Unit - 1

 

                                                      FINANCIAL INSTITUTIONS

Meaning 

Since year 1720, the East India Company set up Bank of Bombay, with the objective of increasing trade Financial Institutions are flourishing. Basically financial institutions are business organizations that act as mobilisers and depositors of savings, and as suppliers of credit or finance. They also provide various financial services to the community.

Thus, it can be say that a financial institution is that type of an institution, which performs the collection of funds from private investors and public investors and utilizes those funds in financial assets. The functions of financial institutions are not limited to a particular country, instead they have also become popular in abroad due to the growing impact of globalization.

                                                Overview of Financial institutions 

Types/ Classification of Financial Institutions

We need to classify the financial institutions and this is done on such basis as their primary activity or the degree of their specialization with relation to savers or borrows with whom they customarily deal.

Banking and non-banking Institutions – 

According to one classification financial institutions are divided into the banking and non banking ones. The banking institutions have quite a few things common with the non banking ones, but their distinguishing character lies in the fact that, unlike other institutions,

(a)    they participate in the economy’s payments mechanism, i.e they provide transactions services,

(b)    their deposit liabilities constitute a major part of national money supply

(c)     They can as a whole create deposits or credit which is money

In other words the distinction between the two has been highlighted by sayers by characterizing the banking institutions as “creators” of credit and non-banking as “suppliers” of credit. While the banking system in India comprises the commercial banks and co-operative banks, the examples of non-banking financial institutions are LIC, UTI

Banking

Commercial banks- The commercial banks generally extend short-term loans to businessmen traders. Since their deposits are for a short period only, they cannot land money for a long period. Ordinarily, these banks extend loans for a period between 3 to 6 month. These banks are not in a position to grant long- term loans to industries because their deposits are only for a short period.

Public sector banks –The term public sector banks is used commonly in India. This refers to banks that have their shares listed in the stock exchanges NSE and BSE and also the government of India  holds majority stake in these banks.

They can also be termed as government owned banks.  Example: State bank of India

Private sector banks - Where as Private Sector Banks are those Banks where the management is controlled by Private Individuals and Government does not have any say in the management of these banks. Maximizing profit is the basic motto.

 Co-operative Sector - The co-operative banking sector has been developed in the country to replace the village moneylender, the predominant source of rural finance, as the terms on which he made finance available have generally been harmful to the development of Indian agriculture. Although the sector receives concessional finance from the reserve bank, it is governed by the state legislation. From the point of view of the money market, it may be said to lie between the organized and unorganized market.

State Co-operative Banks- The state co-operative Bank is a federation of central co-operative banks and acts as a watchdog of the co-operative banking structure in the state. Its funds are obtained from share capital, deposits, loans and overdrafts from the RBI. The state co-operative banks lend money to central co-operative banks and primary societies and not directly to farmers.

Central Co-operative Banks- These are the federations of primary credit societies in a district and are of two types – those having a membership of primary societies only and those having a membership of societies as well as individuals. The funds of the bank consist of share capital, deposits, loans and overdrafts from State Co-operative Banks and joint stocks.

Primary Co-operative Credit Societies- The primary co-operative credit society is an association of borrowers and non-borrowers residing in a particular locality. The funds of the society are derived from the share capital and deposits of members and loans from Central Co-operative Banks. The borrowing power of the members as well as of the society is fixed. The loans are given to members for the purpose of cattle, fodder, fertilizers, pesticides, implements etc.

Land Development Banks- The land Development Banks which are organized in three tiers, namely, state, central and primary level , meet the long term credit requirements of farmers for development purpose in purchase of equipment like pump sets, tractors and other machineries, reclamation of land, fencing, digging up new wells and repairs of old wells etc.

Non Banking

Apart from the banking financial institutions, there are a number of specialized financial institutions in India that have been incorporated for a definite purpose. These institutions include the insurance companies, the housing finance companies, mutual funds, merchant banks, credit reporting and debt collection companies and many more. Some of the specialized financial institutions in India are as follows:

Unit Trust of India (UTI)

Securities Trading Corporation of India Ltd. (STCI)

Industrial Development Bank of India (IDBI)

Industrial Reconstruction Bank of India (IRBI), now (Industrial Investment Bank of India)

Export - Import Bank of India (Exim Bank)

Small Industries Development Bank of India (SIDBI)

National Bank for Agriculture and Rural Development (NABARD)

Life Insurance Corporation of India (LIC)

General Insurance Corporation of India (GIC)

Shipping Credit and Investment Company of India Ltd. (SCICI)

Housing and Urban Development Corporation Ltd. (HUDCO)

National Housing Bank (NHB)

 Government – All those government concerns which are dealing in money market and capital market but do not comes under Indian Banking Act 1949 umbrella example post offices, PPF.

 Public Sector – All those concerns which are owned by public and government (where  more than 50% control is in government hand) are working in Financial system  for the flow of finance.

 Private Sector - Private sector non banking organization means any concerns controlled by individuals and where no direct control of government. These institutions mainly form for profit maximization.

 

                                                     ROLE OF FINANCIAL INSTITUTIONS

The Indian Financial Institutions comprises of an impressive network of banks, other financial and investment institutions, offering wide range of products and services which together function in fairly developed capital and money markets. As such financial institutions have come to occupy an important role in the process of economic development.

In Deposits Deposits are very important part in any economy. Every participator of economy used to deposits his money in banks. Banks not only seen by depositors as a safe place but also work as a place to keep money for investment

In Savings – Savings are the habit of human being. People save their part of earning for securing future requirements. Banks are the main source to increase habit of saving. Banks provide return on depositors savings and banks utilize depositors savings for credit requirement of people.

In Banking: Financial Institutions role is vital in capital market as well as in money market. Banks are the most active participator of money market. Banks accept deposits and savings of citizens and provide return in form of interest. Banks also play role in meeting the requirement of loan of agriculture sector and industry. Co-operative banks are working in rural areas to promote as well as to development agriculture. 

In Agriculture: Agriculture is prime sector of India’s economy. 70% population directly or indirectly giving their contribution in agriculture. Financial Institutions significance can be view in form of Co-operative banking in agriculture sector. No doubt since independence we have become self dependent in farming but also we are exporting agro products.

In Small Industry - Financial institutions role in small industry is to provide easy loans with government support. SSI development always remain key interest are of government because of a large population of middle income group who want to start business..

In Industry – Financial Institutions are shaping every industry of nation like Pharma, auto, retail, energy, infrastructure, education etc. F.I are providing credit facilities to enhance economy size.

In Trade – Trade are now not only flourishing within country but also companies are doing M&A (merger and acquisition) outside of country. In foreign trade and M&A huge money is demanded by organizations here F.I come as a vital source in providing credit facility

In Employment – F.I play role of collectors of deposits and simultaneously bring money in economy by providing loan facilities. As the money come in market new productive activity get start and chance of employment generate.

In Level of standard of living – F.I are providing home loans, car loans, consumer durables loan just to increase living standard of people. Now we can see color television, two wheelers in every second home. F.I role is to increase purchasing power of people to provide options to spend in process to increase living standard.

In Rural Development – F.I helping in rural development, they are meeting money requirement of farmers. Rural areas require different strategies and policies for operations so F.I makes separate plans of banking as rural co-operative bank can be seen its perfect example.

 In Economic Prosperity - F.I foremost role is economic prosperity which is possible by smooth functioning of economy. Strong banking system and fundamentals leads a economy to gain good GDP.

                                                                            Financial Market

Financial market performs a crucial function in the savings-investment process. They are not sources of finance but they are a link between the savers and investors, both individual as well as institutional.

Financial market is the centers or arrangements that provide facilities for buying and selling of financial claims and services. The corporations, financial institutions, individuals, and governments trade in financial products on these markets on organized exchanges or off-exchanges. The participants on the demand and supply sides of these markets are financial institutions, agents, brokers, borrowers, lenders, savers, and others.

 

FUNDAMENTALS OF FINANCIAL MARKETS

Financial markets consist of agents, brokers, institutions, and intermediaries transacting purchases and sales of securities. The many persons and institutions operating in the financial markets are linked by contracts, communications networks which form an externally visible financial structure, laws, and friendships. The financial market is divided between investors and financial institutions.

Basis of Financial Market

Basis of Financial Markets are the Borrowers and Lenders 

Borrowers of the Financial Market can be individual persons, private companies, public corporations, government and other local authorities like municipalities. Individual persons generally take short term or long term mortgage loans from banks to buy any property. Private Companies take short term or long term loans for expansion of business or for improvement of the business infrastructure. Public Corporations like railway companies and postal services also borrow from Financial Market to collect required money. Government also borrows from Financial Market to bridge the gap between govt. revenue and govt. spending. Local authorities like municipalities sometimes borrow in their own name and sometimes govt. borrows in behalf of them from the Financial Market.

Lenders in the Financial Market are actually the investors. Their invested money is used to finance the requirements of borrowers. So, there are various types of investments which generate lending activities. Some of these types of investments are depositing money in savings bank account, paying premiums to Insurance Companies, investing in shares of different companies, investing in govt. bonds and investing in pension funds and mutual funds.

Financial Market is nothing but a tool which is used to raise capital. Just like any other tool, it can be beneficial and can be harmful too. So, the ultimate outcome solely lies in the hands of the people who use it to serve their purpose.

 

Contribution of Financial Markets 

Financial Markets are essential for fund raising. Through Financial Market borrowers can find suitable lenders. Banks also help in the process of financing by working as intermediaries. They use the money, which is saved and deposited by a group of people; for giving loans to another group of people who need it. Generally, banks provide financing in the form of loans and mortgages. Except banks other intermediaries in the Financial Market can be Insurance Companies and Mutual Funds. But more complicated transactions of Financial Market take place in stock exchange. In stock exchange, a company can buy others' company's shares or can sell own shares to raise funds or they can buy their own shares existing in the market.

Purpose of Financial Markets

 To understand financial markets, let us look at what they are used for, i.e. what is their purpose?

Without financial markets, borrowers would have difficulty finding lenders themselves. Intermediaries such as banks help in this process. Banks take deposits from those who have money to save. They can then lend money from this pool of deposited money to those who seek to borrow. Banks popularly lend money in the form of loans and mortgages.

More complex transactions than a simple bank deposit require markets where lenders and their agents can meet borrowers and their agents, and where existing borrowing or lending commitments can be sold on to other parties. A good example of a financial market is a stock exchange. A company can raise money by selling shares to investors and its existing shares can be bought or sold.

The following table illustrates where financial markets fit in the relationship between lenders and borrowers: Relationship between lenders and borrower

                                                     Role of Financial Markets 

1. In the modern economy – The role of financial markets assumes greater importance in the modern economy. Financial markets perform an important function of channeling surplus funds from savers to those who are short of funds, thereby contributing to higher production and efficiency in the economy.

2. In international trade – In wake of increased degree of globalization, financial market facilitate across border movements funds from the countries lacking profitable avenues for investments to countries providing higher returns. Another crucial role of financial market is the pricing and management of economic and financial risks.

3. In monetary policy – Financial market also play a crucial role in the transmission of monetary policy impulses. Developed and stable financial markets also enable central bank to use market-based instruments of monetary policy to target monetary variables more effectively.

 

Recent Trends in Indian Financial Market

India Financial market is one of the oldest in the world and is considered to be the fastest growing and  best among all the markets of the emerging economies. 

The history of Indian capital markets dates back 200 years toward the end of the 18th century when India was under the rule of the East India Company. The development of the capital market in India  concentrated around Mumbai where no less than 200 to 250 securities brokers were active during the second half of the 19th century.

1. Capital market boom : The financial market in India today is more developed than many other sectors because it was organized long before with the securities exchanges of Mumbai, Ahmedabad and Kolkata were established as early as the 19th century. By the early 1960s the total number of securities exchanges in India rose to eight, including Mumbai, Ahmedabad and Kolkata apart from Madras, Kanpur, Delhi, Bangalore and Pune. Today there are 21 regional securities exchanges in India in addition to the centralized NSE (National Stock Exchange) and OTCEI (Over the Counter Exchange of India).

2. Private sector is flourishing: However the stock markets in India  remained stagnant due to stringent controls on the market economy that allowed only a handful of monopolies to dominate their respective sectors. The corporate sector wasn’t allowed into many industry segments, which were dominated by the state controlled public sector resulting in stagnation of the economy right up to the early 1990s. Thereafter when the Indian economy began ‘liberalizing’ and the controls began to be dismantled or eased out, the securities markets witnessed a flurry of IPO’s that were launched. This resulted in many new companies across different industry segments to come up with newer products and services.

3. Changing role of  securities market: A remarkable feature of the growth of the Indian economy in recent years has been the role played by its securities markets in assisting and fuelling that growth with money rose within the economy. This was in marked contrast to the initial phase of growth in many of the fast growing economies of East Asia that witnessed huge doses of FDI (Foreign Direct Investment) spurring growth in their initial days of market decontrol. During this phase in India much of the organized sector has been affected by high growth as the financial markets played an all-inclusive role in sustaining financial resource mobilization. Many PSUs (Public Sector Undertakings) that decided to offload part of their equity were also helped by the well-organized securities market in India.

4. Attraction of FDI and FII towards Indian economy: The launch of the NSE (National Stock Exchange) and the OTCEI (Over the Counter Exchange of India) during the mid 1990s by the government of India was meant to usher in an easier and more transparent form of trading in securities. The NSE was conceived as the market for trading in the securities of companies from the large-scale sector and the OTCEI for those from the small-scale sector. While the NSE has not just done well to grow and evolve into the virtual ‘backbone’ of capital markets in India the OTCEI struggled and is yet to show any sign of growth and development. The integration of IT into the capital market infrastructure has been particularly smooth in India due to the country’s world class IT industry. This has pushed up the operational efficiency of the Indian stock market to global standards and as a result the country has been able to capitalize on its high growth and attract foreign capital like never before.

5. Control of SEBI: The regulating authority for capital markets in India is the SEBI (Securities and Exchange Board of India). SEBI came into prominence in the 1990s after the capital markets experienced some turbulence. It had to take drastic measures to plug many loopholes that were exploited by certain market forces to advance their vested interests. After this initial phase of struggle SEBI has grown in strength as the regulator of India’s capital markets and as one of the country’s most important institutions.