Unit - 5 Venture Capital (Assignment by Suryansh Verma)

 MEANING OF VENTURE CAPITAL

Venture Capital is investing in companies that have undeveloped or evolving products or revenue. It lays particular stress on entrepreneurial attempts and less mature businesses. Venture Capitalists are those who are desirous to accept high risk in order to attain a much more higher rate of return. A Venture Capital fund invests for a very long term, has a relatively small number of “stocks,” and seeks very high returns. If we try to explain Venture Capital financing from both perspectives of the investor side and the entrepreneur side, we should ask and answer those two questions: What does an Investor (also known as a Venture Capitalist) have and what does an entrepreneur have? Venture Capitalists have funds, or they have the ability to raise capital. They have experience in building companies creating wealth from the very beginning of a company up to the exit event. They have associates to help in formation of the company’s network. On the other hand, entrepreneurs have avant‐garde ideas, processes or products. They have the needed skill and practice to build and retain this business The Venture Capitalists invest in companies, because they are looking for opportunities of gaining considerably higher returns than in stock market returns. And entrepreneurs just need the money to fully cash in on the opportunity of their product/service. Thus, the Venture Capital .

Industry makes these two parties to come together and meet each other’s needsThere are four stages in Venture Capital financing. They can be summarized as: 

Seed stage: Financing provided to research, assess and develop an initial concept before a business has reached the start‐up phase. 

Startup stage: Financing for product development and initial marketing. Companies may be in the process of being set up or may have been in business for a short time, but have not sold their products commercially and will not yet be generating a profit. 

Expansion stage: Financing for growth and expansion of a company which is breaking even or trading profitably. Capital may be used to finance increased production capacity, market or product development, and/or to provide additional working capital. This stage includes bridge financing and rescue or turnaround investments. 

Replacement Capital: Purchase of shares from another investor or to reduce gearing via the refinancing of debt.

WHAT IS THE AIM OF VENTURE CAPITAL FINANCING?

Investors are interested in Venture Capital by the anticipation of earning higher yields than they can by investing in publicly traded firms. Likewise, entrepreneurs may be attracted by the feasibility of higher returns on their human and financial assets. In this regard, the aim of Venture Capital financing is to increase the value of innovating companies, to allow today's "emerging" companies to advance into tomorrow's leading firms – by that means providing investors with noteworthy returns on their investment. Venture Capital firms invest in a lot of different new ventures, at least one of which should be successful. Apart from financing the new company, Venture Capital firms usually bring in their experience in the field and a network of al. Venture capital is an important source of equity for start‐up companies.
relations – social capitVCs want two things:

Equity: because if and when the business achieves considerable success, that equity stake will
be worth the invested capital.

Control: because VCs want to reduce the risk that the entrepreneur will run a promising
idea into the ground.

WHAT ARE REQUIREMENTS FOR DEVELOPING THE USE OF VENTURE CAPITAL FINANCING?

The criteria is as follows:

1. Identifiable Competitive Advantage .
2. High Growth Potential .

3. Attractive Valuation Relative to potential.

4. Well Defined Exit Alternatives.

There are some relevant questions to check whether a company is worth‐investment:

1. Does the company's product or service have a clear, differentiated advantage in its
marketplace?

2. Does the company, through intellectual property or other means, have sufficient barriers
to theentry of other competitors who can duplicate their advantage?

3. Does the company have a skilled, honest, realistic, seasoned management team with the ability to carry out the business plan and with the ability to responsively weather se
unanticipated problems and opportunities that ari along the voyage to success?

4. Are the company's customers pleased with the product or service, or with its earlyversions, and are they likely to become repeat customers?

5. Is the valuation of the company and the terms of the offered equity investment attractive enough to warrant the risk involved in the investment?

6. Of all of the above, the need for a strong management team is by far the most critical. For a venture opportunity to be attractive there must be a positive answer to all of these questions. But venture investors will spend most of their effort verifying the quality of
the team of managers who will be spending their money.

7. Once you have traversed all of these hurdles, you're ready to focus on the terms and methods of closing the deal. Once again, a company will turn to its expert legal and financial advisers for help with terms, documents, and closing. 

ADVANTAGES OF VC

I. Industry Consolidation: Most of the industries in Turkey display a fragmented structure, offering lucrative inorganic growth opportunities through consolidation.

II. New Market Expansion: VC Firms expect its portfolio companies not only to be dominant players in the local market but also to have the vision to become regional or global players, provided that they have a suitable business concept for internationalization, in order to mitigate risks related to over‐exposure to one single geographic market. VC Firms do not only financially support international expansion, but also plays a key role to support company management to identify the right market and the mode of entry.

III. Strategic Redirecting: Management Team’s years of past experience in various fields including operations and consulting enables the investment team to engage in a guiding role whilst assessment of portfolio companies’ strategies with a focus on competitive advantage creation.

IV. Operational Improvement: Operational improvement is one of the most widely and successfully applied value creation strategies by VC Firms and enables the portfolio companies to adopt systems and approaches that will continue to create value after VC Firms’ exit. Operational improvement is achieved by improvement of existing or as the case may be, introduction of new management information and reporting systems and also development and implementation of new IT infrastructure, which are standard applications by VC Firms for its portfolio companies, to a greater extent particularly for investments completed recently.

V. Reinforce Management Team: Despite the scarcity of result‐oriented management talent that can deliver VC expectations, due to its local presence and experience, VC Firms not only successfully creates its own pool of capable executives, but also establishes relationships with a vast network of consultants and recruiting firms. For example, CFO’s can be selected and brought in for all of the portfolio companies by VC Firms.

VI. Corporate Governance, Transparency and Restructuring: VC Firms place great emphasis on the transparency, ethics and also efficiency of principals and procedures concerning the management of its portfolio companies. In order to establish financial and operational discipline, VC Firms restructures internal operational processes, policies and procedures, particularly those regarding personnel, expenses‐allowances and procurement, immediately after entry, which has been the case especially for investments completed more recently.

Important questions

Important topics are :

1. Financial system
2. Financial Market and its types
3. Capital market
4. Money Market and functions
5. Institutions in Money and capital markets
6. Functions and types of Capital market
7. RBI - Role and functions
8. Commercial banks - Functions
9. Development banks - objectives and functions
10. IDBI
11. Mutual Funds - Types and functions
12. Capital Venture - Importance and process

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.

 

Unit - 2

 

                                                                          Money Market Institutions 

1)      Commercial Banks: The commercial banks are the most constituents of the money market. They use their short term surplus, funds to grand short term loans to the money market. They also discount and rediscount the commercial papers such as bill of exchange and Treasury bill. Commercial banks always try to maintain a balance between Liquidity and Profitability. 

2)      Non-Bank Financial Institutions: Non bank financial institutions such as insurance companies and other business corporations having short-period surplus funds also operate in the money market.

3)      Acceptance Houses: Acceptance houses and bill brokers are the important constituents of the money market in developed countries. These houses specialize in the acceptance of trade bills on behalf of their customers. Discount houses and bill brokers’ discount buy and sell bills drawn on the acceptance houses.

4)      Central Bank: The Central Bank is the top most financial institution in the money market. It is regarded as the lender of the last resort, banker to the government, banker’s bank and controller of the money market. As a lender of the last resort, the central bank gives temporary financial assistance to commercial banks by rediscounting their eligible bills. The central bank controls the money market with two main instruments, namely, the bank rate and the open market operations.

 

                                                                       Capital Market Institutions

Special financial institutions are the most active parts of Indian Capital Market. Such organizations provide medium and long term loan on easy installments to big business houses 

Such institutions help in promoting new companies; expansions and development of existing companies and meeting the financial requirements of companies during economic slow down.

The following are the main special financial institutions that are most active parts of the Indian Capital Market:

Development Banks : 

·        The Industrial Finance Corporation  of India (I.F.C.I)

·        The Industrial Credit and Investment Corporation of India  (I.C.I.C.I)

·        The Refinance Corporation of India (R.F.C)

·        State Financial Development Corporations (S.F.Cs)

·        National Industrial Development Corporation (N.I.D.C)

·        State Industrial Development Corporation (S.I.D.C)

·        National Small Industries Corporation (N.S.I.C)

·        Industrial Development Bank of India (I.D.B.I)

 

Mutual Funds

 Unit trust of India (UTI)

ICICI Prudential

Reliance Insurance

Birla Sun life Insurance

 

Life Insurance

L.I.C                         HDFC

Bajaj Allianz            Tata AIG

  

Nationalized Commercial Banks (N.C.Bs) 

SBI                           PNB

BOB                         OBC

 

Stock Exchange : 

Bombay Stock Exchange                  

National Stock Exchange

  

Investment Banks 

J P Morgan                           Goldman Sach

Morgan Stanley                     Citigroup

Deutsche Bank                      HSBC

 

Assets Management Companies (AMCs) 

Religare                                 HDFC

SBI                                       ICICI

 

Merchant Banking Institutions (M.B.Is)

SBI Capital Markets                                      Kotak Mahindra capital

Tata Finance Merchant Bankers Ltd          Punjab & Sindh Bank 

Types of Financial Markets

 The financial markets can be divided into different subtypes:

 1. Capital markets which consist of: 

      A) Stock markets, which provide financing through the issuance of shares or common stock, and enable the subsequent trading thereof.

      B) Bond markets, which provide financing through the issuance of bonds, and enable the subsequent trading thereof.

      The capital markets consist of primary markets and secondary markets. Newly formed (issued) securities are bought or sold in primary markets. Secondary markets allow investors to sell securities that they hold or buy existing securities.

      2. Commodity markets: Commodity markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold in standardized contracts.

Top five commodity exchanges: 

New York Mercantile Exchange           USA   

Tokyo Commodity Exchange                Japan  

NYSE Euronext                                   EU      

Dalian Commodity Exchange                China

Multi Commodity Exchange                  India

3. Money markets- The term money market is used in a composite sense to mean financial institutions which deal with short term funds in the economy. It refers to the institutional arrangements facilitating borrowing and lending of short term funds. The money market brings together the lenders who have surplus short term invest able funds and the borrowers who are in need of short term funds. In money market funds can be borrowed for a short period varying from a day, a week, a month, or 3 to 6 months and against different types of instruments such as bills of exchange, bankers acceptances, bonds etc, called near money

4. Derivatives markets - The Derivatives Market is meant as the market where exchange of derivatives takes place. Derivatives are one type of securities whose price is derived from the underlying assets. And value of these derivatives is determined by the fluctuations in the underlying assets. These underlying assets are most commonly stocks, bonds, currencies, interest rates, commodities and market indices. The Derivatives can be classified as Future Contracts, Forward Contracts, Options, Swaps and Credit Derivatives

5. Insurance markets - Insurance, in law and economics, is a form of risk management primarily used to hedge against the risk of a contingent loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for a premium, and can be thought of as a guaranteed and known small loss to prevent a large, possibly devastating loss. An insurer is a company selling the insurance; an insured or policyholder is the person or entity buying the insurance. The insurance rate is a factor used to determine the amount to be charged for a certain amount of insurance coverage, called the premium. Risk management, the practice of appraising and controlling risk, has evolved as a discrete field of study and practice. In other words insurance market means which facilitate the redistribution of various risks.

 6. Foreign exchange markets - The foreign exchange market (currency, Forex, or FX) trades currencies. It lets banks and other institutions easily buy and sell currencies. [1]

The purpose of the foreign exchange market is to help international trade and investment. A foreign exchange market helps businesses convert one currency to another. For example, it permits a Indian business to import U.S goods and pay US dollar even though the business's income is in rupees

In a typical foreign exchange transaction a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market started forming during the 1970s when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.

                                                                                                Money Market

The term money market is used in a composite sense to mean financial institutions which deal with short term funds in the economy. It refers to the institutional arrangements facilitating borrowing and lending of short term funds. The money market brings together the lenders who have surplus short term invest able funds and the borrowers who are in need of short term funds. In money market funds can be borrowed for a short period varying from a day, a week, a month, or 3 to 6 months and against different types of instruments such as bills of exchange, banker’s acceptances, bonds etc, called near money

Functions of the Money Market

The money market performs the following functions:

1.      Adjustment of liquidity position - The basic function of money market is to facilitate adjustment of liquidity position of commercial banks, business corporations and other non banking institutions.

2.      To utilize surplus of Institutions - It provides outlets to commercial banks, business corporations, non bank financial concerns and other investors for their short term surplus funds.

3.      Funds for various borrowers- It provides short terms funds to the various borrowers such as businessmen, industrialists, traders etc.

4.      To government- It provides short terms funds even to government institutions.

5.      Credit control- The money market constitutes a highly efficient mechanism for credit control. It serves as a medium through which the Central Bank of the country (RBI) exercises controls on the credit.

6.      To utilize surplus of businessmen- It enables businessmen to invest their temporary surplus for a short period.

 7.      Provide funds for various uses- It plays a vital role in the flow of funds to the most important uses like expansion plan of any existing company or in forming a new company even in meeting shortcomings of creditors.

Essentials of Money market: 

The money market is not a single homogeneous market but it is composed of several specialized sub markets, each one of which deals in different types of short term credit.

1. Call Money Market: The money market refers to the market for extremely short period loans. Bill brokers and dealers in the stock exchange usually borrow money for short periods from commercial banks. The money is advanced by the commercial bank to bill brokers and dealers in the stock exchange for very short periods of one day, overnight or maximum seven days. Such short period loans are called “call loans” as these can be recalled by the lending bank at any time. There is no collateral security demanded against these loans and the borrower has to repay the loans immediately whenever called for.

Call loans are found useful by commercial banks as they are like cash and bring some income for the banks. Inter-bank call money market is very common in India. The bank which has surplus money for a short period lends to the needy bank.

2. Collateral loan market: The market which deals with collateral loans, i.e., loans backed up by collateral securities like stock and bond etc. is called collateral bond market. The collateral loans are given for a short period generally lasting few months. The borrowers in the market are generally brokers and dealers in stocks and shares, and the lenders are commercial banks. Sometimes, even a smaller bank may raise collateral loans from a bigger bank. The collateral security is returned by the lender on the repayment of loan but if the loan is not repaid the collateral security may be retained by the lender.

3. Bill market or Discount market: The bill market or the discount market refers to the market in which short period papers and bills are bought and sold. The most important short period papers, which are dealt in the bill market, are commercial bills. There are two types of commercial bills, (1) bill of exchange, and (2) treasury bills. The bill of exchange, popularly know as bill, is written instrument containing an unconditional order, signed by the drawer, directing a certain person to pay a certain sum of money only to, or order of a certain person, or to the bearer of the instrument at a fixed time in future or on demand.

 The treasure bill, on the other hand, is a short term government security, usually of the duration of 91 days, sold by the central bank of behalf of the government. There is no fixed rate or interest payable on the treasury bills. The treasure bills are sold by the central bank on the treasury bills. The treasury bills are sold by the central bank on the basis of competitive bidding.

4. Acceptance Market: It refers to the market for banker’s acceptances involved in trade transactions. A banker’s acceptance may be defined as a draft drawn by an individual or a firm upon a bank and accepted by it to pay to the order of a specified person or to the bearer, a certain specified sum of money at specified date in future. It is commonly used to settle payments in international trade.

 

                                                                                             CAPITAL MARKET

The term ‘capital market’ refers to the institutional arrangements for facilitating the borrowing and lending of long term funds.

In the widest sense, it consists of a series of channels through which the savings of community are made available for industrial and commercial enterprises and public authorities. It is concerned with those private savings, individual as well as corporate, that are turned in investments through new capital issues and also new public loans floated by government and semi-government bodies.

A capital market may be defined as an organized mechanism for effective and efficient transfer of money-capital or financial resources from investing parties, i.e. individuals or institutional savers to the entrepreneurs (individuals or institutions) engaged in industry or commerce in the business would either be in the private or public sectors of an economy.

FUNCTION OF CAPITAL MARKET 

1)      MOBILIZATION OF FINANCIAL RESOURCES ON A NATION-WIDE SCALE 

2)      SECURING THE FOREIGN CAPITAL AND KNOW HOW TO FILL UP THE DEFICIT IN THE REQUIRED RESOURCES FOR ECONOMIC GROWTH AT A FASTER RATE.

3)      EFFECTIVE ALLOCATION OF THE MOBILIZED FINANCIAL RESOURCES, BY DIRECTING THE SAME TO PROJECTS YIELDING HIGHEST YIELD OR TO THE PROJECTS NEEDED TO PROMOTE BALANCED ECONOMIC DEVELOPMENT.

 

                                                                                                    PRIMARY MARKET 

The primary market, also called the new issue market, is the market for issuing new securities. Many companies, especially small and medium scale, enter the primary market to raise money from the public to expand their businesses. They sell their securities to the public through an initial public offering.  The primary market is a market for new capitals that will be traded over a longer period.

Definitions of Primary market on the Web: 

The market in which investors have the first opportunity to buy a newly issued security.

                                                                                                  …www.investor.realnetworks.com

The first buyer of a newly issued security buys that security in the primary market. All subsequent trading of those securities is done in the secondary market.

                                                                                                          …www.greekshares.com

 

Features of primary markets are: 

1.      This is the market for new long term equity capital. The primary market is the market where the securities are sold for the first time. Therefore it is also called the new issue market (NIM).

2.      In a primary issue, the securities are issued by the company directly to investors.

3.      The company receives the money and issues new security certificates to the investors.

4.      Primary issues are used by companies for the purpose of setting up new business or for expanding or modernizing the existing business.

5.      The primary market performs the crucial function of facilitating capital formation in the economy.

6.      The new issue market does not include certain other sources of new long term external finance, such as loans from financial institutions. Borrowers in the new issue market may be raising capital for converting private capital into public capital; this is known as "going public."

 

Methods of issuing securities in the primary market are:

Initial public offering;

Rights issue (for existing companies);

Preferential issue.

Process: 

In the primary market, securities are issued on an exchange basis. The underwriters, that is, the investment banks, play an important role in this market: they set the initial price range for a particular share and then supervise the selling of that share.

Investors can obtain news of upcoming shares only on the primary market. The issuing firm collects money, which is then used to finance its operations or expand business, by selling its shares. Before selling a security on the primary market, the firm must fulfill all the requirements regarding the exchange.

After trading in the primary market the security will then enter the secondary market, where numerous trades happen every day. The primary market accelerates the process of capital formation in a country's economy. The primary market categorically excludes several other long-term finance sources, such as loans from financial institutions.

What is "public issue"? 

Many companies have entered the primary market to earn profit by converting its capital, which is basically a private capital, into a public one, releasing securities to the public. This phenomena is known as "public issue" or "going public."

 

                                                                                                         Secondary Market

It is a market for used goods. Here one investor can buy a security from other investors instead of the issuer. All the securities are first created in the primary market and then, they enter into the secondary market. In the Bombay Stock Exchange (BSE), all the stocks belong to the secondary market.

The secondary market, also known as the aftermarket, is the financial market where previously issued securities and financial instruments such as stock, bonds, options, and futures are bought and sold..

In other words a newly issued IPO will be considered a primary market trade when the shares are first purchased by investors directly from the underwriting investment bank; after that any shares traded will be on the secondary market, between investors themselves. In the primary market prices are often set beforehand, whereas in the secondary market only basic forces like supply and demand determine the price of the security

Importance: 

The secondary market has an important role to play behind the developments of an efficient capital market. Secondary market connects investors' favoritism for liquidity with the capital users' wish of using their capital for a longer period. For example, in a traditional partnership, a partner can not access the other partner's investment but only his or her investment in that partnership, even on an emergency basis. Then if he or she may breaks the ownership of equity into parts and sell his or her respective proportion to another investor. This kind of trading is facilitated only by the secondary market.

Example of Secondary market:

In the Bombay Stock Exchange (BSE), National Stock Exchange (NSE) in the India, all the securities belong to the secondary market

Major stock exchanges

Africa              Johannesburg Securities Exchange 

Americas        NASDAQ      

Americas        São Paulo Stock Exchange   

Americas        Toronto Stock Exchange      

Americas        New York Stock Exchange   

Asia-Pacific    Australian Securities Exchange       

Asia-Pacific    Bombay Stock Exchange      

Asia-Pacific    Hong Kong  Stock Exchange

Asia-Pacific    Korea Exchange       

Asia-Pacific    National Stock Exchange of India   

Asia-Pacific    Shanghai Stock Exchange    

Europe            London Stock Exchange        

Europe            Madrid Stock Exchange

Europe            Milan Stock Exchange

Players in the Primary Market

 The important players in the new issue (primary) markets are :

Merchant Banks

Registrars

Collecting and Coordinating banks

Underwriters

Brokers, Agents

Printers

Advertising Agencies

Mailing Agencies

SEBI

 

 

 

                                                                                                         FORWARD MARKET 

A forward rate (or toward exchange rate) is the one which applies to a foreign exchange transaction to be effected on a specific future date. Both the buyer and seller of exchange in the forward market agree that the forward rate will sell a stated amount of the ‘foreign’ currency at an agreed exchange rate to the buyer on a specified future date (say, three month hence) irrespective of the actual exchange rate that may prevail on the said future date. The deal also involves a corresponding payment, in (normally) domestic currency by the buyer of foreign currency to the seller of to.

The spot market is for foreign exchange traded within two business days. However, some transactions may be entered into on one day but not completed until sometime in the future. For example, a French exporter of perfume might sell perfume to a US importer with immediate delivery but not required payment for 30 days. The US importer has an obligation to pay the required francs in 30 days, so he or she may enter into a contract with a trader to deliver dollars for francs in 30 days at a forward rate – the rate today for future delivery.

Thus, the forward rate is the rate quoted by foreign exchange traders for the purchase or sale of foreign exchange in the future. There is a difference between a spot rate and the forward rate known as the ‘spread’ in the forward market. In order to understand how spot and forward rates are determined, we should first know how to calculate the spread between the spot and forward rates.

Consider another example. Suppose the spot Japanese yen of August 6, 1991, sold at $0.006879 while 90 day forward yen was priced at $0.006902. Based on these rates, the swap rate for the 90 day forward yen was quoted as a 23 point premium (0.006902 – 0.006879). Similarly because the 90 day British pound was quoted at $1.6745 while the spot pound was $1.7015, the 90 day British pound sold at a 2.70 point discount.

With reference to its relationship with the spot rate, the forward rate may be at par, at a discount or at a premium.

1)      At par : If the forward exchange rate quoted is exactly equivalent to the spot rate at the time of making the contract, forward exchange rate is said to be at par.

2)      At premium : The forward rate for a currency, say, the US dollar, is said to be at premium with respect to the spot rate when one dollar buys more units of another currency, say t   he rupee, in the forward rather in the spot market. The premium is usually expressed as a percentage deviation from the spot rate on per annum basis.

3)      At discount: The forward rate for a currency, say, the US dollar, is said 10 be at a discount with respect to the spot rate when one dollar buys fewer rupees in the forward than in the spot market.

 

PARTICIPANTS IN THE FORWARD MARKET 

1)      Traders: Traders use spot and forward markets to eliminate the risk of loss of value of export or import orders that are dominated in foreign currencies. The purpose is usually to hedge a position. Traders buy and sell currency in the spot and forward market.

2)      Arbitrageurs: This class of participants seek to earn risk free profits by seeking advantage of differences in prices of currencies (spatial arbitrage), in interest rates among countries (interest rate arbitrage). They use forward contract to hedge risk.

3)      Hedgers : Many multinational firms engage themselves in forward contract to protect the home currency values of foreign currency dominated assets and liabilities on their balance sheet that are not to be realized over the life of the contract. These companies also hedge receivables and payables.

4)      Speculators:  This class of participant actively expose themselves to currency risk by buying and selling currencies in the forward market to profit from the exchange rate fluctuation. The speculators keep their position open. The participation of this class does not depend on their business transaction in other currencies; instead these are based on current prices in the forward market and their expectation about the future spot rates.

5)      Banks: The banks participate in the foreign exchange market for various reasons. When the banks keep their position open, they are speculating and become speculators. The banks also appear as hedgers when they hedge their positions. Since the banks provide foreign exchange services therefore these also conduct transactions on behalf of their clients.

6)      Governments: The participation of the governments in the foreign exchange markets for stabilizing the exchange rate is very important activity because these activities infuse confidence in the functioning of forex markets. Governments may regularly monitor markets and intervene for policy targets they set in for the economy.

 

                                                                                                         Option Market 

A option or currency option confers on its buyer the right either to buy or to sell a specified amount of a currency at a set price known as the strike price. An option that gives the right to buy is known as a ‘call’ while one that gives the right to sell is known as ‘’put’. Depending on the contract terms, an option may be exercisable on any date during the specifies period or it may be exercisable only on the final or expiration date of the period covered by the option contract in return guaranteeing the exercise of an option at its strike price, the option seller or writer charges a premium which the buyer usually pay upfront. Under favorable circumstances, the buyer may choose to exercise it. Alternatively the buyer may be allowed to sell it.

Options Terminology 

Before we proceed to discuss option pricing and applications, we must understand the market terminology associated with options. While our context is that of option on spot foreign currencies, the terms describes below carry over to other types of options as well.

The   two parties to an option contract are the option buyer and the option seller also called option writer. For exchange traded option, as in the case of futures, once an agreement is reached between two traders, the exchange (the clearing house), interposes itself between the two parties, becoming buyer to every seller and sealer to every buyer. The clearing house guarantees performance on the part of every seller.

i)  Call Option: A call option gives the option buyer the right to purchase a currency X; at a stated price Y/X, on or before a stated date. For exchange traded option, one contract represents a standard amount of the currency Y. The writer of a call option must deliver the currency Y if the option buyer chooses to exercise his option.

ii) Put Option: A put option gives the option buyer the right to sell a currency Y against a currency X at a specified price, on or before a specified date. The writer of a put option must take delivery if the option is exercised.

iii) Strike price ( also called  Exercised price ) :  The price specified in the option contract at  which the option buyer can purchase the  currency (call ), or sell the currency  (put ) Y against X . Note carefully that this is not the price of the option; it is the rate of exchange between X and Y that applies to the transaction if the option buyer decides to exercise his option.

 

                                                                              Foreign Exchange Market (Forex Market)

The foreign exchange market (currency, Forex, or FX) trades currencies. It lets banks and other institutions easily buy and sell currencies.

 According to Kindleberger – 

“The foreign exchange market is a place where foreign moneys are bought and sold”

The purpose of the foreign exchange market is to help international trade and investment. A foreign exchange market helps businesses convert one currency to another. For example, it permits a Indian business to import U.S goods and pay U.S doller even though the business's income is in rupees.

In a typical foreign exchange transaction a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market started forming during the 1970s when countries gradually switched to floating exchange rates from the previous exchange rate rule, which remained fixed as per the Bretton Woods system.

Functions of Foreign Exchange Market

 1. Transfer Function: The basic function of any foreign exchange market is to facilitate the conversion of one currency into another, i.e. to accomplish transfers of purchasing power between two countries. This transfer of purchasing power is affected through a variety of credit instruments, such as telegraphic transfers, bank draft and foreign bills.

2. Credit Function: Another function of the foreign exchange market is to provide credit, both national and international, to promote foreign trade; obviously when foreign bills of exchange are used in international payments a credit for about 3 moths, till their maturity, is required.

3. Hedging Function: A third function of foreign exchange market is to hedge foreign exchange risk. In a free exchange market when exchange rate i.e. the price of one currency in terms of another currency, change there may be a gain or loss to party concerned. Under this condition a person or a firm undertake a great exchange risk if there are huge amounts of net claims or net liabilities which are to be met in foreign money. Exchange risk as such should be avoided or reduced. For this exchange market provides facilities for hedging anticipated or actual claims or liabilities through forward contracts in exchange. A forward contract which is normally for three months is a contract to buy or sell foreign exchange against another currency at some fixed date in the future at a price agreed upon now. No money passes at the same time of the contract. But the contract makes it possible to ignore any likely changes in exchange rate. The existence of a forward market thus makes it possible to hedge an exchange position.

Participants in Foreign Exchange Market 

The major participants in the forex market are the large commercial banks; foreign exchange brokers in the interbank market; commercial customers, primarily multinational corporations and central banks, which intervene in the market from time to time smooth exchange rate fluctuations or to maintain target exchange rates. Central bank interference involving buying or selling in the market is often indistinguishable (the same) from the foreign exchange dealing of commercial banks or of other private participants.

 

Unit - 3

                                                                      RESERVE BANK OF INDIA

The RBI is the Central Bank of the country. It has been established as a body corporate under the Reserve Bank of India Act. which came into effect from 1st April 1935. The Reserve Bank was started as share holder bank with a paid-up capital of Rs. 5 crores. On establishment it took over the function of management of currency from the Government of India and power of credit control from the then Imperial Bank of India.

The Reserve Bank of India carries on its operations according to the provisions of the Reserve Bank of India Act, 1934. The act has been amended from time to time.

Role of Reserve Bank of India 

1- To maintain monetary stability so that the business and economic life can deliver welfare gains of a properly functioning mixed economy,

2- To maintain financial stability and ensure sound financial institutions so that monetary stability can be safely pursued and economic units can conduct their business with confidence.

3- To maintain stable payments system so that financial transactions can be safely and efficiently executed. 

4- To promote the development of financial infrastructure of markets and systems, and to enable it to operate efficiently, i.e.., to play a leading role in developing a sound financial system so that it can discharge its regulatory function efficiently.

5- To ensure that credit allocation by the financial systems broadly reflects the national economics priorities and societal concerns.

6- To regulate the overall volume of money and credit in the economy with a view to ensure a reasonable degree of price stability.

Functions of the Reserve Bank of India

The reserve bank of India is the Central Bank of India  and therefore, it performs all those functions which a central bank is required to perform in a country. The function of central banks are broadly the same all over the world, but the scope and content of policy objectives very from country to country and from period to period depending upon a number of factors like development and the structure of the economy, goals to which the government is committed and the general economic situation.

The functions performed by the Reserve Bank can be classified into three categories:-

A) Central banking functions.

B) Supervisory functions.

C) Promotional function functions.

 

                                                                                      A) Central Banking Functions

1. Issue of Banking Notes: The Reserve Bank has the sole right to issue bank notes of all denominates (except one rupee notes which are issued only by the Government of India). This has been done to give the Reserve Bank the complete and control over the currency and the credit system of the country. The Bank has a separate “Issue Department” for this purpose. The Bank follows the “Minimum Reserve System” for issue of bank notes

The Reserve Bank has made adequate arrangements for holding and distributing of currency notes and coins. The issue Department of the Reserve Bank has its office in seventeen important cities of the country. Moreover it is maintaining currency chests all over the country.

2. Banker of government: The Reserve Bank of India act as the banker to Government. It accepts money for the account of Union and State Government in India, makes payment on their behalf, carries out their exchange, remittance and other banking operations and manages the public debt. It makes ways and means advances to the government for 90 days. It advises the government on all monetary and banking matters.

3. Bankers’ Bank: The Reserve Bank of India acts as the banker’s bank. The scheduled banks are required to maintain with the Reserve Bank as cash balance a certain percentage of their time and demand liabilities. It act as a lender of the last resort to them. The scheduled banks can borrow money from the Reserve Bank on the basis of eligible securities or get financial accommodation in times of need or stringency by rediscounting their bills of exchange.

4. Custodian of Foreign Exchange Reserves: The Reserve Bank has been entrusted with the responsibility of maintaining the external value of the rupee and for this purpose the bank holds most of the foreign exchange reserves. Since India  is a member of International Monetary fund, the Reserve Bank has to maintain fixed exchange rates with all other member countries of the Fund. It, therefore, sells and buys foreign exchange to/from authorized persons at rates fixed by the Government.

5. Controller of Credit: The Reserve Bank also functions as the controller of credit. It can control by various methods the creation of credit by commercial banks. Time to time Reserve Bank of India declare monetary policy to control and direct credit system. RBI revise CRR, PLR for this purpose.

 

                                                                                      B) Supervisory Functions 

In order to promote and develop a sound and efficient system of banking in India, the Reserve Bank has been given several supervisory powers over different banking institutions. These powers relate to licensing and establishment, branch expansion, liquidity of assets, management, working, amalgamation, reconstruction and co-operative banks. The Reserve Bank carries out periodical inspections of these banks and calls for such information, which it considers necessary for effective performance of its functions.

Various supervisory functions are-

1. Every bank wishing to commence banking business in India is required to obtain license from the RBI.

2. To ensure that banks are organized and conduct their business on sound financial footing of the banking. Regulation act has prescribed the minimum paid up capital, cash reserves and other liquid assets depending upon the geographical coverage of bank’s operations.

3. Every bank in country is require to obtain permission from the RBI for its branch expansion programme.

 

                                                                                            C) Promotional Functions

The Reserve Bank of India as a central bank of the country has assumed greater responsibilities as development and promotional agency as composed to a merely monetary authority.

It not only controls the credit and currency in the economy or maintains internal/external value of the rupee for ensuring price stability but also acts as a promoter of financial institutions, required for meting specific financial requirements of the developing economy.

At the time of establishment of the Reserve Bank of India in the year 1935 the country lacked a well-developed money market and a well-developed commercial banking system. Moreover, it was industrially a backward country.

The promotional steps taken by the RBI in this direction can be summarized as follows---

(i) It established Bill market Scheme in 1952.

(ii) It has promoted Regional Rural banks (RRBs) with the cooperation of the commercial banks to extend banking facilities to the rural areas.

(iii) It has helped in establishment of Export Import Bank of India (EXIM) to provide finance to exporters. It also helps the commercial banks in opening their branches in foreign countries for helping in the foreign trade of the country.

(iv) The RBI also encourages and promotes research in areas of banking.

                                                                                  COMMERCIAL BANKS

 Meaning of Commercial Banks

Since a modern bank performs a variety of function, it is difficult to give an accurate definition of it. It is on account of this reason that different economists have different definitions of bank.

Indian Companies Act, 1949, has defined the bank, “The accepting for the purpose of lending or investment of deposits of money from the public repayable on demand or otherwise and withdrawal by cheque, draft,order or otherwise.’’

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.

Structure of Banking System in India

The present banking system in India was evolved to meet the financial needs of trade and industry and also to satisfy the institution of the country. The constituents of the present banking system in India are of varying origin and sizes. At the apex is the Reserve Bank of India, the Central Bank of the country. It is a bankers’ bank and lender of the last resort. Besides, it acts as the fiscal agent of the government, manages the currency, and controls the credit in the national interest.

The Reserve Bank of India is followed by the State Bank of India which was created in July 1955 by nationalizing the Imperial Bank of India: the State Bank of India’s subsidiaries; 20 major nationalized scheduled banks; other joint stock banks that came into existence from the 1960’s and onward; foreign exchange banks formed in India in the later half of the 19th century; cooperative banks which had their first existence in 1904 in the garb of the 18th century. Besides, there are indigenous banks and bankers who are centuries old Recently Regional Rural Banks (RRRBs) were formed to assist particularly rural. Thus the banking sector in India comprises the commercial banks, cooperative banks and regional rural banks.

Joint stock banks can be divided into two groups scheduled and non- scheduled banks.

Scheduled Banks 

A scheduled bank is one which is registered in the second schedule of the Reserve Bank of India.

The following conditions must be fulfilled by a bank for inclusion in the schedule;

1- The banker concerned must be in business of banking in India.

2- It is either a company defined in Section 3 of the Indian Companies Act, 1956, or corporation or a company incorporated by or under any law in force in any place outside India or an institution notified by the Central Government in this behalf.

3- It must have paid-up capital and reserves of an aggregate real or exchangeable value of not less than rupees five lakhs.

4- It must satisfy the Reserve Bank of India that its affairs are not conducted in a manner detrimental to the interests of its depositors.

Scheduled banks come under the purview of the various credit control measures of the Reserve Bank of India. They are required to maintain a certain minimum balance in their accounts with the RBI, and do certain things prescribed by law. The scheduled banks are entitled to borrowings and rediscounting facilities from the RBI. These are similar to the member banks of the U.S.A.

Non-Scheduled Banks 

Banks, which are not included in the second schedule of the RBI, are known as non-scheduled banks.

Functions of Commercial Banks

Modern banks perform a large variety of functions and services:

1) Acceptance of Deposits: The bank accepts three types of deposits from the public.

i) Fixed Deposit Account: Money in this account is accepted for a fixed period, say one two or five years. The money so deposited can not be withdrawn before the expiry of the fixed period. The rate of interest on this account is higher than that on other accounts. The longer the period, the higher is the rate of interest. In technical language this type of deposit is known as time or term deposit. It mature at a definite date and entails an interest penalty if it is withdrawn earlier due to some emergency by the depositors.