FINANCIAL INSTITUTION AND MARKETS

Meaning of Finance
The word finance is derived from the Latin word ‘finis’ which means money. Finance is an
activity by which savings especially bank deposits or currency notes are pooled and then placed
in the hands of the investors.
In simple words, finance refers to the management of the flow of money through
organisation. Finance is nothing but provision of money as and when required.

Definitions of Finance
According to Simon Andrade, “Finance is the area of economic activity in which money is
the basis of various embodiments, whether stock market investments, real estate, industrial,
construction, agricultural development, so on”.

According to Bodie and Merton, “Finance is the study of how scarce resources are allocated
over time”.

According to Henry Ford, “Finance or money is an arm or leg which one can either use it or
lose it”.

Meaning of Financial System

Financial system refers to a set of complex and closely connected or inter-linked financial
institutions or organised and unorganised financial markets, financial instruments and services
which facilitate the transfer of funds.

A financial system consists of institutional arrangements through which financial surplus in

the economy are mobilised from units having surplus funds and is transferred to units having
financial deficit. Financial system is a total of financial institutions, financial markets, financial
services, financial practices and procedures.

Meaning of Financial Dualism

Financial systems of most developing countries are characterized by co-existence and
cooperation
between the formal and informal financial sectors. This co-existence of two sectors is
commonly referred to as “Financial dualism.”

Definition of Financial System

According to Robinson, “Financial system is the primary function of the system which is to
provide a link between savings and investment for the creation of new wealth and to permit
portfolio adjustment in the composition of the existing wealth”.
OBJECTIVES OF FINANCIAL SYSTEM
The various objectives of financial system are as follows:
1. To mobilize the resources.
2. To create link between savers and investors.
3. To establish a regular smooth and efficient markets.
4. To create assets for the use of people.
5. To encourage savings and investment.
6. To facilitate economic development of the country.
7. To facilitate for expansion of financial markets.
8. To promote for efficient allocation of financial resources.
9. To make sound decisions based on cash flow and available resources.
10. To establish financial control and clear accounting procedures which ensure that funds are
used for intended purposes.

SIGNIFICANCE AND ROLE OF FINANCIAL SYSTEM

The financial system of our country plays a very important role in the economic
development. The financial system perform a number of functions. Some of the important
functions are as follows:

a) It ensures effective allocation of resources to different investment channels: An effective

financial system always enables proper allocation of resources to different investment
avenues.

b) It plays the role of a catalyst: The financial system plays the role of a catalyst by creation of
credit and providing finance and credit facilities to different investment opportunities.

c) It accelerates the rate of economic development: Financial system mobilises the savings and
also the investment. By doing so capital formation is achieved which in turn leads to allocating
resources to productive activities, which at last leads to the economic development.

d) It fosters industrial development: It is because of Indian financial system, institutions like

IDBI, IFCI, KSFC, ICICI etc. have been developed to foster industrial development. These
institutions help industries by providing financial, technical, marketing assistance.

e) It is a guide for investors education: The financial system play a very important role of
providing all necessary investment opportunities to the investors. The financial institutions,
banks etc. from time to time publish the necessary investors guide with required details about
investments to enlighten the investors.

f) It promotes self employment: The development banks and financial institutions are primarily
established with the objective of promoting self employment. By providing a means of self
employment to young educated men and women, it indirectly solves the problem of
unemployment.
g) It helps in the revival of sick units: The financial institutions in our country have specially
designed loans schemes to assist the revival of sick units. These loans are provided to sick
units at reasonable rate of interest.

h) It acts as the mobiliser of savings: The financial system mobilises and channelises the small
savings to productive activities. In other words, the financial system acts as the transformer
of savings into investment.

i) It is a provider of liquidity: The term liquidity refers to cash or money and other assets which
can be converted into cash within a short duration. Almost all the activities of a financial
system, are liquidity oriented i.e. there is either provision of liquidity or one can see trading in
liquidity.

FUNCTIONS OF FINANCIAL SYSTEM

1. Savings Function
Public savings find their way into the hands of those in production through the financial
system. Financial claims are issued in the money and capital markets which promise future
income flows. The funds with the producers result in production of goods and services thereby
increasing society living standards. This is one of the important functions of a financial system is
to link the savers and investors and thereby help in mobilizing and allocating the savings
efficiently and effectively. By acting as an efficient conduit for allocation of resources, it permits
continuous up-gradation of technologies for promoting growth on a sustained basis.

2. Liquidity Function
The term liquidity refers to ready cash or money and other financial assets which can be
converted into cash without loss of value and time. It provides liquidity in the market through
which claims against money can be resold by the investors and thereby assets can be converted
into cash at any time. This function allows for easy and fast conversion of securities into cash.
Thus, the major function of any financial system is the provision of money and monetary
assets for the purpose of production of goods and services. Therefore all the financial activities
are subjected to either provision of liquidity or trading in liquidity.

3. Payment Function
The financial system offers a very convenient mode for payment of goods and services.
Cheque system, credit card system etc. are the easiest methods of payments. The cost and time
of transactions are drastically reduced. A financial system not only helps in selecting projects to
be funded but also inspires the operators to monitor the performance of the investment. It
provides a payment mechanism for the exchange of goods and services and transfers economic
resources through time and across geographic regions and industries.

4. Risk Function
The term risk and uncertainty can be defined as the probability of happening of an
unexpected event due to which the investors may be under loss in future.
Whenever the mobilised savings are invested into different productive activities, the
investors are exposed to lower risk. This is mainly because of the benefits of ‘diversification’
that is available to even small investors. Every investor’s preference will be influenced by
considerations such as convenience, lower risk, liquidity etc.
Financial intermediaries enable the investors to diversify investments widely which helps in
reducing the risk of capital depreciation and poor dividends. Hence, a combination of financial
assets will help in minimising risk.

5. Policy Function
The government intervenes in the financial system to influence macroeconomic variables like
interest rates or inflation. So if country needs more money government would cut rate of interest
through various financial instruments and if inflation is high and too much money is available in
the system, then government would increase the rate of interest. It makes available price-related
information which is a valuable assistance to those who need to take economic and financial
decisions.

6. Provides Financial Services

A financial system minimizes situations where the information is an asymmetric and likely to
affect motivations among operators or when one party has the information and the other party
does not. It provides financial services such as insurance, pension etc. and offers portfolio
adjustment facilities.
Example: It provides fee based or advisory based financial services such as issue
management, portfolio management, corporate counselling, credit rating, stock broking etc. and
fund based or asset based financial services such as hire purchase, equipment leasing, bill
discounting, housing finance, insurance service, venture capital etc.

7. Lowers the Cost of Transactions

A financial system helps in the creation of a financial structure that lowers the cost of
transactions. This has a beneficial influence on the rate of returns to saver. It also reduces the
cost of borrowings. Thus, the system generates an impulse among the people to save more.

8. Financial Deepening and Broadening

A well-functioning financial system helps in promoting the process of financial deepening
and broadening. Financial deepening refers to an increase of financial assets as a percentage of
the Gross Domestic Product (GDP). Financial broadening refers to building an increasing
number variety of different participants and instruments.

Financial broadening begins when corporations seek to employ labor and capital according
to their relative contribution to production. It can also influence demand for capital goods (and
the labor to create and employ it) which depends on expected consumer demand in a future
period. It also includes Profit-maximization which aims to produce more with more productive
capital and less labor so that production generally becomes increasingly more capital intensive.
STRUCTURE OF INDIAN FINANCIAL SYSTEM OR COMPONENTS OF FINANCIAL
SYSTEM
Components/Constituents/Elements/Parts of Financial System
1. Financial Assets
2. Financial Intermediaries
3. Financial Markets
4. Financial Rates of Return
5. Financial Instruments and
6. Financial Services
7. Financial Institutions

1.FINANCIAL ASSETS
Meaning of financial assets
Financial assets refer to the cash or cash equivalents that are used for production or consumption
or for
further creation of assets. Cash, Bank Deposits, Shares, Debentures, Investment in Gold, Land &
Buildings, Contractual right to receive cash or another financial asset, etc., are called as financial
assets.

Classification of Financial Assets

Financial assets are classified in two ways
1. On the basis of marketability
2. On the basis of nature

Classification of Financial Assets on the basis of marketability

1. Marketable – The financial assets that can be bought and sold are called as marketable
financial
assets. They include Shares, Government Securities, Bonds, Mutual Funds, Units of UTI, Bearer
Debentures
2. Non-marketable – The financial assets that cannot be bought and sold are called as
nonmarketable finance assets. They include Bank Deposits, Provident Funds, LIC Policies,
Company Deposits, Post Office Certificates

Classification of Financial Assets on the basis of nature

1. Money or Cash Asset – Coins, Currency Notes, Bank Deposits
2. Debt Asset – Debenture & Bonds
3. Stock Asset – Equity Shares & Preference Shares

2.FINANCIAL INTERMEDIARIES/FINANCIAL INSTITUTIONS

Different kinds of organizations/institutions which intermediate and facilitate financial
transactions of both individual and corporate customers are called as financial intermediaries or
financial institutions.
Basically they are classified into two types:
1. Unorganized Sector
2. Organized Sector

Unorganized Sector
The sector that is not governed by any statutory or legal authority is known as unorganized
sector. This sector consists of the individuals and institutions for whom there are no standardized
rules and regulations governing their financial dealings. They are not under the supervision and
control of RBI or any other regulatory body. This sector consists of the individuals and
institutions like Local money lenders, Pawn brokers, Traders, Landlords, Indigenous bankers,
etc., who lend money to needy persons and institutions.

Organized Sector
The sector that is governed by some statutory or legal authority is known as organized sector.
This sector consists of the institutions like Commercial Banks, Non Banking Financial
Institutions, etc. They are further classified into two:
1. Capital Market Intermediaries
2. Money Market Intermediaries

Capital Market Intermediaries

Capital Market refers to the market for long term finance. The intermediaries provide long term
finance to individuals and corporate customers. IDBI, SFCs, LIC, GIC, UTI, MFs, EXIM
BANK, NABARD, NHB, NBFCs (Hire Purchasing, Leasing, Investment and Finance
Companies) Government (PF, NSC) etc., are in the organized sector providing long term finance.

Money Market Intermediaries

Money Market refers to the market for short term finance. The intermediaries provide short term
finance to individuals and corporate customers. RBI, Commercial Banks, Co-operative Banks,
Post Office Savings Banks, Government (Treasury Bills) are in the organized sector providing
short term finance.

3.FINANCIAL MARKETS
The group of individuals and corporate institutions dealing in financial transactions are termed as
financial markets. The centres or arrangements that facilitate buying and selling of financial
assets, claims and services are the constituents of financial market. Basically they are classified
into two categories:
1. Unorganized Market
2. Organized Market

Unorganized Market
The sector that is not governed by any statutory or legal authority is known as unorganized
sector. This sector consists of the individuals and institutions for whom there are no standardized
rules and regulations governing their financial dealings. They are not under the supervision and
control of RBI or any other regulatory body. Local money lenders, Pawn brokers, Traders,
Landlords, Indigenous bankers, etc., who lend money are in the unorganized sector.

Organized Market
The sector that is governed by some statutory or legal authority is known as organized sector.
This sector consists of the institutions for whom there are standardized rules and regulations
governing their financial dealings. They are under the supervision and control of RBI and other
statutory bodies. They are further classified into two:
A. Capital Market
B. Money Market
C. Foreign Exchange Market

A. Capital Market
Capital Market refers to the market for long term finance. Financial assets which have a long or
indefinite maturity period are dealt in this market. Capital Market is further classified into the
following three:
a) Industrial Securities Market
b) Government Securities Market
c) Long-term Loans Market

a) Industrial Securities Market - The financial market where industrial securities like
equity shares, preference shares, debentures, bonds, etc., are dealt with is called as
Industrial Securities Market. In this market, the industrial concerns raise their capital and
debts by issuing appropriate securities. This market is again classified into the following
two viz., Primary Market and Secondary Market

Primary Market - The financial market concerned with the fresh issue of industrial securities is
called as primary market. It is also called as new issue market. In this market, industrial
securities which are issued for the first time to the public are dealt.

Secondary Market - The financial market concerned with the purchase and sale of already
existing industrial securities is called as secondary market. In this market, industrial securities
which are already held by the individuals and institutions are bought and sold. Generally, these
securities are quoted in the stock exchanges. This market consists of all the stock exchanges
recognized by the Government of India. Securities Contracts (Regulation) Act, 1956 regulates
the stock exchanges and Bombay Stock Exchange is the main stock exchange in India which
leads the other stock exchanges.

b) Government Securities Market or Gilt-edged Securities Market - The financial

market where Government securities like stock certificates, promissory notes, bearer
bonds, treasury bills, etc., are dealt with is called as Government Securities Market. The
long term securities issued by the Central Government, State Governments, Semi-
government authorities like City Corporations, Port Trusts, etc., Improvement Trusts,
 State Electricity Boards, All India and State level financial institutes and public sector
enterprises are bought and sold in this market.

c) Long-term Loans Market - The financial market where long-term loans are provided to
the corporate customers is called as Long-term Loans Market. Development Banks and
Commercial Banks play a major role in this market. This market is classified into three
categories viz., Term loans market, Mortgages market and Financial guarantees market:

Term loans market - This market consists of the industrial financing institutions which supply
long term loan to corporate customers. They are created by the Government both at the national
level and regional level. They provide term loans to corporate customers and also help them in
identifying investment opportunities. They also encourage new entrepreneurs and support
modernization efforts. IDBI, IFCI, ICICI, SFCs, etc., come under this market.

Mortgages market - This market consists of the institutions which supply mortgage loan mainly
to individuals. The term ‘mortgage’ refers to the transfer of interest in a specific immovable
property to secure a loan.

Financial guarantees market - This market consists of the institutions which provide financial
guarantee to individuals and corporate customers. The term ‘guarantee’ refers to a contract
whereby one person promises another person to discharge the liability of a third person in case of
his default. There are different types of guarantees prominent among them are Performance
guarantee and Financial guarantee.

B. Money Market
Money Market refers to the market for short term finance. Financial assets which have a short
period of maturity are dealt in this market. Near money like Trade Bills, Promissory Notes, Short
term Government Papers, etc., are traded in this market.

Composition of money market (Financial instruments dealt in money market) - The money
market comprises of the following:
1. Call money market
2. Commercial bills market
3. Treasury bills market
4. Short-term loan market

1.Call money market - The market where finance is provided just against a call made by the
borrower is called call money market. In this market finance is provided for an extremely short
period of time.
2.Commercial bills market - The market where finance is provided by discounting of
commercial bills is called as commercial bills market. The term ‘commercial bills’ refer to the
bills of exchange arising out of genuine trade transactions.

3.Treasury bills market - The market where finance is provided against the treasury bills is
called as treasury bills market. The term ‘treasury bill’ refers to the promissory notes or finance
bills issued by the government for its short-term finance requirements.

4.Short-term loans market - The market where finance is provided in the form of short term
loans is called as short term loans market. The term ‘short-term’ refers to a period less than one
year. Commercial banks provide short term loans in the form of overdrafts and cash credits.
These loans are given to meet the working capital requirements of traders and industrialists.

C. Foreign Exchange Market

The market where foreign currencies are bought and sold against domestic currency is called
foreign exchange market. In other words, the system where the domestic currency is converted
into foreign currency and vice-versa is called as foreign exchange market.

4.FINANCIAL RATE OF RETURN

The term ‘financial rate of return’ refers to the percentage of income generated from the financial
assets throughout its effective life. For calculation of financial rate of return, two types of
incomes are considered. The first type of income is the annual income generated i.e., dividend on
shares or interest on securities. The second type of income is the capital appreciation. Capital
appreciation means increase in the value of securities over and above the purchase price of the
securities. Financial rate of return acts as a tool for investment decisions of the public and other
financial institutions. The financial system should offer attractive rate of return on investments so
that the investors would be ready to invest their surplus funds in the financial markets.

5.FINANCIAL INSTRUMENTS
Financial instruments refer to the documents that represent financial claim. A financial claim is
claim to the repayment of a certain amount of money at the end of a specified period along with
interest or dividend. Shares, Government Securities, Bonds, Mutual Funds, Units of UTI,
Debentures, Bank Deposits, Provident Funds, LIC Policies, Company Deposits, Post Office
Certificates, etc., are some of the examples of financial instruments. These instruments are
classified into two types, viz., Primary securities and Secondary securities.

Primary Securities – These are the financial instruments that are issued directly to the savers by
the users of the funds. For example, shares or debentures issued by a joint stock company
directly to the public and institutions are called as primary securities.

Secondary Securities – These are the financial instruments that are issued to the savers by some
intermediaries. For example, units issued by Unit Trust of India and other Mutual Fund
Organizations are called as secondary securities
6.FINANCIAL SERVICES
Financial services refer to the activities of channelizing the flow of funds from the savers to the
users. It involves the mobilization of savings of the persons and institutions who have surplus
funds and allocating or lending them to the persons and institutions who are in need of such
funds. The financial services are categorized into two groups, viz., Traditional services and
Modern services

1. Traditional services refer to the services that the financial institutions are rendering from a
very long time. They are further classified into two viz.,
a) Fund based services and
b) Non-fund or Fee based services.

2. Modern services refer to the services that the financial institutions are rendering in the recent
years.

7. Financial Institutions
Financial institutions are the intermediaries which facilitate smooth functioning of the
financial system by making investors and borrowers meet. They mobilize savings of the surplus
units and allocate them in productive activities promising a better rate of return. Financial
institutions also provide services to entities seeking advice on various issues ranging from
restructuring to diversification plans. They provide whole range of services to the entities who
want to raise funds from the markets elsewhere. Financial institutions act as financial
intermediaries because they act as middlemen between savers and borrowers, where these
financial institutions may be banking or non-banking institutions.

MEANING :
Financial institutions or financial intermediaries are those institutions, which provide financial
services and products which customers needs. Financial institutions provide all those services,
which a customer may not be able to get more efficiently on his own. Example: Customers not
having skill to invest in equity market efficiently can invest money in Mutual Funds and can
avail the benefits of capital market. Financial institutions provide all those financial services,
which are available in financial system.

CLASSIFICATION OF INDIAN FINANCIAL SYSTEM

(A) Organized Financial System

1. Regulators
Market Regulator is a body appointed under an act of Parliament to regulate one or several
markets to ensure integrity. In India, we have specific authorities to regulate each sector to
prevent overlapping.

The main sectors are banking, securities, insurance and pension. In India, we have the
following Regulators:
i) Reserve Bank of India (RBI)
ii) Securities and Exchange Board of India (SEBI)
iii) Ministry of Finance
iv) Ministry of Corporate Affairs
v) Insurance Regulatory Authority of India (IRAI)
vi) Pension Fund Regulatory and Development Authority (PFRDA)

2. Financial Institutions
Financial Institution is an establishment that focuses on dealing with financial transactions,
such as investments, loans and deposits. Conventionally, financial institutions are composed of
organizations such as banks, trust companies, insurance companies and investment dealers.
Almost everyone has to deal with a financial institution on a regular basis. Everything from
depositing money to taking loans and exchanging currencies must be done through financial
institutions.

Indian Financial Institutions are as follows:

i) Credit Rating Information Services of India Limited (CRISIL)
ii) Investment Information and Credit Rating Agency of India (ICRA India)
iii) Insurance Regulatory and Development Authority of India (IRDAI)
iv) Board for Industrial and Financial Reconstruction (BIFR)
v) Export Import Bank of India (EXIM)
vi) National Bank for Agricultural and Rural Development (NABARD)
vii) Small Industries Development Bank of India (SIDBI)
viii) National Housing Bank (NHB)

3. Financial Markets
A financial market is a market in which people and entities can trade financial securities,
commodities and other financial stock at low transaction costs and at prices that reflect supply
and demand. Securities include stocks and bonds and commodities include precious metals or
agricultural goods.

There are both general markets and specialized markets. Markets work by placing many
interested buyers and sellers, including households, firms and government agencies, in one
“place”, thus making it easier for them to find each other. An economy which relies primarily on
interactions between buyers and sellers to allocate resources is known as a market economy in
contrast either to a command economy or to a non-market economy such as a gift economy.

4. Financial Services
Financial services are the economic services provided by the finance industry, which
encompasses a broad range of organizations that manage money, including credit unions, banks,
credit card companies, insurance companies, consumer finance companies, stock brokerages,
investment funds and some government sponsored enterprises. Financial services refer to
services provided by the finance industry. The finance industry encompasses a broad range of
organizations that deal with the management of money.

(B) Unorganized Financial System

1. Money lenders
A moneylender is a person or group who offers small personal loans at high rates of
interest. The Register of Money Lenders required to be maintained under section 4 shall be in
Form 1. Display of the list of licensed money lenders. Every Assistant Registrar shall display on
a notice board in his office a list of money lenders licensed to carry on the business of money
lending in the area under his jurisdiction. Such list shall contain the addresses of the money
lenders.

2. Local Bankers
Local banker is a person who conducts the business of banking; one who, individually, or
as a member of a company, keeps an establishment for the deposit or loan of money, or for
traffic in money, bills of exchange, etc.

3. Traders
A trader is person or entity, in finance, who buys and sells financial instruments such as
stocks, bonds, commodities and derivatives, in the capacity of agent, hedger, arbitraguer and
speculator.

Traders are either professionals or institutions working in a financial institution or a

corporation or individual retail. They buy and sell financial instruments traded in the stock
markets, derivatives markets and commodity markets, comprising the stock exchanges,
derivatives exchanges and the commodities exchanges. Several categories and designations for
diverse kinds of traders are found in finance, these may include:
• Day trader • Floor trader • High-frequency trader
• Pattern day trader • Rogue trader • Stock trader

4. Landlords
A landlord is the owner of a house, apartment, condominium, land or real estate which is
rented or leased to an individual or business, who is called a tenant. When a juristic person is in
this position, the term landlord is used. Other terms include lessor and owner.

5. Pawn Brokers
A pawnbroker is an individual or business that offers secured loans to people, with items of
personal property used as collateral. The word pawn is derived from the Latin word ‘pignus’, for
pledge and the items having been pawned to the broker are themselves called pledges or pawns
or simply the collateral.
If an item is pawned for a loan, within a certain contractual period of time the pawner may
purchase it back for the amount of the loan plus some agreed-upon amount for interest. The
amount of time and rate of interest, is governed by law or by the pawnbroker’s policies. If the
loan is not paid (or extended, if applicable) within the time period, the pawned item will be
offered for sale by the pawnbroker. Unlike other lenders, the pawnbroker does not report the
defaulted loan on the customer’s credit report, since the pawnbroker has physical possession of
the item and may recoup the loan value through outright sale of the item. The pawnbroker also
sells items that have been sold outright to them by customers.

6. Chit Funds
A Chit fund is a kind of savings scheme practiced in India. A Chit fund company means a
company managing, conducting or supervising, as foremen, agent or in any other capacity, chits
as defined in Section 2 of the Chit Funds Act, 1982. According to Section 2(b) of the Chit Fund
Act, 1982, “Chit means a transaction whether called chit, chit fund, chitty, kuri or by any other
name by or under which a person enters into an agreement with a specified member of persons
where every one of them shall subscribe a certain sum of money (or a certain quantity of grain
instead) by way of periodical installments over a definite period and that each such subscriber
shall, in his turn, as determined by lot or by auction or by tender or in such other manner as
may be specified in the chit agreement, be entitled to the prize amount”.

GROWTH OF FINANCIAL SYSTEM IN INDIA

Until independence in the year 1947, there was no strong financial system in India. Private sector
and unorganized financial intermediaries were playing the key role of financing the industry.
They were not following any justifiable way in financing the trade and commerce. On the whole,
the financial system was facing a chaotic condition. The growth of financial system in India
since independence is discussed below:
1.Nationalization of Financial Institutions - After independence, with the adoption of mixed
economy, the government started creating new financial institutions for the supply of finance for
both industrial and agricultural purposes. For this purpose, some important financial institutions
of those days were nationalized. The financial institutions that were nationalized over the years
areas under:
 In the year 1948, Reserve Bank of India (which was established in the year 1935 as a
private sector central bank) was nationalized
 In the year 1955, the then Imperial Bank of India was nationalized and renamed as State
Bank of India
 In the year 1956, 245 life insurance business entities (consisting of 154 life insurance
companies, 16 foreign companies and 75 provident companies) were nationalized and
merged to form Life Insurance Corporation of India.
 In the year 1969, 14 Commercial Banks were nationalized
 In the year 1972, 107 general insurance business entities (consisting of 55 Indian
insurance companies and 52 other general insurance operations of other companies) were
 nationalized and merged to form General Insurance Corporation of India
 In the year 1980 another 6 Commercial Banks were nationalized

2.Establishment of Unit Trust of India – The Unit Trust of India (UTI) was established in the
year 1964 to strengthen the Indian financial system and supply institutional credit to industries. It
was entrusted with the work of mobilization of the savings of the public and provision of credit
facility to institutions for productive purposes. In recent years, it has established the following
subsidiaries:
 The UTI Bank Ltd.,
 The UTI Investor Service Ltd.,
 The UTI Security Exchange Ltd.,

3. Establishment of Development Banks – Development banks are the institutions that provide
medium and long term finance for agriculture and industrial development purposes. These are
established to provide not only credit facility but also assist in discovering investment projects,
preparing project reports, arranging technical advice, managing industrial units, etc. Basically
they are intended to develop backward regions as well as small and new entrepreneurs. The
development banks that were established over the years are as under:

 The Industrial Finance Corporation of India (IFCI) at the central level established in the
year 1948 to provide medium and long term finance to industrial concerns
 The State Financial Corporation (SFCs) at the state level established under the State
Financial Corporation Act, 1951 to provide medium and long term finance to medium
and small industries in the respective states.
 The Industrial Credit and Investment Corporation of India (ICICI) established in the year
1955 to develop large and medium industries in private sector. (Now this is merged with
ICICI Bank)
 The Refinance Corporation of India (RCI) established in the year 1958 with a view to
provide refinance facilities to banks against term loans granted by them to medium and
small units. (Now this is merged with Industrial Development Bank of India.
 The Industrial Development Bank of India (IDBI) established in the year 1964 as a
wholly owned subsidiary of the Reserve Bank of India to act as the apex institution in the
area of development banking and coordinate the activities of all the other financial
institutions. (Now the ownership of IDBI is with the central government)
 The State Industrial Development Corporation (SIDBI) / State Industrial Investment
Corporation (SIIC) established in the year 1990 under Small Industries Development
Bank of India Act, as the Principal Financial Institution for the Promotion, Financing and
Development of the Micro, Small and Medium Enterprise (MSME) sector and for
Coordination of the functions of the institutions engaged in similar activities.

4.Establishment of Agriculture Financing Institutions – Agricultural Refinance and

Development Corporation (ARDC) was established in the year 1963 to finance major
development projects like minor irrigation, farm mechanization, land development, horticulture,
dairy development, etc. However, National Bank for Agriculture and Rural Development
(NABARD) was established in the year 1982 and the ARDC was merged with it. Now the whole
sphere of agricultural finance has been entrusted with NABARD

5.Establishment of Export and Import Bank of India (EXIM Bank) – The Export and Import
Bank of India (EXIM Bank) was established in the year 1982 to take over the operations of the
International Finance Wing of IDBI. Its primary objective is to provide finance to exporters and
importers. It also functions as the principal financial institution for coordinating the working of
other institutions engaged in the financing of foreign trade.

6.Establishment of National Housing Bank (NHB) – The National Housing Bank was
established in the year 1988 as an apex institution to mobilize resources for the housing sector
and to promote housing finance institutions both at regional and local levels. It provides
refinancing, underwriting and guaranteeing facilities to housing finance institutions and
coordinates the working of all agencies connected with housing finance.

7. Establishment of Stock Holding Corporation of India Ltd., (SHCIL) – The Stock Holding
Corporation of India Ltd., (SHCIL) was established in the year 1987 to tone up the stock and
capital markets in India. It provides quick share transfer facilities, clearing services, depository
services, management information services and development services to both individual and
corporate investors.

8.Encouraging Mutual Funds Industry – Both private and public sector financial institutions
are being encouraged to float mutual funds.

9.Encouraging Venture Capital Industry – Both private and public sector financial institutions
are being encouraged to finance through venture capital.

10.Establishment of Credit Rating Agencies – Credit rating agencies like Credit Rating and
Information Services of India Ltd., (CRISIL), Investment Information and Credit Rating Agency
of India Ltd., (ICRA) and Credit Analysis and Research Ltd., (CARE) are being established to
help investors make decision of their investment and also to protect them from risky ventures.

11.Introduction of new financial instruments – New and different types of financial instruments
like public sector bonds, national savings certificates, post office savings scheme, different
variety of shares and debentures, different schemes of insurance, different types of bank deposits,
are being introduced to cater to the needs of different investors.

12.Legislative support – Over a period of time many legislative measures were taken up to
protect the interests of investors and streamline the financial functioning of various institutions.
Capital Issues Control Act, 1947; The Companies Act, 1956; Securities Contracts (Regulation)
Act, 1956; Monopolies and Restrictive Trade Practices Act, 1970; Foreign Exchange Regulation
Act, 1973 etc., are a few examples of legislations that support the smooth functioning and growth
of effective financial system in India.

13.New Economic Policy of 1991: Indian financial system has undergone massive changes
since the announcement of new economic policy in 1991. Liberalisation, Privatisation and
Globalisation has transformed Indian economy from closed to open economy. The corporate
industrial sector also has undergone changes due to delicensing of industries, financial sector
reforms, capital markets reforms, disinvestment in public sector undertakings etc. Since 1990s,
Government control over financial institutions has diluted in a phased manner. Public or
development financial institutions have been converted into companies, allowing them to issue
equity/bonds to the public. Government has allowed private sector to enter into banking and
insurance sector. Foreign companies were also allowed to enter into insurance sector in India.

Weaknesses of Indian Financial System

Even though Indian financial system is more developed today, it suffers from certain
weaknesses. These may be briefly stated below:

1. Lack of co-ordination among financial institutions: There are a large number of financial
intermediaries. Most of the financial institutions are owned by the government. At the same time,
the government is also the controlling authority of these institutions. As there is multiplicity of
institutions in the Indian financial system, there is lack of co-ordination in the working of these
institutions.

2. Dominance of development banks in industrial finance: The industrial financing in India

today is largely through the financial institutions set up by the government. They get most of
their funds from their sponsors. They act as distributive agencies only. Hence, they fail to
mobilise the savings of the public. This stands in the way of growth of an efficient financial
system in the country.

3. Inactive and erratic capital market: In India, the corporate customers are able to raise
finance through development banks. So, they need not go to capital market. Moreover, they do
not resort to capital market because it is erratic and inactive. Investors too prefer investments in
physical assets to investments in financial assets.

4. Unhealthy financial practices: The dominance of development banks has developed

unhealthy financial practices among corporate customers. The development banks provide most
of the funds in the form of term loans. So there is a predominance of debt in the financial
structure of corporate enterprises. This predominance of debt capital has made the capital
structure of the borrowing enterprises uneven and lopsided. When these enterprises face
financial crisis, the financial institutions permit a greater use of debt than is warranted. This will
make matters worse.
5. Monopolistic market structures: In India some financial institutions are so large that they
have created a monopolistic market structure in the financial system. For instance, the entire life
insurance business is in the hands of LIC. The weakness of this large structure is that it could
lead to inefficiency in their working or mismanagement. Ultimately, it would retard the
development of the financial system of the country itself.

6. Other factors: Apart from the above, there are some other factors which put obstacles to the
growth of Indian financial system. Examples are:
a. Banks and Financial Institutions have high level of NPA.
b. Government burdened with high level of domestic debt.
c. Cooperative banks are labelled with scams.
d. Investors’ confidence reduced in the public sector undertaking etc.,
e. Financial illiteracy.

Functions/Role/Importance/Objectives/Advantages of Financial System

1. Provision of liquidity
2. Mobilization of savings
3. Size transformation/Capital formation
4. Maturity transformation
5. Risk transformation
6. Lowering of cost of transaction
7. Payment mechanism
8. Assisting new projects
9. Enable better decision making
10. Meet short and long term financial needs
11. Provide necessary finance to the Government
12. Accelerate the process of economic growth of the country

Features/Characteristics of Financial System

1. Financial system acts as a bridge between savers and borrowers
2. It consists of a set of inter-related activities and services
3. It consists of both formal and informal financial sectors. The existence of both formal and
informal system is also called as financial dualism.
4. It formulates capital, investment and profit generation
5. It is universally applicable at firm level, regional level, national level and international level
6. It consists of financial institutions, financial markets, financial services, financial instruments,
financial practices and financial transactions.
FINANCIAL SECTOR REFORMS
Financial Sector Reforms are the steps taken to change the banking system, capital market,
government debt market, foreign exchange market, etc. An efficient financial sector enables
the mobilization of household savings and ensures their proper utilization in productive
sectors. This article will discuss the various aspects of financial sector reforms related to the
economic reforms of 1991

What is the Financial Sector?

The financial sector constitutes the commercial banks, non-banking financial companies,
investment funds, money market, insurance and pension companies, real estate etc.It forms
the core of an economy which facilitates the mobilization and distribution of financial resources.
It is engaged in providing financial services to the customers of the commercial and retail
segments.

Narasimhan Committee report (1991)

It was established to give reforms pertaining to the financial sector of India including the capital
market and banking sector. Some of its major recommendations have been mentioned below: It
recommended reducing the cash reserve ratio (CRR) to 10% and the statutory liquidity ratio
(SLR) to 25% over the period of time. It suggested fixing at least 10% of the credit for priority
sector lending to marginal farmers, small businesses, cottage industries, etc. In order to provide
required independence to the banks for setting the interest rates themselves for the customers, it
recommended de-regulating the interest rates.

Financial Sector Reforms in India

1. Reforms in the Banking Sector

 Reduction in CRR and SLR has given banks more financial resources for lending to the
agriculture, industry and other sectors of the economy.
 The system of administered interest rate structure has been done away with and RBI no
longer decides interest rates on deposits paid by the banks.
 Allowing domestic and international private sector banks to open branches in India, for
example, HDFC Bank, ICICI Bank, Bank of America, Citibank, American Express, etc.
 Issues pertaining to non-performing assets were resolved through Lok adalats, civil
courts, Tribunals, The Securitisation And Reconstruction of Financial Assets and the
Enforcement of Security Interest (SARFAESI) Act.
 The system of selective credit control that had increased the dominance of RBI was
removed so that banks can provide greater freedom in giving credit to their customers.
2.Reforms in the Debt Market
 The 1997 policy of the government that included automatic monetization of the fiscal
deficit was removed resulting in the government borrowing money from the market
through the auction of government securities.

 Borrowing by the government occurs at market-determined interest rates which have

made the government cautious about its fiscal deficits.

 Introduction of treasury bills by the government for 91 days for ensuring liquidity and
meeting short-term financial needs and for benchmarking.

 To ensure transparency the government introduced a system of delivery versus payment

settlement.

3.Reforms in the Foreign Exchange Market

 Market-based exchange rates and the current account convertibility was adopted in 1993.
 The government permitted the commercial banks to undertake operations in foreign
exchange.
 Participation of newer players allowed in rupee foreign currency swap market to
undertake currency swap transactions subject to certain limitations.
 Replacement of foreign exchange regulation act (FERA), 1973 was replaced by
the foreign exchange management act (FEMA), 1999 for providing greater freedom to
the exchange markets.
 Trading in exchange-traded derivatives contracts was permitted for foreign institutional
investors and non-resident Indians subject to certain regulations and limitations.
 UNIT 2
CAPITAL MARKET & MONEY MARKET

CAPITAL MARKET :The capital market is a market for financial assets which have a long
or indefinite maturity. Generally, it deals with long term securities which have a maturity period
of above one year.

Capital market simply refers to a market for long term funds. It is a market for buying and selling
of equity, debt and other securities. Generally, it deals with long term securities that have a
maturity period of above one year.

Characteristics of Capital Market

1. It is a vehicle through which capital flows from the investors to borrowers.
2. It generally deals with long term securities.
3. All operations in the new issues and existing securities occur in the capital market.
4. It deals in many types of financial instruments. These include equity shares, preference shares,
debentures, bonds, etc. These are known as securities. It is for this reason that capital market is
known as ‘Securities Market’.
5. It functions through a number of intermediaries such as banks, merchant bankers, brokers,
underwriters, mutual funds etc. They serve as links between investors and borrowers.
6. The constituents (players) in the capital market include individuals and institutions. They
include individual investors, investment and trust companies, banks, stock exchanges,
specialized financial institutions etc.

Functions of a Capital Market

The functions of an efficient capital market are as follows:
1. Mobilize long term savings for financing long term investments.
2. Provide risk capital in the form of equity or quasi-equity to entrepreneurs.
3. Provide liquidity with a mechanism enabling the investor to sell financial assets.
4. Improve the efficiency of capital allocation through a competitive pricing mechanism.
5. Disseminate information efficiently for enabling participants to develop an informed opinion
about investment, disinvestment, reinvestment etc.
6. Enable quick valuation of instruments – both equity and debt.
7. Provide insurance against market risk through derivative trading and default risk through
investment protection fund.
8. Provide operational efficiency through: (a) simplified transaction procedures,
(b) lowering settlement times, and (c) lowering transaction costs.
9. Develop integration among: (a) debt and financial sectors, (b) equity and debt instruments, (c)
long term and short-term funds.
10. Direct the flow of funds into efficient channels through investment and disinvestment and
reinvestment.

Distinguish between Money Market and Capital Market

Money market Capital market
1. Short term funds 1. Long term funds
2. Operational/WC needs 2. FC/PC requirements
3. Instruments are: bills, CPs,T-bills, CDs etc., 3. Shares, debentures, bonds etc., are main
instruments in capital market

4. Huge face value for single instrument 4. Small face value of securities

5. Central and coml. banks are major players 5. Development banks, investment
institutions are major players

6. No formal place for transactions 6. Formal place, stock exchanges

7. Usually no role for brokers 7. Brokers playing a vital role

Importance of Capital Market

The importance of capital market is outlined as below:
1. Mobilization of savings: Capital market helps in mobilizing the savings of the country. It
gives an opportunity to the individual investors to employ their savings in more productive
channels.
2. Capital formation: Large amount is required to invest in infrastructural foundation. Such a
large amount cannot be collected from one individual or few individuals. Capital market
provides an opportunity to collect funds from a large number of people who have investible
surplus. In short, capital market plays a vital role in capital formation at a higher rate.
3. Economic development: With the help of capital market, idle funds of the savers are
channelized to the productive sectors. In this way, capital market helps in the rapid
industrialization and economic development of a country.
4. Integrates different parts of the financial system: The different components of the financial
system includes new issue market, money market, stock exchange etc. It is the capital market
which helps to establish a close contact among different parts of the financial system. This is
essential for the growth of an economy.
5. Promotion of stock market: A sound capital market promotes an organized stock market.
Stock exchange provides for easy marketability to securities. A readymade market is available to
buyers and sellers of securities.
6. Foreign capital: Multinational Corporations and foreign investors will be ready to invest in a
country where there is a developed capital market. Thus capital market not only helps in raising
foreign capital but the foreign technology also comes within the reach of the local people.
7. Economic welfare: Capital market facilitates increase in production and productivity in the
economy. It raises the national income of the country. In this way, it helps to promote the
economic welfare of the nation.
8. Innovation: Introduction of a new financial instrument, finding new sources of funds,
introduction of new process etc. are some of the innovations introduced in capital market.
Innovation ensures growth.

Structure of Capital Market in India

1.Primary Market
The primary market in India is where new securities are issued and offered to the public for the
first time. It includes Initial Public Offerings (IPOs) by companies, rights issues, and private
placements. The Securities and Exchange Board of India (SEBI) regulates and oversees the
primary market.

2.Secondary Market
The secondary market is where already issued securities are bought and sold among investors. It
consists of stock exchanges, such as the National Stock Exchange (NSE) and the Bombay Stock
Exchange (BSE), where equity shares, bonds, and other securities are traded. SEBI regulates and
supervises the secondary market as well.

3.Stock Exchanges
The National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) are the two major
stock exchanges in India. They provide electronic trading platforms where investors can buy and
sell securities. These exchanges play a crucial role in price discovery, liquidity provision, and
facilitating fair and transparent trading.

4.Securities Depositories
In India, there are two central securities depositories, namely the National Securities Depository
Limited (NSDL) and the Central Depository Services Limited (CDSL). They facilitate the
electronic holding and settlement of securities, eliminating the need for physical certificates.

5.Regulatory Authorities
The capital market in India is regulated by SEBI, which oversees the functioning of stock
exchanges, brokers, investment banks, and other market intermediaries. SEBI formulates
regulations, monitors market activities, and ensures investor protection and market integrity
CAPITAL MARKET INSTRUMENT
1.Equity Shares- Represent ownership in a company; investors receive dividends and have
voting rights

2. Preference Shares- Carry preferential rights over equity shares, such as fixed dividend
payouts and priority in case of liquidation

3. Debentures- Long-term debt instruments issued by companies, providing fixed interest

payments and repayment of principal

4. Bonds- Fixed-income securities issued by governments and corporations, paying periodic

interest and returning the principal at maturity

5. Commercial Paper- Short-term unsecured promissory notes are issued by corporations

to meet short-term funding needs

6. Treasury Bills- Short-term government securities are issued to raise funds and manage
the short-term liquidity needs of the government

7. Mutual Funds- Pool funds from multiple investors to invest in a diversified portfolio of
securities, managed by professional fund managers

8. Exchange-Traded Funds (ETFs)- Invest in a basket of securities and trade on stock

exchanges like individual stocks

9. Real Estate Investment Trusts (REITs)- Enable investment in income-generating real

estate assets, offering regular income and potential capital appreciation

10. Infrastructure Investment Trusts (InvITs)- Allow investment in infrastructure

projects, providing regular income through distributions from project cash flows

11. Derivatives- Financial contracts with values derived from underlying assets, are used for
hedging, speculation, and risk management
Intermediaries/Players of Capital Markets
The following are the intermediaries: Financial intermediaries are the organizations that assist in
the transfer of money. They serve as a link between the surplus and deficit parties. For example:

1.Brokers: A broker assists in buying and selling shares for a commission.

2.Stock Exchanges: For example, National Stock Exchange (NSE), Bombay Stock
Exchange(BSE), etc

3.Regulator: Securities Exchange Board of India (SEBI) governs the capital markets in India.

Components of Capital Market

There are four main components of capital market. They are: (a) Primary market,
(b) Government Securities Market, (c) Financial Institutions, and (d) Secondary Market
These components of capital market may be discussed in detail in the following :

A. Primary Market /New Issue Market (NIM)

Every company needs funds. Funds may be required for short term or long term. Short term
requirements of funds can be met through banks, lenders, institutions etc. When a company
wishes to raise long term capital, it goes to the primary market. Primary market is an important
constituent of a capital market. In the primary market the security is purchased directly from the
issuer.

Meaning of Primary Market

The primary market is a market for new issues. It is also called new issue market. It is a market
for fresh capital. It deals with the new securities which were not previously available to the
investing public. Corporate enterprises and Govt. raises long term funds from the primary market
by issuing financial securities. Both the new companies and the existing companies can issue
new securities on the primary market. It also covers raising of fresh capital by government or its
agencies. The primary market comprises of all institutions dealing in fresh securities. These
securities may be in the form of equity shares, preference shares, debentures, right issues,
deposits etc.

B. Government Securities Market

This is another constituent of the capital market. The govt. shall borrow funds from banks,
financial institutions and the public, to finance its expenditure in excess of its revenues. One of
the important sources of borrowing funds is issuing Govt. securities. Govt. securities are the
instruments issued by central government, state governments, semi-government bodies, public
sector corporations and financial institutions such as IDBI, IFCI, SFCs, etc. in the form of
marketable debt. They comprise of dated securities issued by both central and state governments
including financial institutions owned by the government. These are the debt obligations of the
government.
Govt. securities are also known as Gilt-edged securities. Gilt refers to gold. Thus govt.
securities or gilt-edged securities are as pure as gold. This implies that these are completely risk
free (no risk of default). Govt. securities market is a market where govt. securities are traded. It
is the largest market in any economic system. Therefore, it is the benchmark for other market.
Government securities are issues by:

 Central Government
 State Government
 Semi-Government authorities like local government authorities, e.g., city
 corporations and municipalities
 Autonomous institutions, such as metropolitan authorities, port trusts,
 development trusts, state electricity boards.
 Public Sector Corporations
 Other governmental agencies, such as SFCs, NABARD, LDBs, SIDCs,
housing boards etc.

C. Financial Institutions
Financial institutions are the most active constituent of the Indian capital market. There are
special financial institutions which provide medium and long term loans to big business houses.
Such institutions help in promoting new companies, expansion and development of existing
companies etc. The main special financial institutions of the Indian capital are IDBI, IFCI, ICICI,
UTI, LIC, NIDC, SFCs etc.

D. Secondary Market
The investors want liquidity for their investments. When they need cash, they should be able to
sell the securities they hold. Similarly, there are others who want to invest in new securities.
There should be a place where securities of different companies can be bought and sold.
Secondary market provides such a place.

Meaning of Secondary Market

Secondary market is a market for old issues. It deals with the buying and selling existing
securities i.e. securities already issued. In other words, securities already issued in the primary
market are traded in the secondary market. Secondary market is also known as stock market. The
secondary market operates through ‘stock exchanges’. In the secondary market, the existing
owner sells securities to another party. The secondary markets support the primary markets. The
secondary market provides liquidity to the individuals who acquired these securities. The
primary market gets benefits greatly from the liquidity provided by the secondary market. This is
because investors would hesitate to buy the securities in the primary market if they thought they
could not sell them in the secondary marketlater.

In India, stock market consists of recognised stock exchanges. In the stock exchanges, securities
issued by the central and state governments, public bodies, and joint stock companies are traded.
Players Indian Capital Market Participants

1. Stock Exchange

A stock exchange is an organized marketplace or facility that brings buyers and sellers together
and facilitates the sale and purchase of stocks. It makes sure that trading transactions are done in
an efficient, orderly, fair, and transparent manner. It enforces rules and regulations that its
publicly listed companies and trading participants must strictly abide by. In this way, the
National Stock Exchange, for instance, fulfills its function as the “guardian” of the Indian stock
market.
2. Investors
Investors, also referred to as stockholders or shareholders, are those who own shares of stock of a
publicly listed company. They are accorded certain privileges like the right to fair and equal
treatment, the right to vote and exercise related rights, and the right to receive dividends and
other benefits due to stockholders. They are classified as either retail or institutional, and local or
foreign.
3. Stockbrokers
A stockbroker or trading participant is licensed by the Securities and Exchange Commission
(SEC) and is entitled to trade at the Exchange. They act as an agent between a buyer and seller of
stocks in the market. For their services as stockbrokers, they receive from their clients either a
buying or a selling commission.
There are two types of stockbrokers
Traditional – those who assign a licensed salesman to handle your account and to take your
orders via a written instruction or a phone call
Online – those whose main interface is the internet where clients execute their orders and access
market information online
4. Listed Companies
Listed companies, also called “issuers”, are those whose shares of stock are traded on the
Exchange. These companies qualified with the stringent listing and reportorial requirements of
the stock exchange, and have gone through initial public offering (IPO) or listing by way of
introduction.
5. Clearing House
A clearing house is a wholly owned subsidiary of the Exchange. It was established to ensure the
orderly settlement of equity trades executed at the Exchange.
6. Depository
The depository acts as securities depository or “custodian” of listed shares of stock that are
traded at the exchange. It was organized to establish a central depository in India and to
implement scripless trading.
 The depository performs book-entry transfer of securities:
 From seller’s to buyer’s accounts during settlement of Exchange trades;
 From one PDTC participant to another per client instruction, and;
 From lender’s to borrower’s account for loan transactions.
7.Settlement Banks
The settlement banks accept deposits of funds for payment of securities bought, confirm
payments of due clearing obligations to SCCP, debit buyer’s cash account and credit seller’s
cash account during settlement, and receive and/or return cash collateral put up by clearing
members to cover their daily trade negative exposures.
8.Transfer Agents
The stock transfer agent is considered the “official keeper” of the corporate shareholder records.
The stock transfer agents provide the issuer or the listed company with a list of holders of its
securities. They effect transfer of beneficial ownership and process corporate actions like stock
or cash dividends, stock rights, stock splits, and collation of proxy forms

New Financial Instruments in the Capital Market

With the evolution of the capital market, new financial instruments are being introduced to suit
the requirements of the market. Some of the new financial instruments introduced in recent years
may be briefly explained as below:

1. Floating rate bonds: The interest rate on these bonds is not fixed. It is a concept which
has been introduced primarily to take care of the falling market or to provide a cushion in
times of falling interest rates in the economy. It helps the issuer to hedge the loss arising
due to interest rate fluctuations. Thus there is a provision to reduce interest risk and
assure minimum interest on the investment. In India, SBI was the first to introduce FRB
for retail investors.

2. Zero interest bonds: These carry no periodic interest payment. These are sold at a huge
discount. These can be converted into equity shares or non-convertible debentures
3. Deep discount bonds: These bonds are sold at a large discount while issuing them.
These are zero coupon bonds whose maturity is very high (say, 15 years). There is no
interest payment. IDBI was the first financial institution to offer DDBs in 1992.

4. Auction related debentures: These are a hybrid of CPs and debentures. These are
secured, redeemable, non-convertible instrument. The interest on them is determined by
the market. These are placed privately with bids. ANZ Grindlays designed this new
instrument for Ashok Leyland Finance.

5. Secured Premium Notes: These are issued along with a detachable warrant. This
warrant gives the holder the right to apply for, or seek allotment of one equity share,
provided the SPN is fully paid. The conversion of detachable warrant into equity shares is
done within the time limit notified by the company. There is a lock in period during
which no interest is paid for the invested amount. TISCO was the first company to issue
SPN (in 1992) to the public along with the right issue.

6. Option bonds: Option bonds can be converted into equity or preference shares at the
option of the investor as per the condition stated in the prospectus. These may be
cumulative or non-cumulative. In case of cumulative bonds the interest is accumulated
and is payable at maturity. In case of non-cumulative bonds, interest is payable at
periodic intervals.

7. Warrants: A share warrant is an option to the investor to buy a specified number of

equity shares at a specified price over a specified period of time. The warrant holder has
to surrender the warrant and pay some cash known as ‘exercise price’ of the warrant to
purchase the shares. On exercising the option the warrant holder becomes a shareholder.
Warrant is yet to gain popularity in India, due to the complex nature of the instrument.

8. Preference shares with warrants: These carry a certain number of warrants. These
warrants give the holder the right to apply for equity shares at premium at any time in one
or more stages between the third and fifth year from the date of allotment.

9. Non-convertible debentures with detachable equity warrants: In this instrument, the

holder is given an option to buy a specified number of shares from the company at a
predetermined price within a definite time frame.

10. Zero interest fully convertible debentures: On these instruments, no interest will be
paid to the holders till the lock in period. After a notified period,these debentures will be
automatically and compulsorily converted into shares.
 11. Fully convertible debentures with interest: This instrument carries no interest for a
specified period. After this period, option is given to apply for equities at premium for
which no additional amount is payable. However, interest is payable at a predetermined
rate from the date of first conversion to second / final conversion and equity will be
issued in lieu of interest.

12. Non-voting shares: The Companies Bill, 1997 proposed to allow companies to issue
non-voting shares. These are quasi -equity instruments with differential rights. These
shares do not carry voting right. Their divided rate is also not predetermined like
preference shares.

13. Inverse float bonds: These bonds are the latest entrants in the Indian capital market.
These are bonds carrying a floating rate of interest that is inversely related to short term
interest rates.

14. Perpetual bonds: These are debt instruments having no maturity date. The investors
receive a stream of interest payment for perpetuity.

RECENT DEVELOPMENT IN INDIAN CAPITAL MARKET

1. Economic Liberalization due to Indian Capital Market:

The economic liberalization has led to more deregulation, liberalization and privatization of
some of the public sector undertakings in India. This has resulted in the shares of some of the
public sector undertakings being made available to the public. The Industrial policy adopted by
the government earlier did not allow investment in core sector by either individuals or private
sector. But, with the privatization of some of the public sector undertakings, the shares are now
available to the public for contribution.
Example: Steel Authority of India (SAIL). The Navarathna companies, consisting of major
public sector undertakings such as ONGC, BHEL, Oil India Ltd, Gas Authority etc., are some of
the companies which are yet to be privatized. Recently, the shares of VSNL were bought by
TATAs.

2. Promoting more private sector banks:

Opening of more private sector banks has resulted in the public contributing to the shares of
these banks in Indian capital Market. Recently, the government has announced 74% equity
participation by foreigners in private sector banks in India. This has not only promoted new
banks but also paved the way for the merger of existing banks with other banks. Example: The
merger of Bank of Madura with ICICI Bank.
3. Promotion of Mutual Funds:
The promotion of mutual funds by nationalized as well as non-nationalized banks has lso
improved the Indian capital market. They were helpful to the public by way of tax saving
schemes. Example: UTI’s monthly income scheme. Mutual Funds promoted by nationalized
banks have increased investments. SEBI has regulated the working of mutual funds and the
banks have to publish their net asset value every week by furnishing the details in leading
newspapers. At present, the condition of some of the mutual funds is very alarming, with the
value of their investment going below the face value ofthe securities. Hence, there is every
possibility of the public losing their confidence in the mutual funds. example: Unit Trust of
India.

4. Regulation of NRI Investments:

The Amendment of Foreign Exchange Regulation Act (FERA) into Foreign Exchange
Management Act (FEMA) has given more encouragement to non resident investors. The
percentage of NRI investment in Indian companies has been increased from 5% to 24%. In the
year 1991, India faced an acute shortage of foreign exchange and the then finance minister
adopted certain methods to improve the foreign exchange reserves. He allowed investment by
any individual NRI in any Indian company from the then existing 5% of paid up capital to 24%.
This had resulted in more inflow of foreign funds into India. Foreign financial institutions have
been made to invest directly in the Indian capital market. The lock-in period of NRIs in equity
shares in Indian companies has been reduced from 3 years to 1 year. Any profit earned while
diluting the shares will attract 20% tax on profit.

5. Direct Foreign Investment:

The Foreign Investment Promotion Board, consisting of the Secretaries of industries, finance and
foreign affairs, have allowed more direct foreign investment in core sector, especially in power
sector.

6. FERA Companies:
Under the Foreign Exchange Regulation Act, a FERA company is one which has 40% equity
participation by foreigners. This limit has been removed and now even foreign companies are
allowed to have 51% equity participation. For example, Colgate Polmolive has increased its
foreign equity participation from 40 to 51%. As a result, we are able to attract more foreign
capital into Indian capital market. The FERA Act has since been amended and is now known as
Foreign Exchange Management Act (FEMA).

7. Online Trading in Indian Capital Market:

Some of the leading stock markets in India have introduced computer system for their trading
activities. The brokers can get hooked-up and do their trading on Online basis. The computer
terminals will enable the public and the brokers to know the price prevailing in the market at any
time. This will prevent speculation activities.
8. Transparency through Online trading:
The online trading through computer has brought in transparency to the transactions in the
market. People are able to know prices prevailing in the market at any time and as such the
brokers cannot deprive their clients of their profits. The manipulation in the opening and closing
prices of shares by the brokers in the market is no longer possible.

9. National Stock Exchange:

A new stock market called National Stock Exchange has been created which has a large number
of companies listed. It is a big competitor to the Bombay Stock Exchange and it is able to even
influence the Bombay Stock Exchange. The National Stock Exchange deals in shares of
companies throughout India and the prices prevailing in the market is a benchmark for stock
prices. The creation of National Stock Exchange has not only widened the market, but has also
subdued the Bombay Stock Exchange. It has paved the way for all the leading companies’
equities being traded through a single market. Thus, it enables the public to know the true picture
of the companies and their real strength.

10. Sensitivity Index in Indian Capital Market:

The calculation of index number has also undergone a change. Sensitivity index has been
introduced which represents important 30 companies whose volume and value of shares
determines the market condition. The sensitivity index is an indication of the conditions
prevailing in the market and the conditions that are likely to be encountered by the market.

11. Circuit-Breaker in Indian Capital Market:

Wild fluctuations in the stock market is a thing of the past. There cannot be any more ‘stock
scam’ as engineered by Harshad Metha. For this purpose, the Bombay stock market has
introduced a cut-off switch which is called circuit breaker. Whenever the market index goes up
by more than 10%, the circuit breaker will go off, bringing the entire operations in the market to
a standstill. This will be for a period of 30 minutes after which the market will resume. This will
bring down the share price. The stock market operates for two hours each day and any
termination in the circuit breaker, after initial 1 and half hours of working will result in the
market closing for the day. Since the market operations cannot be resumed for the day, share
prices will fall. Wild speculation in shares will be a thing of the past.

12. Demating of shares in Indian Capital Market:

The introduction of demating has resulted in improving transactions further. Demating
is a system under which physical delivery of shares is no more adopted. It is called ”scripless
trade”. The shares of individual investors are held by stock holding company and a pass book is
given to individual investors. Any sale or purchase of shares will result in entries made in the
pass book. The companies concerned are also informed for making due alterations in the share
register. This has prevented blank transfer and speculation. Every transaction in the market is not
only recorded but it brings revenue to the Government in the form of registration and stamp
charges. Blank transfers will not be possible and short term speculation in shares cannot be done.
Every share purchased or sold will have to go for registration and hence bogus or benami share
transfer is not possible.

13. Market Makers in Indian Capital Market:

The share price of companies will be decided by the market forces of supply and demand. There
are market makers who will ensure the supply and reasonable price for the stocks of companies.
By the introduction of these market makers, manipulation of share price by the brokers is
prevented.

14. Securities and Exchange Board of India:

The creation of Securities and Exchange Board of India (SEBI) is an important development in
Indian capital market of India. SEBI has not only replaced the Controller of Capital issues, but
has brought in uniformity in the transactions in all stock exchanges.

15. Renewal of Registration:

All the brokers and sub brokers have to register afresh with SEBI and any complaints against
them will be inquired and if found guilty, punishment is given.

16. Over The Counter Exchange of India (OTCEI):

For the purpose of newly promoted companies, another stock exchange with lesser degree of
conditions has been promoted and it is called Over The Counter Exchange of India (OTCEI). It
may not be possible for all the newly companies to list their shares with the existing stock
exchanges. The share capital of these companies will be low and hence there should be an
arrangement for listing such companies’ shares. The creation of Over The Counter Exchange of
India (OTCEI) is helpful to these newly promoted companies.

17. Merchant banker:

Merchant bankers have been permitted to take part in the stock market. Operations and their
functions are also regulated by SEBI. They not only help companies in capital budgeting but also
guide the foreign investors in the purchase of securities. The merchant bankers, through the
financial markets, help some of the Indian companies to obtain fresh capital. They also go in for
syndication of loans and help the newly started companies in the issue of shares.

18. Non Banking Financial Companies:

The role of non-financial companies has also been controlled. RBI has introduced new
conditions, restricting their activities. New norms with regard to capital of non banking financial
companies have been introduced. For chit funds, a separate Act has been passed and it restricts
the maximum bidding to 40%.

19. Forward trading in Indian Capital market:

Forward trading has been introduced since 9th June 2000 in Bombay Stock Exchange on a trial
basis and if found successful, it will be extended. It will be helpful to the investors in
ascertaining the true colors of existing companies.
20. Badla transactions in Indian Capital Market:
Badla is a transfer of a contract from one period to another, where, either the buyer or the seller
is unable to execute the contract for which purpose, the defaulting parties will pay Badla charges
(which are decided by the Stock exchange). At present, SEBI has banned Badla transactions.

21. Restrictions on Mutual Fund’s Investment:

There have been restrictions on the role of mutual funds in the market. They cannot invest more
than 10% of their investable funds in any single company and not more than 10% of single
company’s issue of shares can be purchased by mutual funds.

22. Educating Public:

Press and media have contributed a lot in popularizing the Indian capital market andm they are
highlighting the prices of securities everyday. The mutual funds and merchant banks have been
asked to set apart a portion of their funds towards educating the public on the developments in
the Indian capital market.

23. Government Securities Market:

After the stock scam, the Central Government has de-linked Government securities from trading
along with company securities. In other words, there will be separate market for Government
securities and they will not be dealt along with company securities in the stock market. The
measure was taken by Dr. Manmohan Singh when he was the Finance Minister.

24. Future trading in Indian Capital Market:

Future trading is a contract to buy or sell a particular financial instrument on a future date at a
specific price. The contract enables the parties to transfer according to the changes in the price
from one person to another. By this, the risk is minimized. In every future contract, we have a
buyer and a seller. And if one makes a profit in a particular contract, the other person may try to
minimize his loss through some other contract. Thus, the future market provides scope for the
traders to minimize their loss or the risks in trading of financial instruments. We have different
types of ‘financial futures’.

25. Penalty for insider trading in Indian Capital Market:

In 2002, SEBI Act was amended to make insider trading punishable as a serious offense. The
penalty rate has been enhanced to Rs. 1 lakh per day and the maximum penalty can go up to Rs.
25 crores.

26. Period of settlement in Indian Capital Market:

After removing the Badla, SEBI has introduced T+2…… – system for settling transactions in
Indian capital market. Accordingly, all transactions entered in the capital market, should be
completed within 2 days excluding the date of trading. All the above measures have improved
the working of stock markets in India. If the present situation continues, we can expect in future
the uplinking of our stock market with that of the developed countries.
 Money Market

Money Market
Money market is a market for dealing with financial assets and securitieswhich have a maturity
period of upto one year. In other words, it is a market for purely short term funds.

Money market is a segment of financial market. It is a market for short term funds. It deals with
all transactions in short term securities. These transactions have a maturity period of one year or
less. Examples are bills of exchange, treasury bills etc. These short term instruments can be
converted into money at low transaction cost and without much loss. Thus, money market is a
market for short term financial securities that are equal to money.

Characteristics of Money Market

The following are the characteristics of money market:
1. It is a market for short term financial assets that are close substitutes of money.
2. It is basically an over the phone market.
3. It is a wholesale market for short term debt instruments.
4. It is not a single market but a collection of markets for several instruments.
5. It facilitates effective implementation of monetary policy of a central bank of a country.
6. Transactions are made without the help of brokers.
7. It establishes the link between the RBI and banks.
8. The players in the money market are RBI, commercial banks, and companies.

Functions of Money Market

Money market performs the following functions:
1. Facilitating adjustment of liquidity position of commercial banks, business undertakings and
other non-banking financial institutions.
2. Enabling the central bank to influence and regulate liquidity in the economy through its
intervention in the market.
3. Providing a reasonable access to users of short term funds to meet their requirements quickly
at reasonable costs.
4. Providing short term funds to govt. institutions.
5. Enabling businessmen to invest their temporary surplus funds for short period.
6. Facilitating flow of funds to the most important uses.
7. Serving as a coordinator between borrowers and lender of short term funds.
8. Helping in promoting liquidity and safety of financial assets.
Importance of Money Market
A well developed money market is essential for the development of a country. It supplies short
term funds adequately and quickly to trade and industry. A developed money market helps the
smooth functioning of the financial system in any economy in the following ways:
1.Development of trade and industry: Money market is an important source of finance to trade
and industry. Money market finances the working capital requirements of trade and
industry through bills, commercial papers etc. It influences the availability of finance both in the
national and international trade.

2.Development of capital market: Availability funds in the money market and interest rates in
the money market will influence the resource mobilisation and interest rate in the capital market.
Hence, the development of capital market depends upon the existence of a developed money
market. Money market is also necessary for the development of foreign exchange market and
derivatives market.

3. Helpful to commercial banks: Money market helps commercial banks for investing their
surplus funds in easily realisable assets. The banks get back the funds quickly in times of need.
This facility is provided by money market. Further, the money market enables commercial banks
to meet the statutory requirements of CRR and SLR. In short, money market provides a stable
source of funds in addition to deposits.

4. Helpful to central bank: Money market helps the central bank of a country to effectively
implement its monetary policy. Money market helps the central bank in making the monetary
control effective through indirect methods (repos and open market operations). In short, a well
developed money market helps in the effective functioning of a central bank.

5. Formulation of suitable monetary policy: Conditions prevailing in a money market serve as

a true indicator of the monetary state of an economy. Hence it serves as a guide to the Govt. in
formulating and revising the monetary policy. In short, the Govt. can formulate the monetary
policy after taking into consideration the conditions in the money market.

6. Helpful to Government: A developed money market helps the Govt. to raise short term funds
through the Treasury bill floated in the market. In the absence of a developed money market, the
Govt. would be forced to issue more currency notes or borrow from the central bank. This will
raise the money supply over and above the needs of the economy. Hence the general price level
will go up (inflationary trend in the economy). In short, money market is a device to the Govt. to
balance its cash inflows and outflows.

FEATURES AND OBJECTIVES OF MONEY MARKET

Following are the features of money market:

1. Money market has no geographical constraints as that of a stock exchange. The financial
institutions dealing in monetary assets may be spread over a wide geographical area.
2. Even though there are various centers of money market such as Mumbai, Calcutta, Chennai,
etc., they are not separate independent markets but are inter-linked and interrelated.
3. It relates to all dealings in money or monetary assets.
4. It is a market purely for short-term funds.
5. It is not a single homogeneous market. There are various sub-markets such as Call money
market, Bill market, etc.
6. Money market establishes a link between RBI and banks and provides information of
monetary policy and management.
7. Transactions can be conducted without the help of brokers.
8. Variety of instruments are traded in money market.

OBJECTIVES OF MONEY MARKET

Following are the objectives of money market:
1.To cater to the requirements of borrowers for short term funds, and provide liquidity
to the lenders of these funds.
2. To provide parking place for temporary employment of surplus fund.
3. To provide facility to overcome short term deficits.
4. To enable the central bank to influence and regulate liquidity in the economy.
5. To help the government to implement its monetary policy through open market
operation.

Components / Constituents / Composition of Money Market (Structure of

Money Market)

Money market consists of a number of sub markets. All submarkets collectively constitute the
money market. Each sub market deals in a particular financial instrument. The main components
or constituents or sub markets of money markets are as follows:
1. Call money market
2. Commercial bill market
3. Treasury bill markets
4. Certificates of deposits market
5. Commercial paper market
6. Acceptance market
7. Collateral loan market

I. Call Money Market

Call money is required mostly by banks. Commercial banks borrow money without collateral
from other banks to maintain a minimum cash balance known as cash reserve ratio (CRR). This
interbank borrowing has led to the development of the call money market.
Call money market is the market for very short period loans. If money is lent for a day, it is
called call money. If money is lent for a period of more than one day and upto 14 days is called
short notice money. Thus call money market refers to a market where the maturity of loans varies
between 1 day to 14 days. In the call money market, surplus funds of financial institutions, and
banks are traded. There is no demand for collateral security against call money.
In India call money markets are mainly located in big industrial and commercial centres like
Mumbai, Kolkata, Chennai, Delhi and Ahmadabad.

Participants or Players in the Call Money Market

1. Scheduled commercial banks and RBI
2. Non-Scheduled commercial banks
3. Co-operative banks
4. Foreign banks
5. Discount and Finance House of India
6. Primary dealers

The above players are permitted to operate both as lenders and borrowers. (1) LIC (2) UTI (3)
GIC (4) IDBI (5) NABARD (6) Specific mutual funds, etc. The above participants are permitted
to operate as lenders

2. Commercial Bill Market

Commercial bill market is another segment of money market. It is a market in which commercial
bills (short term) are bought and sold. Commercial bills are important instruments. They are
widely used in both domestic and foreign trade to discharge the business obligations (or to settle
business obligations). Discounting is the main process in this market. Hence commercial bill
market is also known as discount market.
There are specialized institutions known as discount houses for discounting commercial bills
accepted by reputed acceptance houses. RBI has permitted the financial institutions, mutual
funds, commercial banks and cooperative banks to enter in the commercial bill market.

3. Treasury Bills Market

Treasury bill market is a market which deals in treasury bills. In this market, treasury bills are
bought and sold. Treasury bill is an important instrument of short term borrowing by the Govt.
These are the promissory notes or a kind of finance bill issued by the Govt. for a fixed period not
extending beyond one year. Treasury bill is used by the Govt. to raise short term funds for
meeting temporary Govt. deficits. Thus it represents short term borrowings of the Govt.

Advantages or Importance of Treasure Bill Market

Advantages to the Issuer / Govt.

1. The Govt. can raise short term funds for meeting temporary budget deficit.
2. The Govt. can absorb excess liquidity in the economy through the issue of Tbills in the
market.
3. It does not lead to inflationary pressure.

Advantages for the Purchaser/ Investor

1. It is a ready market for purchasers or investors.

2. It is a safety instrument to invest.
3. Treasury bills are eligible securities for SLR requirement.
4. The market provides hedging facility.

4. Certificates of Deposits Market

CD market is a market which deals in CDs. CDs are short term deposit instruments to raise large
sums of money. These are short term deposits which are transferable from one party to another.
Banks and financial institutions are major issuers of CD. These are short term negotiable
instruments.

Advantages of CD Market

1. It enables the depositors to earn higher return on their short term surplus.
2. The market provides maximum liquidity.
3. The bank can raise money in times of need. This will improve their lending
capacity.
4. The market provides an opportunity for banks to invest surplus funds.
5. The transaction cost of CDs is lower.

5. Commercial Paper Market

Commercial Paper Market is another segment of money market. It is a market which deals in
commercial papers. Commercial papers are unsecured short term promissory notes issued by
reputed, well established and big companies having high credit rating. These are issued at a
discount. Commercial papers can now be issued by primary dealers and all India financial
institutions. They can be issued to (or purchased by) individuals, banks, companies and other
registered Indian corporate bodies. (Investors in CP)

Role of RBI in the Commercial Paper Market

The Working Group on Money Market (Vaghul Committee) in 1987 suggested the introduction
of the commercial Paper (CP) in India. As per the recommendation of the committee, the RBI
introduced commercial papers in January 1990. The Committee suggested the following:
(a) CP should be issued to investors directly or through bankers.
(b) The CP issuing company must have a net worth of not less then Rs. 5 crores.
(c) The issuing company’s shares must be listed in the stock exchange.
(d) The minimum amount of issue should be Rs. 1 crore and the minimum denomination of
Rs. 5 lakhs
(e) The CPs issuing cost should not exceed 1% of the amount raised.
(f) RBI is the sole authority to decide the size of issue and timing of issue.
(g) The instrument should not be subject to stamp duty at the time of issue and there should not
be any tax deduction at source.
(h) The interest on CP shall be a market determined.
(i) The issuing companies should get certification of credit rating for every six months and ‘A’
grading enterprises may be permitted to enter the market.

6. Acceptance Market
Acceptance Market is another component of money market. It is a market for banker’s
acceptance. The acceptance arises on account of both home and foreign trade. Bankers
acceptance is a draft drawn by a business firm upon a bank and accepted by that bank. It is
required to pay to the order of a particularparty or to the bearer, a certain specific amount at a
specific date in future. It is commonly used to settle payments in international trade. Thus
acceptance market is a market where the bankers’ acceptances are easily sold and
discounted.

7. Collateral Loan Market

Collateral loan market is another important sector of the money market. The collateral loan
market is a market which deals with collateral loans. Collateral means anything pledged as
security for repayment of a loan. Thus collateral loans are loans backed by collateral securities
such as stock, bonds etc. The collateral loans are given for a few months. The collateral security
is returned to the borrower when the loan is repaid. When the borrower is not able to repay the
loan, the collateral becomes the property of the lender. The borrowers are generally the dealers in
stocks and shares.

Money Market Instruments

As the name suggests, money market instrument is an investment mechanism that allows banks,
businesses, and the government to meet large, but short-term capital needs at a low cost. They
serve the dual purpose of allowing borrowers meet their short-term requirements and providing
easy liquidity to lenders.

Money Market Instruments

Money market is involved in buying and selling of short term instruments. It is through these
instruments, the players or participants borrow and lend money in the money market. There are
various instruments available in the money market. The important money market instruments
are:-
1. Call and short notice money
2. Commercial bills
3. Treasury bills
4. Certificate of deposits
5. Commercial papers
6. Repurchase agreements
7. Money market mutual funds.
8. ADR/GDR
These instruments are issued for short period. These are interest bearing securities. These
instruments may be discussed in detail in the following pages.

1. Call and Short Notice Money

These are short term loans. Their maturity varies between one day to fourteen days. If money is
borrowed or lent for a day it is called call money or overnight money. When money is borrowed
or lent for more than a day and up to fourteen days, it is called short notice money. Surplus funds
of the commercial banks and other institutions are usually given as call money. Banks are the
borrowers as well as the lenders for the call money. Banks borrow call funds for a short period to
meet the cash reserve ratio (CRR) requirements. Banks repay the call fund back once the
requirements have been met. The interest rate paid on call loans is known as the call rate. It is a
highly volatile rate. It varies from day to day, hour to hour, and sometimes even minute to
minute. Features of Call and Short Notice Money
1. These are highly liquid.
2. The interest (call rate) is highly volatile.
3. These are repayable on demand.
4. Money is borrowed or lent for a very short period.
5. There is no collateral security demanded against these loans. This means they
are unsecured.
6. The risk involved is high.

2. Commercial Bills
When goods are sold on credit, the seller draws a bill of exchange on the buyer for the amount
due. The buyer accepts it immediately. This means he agrees to pay the amount mentioned
therein after a certain specified date. After accepting the bill, the buyer returns it to the seller.
This bill is called trade bill.

The seller may either retain the bill till maturity or due date or get it discountedfrom some banker
and get immediate cash. When trade bills are accepted by commercial banks, they are called
commercial bills. The bank discounts this bill by deducting a certain amount (discount) and
balance is paid. A bill of exchange contains a written order from the creditor (seller) to the
debtor (buyer) to pay a certain sum, to a certain person after a certain period. According to
Negotiable instruments Act, 1881, a bill of exchange is ‘an instrument in writing containing an
unconditional order, signed by the maker, directing a certain person to pay a certain sum of
money only to, or to the order of a certain person or to the bearer of the instrument’.
Features of Commercial Bills
1. These are negotiable instruments.
2. These are generally issued for 30 days to 120 days. Thus these are short term credit
instruments.
3. These are self liquidating instruments with low risk.
4. These can be discounted with a bank. When a bill is discounted with a bank, the holder gets
immediate cash. This means bank provides credit to the customers. The credit is repayable on
maturity of the bill. In case of need for funds, the bank can rediscount the bill in the money
market and get ready money.
5. These are used for settling payments in the domestic as well as foreign trade.
6. The creditor who draws the bill is called drawer and the debtor who accepts the bill is called
drawee.

Types of Bills
Many types of bills are in circulation in a bill market. They may be broadly classified as follows:
1.Demand Bills and Time Bills :- Demand bill is payable on demand. It is payable immediately
on presentation or at sight to the drawing. Demand bill is also known as sight bill. Time bill is
payable at a specified future date. Time bill is also known as usance bill.

2. Clean Bills and Documentary Bills: When bills have to be accompanied by documents of
title to goods such as railway receipts, bill of lading etc. the bills are called documentary bills.
When bills are drawn without accompanying any document, they are called clean bills. In such a
case, documents will be directly sent to the drawee.

3. Inland and Foreign Bills :- Inland bills are bills drawn upon a person resident in India and
are payable in India. Foreign bills are bills drawn outside India and they may be payable either in
India or outside India.

4. Accommodation Bills and Supply Bills :- In case of accommodation bills, two parties draw
bills on each other purely for the purpose of mutual financial accommodation. These bills are
then discounted with the bankers and the proceeds are shared among themselves. On the due
dates, the parties make payment to the bank. Accommodation bills are also known as ‘wind
bills’ or ‘kite bills’. Supply bills are those drawn by suppliers or contactors on the
Govt. departments for the goods supplied to them. These bills are not considered as negotiable
instruments.

3. Treasury Bills
Treasury bills are short term instruments issued by RBI on behalf of Govt. These are short term
credit instruments for a period ranging from 91 to 364. These are negotiable instruments. Hence,
these are freely transferable. These are issued at a discount. These are repaid at par on maturity.
These are considered as safe investment.
Thus treasury bills are credit instruments used by the Govt. to raise short term funds to meet the
budgetary deficit. Treasury bills are popularly called Tbills. The difference between the amount
paid by the tenderer at the time of purchase (which is less than the face value), and the amount
received on maturity represents the interest amount on T-bills and is known as the discount
.
Features of T-Bills
1. They are negotiable securities.
2. They are highly liquid.
3. There is no default risk (risk free). This is because they are issued by the Govt.
4. They have an assured yield.
5. The cost of issue is very low. It does not involve stamp fee.
6. These are available for a minimum amount of Rs. 25000 and in multiples thereof.

Types of T-Bills
There are two categories of T-Bills. They are:
1.Ordinary or Regular T-Bills: These are issued to the public, banks and other institutions to
raise money for meeting the short term financial needs of the Govt. These are freely marketable.
These can be bought and sold at any time.

2. Ad hoc T-Bills: These are issued in favour of the RBI only. They are not sold through tender
or auction. They are purchased by the RBI on tap. The RBI is authorised to issue currency notes
against there. On the basis of periodicity T-bills may be classified into four. They are as follows :
1. 91-Day T-Bills
2. 14-Day T-Bills
3. 182-Day T-Bills: - These were introduced in November 1986 to provide short term investment
opportunities to financial institutions and others.
4. 364-Day T-Bills

4. Certificate of Deposits (CDs)

With a view to give investor’s greater flexibility in the development of their short term surplus
funds, RBI permitted banks to issue Certificate of Deposit. CDs were introduced in June 1989.
CD is a certificate in the form of promissory note issued by banks against the short term deposits
of companies and institutions, received by the bank. Simply stated, it is a time deposit of specific
maturity and is easily transferable. It is a document of title to a time deposit. It is issued as a
bearer instrument and is negotiable in the market. It is payable on a fixed date. It has a maturity
period ranging from three to twelve months. It is issued at a discount rate varying between 13%
to 18%. The discount rate is determined by the issuing bank and the market. All scheduled banks
except Regional Rural Banks and scheduled co-operative banks are eligible to issue CDs
to the extent of 7% of deposits. It can be issued to individuals, corporations, companies, trusts,
funds and associations. CDs are issued by banks during period of tight liquidity, at relatively
high interest rate. Banks rely on this source when the deposit growth is low but credit
demand is high. They can be issued to individuals, companies, trusts, funds, associates, and
others. The main difference between fixed deposit and CD is that CDs are easily transferable
from one party to another, whereas FDs are non-transferable.
Features of CDs
1. These are unsecured promissory notes issued by banks or financial institutions.
2. These are short term deposits of specific maturity similar to fixed deposits.
3. These are negotiable (freely transferable by endorsement and delivery)
4. These are generally risk free.
5. The rate of interest is higher than that on T-bill or time deposits
6. These are issued at discount
7. These are repayable on fixed date.
8. These require stamp duty.

Guidelines for Issue of CDs

CDs are negotiable money market instruments. These are issued againstdeposits in banks or
financial institutions for a specified time period. RBI has issued several guidelines regarding the
issue of CDs. The following are the RBI guidelines:
1. CDs can be issued by scheduled commercial banks (excluding RRBs and Local Area Banks)
and select all-India financial institutions.
2. Minimum of a CD should be Rs. 1 lakh i.e., the minimum deposit that could be accepted from
a single subscriber should not be less than Rs. 1 lakh and in the multiples of Rs. 1 lakh thereafter.
3. CDs can be issued to individuals, corporations, companies, trusts, funds, and associations.
NRIs may also subscribe to CDs, but only on a repatriable basis.
4. The maturity period of CDs issued by banks should not be less than 7 days and not more than
one year. Financial institutions can issue CDs for a period not less than one year and not
exceeding 3 years from the date of issue.
5. CDs may be issued at a discount on face value. Bankers/Fls are also allowed to issue CDs on a
floating rate basis provided that the rate is objective, transparent and market based.
6. Banks have to maintain the appropriate CRR and SLR requirements, on the issue price of
CDs.
7. Physical CDs are freely transferable by endorsement and delivery. Dematted CDs can be
transferred as per the procedure applicable to other demat securities.
8. There is no lock in period for CDs. CDs before maturity.
9. Bankers/Fls should issue CDs only in the dematerialised form. However, according to the
depositories Act, 1996 investors have the option to seek a certificate in physical form.
10. Since CDs are transferable, the physical certificate may be presented for payment by the last
holder.

5. Commercial Papers (CPs)

Commercial paper was introduced into the market in 1989-90. It is a finance paper like Treasury
bill. It is an unsecured, negotiable promissory note. It has a fixed maturity period ranging from
three to six months. It is generally issued by leading, nationally reputed credit worthy and highly
rated corporations. It is quite safe and highly liquid. It is issued in bearer form and on discount. It
is also known as industrial paper or corporate paper. CPs can be issued in multiples
of Rs. 5 lakhs subject to the minimum issue size of Rs. 50 lakhs. Thus a CP is an unsecured short
term promissory note issued by leading, creditworthy and highly rated corporates to meet their
working capital requirements. In short, a CP is a short term unsecured promissory note issued
by financially strong companies.

Advantages of Commercial Paper

1. These are simple to issue.
2. The issuers can issue CPs with maturities according to their cash flow.
3. The image of the issuing company in the capital market will improve. This makes easy to raise
long term capital
4. The investors get higher returns
5. These facilitate securitisation of loans. This will create a secondary market for CP.

Disadvantages of Commercial Papers

1. It cannot be repaid before maturity.
2. It can be issued only by large, financially strong firms.

6. Repurchase Agreements (REPO)

REPO is basically a contract entered into by two parties (parties include RBI, a bank or NBFC.
In this contract, a holder of Govt. securities sells the securities to a lender and agrees to
repurchase them at an agreed future date at an agreed price. At the end of the period the borrower
repurchases the securities at the predetermined price. The difference between the purchase price
and the original price is the cost for the borrower. This cost of borrowing is called repo
rate. A transaction is called a Repo when viewed from the perspective of the seller of the
securities and reverse when described from the point of view of the suppliers of funds. Thus
whether a given agreement is termed Repo or Reverse Repo depends largely on which party
initiated the transaction. Thus Repo is a transaction in which a participant (borrower) acquires
immediate funds by selling securities and simultaneously agrees to repurchase the same or
similar securities after a specified period at a specified price. It is also called ready forward
contract.

7. Money Market Mutual Funds (MMMFs)

Money Market Mutual Funds mobilise money from the general public. The money collected will
be invested in money market instruments. The investors get a higher return. They are more liquid
as compared to other investment alternatives.
The MMMFs were originated in the US in 1972. In India the first MMMF was set up by Kothari
Pioneer in 1997. But this did not succeed.

Advantages of MMMFs
1. These enable small investors to participate in the money market.
2. The investors get higher return.
3. These are highly liquid.
4. These facilitate the development of money market.
Disadvantage of MMMFs
1. Heavy stamp duty.
2. Higher flotation cost.
3. Lack of investors education.

8. American Depository Receipt and Global Depository Receipt

ADRs are instruments in the nature of depository receipt and certificate. These instruments are
negotiable and represent publicly traded, local currency equity shares issued by non - American
company. For example, an NRI can invest in Indian Company’s shares without bothering dollar
conversion and other exchange formalities.
If the facilities extended globally, these instruments are called GDR. ADR are listed in American
Stock exchanges and GDR are listed in other than American Stock exchanges, say Landon,
Luxembourg, Tokyo etc.,

Structure of the Indian Money Market

In the Indian money market RBI occupies a key role. It is the nerve centre of the monetary
system of our country. It is the leader of the Indian money market. The Indian money market is
highly disintegrated and unorganized. The Indian money market can be divided into two sectors -
unorganized and organised. In between these two, there exists the co-operative sector. It can be
included in the organised sector. The organised sector comprises of RBI, SBI group of banks,
public sector banks, private sector banks, development banks and other financial institutions.
The unorganized sector comprises of indigenous bankers, money lenders, chit funds etc. These
are outside the control of RBI. This is the reason why Indian money market remains
underdeveloped.

Players or Participants in the Indian Money Market

The following are the players in the Indian money market:
1. Govt.
2. RBI
3. Commercial banks
4. Financial institutions like IFCI, IDBI, ICICI, SIDBI, UTI, LIC etc.
5. Discount and Finance House of India.
6. Brokers
7. Mutual funds
8. Public sector undertakings
9. Corporate units
Recent trends/development in Indian money market
The recent developments in the Indian money market may be briefly explained as below:

1.Integration of unorganized sector with the organized sector : RBI has taken many steps to
bring the institutions in the unorganized sector within its control and regulation. These
institutions are now slowly coming under the organized sector. They started availing of the
rediscounting facilities from the RBI.

2. Widening of call money market: In recent years, many steps have been taken to widen the
call money market. The number of participants in the call money market is increasing. LIC, GIC,
IDBI, UTI and specialized mutual funds have been permitted to enter into this market as lenders
only. The DFHI and STCI have been permitted to operate both as lenders and borrowers.

3. Introduction of innovative instruments: New financial instruments have been introduced in

the money market. On the recommendation of the Chakravarty Committee, the RBI introduced
192 days T-bills since 1986. A new instrument in the form of 364 days T-bills was introduced at
the end of April 1992. Again, new instruments such as CDs, CPs, and interbank participation
certificates have been introduced. Necessary guidelines also have been issued for the operation
of these instruments.

4. Introduction of negotiable dealing system : As negotiable dealing system has been

introduced with a view to facilitating electronic bidding in auctions and secondary market
transactions in Govt. securities and dissemination of information.

5. Offering of market rates of interest: In order to popularize money market instruments, the
ceiling on interest rate has been abolished. Call money rate, bill discounting rate, inter bank rate
etc. have been freed from May 1, 1989. Thus, today Indian money market offers full scope for
the play of market forces in determining the rates of interest.

6. Satellite system dealership: The satellite system dealership was launched in 1996 to serve as
a second tier to primary dealers in retailing of Govt. securities. RBI has decided to allow players
such as provident funds, trusts to participate in government bond auctions, on a non-competitive
basis.

7. Promotion of bill culture: All attempts are being taken to discourage cash credit and
overdraft system of financing and to popularise bill financing. Exemption from stamp duty is
given on rediscounting of derivative usance promissory notes arising out of genuine trade bill
transactions. This is done to promote bill culture in the country.

8. Introduction of money market mutual funds: Recently certain private sector mutual funds
and subsidiaries of commercial banks have been permitted to dealing money market instrument.
This has been done with a view to expand the money market and also to develop secondary
market for money market instruments.
9. Setting up of credit rating agencies: Recently some credit rating agencies have been
established. The important agencies are the Credit Rating Information Services of India Ltd
(CRISIL), Investment Information and Credit Rating Agency of India (IICRA) and, Credit
Analysis and Research Ltd. (CARE). These have been set up to provide credit information
through financial analysis of leading companies and industrial sectors.

10.Adoption of suitable monetary policy: In recent years the RBI is adopting a more realistic
and appropriate monetary and credit policies. The main objective is to increase the availability of
resources in the money market and make the money market more active.

11.Establishment of DFHI: The DFHI was set up in 1988 to activate the money market and to
promote a secondary market for all money market instruments.

12. Setting up of Securities Trading Corporation of India Ltd. (STCI) : The RBI has set up
the STCI in May 1994. Its main objective is to provide a secondary market in Govt. securities. It
has enlarged the T-bill market and the call market and provided an active secondary market for
T-bills. Because of these recent developments, the Indian money market is developing
 Unit 3
Primary Market and Secondary Market
Primary Market (New Issue Market (NIM)
Every company needs funds. Funds may be required for short term or long term. Short term
requirements of funds can be met through banks, lenders, institutions etc. When a company
wishes to raise long term capital, it goes to the primary market. Primary market is an important
constituent of a capital market. In the primary market the security is purchased directly from the
issuer.

Meaning: The primary market is a market for new issues. It is also called new issue market. It is
a market for fresh capital. It deals with the new securities which were not previously available to
the investing public. Corporate enterprises and Govt. raises long term funds from the primary
market by issuing financial securities.

Both the new companies and the existing companies can issue new securities on the primary
market. It also covers raising of fresh capital by government or its agencies.
The primary market comprises of all institutions dealing in fresh securities. These securities may
be in the form of equity shares, preference shares, debentures, right issues, deposits etc.

Primary Market
1. It is the market for new long term capital.
2. The securities are issued by company for the first time directly to the investors.
3. On receiving the money from new issues, the company will issue the security
certificates to the investors.
4. The amount obtained by the company after the new issues are utilized for expansion
of the present business or for setting up new ventures.
5. External finance for long term, usually more than 1 year

Features of New Issue Market

1.It is the market for new long-term capital.
2. The securities are issued by company for the first time directly to the investors.
3. On receiving the money from new issues, the company will issue the security certificates to
the investors.
4. The amount obtained by the company after the new issues are utilized for expansion of the
present business or for setting up new ventures.
5. External finance for long term such as loan from financial institutions is not included in new
issue market. There is an option called “going public” in which the borrowers in new issue
market raise capital for converting private capital into public capital.
6. The financial assets sold can be redeemed by the original holder of security.
Advantages of New Issue/ Primary Market
1. Mobilization of savings.
2. Channelizing savings for productive use.
3. Source of large supply of funds.
4. Rapid industrial growth.

Advantages of Primary Market

Following are the some of the advantages of the new issue market or primary market.
a.Mobilisation of Saving: Primary market helps in mobilising surplus savings of individuals and
others to investment.

b. Channelizing Savings for Productive Use: The funds raised in the primary market are
mainly used for expansion, diversification and modernization purposes of the corporate.

c. Source of Large Supply of Funds: The new issue market is a market for raising long term
capital funds from investors who are spread across the country. Thus large amount of funds can
be raised for a longer period.

d. Rapid Industrial Growth: Investment of the surplus saving by the corporate in industrial
sector led to increase in production and productivity in the economy.

Disadvantages of Primary Market

Primary market operating in the country is not free from any defects and some of
the important defects of the primary market in India are given below.
A.Possibility of Deceiving Investors: The corporate raising money through public issue may
not disclose detailed information in the prospectus, in order to deceive investors.

b. No Fixed Norms for Project Appraisal: The projects for which money is raised are to be
evaluated in terms of financial, economic, profitability and market feasibility by the project
manager. As there are no fixed norms for the appraisal of a project, the evaluation is subject to
the personal capability and judgement of the project.

c. Ineffective Role of Merchant Bankers: The merchant bankers perform most of the pre-issue
and post issue obligations with regarded to the new issue. But it has been observed that they do
not follow the code of conduct and indulge in illegal practices.

d. Lack of Confidence among the Investors: Investors lack confidence i the new issue market
and do not want to invest because of delay in the allotment of securities or delay in refund of
money in case of no allotment by the companies.

e. The new issue market is not able to mobilise adequate savings from the public. Only 10% of
the savings of the household sector go to the primary market.
f. Generally there is a tendency on the part of the investors to prefer fixed income bearing
securities like preference shares and debentures. They hesitate to invest in equity shares. There is
a risk aversion in the new issue market. This stands in the way of a healthy primary market.

g. There is a functional and institutional gap in the new issue market. A wholesale market is yet
to develop for new issue or primary market.

h. In the case of investors from semi-urban and rural areas, they have to incur more expenses for
sending the application forms to centres where banks are authorized to accept them. The
expenses in connection with this include bank charges, postal expenses and so on. All these will
discourage the small investors in rural areas.

New Financial Instruments in the Primary Market

With the evolution of the capital market, new financial instruments are being introduced to suit
the requirements of the market. Some of the new financial instruments introduced in recent years
may be briefly explained as below:
1.Floating rate bonds: The interest rate on these bonds is not fixed. It is a concept which has
been introduced primarily to take care of the falling market or to provide a cushion in times of
falling interest rates in the economy. It helps the issuer to hedge the loss arising due to interest
rate fluctuations. Thus there is a provision to reduce interest risk and assure minimum interest on
the investment. In India, SBI was the first to introduce FRB for retail investors.

2. Zero interest bonds: These carry no periodic interest payment. These are sold at a huge
discount. These can be converted into equity shares or non-convertible debentures

3. Deep discount bonds: These bonds are sold at a large discount while issuing them. These are
zero coupon bonds whose maturity is very high (say, 15 years). There is no interest payment.
IDBI was the first financial institution to offer DDBs in 1992.

4. Auction related debentures: These are a hybrid of CPs and debentures. These are secured,
redeemable, non-convertible instrument. The interest on them is determined by the market.
These are placed privately with bids. ANZ Grindlays designed this new instrument for Ashok
Leyland Finance.

5. Secured Premium Notes: These are issued along with a detachable warrant. This warrant
gives the holder the right to apply for, or seek allotment of one equity share, provided the SPN is
fully paid. The conversion of detachable warrant into equity shares is done within the time limit
notified by the company. There is a lock in period during which no interest is paid for the
invested amount. TISCO was the first company to issue SPN (in 1992) to the public along
with the right issue.

6. Option bonds: Option bonds can be converted into equity or preference shares at the option of
the investor as per the condition stated in the prospectus. These may be cumulative or non
cumulative. In case of cumulative bonds the interest is accumulated and is payable at maturity. In
case of non-cumulative bonds, interest is payable at periodic intervals.

7. Warrants: A share warrant is an option to the investor to buy a specified number of equity
shares at a specified price over a specified period of time. The warrant holder has to surrender
the warrant and pay some cash known as ‘exercise price’ of the warrant to purchase the shares.
On exercising the option the warrant holder becomes a shareholder. Warrant is yet to gain
popularity in India, due to the complex nature of the instrument.

8. Preference shares with warrants: These carry a certain number of warrants.

These warrants give the holder the right to apply for equity shares at premium at any time in one
or more stages between the third and fifth year from the date of allotment.

9. Non-convertible debentures with detachable equity warrants: In this instrument, the

holder is given an option to buy a specified number of shares from the company at a
predetermined price within a definite time frame.

10.Zero interest fully convertible debentures: On these instruments, no interest will be paid to
the holders till the lock in period. After a notified period, these debentures will be automatically
and compulsorily converted into shares.

11.Fully convertible debentures with interest: This instrument carries no interest for a
specified period. After this period, option is given to apply for equities at premium for which no
additional amount is payable. However, interest is payable at a predetermined rate from the date
of first conversion to second / final conversion and equity will be issued in lieu of interest.

12.Non-voting shares: The Companies Bill, 1997 proposed to allow companies to issue non-
voting shares. These are quasi -equity instruments with differential rights. These shares do not
carry voting right. Their divided rate is also not predetermined like preference shares.

13. Inverse float bonds: These bonds are the latest entrants in the Indian capital market. These
are bonds carrying a floating rate of interest that is inversely related to short term interest rates.

14. Perpetual bonds: These are debt instruments having no maturity date. The investors receive
a stream of interest payment for perpetuity.

Players or Participants (or Intermediaries) in the Primary market/Capital

Market
There are many players (intermediaries) in the primary market (or capital market). Important
players are as follows:
1.Merchant bankers: In attracting public money to capital issues, merchant bankers play a vital
role. They act as issue managers, lead managers or comanagers (functions in detail is given in
following pages)

2.Registrars to the issue: Registrars are intermediaries who undertake all activities connected
with new issue management. They are appointed by the company in consultation with the
merchant bankers to the issue.

3. Bankers: Some commercial banks act as collecting agents and some act as co-ordinating
bankers. Some bankers act as merchant bankers and some are brokers. They play an important
role in transfer, transmission and safe custody of funds.

4. Brokers: They act as intermediaries in purchase and sale of securities in the primary and
secondary markets. They have a network of sub brokers spread throughout the length and
breadth of the country.

5. Underwriters: Generally investment bankers act as underwriters. They agreed to take a

specified number of shares or debentures offered to the public, if the issue is not fully subscribed
by the public. Underwriters may be financial institutions, banks, mutual funds, brokers etc.

Methods of Raising Fund in the Primary Market (Methods of Floating New

Issues)
A company can raise capital from the primary market through various methods. The methods
include public issues, offer for sale, private placement, right issue, and tender method.

a. Public Issues
This is the most popular method of raising long term capital. It means raising funds directly from
the public. Under this method, the company invites subscription from the public through the
issue of prospectus (and issuing advertisements in news papers). On the basis of offer in the
prospectus, the investors apply for the number of securities they are willing to take. In response
to application for securities, the company makes the allotment of shares, debentures etc.
Types of Public Issues: Public issue is of two types, namely, initial public offer and follow-on
public offer.

Initial Public Offering (IPO): This is an offering of either a fresh issue of securities or an offer
for sale of existing securities or both by an unlisted company for the first time in its life to the
public. In short, it is a method of raising securities in which a company sells shares or stock to
the general public for the first time.

Follow-on Public Offering (FPO): This is an offer of sale of securities by a listed company.
This is an offering of either a fresh issue of securities or an offer for sale to the public by an
already listed company through an offer document.
Methods of Determination of Prices of New Shares
Equity offerings by companies are offered to the investors in two forms – (a) fixed price offer
method, and (b) book building method.

Fixed Price Offer Method

In this case, the company fixes the issue price and then advertises the number of shares to be
issued. If the price is very high, the investors will apply for fewer numbers of shares. On the
other hand, if the issue is under-priced, the investors will apply for more number of shares. This
will lead to huge over subscription.
The main steps involved in issue of shares under fixed price offer method are as follows:
1. Selection of merchant banker
2. Issue of a prospectus
3. Application for shares
4. Allotment of shares to applicants
5. Issue of Share Certificate

Book-building Method
It was introduced on the basis of recommendations of the committee constituted under the
chairmanship of Y.H. Malegam in October, 1995. Under this method, the company does not
price the securities in advance. Instead, it offers the investors an opportunity to bid collectively.
It then uses the bids to arrive at a consensus price. All the applications received are arranged and
a final offer price (known as cut off price) is arrived at. Usually the cut off price is the weighted
average price at which the majority of investors are willing to buy the securities. In short, book
building means selling securities to investors at an acceptable price with the help of
intermediaries called Book-runners. It involves sale of securities to the public and institutional
bidders on the basis of predetermined price range or price band. The price band cannot exceed
20% of the floor price. The floor price is the minimum price at which bids can be made by the
investors. It is fixed by the merchant banker in consultation with the issuing company. Thus,
book building refers to the process under which pricing of the issue is left to the investors.
Today most IPOs in India use book-building method. As per SEBI’s guidelines 1997, the book
building process may be applied to 100 per cent of the
issue, if the issue size is 100 crores or more.

b. Offer for Sale Method

Under this method, instead of offering shares directly to the public by the company itself, it
offers through the intermediary such as issue houses / merchant banks / investment banks or
firms of stock brokers. Under this method, the sale of securities takes place in two stages. In the
first stage, the issuing company sells the shares to the intermediaries such as issue houses and
brokers at an agreed price. In the second stage, the intermediaries resell the securities to the
ultimate investors at a market related price. This price will be higher. The difference between the
purchase price and the issue price represents profit for the intermediaries. The intermediaries are
responsible for meeting various expenses. Offer for sale method is also called bought out deal.
This method is not common in India.

c. Private Placement of Securities

Private placement is the issue of securities of a company direct to one investor or a small group
of investors. Generally the investors are the financial institutions or other existing companies or
selected private persons such as friends and relatives of promoters. A private company cannot
issue a prospectus. Hence it usually raises its capital by private placement. A public limited
company can also raise its capital by placing the shares privately and without inviting the
public for subscription of its shares. Company law defines a privately placed issue to be the one
seeking subscription from 50 members. In a private placement, no prospectus is issued. In this
case the elaborate procedure required in the case of public issue is avoided. Therefore, the cost of
issue is minimal. The process of raising funds is also very simple. But the number of shares that
can be issued in a private placement is generally limited. Thus, private placement refers to the
direct sale of newly issued securities by the issuer to a small number of investors through
merchant bankers.

d. Right Issue
Right issue is a method of raising funds in the market by an existing company. Under this
method, the existing company issues shares to its existing shareholders in proportion to the
number of shares already held by them. Thus a right issue is the issue of new shares in which
existing shareholders are given pre-emptive rights to subscribe to the new issue on a pro-rata
basis. According to Section 81 (1) of the Companies Act, when the company wants to increase
the subscribed capital by issue of further shares, such shares must be issued first of all to existing
shareholders in proportion of their existing shareholding. The existing shareholders may accept
or reject the right. Shareholders who do not wish to take up the right shares can sell their rights to
another person. If the shareholders neither subscribe the shares nor transfer their rights, then the
company can offer the shares to public. A company making right issue is required to send a
circular to all existing shareholders. The circular should provide information on how additional
funds would be used and their effect on the earning capacity of the company. The
company should normally give a time limit of at least one month to two months to shareholders
to exercise their rights before it is offered to the public. No new company can make right issue.
Promoters offer right issue at attractive price often at a discount to the market price due to a
variety of reasons. The reasons are: (a) they want to get their issues fully subscribed to, (b) to
reward their shareholders, (c) it is possible that the market price does not reflect a share’s true
worth or that it is overpriced, (d) to increase their stake in the companies so as to avoid
preferential allotment.
e. Other Methods of Issuing Securities
Apart from the above methods, there are some other methods of issuing securities. They are:

1. Tender method: Under tender method, the issue price is not predetermined.
The company announces the public issue without indicating the issue price. It invites bids from
various interested parties. The parties participating in the tender submit their maximum offers
indicating the maximum price they are willing to pay. They should also specify the number of
shares they are interested to buy. The company, after receiving various offers, may decide about
the price in such a manner that the entire issue is fairly subscribed or sold to the parties
participating in the tender.

2. Issue of bonus shares: Where the accumulated reserves and surplus of profits of a company
are converted into paid up capital, it is called bonus issue. It simply refers to capitalization of
existing reserves and surpluses of a company.

3. Offer to the employees: Now a days companies issue shares on a preferential basis to their
employees (including whole time directors). This attracts, retains and motivates the employees
by creating a sense of belonging and loyalty. Generally shares are issued at a discount. A
company can issue shares to their employees under the following two schemes: (a) Employee
stock option scheme and (b) employee stock purchase scheme.

4. Offer to the creditors: At the time of reorganization of capital, creditors may be issued shares
in full settlement of their loans.

5. Offer to the customers: Public utility undertakings offer shares to their customers.

Procedure of Public Issue

Under public issue, the new shares/debentures may be offered either directly to the public
through a prospectus (offer document) or indirectly through an offer for sale involving financial
intermediaries or issue houses. The main steps involved in public issue are as follows:
1.Draft prospectus: A draft prospectus has to be prepared giving all required information. Any
company or a listed company making a public issue or a right issue of value more than Rs. 50
lakh has to file a draft offer document with SEBI for its observation. The company can proceed
further after getting observations from the SEBI. The company can open its issue within 3
months from the date of SEBI’s observation letter.

2. Fulfilment of Entry Norms: The SEBI has laid down certain entry norms (parameters) for
accessing the primary market. A company can enter into the primary market only if a company
fulfils these entry norms.

3. Appointment of underwriters: Sometimes underwriters are appointed to ensure full

subscription.
4. Appointment of bankers: Generally, the company shall nominate its own banker to act as
collecting agent. The bankers along with their branch network process the funds procured during
the public issue.

5. Initiating allotment procedure: When the issue is subscribed to the minimum level, the
registrars initiate the allotment procedure.

6. Appointment of brokers to the issue: Recognised members of the stock exchange are
appointed as brokers to the issue.

7. Filing of documents: Documents such as draft prospectus, along with the copies of the
agreements entered into with the lead manager, underwriters, bankers, Registrars, and brokers to
the issue have to be filed with the Registrar of Companies.

8. Printing of prospectus and application forms: After filing the above documents, the
prospectus and application forms are printed and dispatched to all merchant bankers,
underwriters and brokers to the issue.

9. Listing the issue: It is very essential to send a letter to the stock exchange concerned where
the issue is proposed to be listed.

10.Publication in news papers: The next step is to publish an abridged version of the prospectus
and the commencing and closing dates of issues in major English dailies and vernacular
newspapers.

11. Allotment of shares: After close of the issue, all application forms are scrutinised tabulated
and then the shares are allotted against those applications received.

Defects of the Indian Primary Market

The Indian primary market has the following defects:

1. The new issue market is not able to mobilise adequate savings from the public. Only 10% of
the savings of the household sector go to the primary market.
2. The merchant bankers do not play adequate attention to the technical, managerial and
feasibility aspects while appraising the project proposal. In fact, they do not seem to play a
development role. As a result, the small investors are duped by the companies.
3. There is inordinate delay in the allotment process. This will discourage the small investors to
approach the primary market for investing their funds.
4. Generally there is a tendency on the part of the investors to prefer fixed income bearing
securities like preference shares and debentures. They hesitate to invest in equity shares. There is
a risk aversion in the new issue market. This stands in the way of a healthy primary market.
5. There is a functional and institutional gap in the new issue market. A wholesale market is yet
to develop for new issue or primary market.
6. In the case of investors from semi-urban and rural areas, they have to incur more expenses for
sending the application forms to centres where banks are authorized to accept them. The
expenses in connection with this include bank charges, postal expenses and so on. All these will
discourage the small investors in rural areas. Over the years, SEBI, and Central Government
have come up with a series of regulatory measures to give a boost to new issue market.

Secondary Market
The investors want liquidity for their investments. When they need cash, they should be able to
sell the securities they hold. Similarly there are others who want to invest in new securities.
There should be a place where securities of different companies can be bought and sold.
Secondary market provides such a place.

Meaning of Secondary Market

Secondary market is a market for old issues. It deals with the buying and selling existing
securities i.e. securities already issued. In other words, securities already issued in the primary
market are traded in the secondary market. Secondary market is also known as stock market. The
secondary market operates through ‘stock exchanges’. In the secondary market, the existing
owner sells securities to another party. The secondary markets support the primary markets. The
secondary market provides liquidity to the individuals who acquired these securities. The
primary market gets benefits greatly from the liquidity provided by the secondary market. This is
because investors would hesitate to buy the securities in the primary market if they thought they
could not sell them in the secondary market later. In India, stock market consists of recognised
stock exchanges. In the stock exchanges, securities issued by the central and state governments,
public bodies, and joint stock companies are traded.

Stock Exchange
In India the first organized stock exchange was Bombay StockExchange. It was started in 1877.
Later on, the Ahmadabad Stock Exchange and Calcutta Stock Exchange were started in 1894 and
1908 respectively. At present there are 24 stock exchanges in India. In Europe, stock exchanges
are often called bourses.

Meaning and Definition of Stock Exchange/ Security Exchange

It is an organized market for the purchase and sale of securities of joint stock companies,
government and semi- govt. bodies. It is the centre where shares, debentures and govt. securities
are bought and sold.
According to Pyle, “Security exchanges are market places where securities that have been listed
thereon may be bought and sold for either investment orspeculation”.

The Securities Contract (Regulation) Act 1956, defines a stock exchange as “an association,
organisation or body of individuals whether incorporated or not, established for the purpose of
assisting, regulating and controlling of business in buying, selling and dealing in securities”.

According to Hartley Withers, “a stock exchange is something like a vast warehouse where
securities are taken away from the shelves and sold across the countries at a price fixed in a
catalogue which is called the official list”.
In short, stock exchange is a place or market where the listed securities are bought and sold.

Characteristics of a Stock Exchange

1. It is an organized capital market.
2. It may be incorporated or non-incorporated body (association or body of individuals).
3. It is an open market for the purchase and sale of securities.
4. Only listed securities can be dealt on a stock exchange.
5. It works under established rules and regulations.
6. The securities are bought and sold either for investment or for speculative purpose.

STRUCTURE OF SECONDARY MARKET

When securities are traded between investors, issuers no longer receive any cash proceeds.
Investors usually initiate securities purchases in the secondary markets by calling a security
brokerage house. After an account has been opened, a broker relays the clients order to a dealer
making a market in the securities in the securities the investors want since the secondary market
involves the trading of securities initially sold in the primary market, it provides liquidity to the
individuals who acquired these securities.

STRUCTURE/METHODS OF THE SECONDARY MARKET is :

1.Equity
a) Organized stock exchanges
b) over the counter market
c) third market
d) fourth market

2.Bonds
a) Organized exchanges ( a relatively small amount)
b) over the counter market
3.puts and call
a) organized stock market

a)organized exchanges : the individual investors can sell securities to another investor without
the presence and involvement of the firm issued the securities. Such type of secondary trading
takes place on the organized stock exchanges.

b)OTC market :in the past times securities were traded over the counter of banks or in the
offices of security dealers. Today over the counter trades occur in brokers offices, dealer offices,
homes, over the phone, electrically, and any place or even any transport whole over the country
and in foreign countries. The OTC market includes trading in all securities not listed on one of
the exchanges. It also includes trading in listed stocks referring to the third market. Though the
unlisted securities trading market, OTC is one of the most modern and efficient securities
markets in the world. OTC market not physically located in any one place. It consist of a number
of broker dealers throughout the country who are linked together through an e-mail or electronic
communication network. Any security can be traded on the OTC market as long as a registered
dealer is willing to make a market in the security. The OTC market competes with investment
bankers and organized exchanges as OTC dealers can operate as both a primary and a secondary
market.
Risk free securities, government, and corporate bonds, common stocks, etc are traded in the OTC
market.

However the broker dealers in the OTC market can be categorized as follows:
1.OTC House : an OTC house is specialized in OTC issues and rarely belongs to an exchange
2.Investment banking house : an investment banking house is specialized in IPOs and may
diversify by acting as the dealer in both listed and OTC securities.
3.Commercial banks: a commercial bank may be an OTC dealer or broker when it trades
securities.
4.Stock exchanges member house: it can work as an OTC broker or dealer having a separate
department specifically formed to carry on trading in the OTC market.
5.Bond house : a bond house may deal in government and autonomous bond issues trading in
OTC.

c) the third market: it is an OTC marketing stock associated with an exchange. Although
most transaction in listed stock take place on an exchange, a brokerage firm without being a
member of an exchange can make a market in a listed stock. A number of broker-dealers who are
not members of Dhaka Stock exchange can make markets in stocks of DSE listed firms. The
OTC dealers making up the third market provide minimal services for their clients-only
execution of buy – sell orders and record keeping. They are always ready to execute large trades
at much lower commissions. The success or failure of the third market depends on whether the
OTC market in these stocks is as good as the exchange market and whether the relative cost of
the OTC transaction compares favorably with the cost on the exchange.
d)The Fourth market: the method of reducing commission costs in the security
transactions sometimes would be the complete elimination of the broker-dealer firm as a
middlemen. When one investors sells security directly to another investor without a broker-
dealer as a middlemen, they are said to be trading in the fourth market. In all most all cases, both
parties involved in each transaction of the fourth market are institutions. Direct investor-to-
investor trades occur through a communications network between block traders. A block is a
single transaction involving 10000 or more shares. The participants of the forth market bypass
the normal dealer system. However, the organizer of the fourth market collects only a small
commission for helping to arrange a block transaction.

1.The First market : represents organized exchanges where listed securities are traded.
2.Second market: is the over-the-counter market where the unlisted securities are traded.
3.Third market: represents over-the-counter trading of securities which are listed on an
exchange.
4.Fourth market: represents direct trading between two investors bypassing the activities
usually done by the brokerage firms.

Functions of Stock Exchange

Following are some of the most important functions that are performed by stock exchange:
1.Role of an Economic Barometer: Stock exchange serves as an economic barometer that is
indicative of the state of the economy. It records all the major and minor changes in the share
prices. It is rightly said to be the pulse of the economy, which reflects the state of the economy.
2.Valuation of Securities: Stock market helps in the valuation of securities based on the factors
of supply and demand. The securities offered by companies that are profitable and growth-
oriented tend to be valued higher. Valuation of securities helps creditors, investors and
government in performing their respective functions.
3.Transactional Safety: Transactional safety is ensured as the securities that are traded in the
stock exchange are listed, and the listing of securities is done after verifying the company’s
position. All companies listed have to adhere to the rules and regulations as laid out by the
governing body.
4.Contributor to Economic Growth: Stock exchange offers a platform for trading of securities
of the various companies. This process of trading involves continuous disinvestment and
reinvestment, which offers opportunities for capital formation and subsequently, growth of the
economy.
5.Making the public aware of equity investment: Stock exchange helps in providing
information about investing in equity markets and by rolling out new issues to encourage people
to invest in securities.
6.Offers scope for speculation: By permitting healthy speculation of the traded securities, the
stock exchange ensures demand and supply of securities and liquidity.
7.Facilitates liquidity: The most important role of the stock exchange is in ensuring a ready
platform for the sale and purchase of securities. This gives investors the confidence that the
existing investments can be converted into cash, or in other words, stock exchange offers liquidity in
terms of investment.

8.Better Capital Allocation: Profit-making companies will have their shares traded actively,
and so such companies are able to raise fresh capital from the equity market. Stock market helps
in better allocation of capital for the investors so that maximum profit can be earned.
9.Encourages investment and savings: Stock market serves as an important source of
investment in various securities which offer greater returns. Investing in the stock market makes
for a better investment option than gold and silver.

ADVANTAGES OF SECONDARY MARKET:

1.MOBILIZE SAVINGS: When businesses or even individuals hold their money in form of
shares, they can easily mobilize funds for investments. Securities traded in the secondary
markets are not as liquid as cash therefore this limits the ease of accessing cash. Accumulation of
funds for longterm capital projects is therefore easy and possible. The secondary market provides
a convenient platform for the trade of securities hence shares can be easily converted to cash for
investment.

2.INVESTMENT OPPORTUNITIES: As opposed to holding money in savings accounts, the

secondary market provides investors with an opportunity to save and at the same time invest.
Shareholders either earn capital gain from the resale of shares or earn dividends on shares held.
Investment in shares does not require a large capital outlay therefore providing small businesses
with a chance to invest and expand their portfolios.

3.INVESTMENT ADVICE: Apart from providing the investing public a platform to trade in
securities, secondary markets also offer investment advice. Stockbrokers, investment advisers
and other players in the secondary market offer investors advice on complex matters that may
arise in the trade of securities. Investors therefore do not need to be stock market experts to
invest in stocks or bonds. With some form of advice, any interested investors can make money in
the stock exchange.

4. IMPROVES CORPORATE GOVERNANCE: The shares of listed companies trade in the

stock exchange, a secondary market. Managers are only custodians of the company; shareholders
are the owners. Having a large variety of shareholders is beneficial to the company since
managers' accountability improves: The demands of shareholders must be met hence the
management has to be efficient in its operations. Management of listed companies is better than
that of private companies since shareholders keep watch over the managements’ actions.

DISADVANTAGES OF SECONDARY MARKET:

1.DATA DEFINITIONS: Secondary Researcher needs to understand various parameters and

assumptions that primary research had taken while collected information. A term may have
different meaning for different people, example a term 'youth' used is ambiguous and one needs
to find what is the assumed age taken by primaryresearcher.

2. INACCURACY OF DATA: As we are not gathering our own information, first-hand, we are
totally dependent on someone else's efforts. Primary researcher may have been biased or may
have used questionable methods to collect data; this can be pretty risky for secondary researchers
to base their report on such data.

3.TIME LAG ISSUES: Information collected from books, historical surveys are usually not
sync with the times and might have changed drastically. Thus making such information a
foundation of research may be highly risky for the business or project.

4.MAY NOT BE SPECIFIC: Extensiveness of such information is its benefit as well as

drawback. Organization will not get answers to their specific issues through this data directly and
one needs to 'mine' further into it to get relevant information.

5. PROPRIETARY ISSUES: Some of the secondary sources might have copyrighted their
information and using them without permission can lead to various legal complications. Usually
it’s for small organizations and projects secondary market research is preferred because the time
and amount of money required is less.

RECOGNITION OF STOCK EXCHANGES AND CLEARING CORPORATIONS

1.Obligation to seek recognition: No person shall conduct, organise or assist in organising any
stock exchange or clearing corporation unless he has obtained recognition from the Board in
accordance with the Act, rules and these regulations:
Provided that a stock exchange, which has been recognised under the Act as on the date of
commencement of these regulations, shall be deemed to have been recognised under these
regulations and all the provisions of these regulations as they apply to a recognised stock
exchange shall also apply to such stock exchange:

Provided further that an existing clearing house of a recognised stock exchange or any person
who clears and settles trades of a recognised stock exchange, as on the date of the
commencement of these regulations, may continue to do so for a period of three months from the
date of commencement of these regulations or, if he has made an application under regulation 4
for recognition, till disposal of such application.

2.Application for recognition. 4. Subject to compliance with the provisions of Act, rules and
these regulations, an application for recognition as a stock exchange shall be submitted to the
Board in Form A as prescribed under rule 3 of the rules and an application for recognition as a
clearing corporation shall be submitted to Board in Form A as specified in Schedule – I of these
regulations.

3.Fee for application. 5. An applicant seeking recognition as a stock exchange shall pay
application fee in terms of rule 4 of the rules, and an applicant seeking recognition as a clearing
corporation shall also pay application fee as payable by a stock exchange.

4.Documents and particulars for application.

1.An application for recognition as a stock exchange or a clearing corporation, as the case may
be, shall be accompanied by copies of memorandum of association, articles of association, bye-
laws and other documents as provided in sections 3 and 4 of the Act, rule 5 of the rules and these
regulations.
2. In addition to the documents specified in sub-regulation (1), the application for recognition as
a clearing corporation shall be accompanied by the agreement(s) entered into by the applicant
with the recognised stock exchange(s) and depositories.

5.Consideration of grant of recognition.

The application under regulation 4 shall be governed by the provisions of the Act, rules and these
regulations.
An applicant seeking recognition as a stock exchange or clearing corporation shall comply with
the following conditions, namely:—
(a) the applicant is a company limited by shares;
(b) the applicant is demutualised;
(c) the applicant, its directors and its shareholders who hold or intend to hold shares, are fit and
proper persons as described in regulation 20;
(d) the applicant satisfies requirements relating to ownership and governance structure specified
in these regulations;
(e) the applicant satisfies networth requirements specified in these regulations;
(f) the applicant satisfies requisite capability including its financial capacity, functional expertise
and infrastructure.
3. An applicant seeking recognition as a stock exchange shall, in addition to conditions as
specified in sub-regulations (1) and (2), comply
4. An applicant seeking recognition as a clearing corporation shall, in addition to conditions as
specified in sub-regulations (1) and (2), comply
5. The Board may, on being satisfied with the capability of the applicant to comply with the
conditions laid down in this regulation, grant an in-principle approval to the applicant which
shall be valid for a period of one year: Provided that the Board may, upon sufficient cause shown
by the applicant, extend the validity of in-principle approval for a further period not exceeding
six months.

6.Power to make inquiries and call for information. 8. The Board may, before granting
recognition to a stock exchange or clearing corporation, make inquiries and require such further
information or document to be furnished, as it may deem necessary

7.Grant of recognition.

Bombay Stock Exchange (BSE)

BSE is the leading and the oldest stock exchange in India as well as inAsia. It was established in
1887 with the formation of "The Native Share and Stock Brokers' Association". BSE is a very
active stock exchange with highest number of listed securities in India. Nearly 70% to 80% of all
transactions in the India are done alone in BSE. Companies traded on BSE were 3,049 by March,
2006. BSE is now a national stock exchange as the BSE has started allowing its members to set-
up computer terminals outside the city of Mumbai (former Bombay). It is the only stock
exchange in India which is given permanent recognition by the government.

In 2005, BSE was given the status of a fully fledged public limited company along with a new
name as "Bombay Stock Exchange Limited". The BSE has computerized its trading system by
introducing BOLT (Bombay on Line Trading) since March 1995. BSE is operating BOLT at 275
cities with 5 lakh (0.5 million) traders a day. Average daily turnover of BSE is near Rs. 200
crores.

The Bombay Stock Exchange is the first and oldest stock exchange in India which was founded
in 1875 as the Naive Share and Stock Brokers Association. The BSE is located in Mumbai,
India, and lists more than 5000 companies with a total market capitalization of $3.5 trillion.
Also, BSE is one of the largest stock exchanges in the world, along with NYSE, NASDAQ,
LSE, and SSE.
FUNCTIONS OF BSE
The following are the primary functions of the Bombay Stock Exchange –
1.Price Determination: The prices of securities in the secondary market depend on the
securities’ demand and supply. Thus, BSE helps in this process by constantly valuing all the
listed securities. And investors can easily track the prices of these securities through the index
popularly known as SENSEX.
2.Contribution to the Economy: BSE offers a trading platform for securities of various
companies. The trading process involves continuous reinvestment and disinvestment. This gives
an opportunity for capital formation, funds movement and boosting of the economy.
3.Facilitates Liquidity: The most important function of BSE is ensuring a ready platform for the
sale and purchase of securities. This gives investors the confidence to convert the existing
securities into cash anytime. Thus, investors can buy and sell anytime offering them high
liquidity.
4.Transactional Safety: BSE ensures that the securities are listed after verifying the company’s
position. Also, all listed companies must adhere to the rules and regulations laid out by the
governing body, i.e. Securities and Exchange Board of India (SEBI).

National Stock Exchange (NSE)

Formation of National Stock Exchange of India Limited (NSE) in 1992 is one important
development in the Indian capital market. The need was felt by the industry and investing
community since 1991. The NSE is slowly becoming the leading stock exchange in terms of
technology, systems and practices in due course of time. NSE is the largest and most modern
stock exchange in India. In addition, it is the third largest exchange in the world next to two
exchanges operating in the USA.

The NSE boasts of screen based trading system. In the NSE, the available system provides
complete market transparency of trading operations to both trading members and the participates
and finds a suitable match. The NSE does not have trading floors as in conventional stock
exchanges. The trading is entirely screen based with automated order machine. The screen
provides entire market information at the press of a button.

FUNCTIONS OF NSE:
The following are the major functions of NSE –
1.Establishing a nation-expansive trading facility for debt, equity and other asset classes
accessible to investors.

2.Providing investors with an equal opportunity to participate in the trading system through an
appropriate communication network.
3.Ensuring a fair, efficient and transparent securities market to investors using electronic trading
systems

4.Enabling shorter trade settlement periods and book-entry settlement systems.

Meeting the current international standards set for the financial securities markets.

Over The Counter Exchange of India (OTCEI)

The OTCEI was incorporated in October, 1990 as a Company under the Companies Act 1956. It
became fully operational in 1992 with opening of a counter at Mumbai. It is recognised by the
Government of India as a recognized stock exchange under the Securities Control and
Regulation Act 1956. It was promoted jointly by the financial institutions like UTI, ICICI, IDBI,
LIC, GIC, SBI, IFCI, etc.

The function of Over the Counter Exchange of India (OTCEI) are:-

1.The main function is to help smaller companies to generate capital, which is not possible at the
National Exchanges because of their incapability to meet the requirements.

2.It delivers an opportunity to generate funds through capital market instruments which are
priced relatively. The companies can mediate the issue price.

3.It also stimulates transactions to be completed promptly and investors to finalize the deals in a
course of a few days.

4.It increases the liquidity and marketability of the shares which are traded. The two-way prices
are cited regularly to deliver adequate opportunities for investors to exit.

Listing of Securities
The inclusion of the name of a company in the official list of securities, which can be dealt with
in a stock exchange, is called listing. It implies the securities of a company to the trading
privileges on a stock exchange.

LISTING OF SECURITIES - CONCEPT For trading in the stock market, a company has to
list its securities in the stock exchange. It means that the name of the company is registered in the
stock exchange. The company has to fulfill certain conditions according to Companies Act. The
company has to offer its shares or debentures to the public for subscription. Only then, the
company will be allowed to list its security in the stock exchange. For listing shares in the stock
exchange, a company must have minimum of Rs. 5 crores as its equity capital and 60% of this
i.e., Rs. 3 crores is offered to the public.
A stock exchange does not deal in the securities of all companies. Only those securities that are
listed are dealt with the stock exchange. For the purpose of listing of securities, a company has to
apply to the stock exchange. The stock exchange will decide whether to list the securities of the
company or not. If permission is granted by the stock exchange to deal with the securities
therein, then such a company is included in the official trade list of the stock exchange.This is
technically known as listing of securities. Thus listing of securities means permission to quote
shares and debentures officially on the trading floor of the stock exchange. Listing of securities
refers to the sanction of the right to trade the securities on the stock exchange. In short, listing
means admission of securities to be traded on the stock exchange. If the securities are not listed,
they are not allowed to be traded on the stock exchange.

Objectives of Listing
The main objectives of listing are:
1. To ensure proper supervision and control of dealings in securities.
2. To protect the interests of shareholders and the investors.
3. To avoid concentration of economic power.
4. To assure marketing facilities for the securities.
5. To ensure liquidity of securities.
6. To regulate dealings in securities.

Advantages of Listing

A. Advantages to Company:-
1. It provides continuous market for securities (securities include shares, debentures, bonds etc.)
2. It enhances liquidity of securities.
3. It enhances prestige of the company.
4. It ensures wide publicity.
5. Raising of capital becomes easy.
6. It gives some tax advantage to the company.

B. Advantages to Investors:-
1. It provides safety of dealings.
2. It facilitates quick disposal of securities in times of need. This means that listing enhances the
liquidity of securities.
3. It gives some tax advantage to the security holder.
4. Listed securities command higher collateral value for the purpose of bank loans.
5. It provides an indirect check against manipulation by the management.

Disadvantages of Listing
1. It leads to speculation
2. Sometimes listed securities are subjected to wide fluctuations in their value.
This may degrade the company’s reputation.
3. It discloses vital information such as dividends and bonus declared etc. to
competitors.
4. Company has to spend heavily in the process of placing the securities with
Public

TYPES OF LISTING OF SECURITIES

1.Initial listing: Here, the shares of the company are listed for the first time on a stock exchange.

2. Listing for public Issue: When a company which has listed its shares on a stock exchange
comes out with a public issue.

3. Listing for Rights Issue: When the company which has already listed its shares in the stock
exchange issues securities to the existing shareholders on rights basis.

4. Listing of Bonus shares: When a listed company in a stock exchange is capitalizing its profit
by issuing bonus shares to the existing shareholders.

5. Listing for merger or amalgamation: When the amalgamated company issues new shares to
the shareholders of amalgamated company, such shares are listed.

PROCEDURE FOR LISTING REQUIREMENTS

For listing the shares in the stock exchange, the public limited company will have to submit
supporting documents. They are:
1. Certified copies of Memorandum, Articles of Association, prospectus and agreements with
Underwriters.
2. All particulars regarding capital structure.
3. Copies of advertisements offering securities for sale during the last 5 years.
4. Copies of Balance sheet, audited accounts and auditors’ report for the last 5 years.
5. Specimen copies of shares and debentures, certificate letter of allotment, and letter of regret.
6. A brief history of the company since incorporation with any changes in capital structure,
borrowings, etc.
7. Details of shares and debentures issued for consideration other than cash.
8. Statement showing distribution of shares and particulars of commission, brokerage, discounts
or special terms towards the issue of shares.
9. Any agreement with financial institutions.
10. Particulars of shares forfeited.
11. Details of shares or debentures for which permission to deal with is applied for.
12. Certified copy of consent from SEBI.
THE TRADING/SETTLEMENT PROCEDURE IN A STOCK EXCHANGE
Before selling the securities through stock exchange, the companies have to get their securities
listed in the stock exchange. The name of the company is included in listed securities only when
stock exchange authorities are satisfied with the financial soundness and other aspects of the
company.

Previously the buying and selling of securities was done in trading floor of stock exchange;
today it is executed through computer and it involves the following steps:

The Trading procedure involves the following steps:

1.Selection of a broker: The buying and selling of securities can only be done through SEBI
registered brokers who are members of the Stock Exchange. The broker can be an individual,
partnership firms or corporate bodies. So the first step is to select a broker who will buy/sell
securities on behalf of the investor or speculator.

2. Opening Demat Account with Depository: Demat (Dematerialized) account refer to an

account which an Indian citizen must open with the depository participant (banks or stock
brokers) to trade in listed securities in electronic form. Second step in trading procedure is to
open a Demat account. The securities are held in the electronic form by a depository. Depository
is an institution or an organization which holds securities (e.g. Shares, Debentures, Bonds,
Mutual (Funds, etc.) At present in India there are two depositories: NSDL (National Securities
Depository Ltd.) and CDSL (Central Depository Services Ltd.) There is no direct contact
between depository and investor. Depository interacts with investors through depository
participants only. Depository participant will maintain securities account balances of investor
and intimate investor about the status of their holdings from time to time.

3.Placing the Order: After opening the Demat Account, the investor can place the order. The
order can be placed to the broker either (DP) personally or through phone, email, etc. Investor
must place the order very clearly specifying the range of price at which securities can be bought
or sold. e.g. “Buy 100 equity shares of Reliance for not more than Rs 500 per share.”

4.Executing the Order: As per the Instructions of the investor, the broker executes the order i.e.
he buys or sells the securities. Broker prepares a contract note for the order executed. The
contract note contains the name and the price of securities, name of parties and brokerage
(commission) charged by him. Contract note is signed by the broker.

5. Settlement: This means actual transfer of securities. This is the last stage in the trading of
securities done by the broker on behalf of their clients. There can be two types of settlement.
(a) On the spot settlement: It means settlement is done immediately and on spot settlement
follows. T + 2 rolling settlement. This means any trade taking place on Monday gets settled by
Wednesday.
(b) Forward settlement: It means settlement will take place on some future date. It can be T + 5
or T + 7, etc. All trading in stock exchanges takes place between 9.55 am and 3.30 pm. Monday
to Friday.

Defects of Stock Exchanges (or Capital Market) in India

The Indian stock market is suffering from a number of weaknesses. Important weaknesses are as
follows:

1.Speculative activities: Most of the transactions in stock exchange are carry forward
transactions with a speculative motive of deriving benefit from short term price fluctuation.
Genuine transactions are only less. Hence market is not subject to free interplay of demand and
supply for securities.

2. Insider trading: Insider trading has been a routine practice in India. Insiders are those who
have access to unpublished price-sensitive information. By virtue of their position in the
company they use such information for their own benefits.

3. Poor liquidity: The Indian stock exchanges suffer from poor liquidity. Though there are
approximately 8000 listed companies in India, the securities of only a few companies are
actively traded. Only those securities are liquid. This means other stocks have very low liquidity.

4. Less floating securities: There is scarcity of floating securities in the Indianstock exchanges.
Out of the total stocks, only a small portion is being offered for sale. The financial institutions
and joint stock companies control over 75% of the scrips. However, they do not offer their
holdings for sale. The UTI, GIC, LIC etc. indulge more in purchasing than in selling. This
creates scarcity of stocks for trading. Hence, the market becomes highly volatile. It is subject to
easy price manipulations.

5. Lack of transparency: Many brokers are violating the regulations with a view to cheating the
innocent investing community. No information is available to investors regarding the volume of
transactions carried out at the highest and low

6. High volatility: The Indian stock market is subject to high volatility in recent
years. The stock prices fluctuate from hour to hour. High volatility is not conducive for the
smooth functioning of the stock market.

7. Dominance of financial institutions: The Indian stock market is being dominated by few
financial institutions like UTI, LIC, GIC etc. This means these few institutions can influence
stock market greatly. This actually reduces the level of competition in the stock market. This is
not a healthy trend for the growth of any stock market.
8. Competition of merchant bankers: The increasing number of merchant bankers in the stock
market has led to unhealthy competition in the stock market. The merchant bankers help the
unscrupulous promoters to raise funds for non-existent projects. Investors are the ultimate
sufferers.

9. Lack of professionalism: Some of the brokers are highly competent and professional. At the
same time, majority of the brokers are not so professional. They lack proper education, business
skills, infrastructure facilities etc. Hence they are not able to provide proper service to their
clients.

Difference between Primary and Secondary Market

Primary Market Secondary Market
1. It is a market for new securities. 1. It is a market for existing or
2. It is directly promotes capital second hand securities
formation. 2. It is directly promotes capital
3. Investors can only buy securities. formation.
They cannot sell them. 3. Both buying and selling of
4. There is no fixed geographical securities takes place
location. 4. There is a fixed geographical
5. Securities need not be listed. location (stock exchanges)
6. It enables the borrowers to raise 5. Only listed securities can be
capital bought and sold
6. It enables the investors to invest
money in securities and sell and
encash as they need money

Securities Exchange Board of India (SEBI)

Securities and Exchange Board of India (SEBI) is the nodal agency to regulate the capital market
and other related issues in India. It was established in 1988 as an administrative body and was
given statutory recognition in January 1992 under the SEBI Act 1992 which came into force on
January 30, 1992. Before that, the Capital Issues (Control) Act, 1947 was repealed. SEBI has
been constituted on the lines of Securities and Exchange Commission of USA. SEBI is
consisting of the Chairman and 8 Members (one member representing the Reserve Bank of India,
two members from the officials of Central Government and five other public representatives to
be appointed by the Central Government from different fields). Securities and Exchange Board
of India has been playing an active role in the Indian Capital Market to achieve the objectives
enshrined in the Securities and Exchange Board of India Act, 1992.
Functions of SEBI
1.Protective Function: The protective function implies the role that SEBI plays in protecting the
investor interest and also that of other financial participants. The protective function includes the
following activities.
a. Prohibits insider trading: Insider trading is the act of buying or selling of the securities by
the insiders of a company, which includes the directors, employees and promoters. To prevent
such trading SEBI has barred the companies to purchase their own shares from the secondary
market.
b. Check price rigging: Price rigging is the act of causing unnatural fluctuations in the price of
securities by either increasing or decreasing the market price of the stocks that leads to
unexpected losses for the investors. SEBI maintains strict watch in order to prevent such
malpractices.
c. Promoting fair practices: SEBI promotes fair trade practice and works towards prohibiting
fraudulent activities related to trading of securities.
d. Financial education provider: SEBI educates the investors by conducting online and offline
sessions that provide information related to market insights and also on money management.
2.Regulatory Function: Regulatory functions involve establishment of rules and regulations for
the financial intermediaries along with corporates that helps in efficient management of the
market.
The following are some of the regulatory functions.
a. SEBI has defined the rules and regulations and formed guidelines and code of conduct that
should be followed by the corporates as well as the financial intermediaries.
b. Regulating the process of taking over of a company.
c. Conducting inquiries and audit of stock exchanges.
d. Regulates the working of stock brokers, merchant brokers.

3.Developmental Function: Developmental function refers to the steps taken by SEBI in order
to provide the investors with a knowledge of the trading and market function. The following
activities are included as part of developmental function.
1. Training of intermediaries who are a part of the security market.
2. Introduction of trading through electronic means or through the internet by the help of
registered stock brokers.
3. By making the underwriting an optional system in order to reduce cost of issue.
Role of SEBI in Secondary Market
1.Governing Board
2.Infrastructure
3.Settlement and Clearing
4.Debt Market
5.Price Stablisation
6.Delisting
7.Brokers
8.Insider Trading

1.Governing Board
Governing board brokers and non-brokers representation made 50:50,60% of brokers in
arbitration, disciplinary &default committees For trading members 40% representation

2.Infrastructure
Trade on the stock exchange NSE was established with the screen based trading On-line screen
based trading terminals

3.Settlement and Clearing

Weekly settlements Auctions for non-delivered shares within 80days of settlement Advice to set up
clearing houses, clearing corporation or settlement guarantee fund Warehousing facilities
permitted by SEBI.

4.Debt Market Segment

Regulates through SEBI (depository & participants) regulation Act 1996. Listing of debt
instruments Investment Range for FIIs Dual rating for above Rs.500 million

5.Price Stabilistion
Division to monitor the unusual movements in prices. Monitor prices of newly listed scrip from
the first dayof trading. Circuit breaker system and other monitoringrestrictions could be applied
Imposing of special margins of 25% on purchase inaddition to regular margin. Price filters
Price bands

6.Delisting
On voluntary de-listing from regional stock exchanges buy offer to all share holders Promoters
to buy or arrange buyers for thesecurities 3 yrs listing fees from companies and be keptin
Escrow A/c with the stock exchange
7..InsiderTrading
The most profitable technique employed in the stock market is using one’s access to price sensitive
information ahead of others.
For example Hindustan Lever announced merger of Broke Bond Lipton India with itself on April 16,1996.Once
the information became public, the trading volume and price declined. Toprevent this SEBI has come out with
the SEBI Insider Trading regulation 1992.

8..Broker
The regulation of the functioning of the brokers starts with the registration of the brokers.
The registration is given on the basis of the eligibilty to be a member of any stock exchange, infrastructure facilities
like adequate office space, equipment and manpower.
He should have past experience in the business of buying, selling or dealing in securities.

9.Other Roles :
It will issue guidelines for the proper functioning of the secondary market.
It has the power to call periodical returns from stock exchanges.
It has the power to prescribe maintenance of certain documents by the stock exchanges.
It may call upon the exchange or any member to furnish explanation or information relating to
the affairs of the stock exchange or any members.

Secondary Market Reforms by the SEBI:

Since the establishment of Securities and Exchange Board of India (SEBI) in 1992, the decade’s
old trading system in stock exchanges has been under review. The main deficiencies of the
system were found in two areas: (i) the clearing and settlement system in stock exchanges
whereby physical delivery of shares by the seller and the payment by the buyer was made, and
(ii) procedure for transfer of shares in the name of the purchaser by the company. The
procedure was involving a lot of paper work, delays in settlement and nontransparency in costs
and prices of the transactions. The prevalence of ‘Badla’ system had often been identified as a
factor encouraging speculative activities. As a part of the process of establishing transparent
rules for trading, the ‘Badla’ system was discontinued in December 1993. The Securities and
Exchange Board of India directed the stock exchanges at Mumbai, Kolkata, Delhi and
Ahmadabad to ensure that all transactions in securities are concluded by delivery and payments
and not to allow any carry forward of the transactions. The floor-based open outcry system has
been replaced by on-line electronic system. The period settlement system has given way to the
rolling settlement system. Physical share certificates system has been outdated by the electronic
depository system. The risk management system has been made more comprehensive with
different types of margins introduced. FII’s have been allowed to participate in the capital
market. Stringent steps have been taken to check insider trading. The interest of minority
shareholders has been protected by introducing takeover code. Several types of derivative
instalments have been introduced for hedging. As a result of the reforms/initiatives taken by
Government and the Regulators, the market structure has been refined and modernized. The
investment choices for the investors have also broadened. The securities market moved from T+3
settlement periods to T+2 rolling settlement with effect from April 1, 2003. Further, straight
through processing has been made mandatory for all institutional trades executed on the stock
exchange. Real time gross settlement has also been introduced by RBI to settle inter-bank
transactions online real time mode.
 UNIT – 4
Banking and Developmental Financial Institutions

Banking Institutions:
Banking institutions mobilise the savings of the people. They provide a mechanism for the
smooth exchange of goods and services. They extend credit while lending money. They not only
supply credit but also create credit. There are three basic categories of banking institutions. They
are commercial banks, co-operative banks and developmental banks.

Banking Financial Institutions

Banking financial institutions are those financial institutions which carry\ on banking activities.
Banking business is carried on by these institutions after obtaining an approval under Banking
Regulation Act, 1949 and RBI. It accepts deposits from the public. It lends money to people
engaged in commerce, industry and agriculture. It finances foreign trade and deals in foreign
exchange. It provides short, medium and long term credit. It acts as an agent of RBI. It
deals in stocks and shares, trusteeship, executorships etc. In short, the bank can be aptly
described, as ‘department store of finance’ because it engages itself in every form of banking
business.

Functions of Banks
The functions of commercial banks can be broadly categorized into
a) Primary functions
b) Secondary functions.

Primary Functions
Following are the primary functions rendered by banks.
1.Accepting of Deposits
The primary function of commercial banks is to accept money from the people in the form of
deposits which are usually repayable on demand or after the expiry of a fixed period. For these
deposits, the banks pay a rate of interest, which is called as interest expenditure. Thus, banks act
as a custodian of depositors‟ funds. The deposits may be of various types such as savings
deposits, current deposits, fixed deposits and recurring deposits.

A.Savings deposits encourage customers to save money and promote banking habit among the
public. Savings Bank accounts provide a low rate of interest and they have restrictions on the
number of withdrawals by the customers.
b.Current Deposit accounts are opened by business people. These accounts have no restrictions
on the number of withdrawals and are subject to service changes. There is no interest payment
but current account holders can also avail the benefits such as overdraft and cash credit facilities.

c.Fixed deposits accounts can be opened by any person who wants to deposit a lump sum funds
at one time for a specific time period. These accounts provide higher rate of interest depending
on the time period for which it is deposited. These accounts do not allow withdrawal before the
expiry of the period.

d.Recurring deposit accounts are normally opened and operated by persons who get regular
income such as salary class and petty shop owners. A specific amount of money is deposited
periodically, say, monthly for a specific period, say, one year. These accounts provide higher rate
of interest and do not allow withdrawal before the expiry of the period.

2.Lending Loans and Advances

The second primary function of commerce bank is to lend loans and advances to the
corporate sector and households. Normally, the rate of interest levied on these loans and
advances is higher than what it pays on deposits. The interest income is the major source of
income for commercial banks. The difference in the interest rates (Interest Received and Interest
Paid) is called Interest Spread, which contributes to its profitability. Apart from leading, the
banks usually keep some portion of funds to meet the demands of depositors and running
expenses. The various types of loans and advances include overdraft, cash credit, loans,
discounting of bills of exchange.

a.Over Draft (OD) is a facility extended by banks to the current account holders who maintain
their accounts for business purposes. In this facility, the current account holders can withdraw
more money fromtheir accounts than what they maintain as balance. Under this facility, banks
honour the cheques drawn by the customers of the current account even if sufficient money is not
available in their account. This overdrawing limit will be fixed by the banks for a certain period,
based on the credit quality of the current account holders and their history of dealing with the
bank. The amount overdrawn will be considered as loan and interest will be charged on the
actual amount withdrawn.

b.Cash Credit (CC) is a facility extended by banks to current account holders and other who do
not have account. In this facility, banks sanction a credit limit to a borrower for a certain period
(usually for a longer period than overdraft) after verifying the credit worthiness, history of bank
dealings and the track record of business. Normally banks expect security of tangible assets
(such as stock of inventory) and/or guarantees for sanction cash credit facility. Interest will be
charged on the portion of amount withdrawn from the cash credit account but not on the entire
amount sanctioned to the borrower.
Loans are normally sanctioned for a short term period (say one year) or medium term (say
three to five years). At present, banks lend long term loans also. Repayment of loan will be made
in various installments (say monthly, quarterly, semiannually, annually) over a specific period of
time or in a lump sum. Banks charge interest on the actual amount of loan sanctioned and rate of
interest is somewhat lower than what is charged on OD or CC facility. Regarding the collateral
(security), banks expect some tangible assets (like stock of raw materials, finished goods) from
the borrower. There are various types of loans such as secured loans, mortgage loans,
educational loans, personal loans, etc. Examples for secured loans include two wheeler loans to
the individuals, working capital loans to the business firms, etc. Mortgage loans are given to the
borrowers to purchase immovable tangible assets such as land, buildings, homes, etc. with a
lien/charge on the asset which will serve as collateral. At present, majority of the banks are
granting home loans to the customers. Educational loans for higher studies and professional
courses are given by banks to the students at a reasonable rate of interest. Personal Loans
(Consumer finance) for individuals are provided on easy terms and conditions to buy consumer
durables like T.V, refrigerators etc.

c.Discounting of Bill of Exchange is another method of granting advances to the traders. The
banks can advance funds by purchasing or discounting the bills from traders which arise from
trade. Trade bills are those bills which emerge due to credit sale to customers. If the traders
require money before the expiry of the bills, they can discount the bills with the banks. The
banker will pay an amount to the drawer or beneficiary of the bill (usually trader who sold goods
on credit basis to customers) after deducting the discount amount. On maturity of the bill, the
banker will receive the amount from the drawee or acceptor of the bill (the customer who bought
goods on credit terms).

Secondary Functions
Following are the secondary functions performed by the banksBesides the primary functions of
accepting deposits and lending loans and advances, banks perform various other functions, which
are called secondary functions. They include agency functions and utility functions.

1.Agency Functions
The banks act as agent of their customers and perform a number of agency functions which
include transfer of funds, collection of cheques, periodic payment, periodic collections, portfolio
management and other agency functions.Transfer of Funds is made by banks from one branch to
another or from one place to another for customers. At present, banks use technology and
telecommunication systems to facilitate these transfers. Example: Electronic fund transfers
(EFT). For this service, banks collect service charges. Collection of Cheques is facilitated by
banks through clearing section. Thus, the cheques deposited or presented for collection are
credited to the customers‟ account once they collect the same through clearing process. This
includes the cheques of the same bank or other banks and within the station and outstation. For
providing this service, they charge collection charges which are very nominal.Periodic Payments
such as payment of public utility bills, rent, interest, etc. are made by banks on behalf of the
customers based on their standing instructions. A specific example: Payment of housing loan
interest from salary account.Periodic Collections such as receipt of salary, pension, dividend,
interest, rent, etc. are made by banks on behalf of the customers based on their standing
instructions. A specific example: Receipt of dividend from investments.
Portfolio Management services are offered by banks to guide the customers or clients on their
investment decisions to buy or sell the securities (shares and debentures) to achieve optimal
portfolio for getting maximum returns. Other Agency Functions like acting as trustee,
administrator, adviser, executor, etc. on behalf of the customer or client are provided by banks.

2.General Utility Functions/Financial Services

The banks performs general utility functions such as issue of drafts,letter of credits, locker
facility, underwriting of shares, dealing in foreign exchange, project counseling, social
responsibility programmes and other utility functions. Issue of Drafts, Traveller Cheques and
Letter of Credits are done by banks for facilitating the transfer of money from one place to
another and for giving guarantee for import trade. Travellers‟cheques is also issued by banks.
Safety Locker Facility is provided to customers for safe keeping their valuables such as
documents, gold, silver articles and other values. Underwriting of Shares and debentures are
done by banks in the capacity of merchant banker through their subsidiaries. In the case of
client‟s capital issue fails in the market, the banks assume the risk of under subscription by
underwriting the issue. For this, banks receive underwriting commissions.
Dealing in Foreign Exchange can be undertaken by banks as they are allowed by RBI. They will
act as deal makers or traders depending on their position. Project Reports are being prepared on
behalf of the clients or customers. Many corporate which take up projects and look for financial
assistance have to prepare project reports for submitting the same to the Financial Institutions or
Banks. This project report preparation requires expertise personnel which the banks possess.
Banks collect consultancy charges from their clients or customers.Social Responsibility
Programmes such as public welfare campaigns, adult literacy programmes, maintenance of
schools, parts, blood donation camps, etc. are undertaken by banks to showcase their social
responsibility.
Other Utility Functions may include any other function the bank may render for customers.
Examples include collecting and supplying business information, acting as a referee to a
financial standing of customers, etc.

Types of Banks
The following explains the various types of banks based on structure, ownership and function
Based on the Structure or Organizational Setup Banks can be of five types based on the
structure or organizational setup, viz., unit bank, branch bank, group bank, chain bank and
correspondent bank.

1.Unit Bank is a type of bank under which the banking operations are carried by a single
branch with a single office and they limit their operations to a limited area. Normally, unit banks
may not have any branch or it may have one or two branches. This unit banking system has its
origin in United State of America (USA) and each unit bank has its own shareholders and board
of management. In USA, each State may have many unit banks but each unit bank limits its
operation within the State or country.
There may be many central banks and they control the unit banks operating in their States.
Collectively the central banks are called Federal Reserve Banks.

2) Branch Bank is a type of banking system under which the banking operations are carried
with the help of branch network and the branches are controlled by the Head Office of the bank
through their zonal or regional offices. Each branch of a bank will be managed by a responsible
person called branch manager who will be assisted by the officers, clerks and sub-staff. In
England and India, this type of branch banking system is in practice. In India, State Bank of
India (SBI) is the biggest public sector bank with a very wide network of 16000 branches.

3) Group Bank is a system of banking under which there will be holding company
controlling the subsidiary companies which carry out banking business. In some cases, both the
holding and subsidiary companies may carry out banking business. An apt example in India is
SBI which has many subsidiary banks such as State Bank of Mysore, State Bank of Indore, State
Bank of Hyderabad, State Bank of Bikaner and Jaipur, State Bank of Patiala and State Bank of
Travancore. These subsidiaries carry out banking and other operations such as leasing, merchant
banking and so on.

4) Chain Bank is a system under which different banks come under a common control
through common shareholders or by the inter-locking of directors. An apt example in India is
KarurVysya Bank and Lakshmi Vilas Bank having their head offices located in the same place,
viz., Karur and sharing common directors by which they may have common management policy.

5) Correspondent Bank is a bank which link two banks of different stature or size. Many
Indian banks act as correspondent bank for many foreign banks.

Based on the Ownership

Banks can be of four types based on the ownership. They are public sector banks, private sector
banks, foreign banks and cooperative banks.

1) Public Sector Banks are those banks in which majority stake (i.e., more than 50% of the
shares) is held by the government of the country. The words such as “The” or “Ltd” will not be
found in their names because the ownership of these banks are with the government and the
liability is unlimited in nature. Some examples of public sector banks in India include Andhra
Bank, Canara Bank, Union Bank of India, Allahabad Bank, Punjab National Bank, Corporation
Bank, Indian Bank and so on.
2) Private Sector Banks are those banks which are owned by group of private shareholders.
They elect board of directors which manages the affairs of the banks. Some examples of private
banks in India include The Lakshmi Vilas Bank Ltd., The Karur Vysya Bank Ltd., The City
Union Bank Ltd., HDFC Bank, Axis Bank and son.

3) Foreign Banks are those banks which belong to foreign countries and have their
incorporated head office in foreign countries and branch offices in other countries. The share
capital of the foreign banks will be fully contributed by the foreign investors. Some examples of
foreign banks in Indian include ABM Amro bank, Standard Chartered Bank, JP Morgan Chase
Bank and so on.

4) Cooperative Banks are those banks which are run by following cooperative principles of
service motive. Their main motive is not profit making but to help the weaker sections of the
society. Some examples of cooperative banks in India include Central Cooperative Banks, State
Cooperative Banks.

Based on the Functions

Banks can be of various types based on the functions they perform. They include savings banks,
commercial banks, industrial banks, agricultural development banks, land mortgage/development
banks, cooperative banks, exchange banks, indigenous banks, consumer banks, central bank.

1.Saving Banks are established to encourage savings habit among the people. There are no
separate banks called savings banks but postal department perform the functions of savings bank.
People can save even very small amount in these banks and these banks discourage withdrawals
by limiting the number of withdrawals during a year. The amount collected from the customers is
invested in securities such as bonds, government securities, etc. The main objective of these
banks is to promote thrift and savings among the people. People who prefer these banks include
salaried people and low income groups. At present, in India all the commercial banks act as
savings banks besides providing various other services.

2) Commercial Banks are established to help the people who carry out trade and commerce,
i.e., businessmen. They mobilize deposits from public and lend short-term loans to businessmen
in the form of overdrafts, cash credit, etc for their commercial activities. As the commercial
activities are of paramount importance to economic development, the commercial banks play a
key role in promoting commercial activities in the country. Normally they do not provide long-
term loans but provide short to medium term loans to traders for their working capital needs.
Apart from lending, they also provide a host of services such as cheque collection, discounting
bills of exchange, facilitating money transfer, etc. These commercial banks are subject to
Reserve Bank of India‟s regulation.
3) Industrial Banks / Investment Banks are those banks which provide long term loans to
industries for the purpose of expansion and modernization. They raise capital by issue of shares
and debentures and provide long term loans to industries. These banks are also responsible for
the development of backward areas for which they promote industries in those places. In India,
examples for industrial banks include Industrial Finance Corporation of India (IFCI), earlier
Industrial Credit and Investment Corporation of India (ICICI- Now universal bank) and earlier
Industrial Development Bank of India (IDBI-now universal bank).
Investment bank is a financial and banking organization, which provides both financial as well as
advisory banking services to their clients. Besides this, they also deal with research, marketing
and sales of a range of financial products like commodities, currency, credit, equities etc. As
investment banks, they contribute to share capital and/or takepart in capital issue management
for promoting the companies by underwriting their issues and facilitate public to buy those
shares. The industrial activities are promoted by these banks and they also mobilize long term
deposits. In India, Bank of America, JP Morgan and BNP Paribas are some of the leading
investment banks.

4) Agricultural/Land Development Banks are those banks which are known as Land
Mortgage or Agricultural Banks as they provide finance to agricultural sector. They provide long
term loan for agriculture for the purposes of purchase of new land, purchase of heavy
agricultural machinery such as tractor, repayment of old debt, conservation of soil and
reclamation of loans. In India, Government of India has guaranteed the debentures issued by
agricultural/land development banks. In Tamil Nadu, we have Tamil Nadu Cooperative Land
Development bank. They follow the principles of cooperative banks and help the weaker
sections. Commercial banks do not take active part as they view agricultural financing as risky
one and hence, Agricultural Development Banks play a key role in this activity.

5) Co-operative Banks are those banks which are registered under the Cooperative Societies
Act 1912. These banks collect share capital from the public and lend to economically weaker
sections. They provide financial assistance to farmers, salaried class, small scale industries, etc.
They can be found in rural and urban areas and the functions are similar to commercial banks
except that they charge less interest for the loans and advances.

6) Regional Rural Banks are those banks which are established by the Government under
the Regional Rural Banks Act of 1976 with a specific purpose to provide credit and other
facilities to the small and marginal farmers, agricultural labourers, artisans and small
entrepreneurs in rural areas. Each RRB operates within the specified local areas.

7) Exchange Banks are also called as foreign exchange banks and they are incorporated
outside the country but carry out business in India. They provide foreign exchange subject to the
rules and regulations of the country in which they are operating. They also provide finance to
exporters and letter of credit/guarantee toimporters. They help in remitting of funds from one
country to another country, discount foreign bills, buy and sell gold silver, promote foreign trade.
Examples of exchange bank include Bank of America, Hong Kong Bank, etc.

8) Indigenous Banks refer to money lenders and Sahukars. The money lenders using their
own funds and deposits mobilized from public, grant loans to the needy people. They are more
popular in villages and small towns. Usually, they act as traders and bankers simultaneously. In
India, we have well known Indian communities such as Marwaries, Multani run their indigenous
banks.

9) Consumers Banks operate only in advanced countries like USA and Germany. The
primary objective of these banks is to provide loans to customers to purchase consumer durables
like Car, TV, Washing Machine, Furniture, etc. The consumers repay the loans in easy
installments.

10) Central / Federal / National Bank is a leader of all the banks in a country. Every
county has a central bank. The prime responsibility of a Central Bank is to regulate the banking
system and control monetary policy. These banks are called as banker to the bankers as they give
financial accommodation to commercial banks. They are non-profit making institutions and they
also act as banker to the government, issue currency notes, etc. They maintain foreign exchange
reserves of the country and all the government accounts are maintained with them. They help in
money circulation in the economy and provide financial accommodation to the government in
case of necessity through purchase of treasury bills in the money market. In India, Reserve Bank
of India, in USA, Federal Reserve (a group of central banks), in UK, Bank of England are the
central bank.

Banking financial institutions mainly comprise of commercial banks.

A. Commercial banks
A Bank is a financial Institution whose main business is accepting deposits and lending loans. A
Banker is a dealer of money and credit. Banking is an evolutionary concept i.e. expanding its
network of operations. According to Banking revolutions Act 1949, the word BANKING has
been defined as “Accepting for the purpose of lending and investment of deposits of money from
the public repayable on demand or otherwise”.

Functions of Commercial Banks

Globalisation transformed commercial banks into super markets of financial services. The
important functions of commercial banks are explained below:

I. Primary Functions
These are further classified into 2 categories
i) Accepting Deposits: -
Deposits are the capital of banker. Therefore, it is first Primary function of the banker. He
accepts deposits from those who can save and lend it to the needy borrowers. The size of
operation of every bank is determined by size and nature of Deposits. To attract the saving from
all sort (categories) of individuals, Commercial banks accepts various types of deposits account
they are:
a) Fixed Deposits
b) Current Deposits
c) Saving Bank account
d) Recurring Deposits
ii) Lending Loans: -

The 2nd important function of the commercial bank is advancing loans. Bank accepts deposits
to lend it at higher rate of interest. Every Commercial Bank keep the rate of interest on its
deposit at lower level or less that what he charges on its loans which is as NIM (Net Interest
Margin). The banker advances different types of loans to the individual and firms. They are: -
a) Overdraft
b) Cash Credit
c) Term Loan
d) Discounting Bill

II) Secondary Functions

i) Agency functions:
Bankers act as an agent to the customers it means he performs certain functions on behalf of the
customers such services are called Agency Services. Example:
a) Bank pay electricity bill, water bill, Insurance Premium etc.
b) They guide the customer in Task Planning.
c) Bank provides safety locker facility.
d) Pay salaries of customer’s employees.

ii) General Utility Services: -

Bankers are the past of society. They offer: several services to general public they are:-
a) It provides cheap remittance (transfer) facilities.
b) The banks issue traveller cheque for safe travelling to its customers.
c) Banks accepts and collects foreign Bills of Exchanges.
d)Other than these services the bankers also provide ATM services, Internet Banking, Electronic
fund transfer (EFT), E-Banking to provide quick and proper
services to its customers.

iii) Credit Creation: -

It is a unique function of Commercial Banks. When a bank advances loan to its customer if
doesn’t lend cash but opens an account in the borrowers name and credits the amount of loan to
that account. Thus, whenever a bank grants loan, it creates an equal amount of bank deposits.
Creation of deposits is called Credit Creation. In simple words we can define Credit creation as
multiple expansions of deposits. Creation of such deposits will results an increase in the stock
deposits. Creation of such deposits will results an increase in the stock of money in an economy.

Non-banking Institutions:
The non-banking financial institutions also mobilize financial resources directly or indirectly
from the people. They lend the financial resources mobilized. They lend funds but do not create
credit. Companies like LIC, GIC, UTI, Development Financial Institutions, Organisation of
Pension and Provident Funds etc. fall in this category. Non-banking financial institutions can be
categorized as investment companies, housing companies, leasing companies, hire purchase
companies, specialized financial institutions (EXIM Bank etc.) investment institutions, state
level institutions etc.

Developmental Financial Institutions:

A development finance institution (DFI) also known as a development bank or development
finance company (DFC) is a financial institution that provides risk capital for economic
development projects on non commercial basis. They are often established and owned by
governments or charitable institutions to provide funds for projects that would otherwise not be
able to get funds from commercial lenders.

Development banks in India are classified into following four groups:

1.Industrial Development Banks: It includes, for example, Industrial Finance Corporation of

India (IFCI), Industrial Development Bank of India (IDBI), and Small Industries Development
Bank of India (SIDBI).

2. Agricultural Development Banks: It includes, for example, National Bank for Agriculture &
Rural Development (NABARD).

3. Export-Import Development Banks: It includes, for example, Export- Import Bank of India
(EXIM Bank).

4. Housing Development Banks: It includes, for example, National Housing Bank (NHB).
State Finance Corporations (SFCs)
The Govt. after independence realised the need of creating a financial corporation at the state
level for catering to the needs of industrial entrepreneurs. As a result, the Govt of India after
consultation with the State governments and the Reserve Bank of India, introduced State Finance
Corporations bill in the Parliament in 1951. SFC Act came into existence with effect from
August 1, 1952. The Act permitted the State Governments. to establish financial corporation’s
for the purpose of promoting industrial development in their respective states by providing
financial assistance to medium and small scale industries.

Functions of State Finance Corporations

The main function of the SFCs is to provide loans to small and medium scale industries engaged
in the manufacture, preservation or processing of goods, mining, hotel industry, generation or
distribution of power, transportation, fishing, assembling, repairing or packaging articles with the
aid of power etc.

Other functions are follows:

1. Granting loans or advances or subscribing to shares and debentures of the industrial
undertaking repayable within twenty years.
2. Guaranteeing loans raised by the industrial concerns repayable within twenty years.
3. Underwriting of the shares, bonds and debentures subject to their disposal in the market within
seven years.
4. Guaranteeing deferred payments for the purchase of capital goods by industrial concerns
within India.
5. Providing loans for setting up new industrial units as well as for expansion and modernization
of the existing units.
6. Discounting the bills of small and medium scale industries
7. The SFCs underwrite new stocks, shares, debentures etc., of industrial concerns for a period
not exceeding 20 years
8. The SFCs provide guarantee loans raised in the capital market by scheduled banks, industrial
concerns, and state co-operative banks to be repayable within 20 years.
9. SFCs also perform various other functions like appraisal of investment projects, credit
syndication, project documentation, placement of debt, industry research, legal advisory services,
etc., to small and medium sized industries.

Life Insurance Corporation of India (LIC)

The Life Insurance Corporation of India was set up under the LIC Act, 1956 under which the life
insurance was nationalised. As a result, business of 243 insurance companies was taken over by
LIC on 1-9-1956. It is basically an investment institution, in as much as the funds of policy
holders are invested and dispersed over different classes of securities, industries and regions, to
safeguard their maximum interest on long term basis. Life Insurance Corporation of India is
required to invest not less than 75% of its funds in Central and State Government securities, the
government guaranteed marketable securities and in the socially-oriented sectors. At present, it is
the largest institutional investor. It provides long term finance to industries. Besides, it extends
resource support to other term lending institutions by way of subscription to their shares and
bonds and also by way of term loans.

Life Insurance Corporation of India which has entered into its 57th year has emerged as the
world’s largest insurance co. in terms of number of policies covered. The Life Insurance
Corporation of India’s total coverage of policies including individual, group and social schemes
has crossed the 11 crore.

Role and Functions of Life Insurance Corporation of India

The role and functions of Life Insurance Corporation of India may be summarised as below:
1.It collects the savings of the people through life policies and invests the fund in a variety of
investments.

2.It invests the funds in profitable investments so as to get good return. Hence the policy holders
get benefits in the form of lower rates of premium and increased bonus. In short, Life Insurance
Corporation of India is answerable to the policy holders.

3. It subscribes to the shares of companies and corporations. It is a major shareholder in a large

number of blue chip companies.

4. It provides direct loans to industries at a lower rate of interest. It is giving loans to industrial
enterprises to the extent of 12% of its total commitment.

5. It provides refinancing activities through SFCs in different states and other industrial loan-
giving institutions.

6. It has provided indirect support to industry through subscriptions to shares and bonds of
financial institutions such as IDBI, IFCI, ICICI, SFCs etc. at the time when they required initial
capital. It also directly subscribed to the shares of Agricultural Refinance Corporation and SBI.

7. It gives loans to those projects which are important for national economic welfare. The
socially oriented projects such as electrification, sewage and water channelising are given
priority by the Life Insurance Corporation of India.

8. It nominates directors on the boards of companies in which it makes its investments.

9. It gives housing loans at reasonable rates of interest.

10. It acts as a link between the saving and the investing process. It generates the savings of the
small savers, middle income group and the rich through several schemes.
11. Formerly LIC has played a major role in the Indian capital market. To stabilise the capital
market it has underwritten capital issues. But recently it has moved to other avenues of
financing. Now it has become very selective in its underwriting pattern.

General Insurance Corporation of India (GIC)

General insurance industry in India was nationalised and a government company known as
General Insurance Corporation of India was formed by the central government in November,
1972. General insurance companies have willingly catered to these increasing demands and have
offered a plethora of insurance covers that almost cover anything under the sun. Any insurance
other than ‘Life Insurance’ falls under the classification of General Insurance. It comprises of:-
a. Insurance of property against fire, theft, burglary, terrorism, natural disasters etc
b. Personal insurance such as Accident Policy, Health Insurance and liability insurance which
cover legal liabilities.
c. Errors and Omissions Insurance for professionals, credit insurance etc.
d. Policy covers such as coverage of machinery against breakdown or loss or damage during the
transit.
e. Policies that provide marine insurance covering goods in transit by sea, air, railways,
waterways and road and cover the hull of ships.
f. Insurance of motor vehicles against damages or accidents and theft All these above mentioned
form a major chunk of non-life insurance business.

General insurance products and services are being offered as package policies offering a
combination of the covers mentioned above in various permutations and combinations. There are
package policies specially designed for householders, shopkeepers, industrialists, agriculturists,
entrepreneurs, employees and for professionals such as doctors, engineers, chartered
accountants etc. Apart from standard covers, General insurance companies also offer customized
or tailor-made policies based on the personal requirements of the customer.

Classification of Indian General Insurance Industry

General Insurance is also known as Non-Life Insurance in India. There are totally 16 General
Insurance (Non-Life) Companies in India. These 16 General Insurance companies have been
classified into two broad categories namely:
a) PSUs (Public Sector Undertakings)
b) Private Insurance Companies

a) PSUs (Public Sector Undertakings):-

These insurance companies are wholly owned by the Government of India.
There are totally 4 PSUs in India namely:-
• National Insurance Company Ltd
• Oriental Insurance Company Ltd
• The New India Assurance Company Ltd
• United India Insurance Company Ltd

b) Private Insurance Companies:-

There are totally 12 private General Insurance companies in India namely:-
• Apollo DKV Health Insurance Ltd
• Bajaj Allianz General Insurance Co. Ltd
• Cholamandalam MS General Insurance Co. Ltd
• Future General Insurance Company Ltd
• HDFC Ergo General Insurance Co Ltd,etc

Role and Functions of GIC:

1.To carry on of any part of the general insurance, if it thinks it is worthwhile to do so
2.To assist, advise, and aid the acquiring companies in the matter of setting up the standards of
conduct and fair practice in the business of general insurance.
3.To render efficient services to the general insurance policyholders.
4.To issue directives to the acquiring companies in relation to the conduct of the business of
general insurance.
5.To advise the acquiring companies in the matters concerning investing their funds.
6.To issue directions to the acquiring companies and encourage competition among them in
order to render efficient services.

Unit Trust of India (UTI)

The Unit Trust of India was set up in February 1964 under the Unit Trust of India Act of 1963, in
the public sector. It plays an important role in mobilizing savings of investors through sale of
units and channelizing them into corporate investments. Over the years, it has introduced a
variety of growth schemes to meet needs of diverse section of investors. After an amendment to
its Act in April 1986, Unit Trust of India has started extending assistance to corporate sector by
way of term loans, bills rediscounting, equipment leasing and hire purchase facilities.
The management of the trust is entrusted to the Board of Trustees. The chairman of the Board
and 4 other trustees are appointed by the RBI. One trustee each is nominated by the LIC and the
SBI, and 2 other trustees are elected by other subscribers to the capital of the trust.
Unit Trust of India has recently set up an Asset Management Company to bring some of its
mutual fund schemes under its purview. It also engaged in investment banking business, stock
broking, consultancy etc. Sanctions up to March, 1993, amounted to Rs. 7520.6 crores. One of
the striking features of purpose-wise UTI sanctions reveals that working capital requirements of
industrial concerns have received the maximum attention (over 50-55%). Similarly private sector
accounts for the highest share in Unit Trust of India sanctions (about 67%) followed by public
sector (32%). Unit Trust of India is the first unit trust in the public sector in the world.
Functions of UTI
1.Mobilize the saving of the relatively small investors.
2.Channelize these small savings into productive investments.
3.Distribute the large scale economies among small income groups.
4.Encourage savings of lower and middle-class people.
5.Sell nits to investors in different parts of the country.
6.Convert the small savings into industrial finance.
7.To give investors an opportunity to share the benefits and fruits of industrialization in the
country.
8.Provide liquidity to units.
9.Accept discount, purchase or sell bills of exchange, warehouse receipt, documents of title to
goods etc.,
10.To grant loans and advances to investors.
11.To provide merchant banking and investment advisory service to investors.
12.Provide leasing and hire purchase business.
13.To extend portfolio management service to persons residing in other countries.
14.To buy or sell or deal in foreign currency.
15.Formulate a unit scheme or insurance plan in association with GIC.
16.Invest in any security floated by the RBI or foreign bank.

EXIM BANK
EXIM Bank of India
The EXIM Bank, effective from 1 January 1982, was established to be responsible for the
business of the IDBI (Industrial Development Bank of India) global finance branch and to
deliver monetary support to exporters and importers. It serves as a chief financial foundation for
collaborating with the functioning of other organisations involved in the financing of exports and
imports of services and products.
The EXIM Bank is a growth engine for a range of services and products of Indian businesses.
This includes export production, import of technology and export product development, pre-
shipment and post-shipment, export marketing and overseas investment. It is a catalyst and key
player in promoting cross-border investment and trade.
Functions of the EXIM Bank
Now that we are aware of the meaning, importance, objectives, and financial products
concerning the EXIM bank, one of the prime Regulators of Banks and Financial Institutions, let
us also take a look at some of its prime functions. The major functions of the EXIM Bank
include:

1.Financing exports and imports of goods and services from India

2.Financing the import and export of goods and services other countries as well
3.Underwriting shares/ stocks/ debentures/ bonds of companies that carry out foreign trade
4.Financing the import and/ or export of machinery and equipments on lease or hire-purchase
basis
5.Undertaking functions of a merchant bank for the importer or exporter in transactions of
foreign trade
6.Providing refinancing services to banks and other financial institutions for their capital
requirements of foreign trade
7.Offering short-term loans or lines of credit to foreign banks and governments

NABARD
National Bank for Agricultural and Rural Development provides monetary support to RURAL
small-scale AGRICULTURE & allied activities. This article highlights the function of
NABARD along with its roles and achievements.

National Bank for Agricultural and Rural Development (NABARD) is a government body
regulated by the ministry of finance of India. The aggregate function of NABARD is to provide
monetary or Credit support to small-scale rural industries lacking due to less or no support. The
organisation aims to promote rural business and uplift the economic conditions of rural areas.
Healthy development contributes to building a better lifestyle and generates employment
opportunities in the role of NABARD. NABARD looks after co-operating banks which offer
funding at low rates and effortless returning policies. RBI supervises all the banks under the
Banking Regulation Act of 1949

NABARD was founded on July 12, 1982, in Mumbai by the government of India to facilitate
Credit or money flow for the development and enhancement of cottage, agricultural and small-
scale village industries. DR. G.R. Chintala is the present chairman of NABARD, who came into
power in May 2020. NABARD follows the tagline, “Goan Badhe toh Desh Badhe”, as India is a
country of villages, so its development policies focus on villages through supporting industries.
State cooperative banks, State cooperative agricultural and rural development banks, Primary
agricultural credit societies and District central cooperative banks are examples of NABARD.

FUNCTIONS OF NABARD
NABARD has a decided set of functions meant to be fulfilled under a certain period by financing
and uplifting the industries. These functions of NABARD include planning, organising and
controlling agricultural activities. Here are the functions of NABARD:-
1.Proving service to the rural public by financing and investing in a small-scale business that
sells local and handmade products that aim to gain profit and promote heritage.
2.Formulating plans, policies, and activities to develop a strong base and capacity to finance
several industries at one time and keeping a check on them by managing records.
3.Providing training to employees for productive, smooth, disciplined and consistent services in
Investment and advice to beginner industries.
4.Establishing the coordination and connection among banks gives credit flow to the state and
central government and RBI to maintain transparency in policy formulation and regulation.
5.Integrated Rural Development Programme counts under a high-priority project run by the
government, which includes refinancing accounts for poverty mitigation by offering the highest
share in support.
6.It maintains links with self-help groups that aim to uplift the poor people’s conditions and be
an independent lifestyle for them.
7.NABARD runs a uniform inspection to ensure the welfare of rural areas and farmers.
“VIKAS VAHINI” is a programme specially formulated for the development of farmers across
rural regions.

8.After running several programmes in rural areas, it conducts studies and stops the downgoing
points and corrects them with measure and refinance the mission, which aims to restructure the
growth and boost its fullest.
ROLE OF NABARD
Here is the role of NABARD:-
1.NABARD is an apex organisation that monitors the rural area and forms cooperative banks to
provide credit flow at the lowest rates to support the poor population.
2.The role of NABARD behind offering at low rates from RBI financed banks is to upgrade their
financial problems.
3.It is also called a refinancing organisation that promotes those projects which generate
employee and skill development programs in the rural sector and connects these projects to self-
help groups.
4.Another role of NABARD is to stay connected to RBI and government authorities to fulfil the
target allotted according to the specific period and benefit the rural public equally.
5.NABARD has formed a special research centre for better techniques, strategies and policies for
wholesome consistent elevation, and it regularly monitors and takes corrective actions.

SIDBI
SIDBI commonly known as the Small Industries Development Bank of India, was
established as a statutory body in 1988 under a special Act of the Indian Parliament and which
came into force on April 2, 1990. SIDBI has set up its headquarters in Lucknow; Uttar
Pradesh. It is one of the four All-India Institutions, the others being NABARD; EXIM;
and NHB.
Initially, SIDBI was fully involved in industrial development activities in the country by
managing SIDF (Small Industries Development Fund) and NEF (National Equity Fund) and was
the financial base for funding the MSME (Micro, Small, and Medium enterprises) sector .
Functions of SIDBI:
1.SIDBI emerged as a single window operation to meet its financial and improvement needs as
well as to make the MSME sector strong, vibrant, and globally competitive.
2.SIDBI helps financial institutions in lending to small-scale industries so that they have a
healthy financial position and also provides non-financial assistance to business owners by
helping them procure raw materials.
3.SIDBI engages commercial banks and other financial institutions to grant credit to small-scale
industries and encourage credit by small independent company business units and also provide
resource assistance to them.
4.SIDBI also provides venture capital assistance through Venture Capital Fund, and it also co-
promotes state-level venture funds.
5.SIDBI conducts surveys in specific geographical locations to determine the potential of
developing MSMEs in the specific area where it is found.
6.SIDBI helps in expanding business areas for small-scale industry sector products in domestic
and international markets in partnership with commercial banks.
7.SIDBI also aims to enhance shareholder wealth through modern technologies and innovative
ideas by providing a digital platform. It also provides services like factoring and leasing to
domestic independent company business units in the small-scale sector.
8.SIDBI also provides an additionally timely flow of credit for working capital as well as term
loans to small-scale enterprises in collaboration with commercial banks.
9.SIDBI takes initiatives for modernization and technological upgradation of existing industrial
units to become future units that generate more wealth and employment.
10.SIDBI also acts as a nodal agency for various ministries of the Government of India :
 Ministry of MSME.
 Ministry of commerce and industry.
 Ministry of Textiles.
 Ministry of food processing industry,
 MUDRA

 The Micro Units Development Refinance Agency (MUDRA) Bank is a refinancing

institution for micro-finance institutions.
 MUDRA is currently conceived not only as a refinance institution, but also as
a regulator for microfinance institutions (MFIs).
 MUDRA would be in charge of developing and refinancing the micro-enterprise sector
by assisting finance institutions that lend to micro/small business entities engaged
in manufacturing, trading, and service activities.
 MUDRA would collaborate with banks, microfinance institutions, and other lending
institutions at the state and regional levels to provide microfinance support to the
country's microenterprise sector.
 The GOI decided that MUDRA would provide refinancing assistance, monitor PMMY
data by managing the web portal, and facilitate the offering of guarantees for loans made
under PMMY.
 MUDRA Bank operates through financing institutions, which in turn connect with last
mile lenders such as Micro Finance Institutions (MFIs), Primary Credit Cooperative
Societies, Self Help Groups (SHGs), Non-Bank Financial Companies (NBFCs) (other
than MFIs), and other lending institutions.
 Microfinance institutions (MFIs) can become Member Lending Institutions
(MLIs) of MUDRA (SIDBI) Bank for refinancing and National Credit Guarantee Trustee
Company (NCGTC) for credit guarantee.

MUDRA Bank – Roles & Responsibilities

1. Developing policy guidelines for micro/small enterprise financing businesses.
2. MFI registration, regulation, accreditation, and rating establishing responsible financing practises
to prevent indebtedness and ensure proper client protection principles and recovery methods
Creation of a standardised set of covenants governing last-mile lending to micro/small businesses.
3. Promoting appropriate technology solutions for the lastmile. Creating and implementing a Credit
Guarantee Scheme to provide guarantees for loans made to micro-enterprises.
4. Developing a good architecture for Last Mile Credit Delivery to Micro Businesses through
the Pradhan Mantri Mudra Yojana scheme.
National Housing Bank (NHB)
The NHB was previously an integral part of the Reserve Bank of India (RBI) until the
Government of India purchased it in 2019 with the entire stake for INR 1,450 Crores. This step
by the union was taken as per the Narasimha-II Committee Report of 2001.
NHB primarily raises the required funds from bonds, borrowings, debentures, etc.
As per the Bank Regulations Act, the bonds of the NHB are accepted as security in the
commercial banks that can be used to meet the statutory liquidity.
Moreover, the bonds can successfully seek external assistance from several international
organisations, including USAID and OECF Japan. Another major component of the NHB is that
it refinances Housing Finance Companies at varying rates depending on the size of the loan.

National Housing Bank – Role & Importance

1. Ensuring adequate financing for housing infrastructure development, as well as a
continuous flow of liquidity to various housing finance institutes for timely financing to
all income segments.
2. Ensure proper regulation and oversight of all housing finance companies operating
throughout the country.
3. The NHB is also in charge of auditing such companies, ensuring their compliance with
the relevant guidelines, and ensuring that the organisations make credit available at
affordable rates in order to provide housing facilities for all.
4. The NHB was also created with the goal of increasing the number of housing units in the
country.
5. As a result, the National Housing Bank plays an important role in making land available
for housing development by acting as a facilitator to enable companies in the housing
sector to raise funds and smooth the entire function, resulting in increased efficiency and
productivity.

Functions
National Housing Bank – Functions
1. It is primarily in charge of registering and supervising all Housing Finance Companies
(HFCs), as well as maintaining surveillance through on-site and off-site mechanisms and
coordinating with other regulators.
2. Supervision and control of housing companies operating in India under the authority
granted by the National Housing Bank Act.
3. Raising funds on a large scale and refinancing for housing finance companies,
cooperative banks, and other housing agencies for onward lending to individuals and
housing infrastructure companies.
4. Regulating and ensuring that housing finance companies meet all regulatory capital
requirements outlined in the BASEL guidelines.
5. Assuring that they have a proper risk management system in place, as well as good
governance practises, and so on.
 UNIT – 5
NON-BANKING FINANCIAL INSTITUTIONS AND FOREX MARKET

Non-Banking Financial Companies are rising fast as an integral part of the Indian financial
system. A non-banking financial institution (NBFI) or non-bank financial company (NBFC) does
not have a full banking license but facilitate bank-related financial services like investment,
contractual savings, and market brokering and risk pooling. They play a big role in strengthening
the economy and have been able to carve out a place for themselves in meeting the credit needs
of both wholesale and retail customers.

Definition of Non-banking Finance Company,

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act,
1956 and is engaged in the business of loans and advances, acquisition of shares, securities,
leasing, hire-purchase, insurance business, and chit business.

Functions of NBFCs
The NBFCs mainly perform the functions of receiving of deposits, lending of money and
investment of money.

1.Receiving deposits – NBFCs receive mainly two types of deposits. They are:
a) Regulated Deposits – The deposits on which there is a ceiling limit or certain other
restrictions prescribed by the RBI are called regulated deposits. For example, hire purchase
companies and equipment leasing companies can receive deposits only upto ten times of
their net-owned funds.
b) Exempted Deposits – The deposits on which there are no ceiling limits or other restrictions
by any controlling authority are called exempted deposits. These deposits include borrowing
from other banks and financial institutions, money received from Government, intercompany
borrowings, security deposits, money received from local authorities, directors, etc.

2.Lending of money – NBFCs lend money in various forms like hire purchase finance, leasing
finance, consumption finance, finance for social activities, housing finance, development
finance, etc.

3.Investment of money – NBFCs invest their surplus funds in various forms of securities like
shares, stock,
debentures, bonds, etc.
ROLE OF NBFI IN THE FINANCIAL SYSTEM
 NBFIs act as a supplement to banks by providing infrastructure to distribute excess
resources to individuals and companies with deficits.
 NBFIs also serve the additional purpose of introducing competition in financial services.
 Unlike banks who may offer a packaged deal on a set of financial services, NBFIs offer
customized services to suit the specific needs of clients NBFIs specializing in one
particular sector develop an informational advantage.
 From loans and credit facilities to private education funding and retirement planning,
from trading in money markets to underwriting stocks and shares, and Term Finance
Certificates, NBFCs offer almost all banking services.
 Theyprovide wealth management services like managing stocks and shares portfolios,
discounting services like discounting of instruments and give advice on merger and
acquisition activities.
 The number of NBFCs has increased greatly in the last several years due to venture
capital companies, retail and industrial companies have entered the lending business.
NBFCs also often support property investments in property besides preparing feasibility,
market or industry studies for companies.
 NBFCs are usually not allowed to take deposits from the general public and have to find
options for funding their operations.
 NBFCs do not provide cheque books nor do they provide a saving account and current
account. They are only authorized to takes fixed deposit or time deposits.

TYPES OF NBFC’S
The Non-Banking Finance Companies operating in India fall in the following broad categories.

(1) Equipment Leasing Company is a company which carries on as its principal business,
the business of leasing of equipments or the financing of such activity. Apart from their Net
Owned Funds (NOF), the leasing companies raise finds in the form of deposits from other
companies, banks and the financial institutions. Public deposits and inter-corporate deposits
account for 74 percent of their total funds. Leasing is a form of rental system. A lease is a
contractual arrangement whereby the lessor grants the lessee the right to use an asset in return for
periodical lease-rent payments.
There are two types of leasses (i) operating lease, and (ii) financial or capital lease. The
operating lease is a short-term lease which can be cancelled. Financial lease is a non-concealable
contractual commitment.
(2) Hire Purchase Finance Company is a company which carries on as its principle
business, hire purchase transactions or the financing of such transactions. The sources of hire-
purchase finance are
(i) Hire purchase Finance Companies.
(ii) Retails and Wholesale Traders.
(iii) Bank and Financial Institutions.

Hire-purchase finance or credit is a system under which term loans for purchase of goods,
producer goods or consumer goods and services are advanced which have to be liquidated under
an installment plan. The period of credit is generally one to three years. The hire purchase
credits available for a wide range of products and services. Hire-purchase finance companies are
the public or private limited companies or partnership firms engaged in giving credit for
acquiring durable goods.

(3) Housing Finance Company is a company which carries on as its principle business,
the financing of the acquisition or construction of houses including the acquisition or
development of plots of lands for construction of houses. These companies are supervised by
National Housing Bank, which refinances housing loans by scheduled commercial banks, co-
operative banks, housing finance companies and the apex co-operative housing finance societies.

(4) Investment Company means any company which carries on as its principle business the
acquisition of securities. These types of companies are investment holding companies formed by
business houses. As such they provide finance mainly to companies associated with these
business houses. As compare to open-end investment companies or mutual funds/units trust,
these investment companies are close end companies having a fixed amount of share capital.
Almost all prominent industrial groups have their own investment companies.

(5) Loan Company is a company which carries on as its principle business, the providing of
finance whether by making loans or advances or otherwise for any activity other than its own.
(This category excludes No.1 to No. 3 above categories). These types of companies are generally
small partnership concerns which obtain funds in the form of deposits from the public and give
loans to wholesale and retail traders, small scale industries and self-employed persons. These
companies collect fixed deposits from the public by offering higher rates of interest and give
loans to others at relatively higher rates of interest.

(6) Mutual Benefit Finance Company (i.e. Nidhi Company ) means any company
which is notified by the Central Government under section 620A of the Companies Act, 1956.
The main sources of funds for nidhis are share capital, deposits from their members and deposits
from the public. Nidhis give, loans to their membersfor several purposes like marriages,
redemption of old debts, construction and etc. The nidhis normally follow the easy procedures
and offer saving schemes and make credits available to those whose credit needs remain unmet
by his commercial banks.
(7) Chit Fund Company is a company which collects subscriptions from specified number
of subscribers periodically and in turn distributes the same as prizes amongst them. Any other
form of chit or kuri is also included in this category. The chit fund companies operations are
governed by the Chit Fund Act, 1982, which is administered by State Governments. Their
deposit taking activities are regulated by the Reserve Bank. The chit fund companies enter into
an agreement with the subscribers that everyone of them shall subscribe a certain amount in
installments over a definite period and that every one of such subscriber shall in his turn, as
determined by lot or by auction or by tender, be entitled to a prize amount.

(8) Residuary Non-Banking Company is a company which receives deposits under any
scheme by way of subscriptions/contributions and does not fall in any of the above categories.

(9) Insurance Companies:

Both general and life insurance companies are usual lenders in the money market. Being cash
surplus entities, they do not borrow in the money market. With the introduction of CBLO
(Collateralized Borrowing and Lending Obligations), they have become big investors. In
between capital market instruments and money market instruments, insurance companies invest
more in capital market instruments. As their lending programmes are for very long periods, their
role in the money market is a little less.

(10) Mutual Funds:

Mutual funds offer varieties of schemes for the different investment objectives of the public.
There are many schemes known as Money Market Mutual Fund Schemes or Liquid Schemes.
These schemes have the investment objective of investing in money market instruments. They
ensure highest liquidity to the investors by offering withdrawal by way of a day’s notice or
encashment of units through Bank ATMs. Naturally, mutual funds invest the corpus of such
schemes only in money market. They do not borrow, but only lend or invest in the money
market.

(11) VENTURE CAPITAL FUNDS

A Venture Capital Fund, also known as VCF, is a type of an investment fund which investors
provide to homegrown or foreign startups that might have a long term growth potential in the
near future. This type of financing is generally undertaken by strong investors, investment banks
or high net worth individuals. It is often risky for investors who allocate funds to seed a startup,
but the returns over the long term in case of a successful business are lucrative. SEBI (Securities
and Exchange Board of India) is the prominent government body which has set up guidelines
regarding venture capital investment and stake-holding.
Types of Venture Capital Funds
Every startup has different stages of business operations which require funding at regular
intervals. The three main types are mentioned below:

1.Early Stage Financing

This is the initial stage of investment or the first step. Due to the complex natureof business, this
is further divided into 3 substages - seed financing, startup financing and first stage financing.
Seed financing is the first set of money given to the founder for establishing their startup. Startup
financing is when the set of money is given for the development of products and services. When
a startup intends to expand business, it requires first stage financing.

2.Expansion Financing
This is the second stage, once the startup has utilized its seed funding and requires funds for
expansion and marketing. Expansion financing also includes bridge financing - the funds that are
required by a startup during an IPO (Initial Public Offering).

3.Acquisition or Buyout Financing

When a company needs funds to acquire another company or parts of a company, it is known as
acquisition financing. A buyout financing is when a company seeks to acquire another
company’s particular product.

(12) FACTORING :
The Factoring Act, 2011 defines the ‘Factoring Business’ as “the business of acquisition of
receivables of assignor by accepting assignment of such receivables or financing, whether by
way of making loans or advances or in any other manner against the securityinterest over any
receivables”.

Factoring in India:
Factoring is the conversion of credit sales into cash. In factoring, a financial institution (factor)
buys the accounts receivable of acompany (Client) and pays up to 80%(rarely up to 90%) of the
amount immediately on agreement.

Factoring company pays the remaining amount (Balance 20% minus finance cost minus
operating cost) to the client when the customer paysthe debt.
Collection of debt from the customer is done either by the factor or theclient depending upon the
type of factoring.

The account receivable in factoring can either be for a product or service. Examples are factoring
against goods purchased, factoring in construction services (in government contracts it is assured
that the government body can pay back the debt in the stipulated period of factoring and hence
contractors can submit the invoices to get cash instantly), factoring against medical insurance etc.
Let us see how factoring is done against an invoice of goods purchased.

Different types of Factoring

Following are major types of factoring:
1.Disclosed and Undisclosed
2.Recourse and Non-recourse
1.Disclosed Factoring

In disclosed factoring client's customers are notified of the factoringagreement. Disclosed type can
either be recourse or non-recourse.

2.Undisclosed factoring
In undisclosed factoring, client's customers are not notified of the factoringarrangement. Sales
ledger administration and collection of debts are undertaken by the client himself. Client has to
pay the amount to the factorirrespective of whether customer has paid or not. But in disclosed
type factor may or may not be responsible for the collection of debts dependingon whether it is
recourse or non-recourse.

3.Recourse factoring
In recourse factoring, client undertakes to collect the debts from thecustomer.
If the customer don't pay the amount on maturity, factor will recover theamount from the client.
This is the most common type of factoring.
Recourse factoring is offered at a lower interest rate since the risk by the factor is low.
Balance amount is paid to client when the customer pays thefactor.
4.Non-recourse factoring
In non-recourse factoring, factor undertakes to collect the debts from thecustomer. Balance
amount is paid to client at the end of the credit periodor when the customer pays the factor
whichever comes first.
The advantage of non-recourse factoring is that continuous factoring willeliminate the need for
credit and collection departments in the organization.

What is an NBFC-Factor?
NBFC- Factor means a non-banking financial company fulfilling the Principal business
criteria i.e. whose financial assets in the factoring business constitute at least 75 percent of its
total assets and income derived from factoring business is not less than 75 percent of its gross
income, has Net Owned Funds of Rs. 5 crore and has been granted a certificate of registration
by RBI under section 3 of the Factoring Regulation Act, 2011.

(13) Forfeiting :
 Forfaiting in French means to give up one’s right. Thus, in forfaiting theexporter hands
over the entire export bill with the forfaiter and obtainspayments.

 The exporter has given up his right on the importer which is now taken bythe forfaiter. By
doing so, the exporter is benefited as he gets immediate finance for his exports.

 The risk of his exports is now borne by the forfaiter. In case if the importerfails to pay,
recourse cannot be made on the exporter.

 Forfaiting is the sale by an exporter of export trade receivables, usuallybank guaranteed,

without recourse to the exporter.

 Such receivables include Letters of Credit (with or without Bills of Exchange)

Promissory Notes with Aval (guarantee), Bill of Exchange withAval, Bank Guarantees
Payable to an Exporter in one country from an Importer in another country.

 Forfaiting as a financing concept has been in use across the worldsince the 1960s.
 The word forfait means to forgo one's right to something.

 In the context of export finance, the exporter forgoes his right to receive payment from
the importer at later date and surrenders theright to collect payment to a third party or
agency (known as forfeiter).

 Instead the exporter receives an immediate reimbursement of hispayment less certain

discounts from the forfeiter.
  Normally, these payments are due at a later date, forcing the exporterto bear the cost for
the intervening period, as well as being exposed to the risks of exchange rate
fluctuations, political situations etc.

Difference Between Factoring and Forfaiting

CREDIT RATING AGENCIES IN INDIA
The credit rating agencies in India were mainly formed to assess the condition of the financial
sector and to find out avenues for more improvement. The credit rating agencies offer various
services as:
· Operation Up gradation
· Training to Employees
· Scrutinize New Projects and find out the weak sections in it
· Rate different sectors
The two most important credit rating agencies in India are:
· CRISIL
· ICRA

 Custodial services offer the safekeeping of assets.

 depository offers multiple services about financial assets and their transfer. For
example, the Bank of New York is a custodian. Whereas NSDL and CDSL are renowned
depositories.

A Custodian is a person or institution that maintains the custody of assets or things.

In the business world, a custodian is usually a bank or any other financial institution that is
responsible for ensuring the safety of assets that are handed over for safekeeping.
A depository is a place in which things or assets are deposited for the purposes of safekeeping. In
terms of business, a depository is known as a financial institution or organization that accepts
deposits and holds securities and other financial assets.
While custodians merely hold custody of assets and financial securities, depositories go one step
further to the services provided by a custodian and assume greater control, liability and
responsibility for the assets they hold.

Foreign exchange market.

The foreign exchange market (forex, FX, or currency market) is a form of exchange for the
global decentralized trading of international currencies. Financial centers around the world
function as anchors of trading between a wide range of different types of buyers and sellers
around the clock, EBS and Reuters' dealing 3000 are two main interbank FX trading platforms.
The foreign exchange market determines the relative values of different currencies.

The foreign exchange market is over a counter (OTC) global marketplace that determines
the exchange rate for currencies around the world. This foreign exchange market is also known
as Forex, FX, or even the currency market. The participants engaged in this market are able to
buy, sell, exchange, and speculate on the currencies. These foreign exchange markets are
consisting of banks, forex dealers, commercial companies, central banks, investment
management firms, hedge funds, retail forex dealers, and investors. In our prevailing section, we
will widen our discussion on the ‘Foreign Exchange Market’.
Types of Foreign Exchange MarketThe Foreign Exchange Market has its own varieties. We will
know about the types of these markets in the section below:The Major Foreign Exchange
Markets –
 Spot Markets
 Forward Markets
 Future Markets
 Option Markets
 Swaps Markets

1.Spot Market In this market, the quickest transaction of currency occurs. This foreign
exchange market provides immediate payment to the buyers and the sellers as per the current
exchange rate. The spot market accounts for almost one-third of all the currency exchange, and
trades which usually take one or two days to settle the transactions.

2.Forward Market In the forward market, there are two parties which can be either two
companies, two individuals, or government nodal agencies. In this type of market, there is an
agreement to do a trade at some future date, at a defined price and quantity.

3.Future Markets The future markets come with solutions to a number of problems that are
being encountered in the forward markets. Future markets work on similar lines and basic
philosophy as the forward markets.

4.Option Market An option is a contract that allows (but is not as such required) an investor to
buy or sell an instrument that is underlying like a security, ETF, or even index at a determined
price over a definite period of time. Buying and selling ‘options’ are done in this type of market.

5.Swap Market A swap is a type of derivative contract through which two parties exchange the
cash flows or the liabilities from two different financial instruments. Most swaps involve these
cash flows based on a principal amount.

Exchange rate. Exchange rate (also known as a foreign-exchange rate, forex rate,
FX rate or Agio) between two currencies is the rate at which one currency will be exchanged for
another. It is also regarded as the value of one country's currency in terms of another currency.
Advantages of Foreign Exchange Market
● High liquidity: The forex market is the largest and most liquid market in the world, making it
easy to buy and sell currencies quickly.
● Accessibility: The forex market is open 24 hours a day, 5 days a week, and can be accessed
by anyone with an internet connection.
● Diverse trading options: Traders can choose from a wide range of currency pairs and
trading strategies, providing ample opportunities for profit.
● Low transaction costs: The cost of trading in the forex market is relatively low compared to
other financial markets.
● Leverage: Forex trading allows traders to use leverage to increase their trading position,
potentially amplifying profits.
● Global market: The forex market is a global market, making it a valuable tool for
international businesses to manage their currency risk.
● Transparency: The forex market is highly transparent, with real-time price data available to
all market participants.
Disadvantages of Foreign Exchange Markets
● Volatility: The forex market is highly volatile and can experience sudden and significant
price movements, which can lead to large losses for traders.
● Risk of leverage: While leverage can increase potential profits, it can also magnify losses
and lead to significant financial risk.
● High competition: The forex market is highly competitive, and traders must compete with
other market participants, including large financial institutions.
● Limited regulation: The forex market is not as regulated as other financial markets, which
can lead to fraudulent activities and scams.
● Complex market: The forex market can be complex, and traders must have a good
understanding of the market and its various factors that affect currency values.
● Economic and political events: The forex market is highly influenced by economic and
political events, which can cause significant volatility and unpredictability.
● High barriers to entry: Trading in the forex market requires a significant amount of
knowledge, experience, and capital, making it difficult for inexperienced traders to participate.
Importance of FOREX Market :
Facilitate Currency Conversion
1. It is the primary function of the foreign exchange market. Transferring money or
currencies from one nation to another in order to settle accounts is the fundamental and
most obvious functions of foreign exchange market. In essence, the foreign exchange
market transforms one currency to another.
2. Provide Instruments to Manage Foreign Exchange Risk.An investor would need to
completely refrain from investing in foreign assets in order to minimise FX risk. But,
using currency forwards or futures, foreign exchange rate risk can be reduced. Providing
instruments to manage foreign exchange risk is thus one of the functions of foreign
exchange market.
3. Allow Investors to Speculate in the Market for Profit.Because exchange values between
currencies are constantly fluctuating, both on an intraday and long-term basis, the foreign
currency exchange or forex market is well-liked by speculators. Because there are so
many distinct currency pairs that may be traded, the foreign exchange market also offers
regular trading possibilities, which makes up the one of the other functions of foreign
exchange market.
4. High Liquidity:The foreign exchange market is the most easily liquefiable financial
market in the whole world.
5. Dynamic Market:In foreign exchange market is highly dynamic in nature. The value of
currencies changes every second in foreign exchange market.
6. Market Transparency:The foreign exchange market is highly transparent. The traders in
the foreign exchange market have full access to all market data and information.

Foreign Exchange Rate is defined as the price of the domestic currency with respect to
another currency. The purpose of foreign exchange is to compare one currency with another for
showing their relative values.
Foreign exchange rate can also be said to be the rate at which one currency is exchanged with
another or it can be said as the price of one currency that is stated in terms of another currency.

Currency Fluctuation means the value of one country's currency fluctuates with the value
of another country's currency. Every day, changes in the exchange rates between different
currencies can impact their value.
Factors Affecting Currency Exchange Rate
1. Inflation Rates
Changes in market inflation cause changes in currency exchange rates. A country with a lower
inflation rate than another's will see an appreciation in the value of its currency. The prices of
goods and services increase at a slower rate where the inflation is low. A country with a
consistently lower inflation rate exhibits a rising currency value while a country with higher
inflation typically sees depreciation in its currency and is usually accompanied by higher interest
rates.
2. Interest Rates
How do interest rates affect money exchange rates? Changes in interest rate affect currency value
and dollar exchange rate. Forex rates, interest rates, and inflation are all correlated. Increases in
interest rates cause a country's currency to appreciate because higher interest rates provide higher
rates to lenders, thereby attracting more foreign capital, which causes a rise in exchange rates.
3. Country's Current Account/Balance of Payments
A country's current account reflects balance of trade and earnings on foreign investment. It
consists of total number of transactions including its exports, imports, debt, etc. A deficit in
current account due to spending more of its currency on importing products than it is earning
through sale of exports causes depreciation. Balance of payments fluctuates exchange rate of its
domestic currency.
4. Government Debt
Government debt is public debt or national debt owned by the central government. A country
with government debt is less likely to acquire foreign capital, leading to inflation. Foreign
investors will sell their bonds in the open market if the market predicts government debt within a
certain country. As a result, a decrease in the value of its exchange rate will follow.
5. Terms of Trade
A trade deficit also can cause exchange rates to change. Related to current accounts and balance
of payments, the terms of trade is the ratio of export prices to import prices. A country's terms of
trade improves if its exports prices rise at a greater rate than its imports prices. This results in
higher revenue, which causes a higher demand for the country's currency and an increase in its
currency's value. This results in an appreciation of exchange rate.
6. Political Stability & Performance
A country's political state and economic performance can affect its currency strength. A country
with less risk for political turmoil is more attractive to foreign investors, as a result, drawing
investment away from other countries with more political and economic stability. Increase in
foreign capital, in turn, leads to an appreciation in the value of its domestic currency. A country
with sound financial and trade policy does not give any room for uncertainty in value of its
currency. But, a country prone to political confusions may see a depreciation in exchange rates.
7. Recession
When a country experiences a recession, its interest rates are likely to fall, decreasing its chances
to acquire foreign capital. As a result, its currency weakens in comparison to that of other
countries, therefore lowering the exchange rate.
8. Speculation
If a country's currency value is expected to rise, investors will demand more of that currency in
order to make a profit in the near future. As a result, the value of the currency will rise due to the
increase in demand. With this increase in currency value comes a rise in the exchange rate as
well.