Financial Services

(MBA-2F07)

UNIT-I
Introduction
Introduction to Financial Services

Course Coordinator: Dr. Saboohi Nasim

FMS&R, AMU

Unit I (Syllabus)
Introduction to Financial System and Financial
Markets, Instruments
Evolution of Indian Financial System
Financial Services: concepts, features,
constituents and types
Regulatory Framework for Financial
Services(NBFC)
Stock Exchanges of India; SEBI

EVOLUTION OF INDIAN FINANCIAL SYSTEM

PHASES IN THE EVOLUTION OF

INDIAN FINANCIAL SYSTEM

Phase I: Indian Financial System (IFS) on

the eve of Planning (Up to 1951)
Phase II: IFS in the Post Independence
Period (1951-late 1980s)
Phase III: Financial Sector Reforms since
early 1990s.
GLOBAL FINANCIAL CRISIS
&
ITS IMPACT ON INDIAN
ECONOMY/FINANCIAL
SECTOR

PHASE - I
Indian Financial System (IFS) on the eve of
Planning (Up to 1951)

PHASE - I

Indian Financial System (IFS) on the eve of Planning

(Up to 1951)
Evolution of various constituents of the Financial
System
Currency & Money Supply
Banking Sector
Small Savings
Insurance Funds
Stock Market
Public Deposits
Government Securities & Treasury Bills

Currency & Money Supply

Indian currency not standardized before
Independence
Till 1893--- silver standard (for 60yrs)
1893-1931---Gold Exchange standard
1931---Sterling Exchange standard introduced
Paper Currency
Used since the beginning of 19th century
Issued by commercial banks
1861- Govt. acquired the monopoly of issuing notes

Currency & Money Supply (Contd)

Progress of Monetization
Volume of currency in circulation
1874
1948
Rs. 11cr
Rs. 1199 Cr
Total Money Supply
1935
1945
1950
Rs. 285 cr
Rs. 2052 cr
Rs. 1833 cr

Currency constituted a major portion of money

supply (increased from 52% in 1935 to 67 % in
1952)

Banking Sector
Indigenous Bankers
Dominated the banking sector till 1910
Acted as bankers to the Govt./ companies
till 1860 (collected revenues, transferred
funds, mint-masters, money changers.)
Scope of their function declined with the
emergence of modern banks

Banking Sector (contd)

Structure & Growth of Modern Banks
Foundation of modern banking with the
establishment of 3 presidency banks
Bank of Bengal (1806)
Bank of Bombay (1840)
Bank of Madras (1846)

Exchange banks & some Indian joint stock

banks set up in later half of the 19th
century

Banking Sector (contd)

Rapid progress in the Modern Banking
System in early 20th century
1921- Imperial Bank of India formed by the
amalgamation of the three presidency banks;
functioned as the quasi central banks
1935- RBI was established
By 1950, Indian Banking System comprised of

RBI

IBI

Co-operative
Banks

Exchange
Banks

Indian Joint
stock Banks

Banking Sector (Contd.)

Feature of Indian Banking System
High degree of concentration in the banking
business (top 7 banks & IBI accounted for most
of banking business); declined after 1935.
Smaller banks were responsible for providing
banking facilities to the masses (2/3rd of places
on the banking map of India)
Deposits- mainstay of all banks; IBI invested
more in govt. securities than the class A1 banks

Banking Sector (Contd.)

Feature of Indian Banking System.
Credit/ deposit ratio was low in general
Cash /credit overdraft followed by loanpopular forms
of bank credit
Banks invested more in short term govt. securities.
Investment in industrial securities was very low (4%)
Bill Financing and Call money market not developed
Sectoral distribution of advances (1948):
Commerce (46%) ; Agriculture(2%); Industry(31%)

86% of the banks advances were on secured basis

Banking Sector (Contd.)

Gaps in Banking Services
Lack of supply of long-term funds to all
industrial units (8 industrial banks set up in
1923; liquidated in 1935)
Lack of supply of any form of capital to small
scale units
Lack of supply of funds to the agricultural sector
(Cooperative banks set up in 1916, but were not
effective)

Small Savings
Oldest medium for community savings
Govt. run savings bank- attached with
presidency banks, district treasuries/ Post
office savings bank (POSB)
By 1896 POSB- monopolized the small
saving business; variety in saving schemes
introduced only since 1915.

Stock Market
First Stock Exchange established in Bombay in 1887
Volume of funds raised increased significantly in
first half of 20th century
Capital raised primarily through issuance of
ordinary shares
Debentures not popular before 1960s

Public Deposits
Wide spread practice of using public
deposits by Deposit Companies in financing
of fixed assets (cause of serious concern for
the monetary authorities)
Deposits accounted for 11% & 39 % of total
funding of Bombay & Ahmedabad Mills1930.
Interest rates on deposits were less than the
average lending rates of common banks

Insurance Funds
Life Insurance business began with the
enactment of Life Insurance Companies Act1912
Carried by various Indian Co.s, Foreign Co.s,
Provident Societies, Post & Telegraph Dept.
1928
No. of Life insurance Co.s
70
No. of Non Life insurance Co.s 128

1950
244
174

Govt. Securities & Treasury Bills

Market for Government Securities expanded
phenomenally
Amount of gross issue of such securities increased
from Rs 2 cr (1890) to Rs. 382 cr (1948)
Treasury Bills first issued in India in 1917; used to
induce inflow of foreign funds
RBI- discounted the Treasury Bills

PHASE - II
IFS in the Post Independence Period (1951late 1980s)

FINANCIAL REFORMS DURING PHASE II

Evolved in response to the

imperatives of planned economic
development
Distribution of resources by the
Financial System to be aligned with
the
priorities
of
FYPs
Governmental Control

FINANCIAL REFORMS DURING PHASE II

ELEMENTS OF FINANCIAL REFORMS

Public
Ownership of
Financial
Institutions

Fortification
of
Institutional
Structure

Protection
to
Investors

Participation
of Financial
Institutions in
Corporate
Management

(A) Public Ownership of Financial

Institutions
Progressive transfer of important constituents of
IFS from private ownership to public control

Mechanism
Adopted

NATIONALIZATION

NEW
INSTITUTIONS

Nationalization Timeline
1948

1956

1969

1972

Marked
the
beginning

Landmark in the history

of public control

1980

New Institutions
Battery of new institutions established in the
public sector
Wide range of special purpose financial institutions
(development banks, term lending institutions)
established at national, regional and state levels
Creation of an investment trust organization in the
public sector-UTI financial innovation
Entire industrial financing system owned, controlled
and led by the govt.

(B)Fortification
Fortification of Institutional Structure
Strengthening of
institutional
structure

Development
Banks

Changes in structure
& policies
Commercial
Banks

UTI

LIC

Fortification of Development Banks

Massive growth in number & functions performed

1948-Industrial Finance Corporation of India (IFCI)

marked the beginning of development banking in India
Filled the gap in long term Industrial financing

1951-State Finance Corporation (SFC)

Set up under SFC Act to assist SMEs
Excessive control & caution
Failed to deliver

1954- National Industrial Development

Corporation (NIDC)
Shift from finance to development
Ended up as a financing agency
Functioning as consultancy organization presently

Fortification of Development Banks..

1955-Industrial Credit & Investment Corporation of
India (ICICI)
represent the diversification of development banking in India
Pioneer in many functions (underwriting of issues of capital;
channelization of private currency loans to private sector.)

1958-Refinance Corporation of India(RCI)

To provide refinance facilities to banks extending term loans
to SMEs(e.g SFCs)
Merged with IDBI later in 1964

1964- Industrial Development Bank of India (IDBI)

Step towards an integrated structure of financing institution
in India
Apex institution financing & coordinating agency
Delinked from RBI (1974)-converted into a holding co.

Fortification of Development Banks.

1971-Industrial Reconstruction Corporation of
India (IRCI)
Estbd. For the rehabilitation of sick units; jointly set up by
IDBI & LIC renamed as IRBI in 1984
Converted into a full fledged public financial institution &
renamed as Ind. Investment Bank of India (IIBI) in 1997

Technical Consultancy Organization(TCO)

Diversification of development banking in India
Joint partnership of IDBI, IFCI & ICICI

1989- Small Industries Development Bank of India

(SIDBI)
Institutional innovation
Development of small industries

Variegated structure of development banks-providing

finance to the industry in diverse forms

Fortification of Life Insurance Corporation

Step towards fortifying industrial financing deliberate &
conscious effort to re-mould the financial system
Amalgamation of 245 life insurance companies to form
LIC-transfer of important savings from private to public
ownership(1956)
Concentration of huge investible resources (long term)
used in
Underwriting of corporate issues
Participation in purchase of securities
Direct lending to the industry

Fortification of Unit Trust of India (UTI)

Culmination of a long overdue need of the capital
market
Introduced new form of financial asset-unit
schemes to suit different class of investors
Government Support-initial capital contributed by
various financial institutions; tax exemption
extended.
Emerged as the most dominant buyer of the
industrial securities in India (LIC relegated to the
second position)

Fortification of Commercial Banks

Redefining the structure & policies of the existing
commercial banks
The orthodox functions of deposit banking and supply of
short-term funds broadened
Committee on Finances for Private sector (Shroff
Committee, 1954) recommended participation of banks in
underwriting of issue of capital
Entry of banks in merchant banking activities;
participation of commercial banks in long term financing
institutionalized by the creation of subsidiaries like SBI
Capital Mkt., PNB Capital Mkt..

(C) Protection to Investors

Industrial securities as a form of saving not popular before
1951, due to general distrust of public of private
businesses (corporate fraud & abuses were rampant)
Extensive and drastic legal reforms introduced, focusing
on ..
1
Remodeling
the legal &
administrative
aspect of
companies

2
Tightening of
the listing
requirements
of Stock

3
Control of
Capital issues
& industrial
licensing

Significant Legislative reforms

1973

1969

1956

Foreign Exchange
Regulation Act
Monopolies & Restrictive
Trade Practices Act

Companies Act
Securities Contract (Regulation) Act

1947

Capital Issues (Control) Act

Capital Issues Control Act 1947

Potent tool in the hands of the government to
prevent investment in non-essential activities
(introduced through the Defence of India Rules in
1943)
Regulated the capital structure of companies;
timing of issues, scrutinized the reorganization
(M&A); pricing of issuesetc
Implemented thru Controller of Capital- Ministry
of Finance
Repealed in May 1992

Securities Contract Regulation Act 1956

To prevent undesirable transactions in securities by
regulating the business of dealing therein
Government empowered to provide/withdraw recognition to
stock exchanges ; only recognized SE can function
Reforms in stock exchange trading methods & practices
Provisions for listing of securities on the SE

Act enforced by the Directorate of SE- Ministry of

Finance
Delegation of powers to SEBI in 1994; Amendments to the
Act in 1996

The Companies Act 1956

Important step in the development of
corporate enterprises in India
Most important piece of legislation that
empowers the Central Government to
regulate
the
formation,
financing,
functioning and winding up of companies
Administered by the Central Government
through the Ministry of Corporate Affairs and
the Offices of Registrar of Companies

The Companies Act 1956

Underlying objective- protection of investors- weaving
an integrated pattern of relationship between promoters,
investors & management. For e.g.
Due recognition of the legitimate interest of shareholders and
creditors
A fair and true disclosure of the affairs of companies in their
annual published balance sheet and profit and loss accounts.
Proper standard of accounting and auditing.
Recognition of the rights of shareholders to receive
reasonable information

Important changes in content of prospectus; allotment

of shares; capital structure of co.; terms & conditions
for establishment of co. etc in the subsequent
amendments in 2000, 2001, 2002, and 2006.

Monopolies & Restrictive Trade Practices Act, 1969

Enforced since June 1970, with an objective
To ensure that the functioning of the economic system does
not result in the concentration of economic power
To control such MRTP that was injurious to the public
welfare

In 1984, MRTP Act ammended to include Unfair

Trade Practices
False representation of products or services, including false description,
guarantee, warranty or performance of a product or service.
Advertisement of false bargain price.
Contest, lotteries, game of chance or skill for promotion of sale.
Sale of goods not in conformity with safety standards provided by the law.
Hoarding or destruction of goods or refusal to sell goods.

Monopolies & Restrictive Trade Practices Act, 1969

The Director General Investigation and Registration (DGIR) was
created to investigate into a claim of a restrictive or an unfair trade
practice and took cases before the benches of the
MRTP
Commission.
The Commission was active in regulating the UTP especially in
Contest, lotteries, game of chance or skill for promotion of sale until
the HMMs case which was overruled by the Supreme court.

HMM Ltd manufactured and marketed Horlicks; In September 1985,

it advertised a scheme called the Hidden Wealth Prize Offer. A lucky
purchaser of a bottle of Horlicks could find a coupon inside the
bottle. The coupons indicated the prizes which included five Hotline
Colour TVs, ten gift vouchers of Rs 2,000 each for Hotline appliances,
and other cash prizes

Monopolies & Restrictive Trade Practices Act, 1969

In the changed context of liberalization and
globalization,
the relevance of MRTP was
questioned and has thus been repealed.
A new law called The Competition Act, 2002 has
been enacted instead, for protecting and
enhancing competition in the economy.
The Unfair trade practices part has been shifted
under the Consumer Protection Act, 1986.

Foreign Exchange Regulation Act 1973

To regulate the foreign exchange market
Regulated foreign investments with the aim of diluting
equity holding in foreign companies- to instill confidence
among the investing public
FERA provisions imposed restrictions on locally
incorporated companies with foreign equity holding in
excess of 40 per cent (known as "FERA companies")
Provisions relaxed later in the changed context of 1990s.
FERA was replaced by FEMA (1999)

(D) Participation of Financial Institutions

in Corporate Management
Shift towards participation of financial
institutions in the management of the assisted
concerns
Major shift from supplying finance to
making an impact on the corporate power
structure
Large shareholding & voting rights leading
to Board representation
Control
over
Board
composition,
appointment of CEOsetc
Powerful
role
as
loan
provider/
administrator

(D) Participation of Financial Institutions

in Corporate Management
GOI conscious policy for PFI to control the
company financed by them
(Dutta Committee, 1969)

Reasons

PFIs switching of investment was difficult

due to large size of holdings

Thrust on Development Banking than

mere Financing

Deficiencies in the Financial Reforms

of Phase II
Deficiency in the
Form of
Financing

Weakness in the
Institutional
Structure
WEAKNESSES

Problems of
Small & new
Enterprises

Lack of
Institutional
Arrangement
in New Issue
Market

Weakness in the Institutional

Structure
IFS heavily dominated by Development Finance
Institutes
Created as artificial limbs in the system to
address the lack of funds
Not capable of mobilizing funds-played limited role
as distributors
Could not grow with the requirements of the
industrial sector

Deficiency in the Form of

Financing
DFIs extended funds in the form of loans
Led to the pre-ponderence of debt in the
financial structure of industrial enterprises
Lopsided capital structure-High debt equity
ratio
Serious problems in recovery; affected the
financial viability of the DFIs themselves
Urgent need to integrate them with the
ultimate pool of savers

Problems of Small & New

Enterprises
Unable to meet the finance needs of this sector
Small enterprises did not fall into the investment
portfolio of the two dominating investing
institutions of that time-LIC & UTI
SIDBI-Small Industries Development Bank of India
formed in 1989- high cost of capital

Lack of Institutional Arrangement

in New Issue Market
Underwriting was the only
support offered by the Institutions
Required an integrated , unified,
comprehensive service providerMerchant banking

PHASE - III
Financial Sector Reforms since early 1990s

Phase III: Post 1990s Evolution of

Indian Financial System
Profound Transformation

Planned
Economic
Development

Free Market
Economics
Liberalization
Deregulation
Globalization

-State controlled FS
Major Economic Policy Changes
Delicensing of industries
Trade liberalization
Currency reforms
privatization
Disinvestments..etc

Financial Reforms during Phase-III

Investor
Protection

Integration
of the Financial
Structure with the
Savings pool
Privatization
of
Financial
Institutions

Re-Organization
of
Institutional
Structure

Privatization of Financial Institutions

State monopoly on financial institutions dismantled in
phased manner
DFIs converted into public company (IDBI, IFCI.)
Private MFs set up under SEBI guidelines
Private banks came into existence- RBI guidelines
Insurance Regulatory Authority IRA (IRDA Act-1999)allowed private insurance companies to operate

Revolutionary changes in IFS- accelerated during

2000s

Re-organization of Institutional Structures

Important changes in the roles, structure & policies of
financial institutions and markets

Mutual
Funds

DFIs
Commercial
Banks
NBFCs

Changes
Across

Securities
Market
Money
Market

Re-organization of
Development Financial Institutions (DFIs)
Newer forms of financing - direct
financing, lease financing, underwriting,
loans for working capital..
Growing focus on non-fund based
financial services- project counseling,
portfolio mgt. , trusteeship, merchant
banking..

Re-organization of
Development Financial Institutions (DFIs)
Changes in the pattern of financing of DFIs
Lesser dependence on government, RBI.
Funds sourced from capital market- issue of stocks, bonds,
etc..
Govt. guaranteed bonds only for SIDBI, NABARD, NHB..

Changes in the type of organizations/institutions

sponsored by DFIs
FOCUS

SPONSORED ORGANIZATION

Development Finance

TCO, MDI, IFMR.

Capital market development

orientation

CRISIL, ICRA, CARE, NSE, OCTEI,

DFIs new role in 1990s: To supplement capital

market and not substitute it (1980s)

Re-organization of
Commercial Banks
Major transformation in structure,
policies, and accounting norms and
standards..
Prudential Banking Norms introduced
(Narsinham Committee, 1991)- income
recognition, asset classification, capital
adequacy norms.

Re-organization of
Commercial Banks
Important policy initiatives to increase the
profitability of the banks
Reduction in SLR, CRR
Investment limit in shares /debentures increased
from 1.5% to 5%
Leasing, Factoring, H/P business upto 10% of total
advances
Closure of unprofitable branches, mergers of banks..
Greater operational flexibility, deregulation of
interest rates.

Re-organization of
NBFCs (Non-Banking Finance Cos,)
Emerged as a significant element of IFS; broadened
the range of financial services
Fund based NBFCs--- equipment leasing, Bill
Discounting, Hire Purchase financing, VCF.
Fees based / Advisory NBFCs---Issue Management,
Portfolio Mgt., M&A advisory..
Increase in number, deposits, and innovation in
functioning of NBFCs in recent years.
Regulatory
framework
evolved
(Khanna
Committee, 1996; Vasudev Committee, 1998; )

Re-organization of Mutual Funds

Remarkable growth in MF industry
Comprises of domestic MFs by UTI, bank
subsidiaries, insurance organizations; private
sectors with foreign collaborations, .
Variety of schemes to suit the requirements of
heterogeneous category of investors
Increase in number of schemes and funds
managed by the MF companies
Regulatory framework laid down by SEBI

Re-organization of Securities Market

Emerged from a marginal institution(mid 80s) to a
significant mechanism of IFS today
Transformation in securities market reflected in
Increase in quantum of funds raised and number of
investors in the primary market
Increase in number of stock exchanges and listed
stocks
Speedy rise in market capitalization and volume of
trade
Entry of sophisticated investors like FIIs & MFs

Re-organization of Securities Market

Developments in Primary Market
Entry of market specialists
Issue procedure & activities reforms SEBI norms

Developments in Secondary Market

Rigorous norms for intermediaries introduced by SEBI
Screen based trading system- from open outcry system to
automated system
Dematerialization of securities- NSDL and CDSL
Reduction in trading cycle (from T+5 to T+2)
Derivative trading (June, 2000)
Corporatization and Demutualization of SE( June, 2001)

Re-organization of Money Market

Characteristics of money market till 1990s
Narrow base- limited no. of participants
Paucity of Instruments (only 91 days T-Bills, inter- bank
deposits and loans, .)
Highly regulated interest rates

Post 1990 reforms in Money Market

Emergence of Specialized institutions- Primary Dealers
Introduction of new instruments (CP, CD, Repo.)
Trend towards integration of forex and money market

Measures for Increased Protection to

Investors

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CHANGES
IN THE
FINANCIAL
MARKET

INADEQUACY
OF THE OLD
LEGISLATIVE
FRAMEWORK

INTEGRATED
REGULATORY
FRAMEWORK
REQUIRED

Measures for Increased Protection to

Investors

SEBI ACT
1992

LANDMARK
LEGISLATION

DEPOSITORIES
ACT
1996

SEBI( Securities & Exchange Board of India)

Established on April 12, 1992 in accordance with
the provisions of the Securities and Exchange
Board of India Act, 1992
Initially (1988) established as an administrative
body, later replaced by SEBI Act making it a
statutory autonomous body
Basic Objective
..to protect the interests of investors in
securities and to promote the development of,
and to regulate the securities market

SEBI( Securities & Exchange Board of India) .

Its regulatory jurisdiction extends over corporates in the
issuance of capital and transfer of securities, in addition
to all intermediaries and persons associated with
securities market.
It can conduct enquiries, audits and inspection of all
concerned and adjudicate offences under the Act.
It has powers to register and regulate all market
intermediaries and also to penalize them in case of
violations of the provisions of the Act, Rules and
Regulations made there under.
SEBI has full autonomy and authority to regulate and
develop an orderly securities market.

Depositories Act, 1996

It provides for the establishment of depositories in
securities with the objective of ensuring free
transferability of securities with speed, accuracy
and security
(a) making securities of public limited
companies freely transferable subject to
certain exceptions;
(b) dematerializing the securities in the
depository mode; and
(c) providing for maintenance of ownership
records in a book entry form.

Depositories Act, 1996

The Act envisages transfer of ownership of
securities electronically by book entry without
making the securities move from person to person.
The Act has made the securities of all public limited
companies freely transferable, restricting the companys
right to use discretion in effecting the transfer of
securities.
Two Depositories
NSDL-National Securities Depository Ltd (1996)-NSE, IDBI, UTI
CDSL-Central Depository Services (India) Limited (1999)- BSE, SBI, BOI..