Corporate Affairs (MCA)
Merchant Banking
Company, Venture
Capital Fund Companies, Enforcement Agency :
Stock Broking, SEBI State Governments
Collective Investment
Schemes(CTS)

Nidhi Companies,
MCA
Mutual Benefit Companies

Chit Fund Companies State Government Companies

Insurance Companies IRDA

Source: Reserve Bank of India.

SECURITIES AND EXCHANGE BOARD OF INDIA

With increasing interest in stock markets by ordinary investors, the Indian government decided to establish a
regulatory body to control the securities market; thus, SEBI was formed in 1992. The main objectives of SEBI include
keeping a check on malpractices in the securities market and protecting the investors’ interests.
Specifically, SEBI has three important types of functions:
• Protective functions: SEBI issues various guidelines to the financial intermediaries and also supervises these
organizations so that malpractices can be minimized and investors’ interests are protected.
• Developmental functions: Various developmental activities are undertaken by SEBI, including increasing investor
awareness, arranging training of financial intermediaries, and promoting activities of the stock exchange. The
objective is to increase the level of business in the securities market.
• Regulatory functions: To regulate the securities market, SEBI frames rules and regulations, issues operational
guidelines, and registers and regulates the work of all individuals and entities associated with the stock
exchange in any manner, including brokers, mutual funds, and other participants.

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INSURANCE REGULATORY AND DEVELOPMENT AUTHORITY

IRDA was constituted in 1999 to regulate and govern India’s insurance industry. With its headquarters in Hyderabad,
in the state of Telengana, IRDA conducts the following responsibilities:
• Issue certificates of registration to applicants, and renewing, modifying, withdrawing, suspending, or cancelling
such registration, as necessary.
• Protect the interests of policy holders in matters concerning assignment of policy, nomination by policy
holders, insurable interests, settlement of insurance claims, surrendering value of policies, and other terms and
conditions of contracts of insurance.
• Specify requisite qualifications, code of conduct, and practical training for intermediaries or insurance
intermediaries and agents.
• Specify the code of conduct for surveyors and loss assessors.
• Promote efficiency in the conduct of insurance business.
• Promote and regulate professional organizations connected with the insurance and re-insurance business.
• Call for information, undertake inspections, and conduct enquiries and investigations, including audits of insurers,
intermediaries, insurance intermediaries, and other organizations connected with the insurance business.
• Control and regulate rates, advantages, terms, and conditions that may be offered by insurers in respect to life
insurance and general insurance business.
• Specify the form and manner in which books of accounts shall be maintained and statements of accounts shall
be rendered by insurers and other insurance intermediaries.
• Regulate the investment of funds by insurance companies.
• Adjudicate disputes between insurers and intermediaries or insurance intermediaries.
• Specify the percentage of life insurance business and general insurance business to be undertaken by the insurer
in the rural or social sector.

PENSION FUND REGULATORY AND DEVELOPMENT AUTHORITY

By virtue of the Pension Fund Regulatory and Development Authority Act passed by the Government of India in 2013,
PFRDA was made the sole authority to regulate the pension system in India. The Preamble of the Pension Fund
Regulatory and Development Authority Act describes the basic functions of the PFRDA as follows:
To promote old age income security by establishing, developing and regulating pension funds, to
protect the interests of subscribers to schemes of pension funds and for matters connected therewith
or incidental thereto.
PFRDA performs the following basic functions:
• Periodically issue notifications, circulars, and guidelines, or directions to the pension funds appointed by PFRDA
as to how the funds can be managed in accordance with the provisions of the Act.
• Ask for periodical reports from the pension funds, as required under the provisions of the Act, rules and
regulations, or any other guidelines issued by PFRDA.
• Issue guidelines as to how the valuation of the schemes would be done by the pension funds.
• Appoint various intermediaries in the system such as the Central Record Keeping Agency, pension funds,
custodians, points of presence, aggregators, trustee banks, annuity service providers, and NPS trusts.
• Monitor the performance of the various intermediaries.
• Regulate the manner in which subscriber contributions are invested by pension funds.
• Periodically ensure that all stakeholders comply with the guidelines and regulations issued by PFRDA.

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INCREASING DIGITIZATION
Financial institutions have always been prompt adopters of technology. Since the emergence of private banks in
India, retail clients have also been quick to adopt new technologies in the financial segment. Although Internet
banking and online broking services have been active for many years, other financial products and services offered
in digital form have seen a surge in interest. With the increase in the use of smart phones and the development of
mobile telecom infrastructure, more and more clients are accessing financial products and services using a digital
platform. Financial services organizations are increasingly seizing the opportunity to distribute their products
digitally in a more cost effective means.
However, as reported by the Mobile Association of India and KANTAR-IMRB in October 2017, although 59% of
urban populations use mobile devices to access the internet, only 18% of people in rural areas do so. As Figure 1.5
shows, even among mobile device users, only 42% of urban users and 15% of rural users use their mobile device for
online financial transactions. Therefore, there is still great untapped potential for Indian financial service providers to
offer their services digitally.

Figure 1.5 | Mobile Internet Access Among Urban and Rural Populations

Mobile Internet Users Purpose of Access (in %)

456 478

389

280 291 85
306 82
236 72
219 58
60
187
176
153 49
42
36
87 15
14

Oct’15 Dec’16 Dec’17(est) June’18(est) Urban Rural

Online Communication Entertainment Social Networking

Urban Rural Total

Other Online Services Online Finance & Transactions

Source: Kantar-IMRB All India Mobile Internet Users Estimates, October 2017.

As more and more financial technology (fintech) companies are entering the online financial market, traditional
financial intermediaries are facing considerable challenges distributing their products faster and more cost
effectively. In addition to banking, financial products and services such as mutual funds and insurance companies
are also offering their products and services online. Clients can choose their own plans and even subscribe to the
plans online, without the direct help of a human intermediary.
The demonitization of currency notes announced by the Indian government on November 8, 2016 increased the
focus on electronic payments among retail clients. The Report of the Working Group on FinTech and Digital Banking,
prepared by RBI, disclosed the following findings:
The Indian FinTech industry grew 282% between 2013 and 2014, and reached USD 450 million in
2015. At present around 400 FinTech companies are operating in India and their investments are
expected to grow by 170% by 2020. The Indian FinTech software market is forecasted to touch USD
2.4 billion by 2020 from a current USD 1.2 billion, as per NASSCOM. The transaction value for the
Indian FinTech sector is estimated to be approximately USD 33 billion in 2016 and is forecasted to
reach USD 73 billion in 2020.

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There are numerous benefits of technology’s involvement in the financial services industry. Some of those benefits
are briefly discussed below.

INCREASED SECURITY
Most banks have developed their customized and dedicated banking software with the assurance that all the
banking records are secured. Even transactions involving ATMs, Internet banking, or mobile banking facilities are
protected with personalized passwords or personal identification numbers that restrict access to the bank account
to the client.

FASTER SERVICE
All bank branches are now linked through a dedicated network. Each client’s information can be accessed by any
other branch within seconds, unlike times in the past when regular mail or couriers were used. Therefore, services
such as account opening, loan processing, and cheque clearance now take a fraction of the time they did in the past.

REDUCED COST
With the improvement of technology, the cost per transaction has been reduced significantly. Banks now employ
fewer employees than in recent years. The estimated cost to the bank for each transaction is currently ₹70–75 at
the branch, ₹15–16 at an ATM, ₹2 or less using online banking, and ₹1 or less using mobile banking. Other financial
institutions such as AMCs and NBFCs have also seen significantly lower costs thanks to digital technology. Lower
costs have resulted in increased profits for intermediaries. Clients also benefit by being able to conduct transactions
from their home or any nearby ATM, saving the cost and time of visiting one specific bank branch.

INCREASED COMFORT
Perhaps the greatest advantage of technology is the increased comfort that clients now experience by having the
luxury to complete their financial transactions anytime, from anywhere in the world. They can monitor and access
their accounts 24 hours a day using a computer or smart phone at their leisure, never having to wait for banking
hours at any particular bank branch.

GROWTH IN THE FINANCIAL SERVICES INDUSTRY

Currently India has are 27 public sector banks, 21 private sector banks, 49 foreign banks, 56 regional rural banks,
1,562 urban co-operative banks, and 94,384 rural co-operative banks. There has been tremendous growth in
the banking sector in recent years. During the period of 2007–2018, lending by banks increased at a rate of
10.94%, while deposits during the same period increased at a rate of 11.66%. As of September 2018, total credit
extended by commercial banks amounted to ₹90,579.89 billion (US$1,290.68 billion) and deposits amounted to
₹118,501.82 billion (US$1,688.54 billion).
Indian mutual funds have seen their assets under management (AUM) grow from ₹22.71 trillion in March 2018
to ₹24.58 trillion in March 2019, registering a growth rate of 8.23%. However, there has been volatility during that
period, with net outflows from the mutual fund sector. This trend is illustrated in Figure 1.6.

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Figure 1.6 | Mutual Fund Assets Under Management

24.70

24.31
24.09
23.96

23.57 23.59
23.43
23.25 23.15
23.17 23.21

22.71
22.60

17 8 18 18 18 -18 Jun-1
8
Jul-1
8 18 18 -18 -18 -18
Dec- Jan-1 Feb
- Mar- Apr- May Aug- Sep- Oct Nov Dec

Source: Association of Mutual Funds in India.

However, systematic investment loans (SIPs) have been on a constant growing curve, reflecting investor confidence
in the long-term prospects of the securities market. As per AMFI, MF industry had added about 9.13 lacs SIP
accounts each month on an average during the FY 2018-19, with an average SIP size of about ₹3,070 per SIP
account, as shown in Figure 1.7.

Figure 1.7 | Growth in the Systematic Investment Loans, 2013–2018 (in ₹ Million)

Month SIP Contribution ₹ crore

FY 2018 – 19 FY 2017 – 18 FY 2016 – 17

Total during FY 92,693 67,190 43,921

March 8,055 7,119 4,335

February 8,095 6,425 4,050

January 8,064 6,644 4,095

December 8,022 6,222 3,973

November 7,985 5,893 3,884

October 7,985 5,621 3,434

September 7,727 5,516 3,698

August 7,658 5,206 3,497

July 7,554 4,947 3,334

Jun 7,554 4,744 3,310

May 7,304 4,584 3,189

April 6,690 4,269 3,122

Source: AMFI

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Further research shows that individual investors constitute almost 53.6% of AUM in December 2018, in comparison
to 50.6% in December 2017. Institutional investors (e.g., banks, foreign institutional investors, foreign and domestic
companies, and high-net-worth clients investing more than ₹500,000 in a single scheme) account for 46.4% of
the total market. Although 68% of individual assets were invested in equity oriented schemes, 78% of institutional
investors’ AUM were held in liquid or money market and debt funds, as shown in Figure 1.8.

Figure 1.8 | Composition of Investors’ Holdings

Institutions Individuals

1% 6%

25%
46% 34%
68%
11%

9%

Debt oriented schemes ETFs, FoFs

Equity oriented schemes Liquid/ Money Market

Source: Association of Mutual Funds in India.

The Insurance sector also witnessed steady growth. In 2018, the gross amount of premiums collected was
₹5.53 trillion (US$94.48 billion). Of that amount, ₹4.58 trillion (US$71.1 billion) was from life insurance and
₹1.51 trillion (US$23.38 billion) was from non-life insurance products. Most of the life insurance market is still
dominated by the Life Insurance Corporation of India. However, private companies have been steadily increasing
their share of the life insurance market, which was 31.8% in September 2018, compared to only 2% in 2003.
In general insurance business, private companies have managed to capture almost 50% market share, as of
September 2018, as shown in Figure 1.9.

Figure 1.9 | Year on year Gross Insurance Premiums in India

Gross Premiums Written in India (US$ bn) Growth in Life Insurance Premiums(US$ bn)
41.0
37.7
35.3
94.5 33.3
30.1 30.1
84.7 27.3 27.2
26.3
71.8 13.4
Market 56.0
60.7
64.0
17.7
18.6 17.6
21.5

Size 49.0 13.1

8.6

FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19

New Business Premium Renewal Premium

Note: New business premium is up to September 2018 and Renewal premium is up to June 2018

Source: Insurance Regulatory and Development Authority

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There is a huge potential for growth in the insurance segment. Overall insurance penetration (i.e., premiums as
a percentage of GDP) was still very low in 2017, at 3.69%. The overall insurance industry is expected to reach
US$280 billion by 2020. India’s life insurance industry is expected grow at an annual rate of 12–15% for the next
three to five years.

GENERAL ECONOMIC GROWTH INDICATORS

As a wealth advisor, you must follow and monitor the macro economic factors that affect your client’s investment
returns. The Indian economy is considered the fastest-growing major global economy. In the next 10–15 years, it
is expected to become one of the top three economies in the world. Some important factors have secured India’s
position as a major global economy:
• According to the National Association of Software and Services Companies, approximately 1,400 new start-ups
were founded in India in 2016. Overall, India has 4,750 start-ups, which ranks third-highest in the world, and
is expected to have 100,000 start-ups by 2025, with a collective value of US$500 million, and employing a
workforce of 3.25 million people.
• During the period of April–November 2018, Indian exports increased by 15.48% over the previous year,
amounting to US$351.99 billion.
• The Nikkei India Manufacturing Purchasing Managers’ Index for December 2018 indicated healthy growth in the
manufacturing sector.
• In April–November 2018, total income tax collected reached ₹2.5 trillion (US$35.88 billion).
• During the period of April 2000 to June 2018, US$389.60 billion in foreign direct investment was recorded,
among the highest levels in the world.
• In 2017, approximately 10.8 million new jobs were created in India.
• India’s ranking in the World Bank’s Doing Business Report is currently 77 among 190 countries, for an
improvement by 23 spots over 2017.
• India is a world leader in inward remittances received; according to the World Bank’s Migration and
Development Brief, total remittances received by India in 2018 were approximately US$80 billion.

As shown in Table 1.2, India’s GDP growth rate in the third quarter of 2018 was estimated at 7.10%, which was
highest among G20 countries.

Table 1.2 | GDP Annual Growth Rate of the G20 Countries in September 2018

Country GDP Growth Rate

India 7.10

China 6.50

Indonesia 5.17

United States 3.00

Australia 2.80

Mexico 2.50

Saudi Arabia 2.50

Netherlands 2.40

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Table 1.2 | GDP Annual Growth Rate of the G20 Countries in September 2018

Country GDP Growth Rate

Spain 2.40

Switzerland 2.40

Singapore 2.20

Canada 2.10

South Korea 2.00

Euro Area 1.60

Turkey 1.60

Russia 1.50

United Kingdom 1.50

France 1.40

Brazil 1.30

Germany 1.10

South Africa 1.10

Italy 0.70

Japan 0.00

Argentina –3.50

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SUMMARY
Now that you have completed this lesson, let’s review your learning objectives:
1. Understand the Indian financial system.
• The Indian financial system comprises financial intermediaries, financial markets, financial instruments, and
financial services. All four elements of the financial system are closely related and complementary to each
other.
• The Indian financial sector’s history can be divided in two distinct phases: pre-independence and post-
independence.
• The post-independence phase can again be categorized under three stages: pre-nationalization,
nationalization, and liberalization.

2. Understand the banking structure in India.

• The central bank of any country regulates and manages the entire banking system of that country.
Specialized banks are set up for specific purposes related to the general development of the Indian economy.
The primary function of commercial banks is to accept deposits from clients and grant loans.
• Co-operative banks are registered under the Co-operative Societies Act of 1965 and their banking related
activities are regulated and supervised by RBI or by NABARD, as per guidelines issued by RBI.
• Financial intermediaries are institutions that facilitate the meeting of investors and borrowers. These
intermediaries mobilize the savings of individuals or businesses and allocate them to more productive
activities. Financial intermediaries also provide advisory services on activities such as raising funds from the
market, mergers and acquisitions, and corporate restructuring.

• The financial market is a place where savers and borrowers transact with each other through financial
intermediaries.
• Financial instruments are contracts that can be traded between interested parties against immediate cash or
a right to receive cash at some future date.
• Financial services provided by financial intermediaries include merchant banking services, credit card
services, and financial advisory services.

3. Discuss the regulations in the Indian financial sector.

• The Indian financial system is highly regulated, with various independent regulators monitoring and
controlling various financial markets, such as banking, insurance, pension funds, and equity markets.
• Some of the most prominent regulators in the Indian financial system are RBI, SEBI, IRDA, and PFRDA.

4. Understand the trends in the Indian financial sector.

• With the emergence of private banks in India, retail clients have been quick to adopt new technologies in the
financial segment. The financial services organizations are increasingly using the opportunity to distribute
their products digitally in a cost-effective manner.
• The financial services industry, including banking, mutual funds and insurance, has been growing at a
tremendous rate in recent years.

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