Principles & Principles & Practices of Banking Practices of Banking Module A Module A Indian Financial Indian Financial System System K Chockalingam K Chockalingam IIBF IIBF
Jan 29, 2015
Principles & Practices of Principles & Practices of BankingBanking
Module AModule A
Indian Financial SystemIndian Financial System
K ChockalingamK Chockalingam
IIBFIIBF
Financial System Financial System
An institutional framework existing in a An institutional framework existing in a country to enable financial transactionscountry to enable financial transactions
Three main partsThree main parts Financial assets (loans, deposits, bonds, equities, Financial assets (loans, deposits, bonds, equities,
etc.)etc.) Financial institutions (banks, mutual funds, insurance Financial institutions (banks, mutual funds, insurance
companies, etc.)companies, etc.) Financial markets (money market, capital market, Financial markets (money market, capital market,
forex market, etc.)forex market, etc.)
Regulation is another aspect of the Regulation is another aspect of the financial system (RBI, SEBI, IRDA, FMC)financial system (RBI, SEBI, IRDA, FMC)
Financial assets/instrumentsFinancial assets/instruments Enable channelising funds from surplus units to Enable channelising funds from surplus units to
deficit unitsdeficit units There are instruments for savers such as There are instruments for savers such as
deposits, equities, mutual fund units, etc.deposits, equities, mutual fund units, etc. There are instruments for borrowers such as There are instruments for borrowers such as
loans, overdrafts, etc.loans, overdrafts, etc. Like businesses, governments too raise funds Like businesses, governments too raise funds
through issue of bonds, Treasury bills, etc.through issue of bonds, Treasury bills, etc. Instruments like PPF, KVP, etc. are available to Instruments like PPF, KVP, etc. are available to
savers who wish to lend money to the savers who wish to lend money to the governmentgovernment
Money Market InstrumentsMoney Market Instruments Call money- money borrowed/lent for a day. Call money- money borrowed/lent for a day.
No collateral is required.No collateral is required. Inter-bank term money- Borrowings among Inter-bank term money- Borrowings among
banks for a period of more than 7 daysbanks for a period of more than 7 days Treasury Bills- short term instruments issued Treasury Bills- short term instruments issued
by the Union Govt. to raise money. Issued at by the Union Govt. to raise money. Issued at a discount to the face valuea discount to the face value
Certificates of Deposit- Issued by banks to Certificates of Deposit- Issued by banks to raise money. Minimum value is Rs. 1 lakh, raise money. Minimum value is Rs. 1 lakh, tradable in the markettradable in the market
CDs can be issued by banks/FIsCDs can be issued by banks/FIs
Money Market Instruments Money Market Instruments (2)(2) Commercial Paper (CPs) are issued by Commercial Paper (CPs) are issued by
corporates to raise short term moneycorporates to raise short term money Issued in multiple of Rs.25 lakhs, can be Issued in multiple of Rs.25 lakhs, can be
issued by companies with a net worth of issued by companies with a net worth of at least Rs. 5 croresat least Rs. 5 crores
CP is an unsecured promissory note CP is an unsecured promissory note privately placed with investors at a privately placed with investors at a discount rate to face value. The maturity discount rate to face value. The maturity of CP is between 3 and 6 monthsof CP is between 3 and 6 months
Financial InstitutionsFinancial Institutions Includes institutions and mechanisms Includes institutions and mechanisms
whichwhich Affect generation of savings by the communityAffect generation of savings by the community Mobilisation of savingsMobilisation of savings Effective distribution of savingsEffective distribution of savings
Institutions are banks, insurance Institutions are banks, insurance companies, mutual funds- companies, mutual funds- promote/mobilise savingspromote/mobilise savings
Individual investors, industrial and Individual investors, industrial and trading companies- borrowerstrading companies- borrowers
Financial MarketsFinancial Markets
Money Market- for short-term funds Money Market- for short-term funds (less than a year)(less than a year)
Organized (Banks)Organized (Banks) Unorganized (money lenders, chit funds, etc.)Unorganized (money lenders, chit funds, etc.)
Capital Market- for long-term fundsCapital Market- for long-term funds Primary Issues MarketPrimary Issues Market Stock MarketStock Market Bond MarketBond Market
Organized Money MarketOrganized Money Market
Call money marketCall money market Bill MarketBill Market
Treasury billsTreasury bills Commercial billsCommercial bills
Bank loans (short-term)Bank loans (short-term) Organized money market comprises Organized money market comprises
RBI, banks (commercial and co-RBI, banks (commercial and co-operative)operative)
Call money market (1)Call money market (1)
It deals with one-day loans (overnight, to be It deals with one-day loans (overnight, to be precise) called call loans or call moneyprecise) called call loans or call money
Participants are mostly banks. Also called inter-Participants are mostly banks. Also called inter-bank call money market.bank call money market.
The borrowing is exclusively limited to banks, The borrowing is exclusively limited to banks, who are temporarily short of funds.who are temporarily short of funds.
On the lending side, besides banks with excess On the lending side, besides banks with excess cash and as special cases few FIs like LIC, UTIcash and as special cases few FIs like LIC, UTI
All others have to keep their funds in term All others have to keep their funds in term deposits with banks to earn interestdeposits with banks to earn interest
Call money market (2)Call money market (2) Call loans are generally made on a clean basis- Call loans are generally made on a clean basis-
i.e. no collateral is requiredi.e. no collateral is required The main function of the call money market is The main function of the call money market is
to redistribute the pool of day-to-day surplus to redistribute the pool of day-to-day surplus funds of banks among other banks in temporary funds of banks among other banks in temporary deficit of fundsdeficit of funds
The call market helps banks earn interest and The call market helps banks earn interest and yet improve their liquidityyet improve their liquidity
It is a highly competitive and sensitive marketIt is a highly competitive and sensitive market It acts as a good indicator of the liquidity It acts as a good indicator of the liquidity
positionposition
Bill MarketBill Market Treasury Bill market- Also called the T-Bill Treasury Bill market- Also called the T-Bill
marketmarket– These bills are short-term liabilities (91-day, 182-These bills are short-term liabilities (91-day, 182-
day, 364-day) of the Government of Indiaday, 364-day) of the Government of India– It is an IOU of the government, a promise to pay the It is an IOU of the government, a promise to pay the
stated amount after expiry of the stated period stated amount after expiry of the stated period from the date of issuefrom the date of issue
– They are issued at discount to the face value and at They are issued at discount to the face value and at the end of maturity, the face value is paidthe end of maturity, the face value is paid
– The rate of discount and the corresponding issue The rate of discount and the corresponding issue price are determined at each auctionprice are determined at each auction
Commercial Bill market- Not as developed in Commercial Bill market- Not as developed in India as the T-Bill marketIndia as the T-Bill market
Indian Banking SystemIndian Banking System Central Bank (Reserve Bank of India)Central Bank (Reserve Bank of India) Commercial banksCommercial banks Co-operative banksCo-operative banks Banks can be classified as:Banks can be classified as:
Scheduled (Second Schedule of RBI Act, 1934)Scheduled (Second Schedule of RBI Act, 1934) Non-ScheduledNon-Scheduled
Scheduled banks can be classified as:Scheduled banks can be classified as: Public Sector Banks Public Sector Banks Private Sector Banks (Old and New) Private Sector Banks (Old and New) Foreign Banks Foreign Banks Regional Rural Banks Regional Rural Banks
Indigenous bankersIndigenous bankers
Individual bankers like Shroffs, Seths, Sahukars, Individual bankers like Shroffs, Seths, Sahukars, Mahajans, etc. Combine trading and other Mahajans, etc. Combine trading and other business with money lending.business with money lending.
Vary in size from petty lenders to substantial Vary in size from petty lenders to substantial ShroffsShroffs
Act as money changers and finance internal Act as money changers and finance internal trade through hundis (internal bills of exchange)trade through hundis (internal bills of exchange)
Indigenous banking is usually family owned Indigenous banking is usually family owned business employing own working capitalbusiness employing own working capital
At one point, it was estimated that IB met about At one point, it was estimated that IB met about 90% of the financial requirements of rural India90% of the financial requirements of rural India
RBI and indigenous bankers RBI and indigenous bankers (1)(1) Methods employed by the indigenous bankers Methods employed by the indigenous bankers
are traditional with vernacular system of are traditional with vernacular system of accounting.accounting.
RBI suggested that bankers give up their trading RBI suggested that bankers give up their trading and commission business and switch over to the and commission business and switch over to the western system of accounting.western system of accounting.
It also suggested that these bankers should It also suggested that these bankers should develop the deposit side of their businessdevelop the deposit side of their business
Ambiguous character of the hundi should stopAmbiguous character of the hundi should stop Some of them should play the role of discount Some of them should play the role of discount
houses (buy and sell bills of exchange)houses (buy and sell bills of exchange)
RBI and indigenous bankers RBI and indigenous bankers (2)(2) IB should have their accounts audited by IB should have their accounts audited by
certified chartered accountantscertified chartered accountants Submit their accounts to RBI periodicallySubmit their accounts to RBI periodically As against these obligations the RBI promised As against these obligations the RBI promised
to provide them with privileges offered to to provide them with privileges offered to commercial banks includingcommercial banks including– Being entitled to borrow from and rediscount bills Being entitled to borrow from and rediscount bills
with RBIwith RBI The IB declined to accept the restrictions as The IB declined to accept the restrictions as
well as compensation from the RBIwell as compensation from the RBI Therefore, the IB remain out of RBI’s purviewTherefore, the IB remain out of RBI’s purview
Development Oriented Development Oriented BankingBanking Historically, close association between banks and Historically, close association between banks and
some traditional industries- cotton textiles in the some traditional industries- cotton textiles in the west, jute textiles in the eastwest, jute textiles in the east
Banking has not been mere acceptance of Banking has not been mere acceptance of deposits and lending money to include deposits and lending money to include development bankingdevelopment banking
Lead Bank Scheme- opening bank offices in all Lead Bank Scheme- opening bank offices in all important localitiesimportant localities
Providing credit for development of the districtProviding credit for development of the district Mobilising savings in the district. ‘Service area Mobilising savings in the district. ‘Service area
approach’ approach’
Progress of banking in India Progress of banking in India (1)(1) Nationalisation of banks in 1969: 14 banks Nationalisation of banks in 1969: 14 banks
were nationalisedwere nationalised Branch expansion: Increased from 8260 in Branch expansion: Increased from 8260 in
1969 to 68500 in 20051969 to 68500 in 2005 Population served per branch has come Population served per branch has come
down from 64000 to 15000down from 64000 to 15000 A rural branch office serves 15 to 25 A rural branch office serves 15 to 25
villages within a radius of 16 kmsvillages within a radius of 16 kms Still only 32,180 villages out of 5 lakh have Still only 32,180 villages out of 5 lakh have
been coveredbeen covered
Progress of banking in IndiaProgress of banking in India (2)(2) Deposit mobilisation:Deposit mobilisation:
1951-1971 (20 years)- 700% or 7 times1951-1971 (20 years)- 700% or 7 times 1971-1991 (20 years)- 3260% or 32.6 times1971-1991 (20 years)- 3260% or 32.6 times 1991- 2006 (11 years)- 1100% or 11 times1991- 2006 (11 years)- 1100% or 11 times
Expansion of bank credit: Growing at 20-Expansion of bank credit: Growing at 20-30% thanks to rapid growth in industrial 30% thanks to rapid growth in industrial and agricultural outputand agricultural output
Development oriented banking: priority Development oriented banking: priority sector lendingsector lending
Progress of banking in India Progress of banking in India (3)(3) Diversification in banking: Banking has Diversification in banking: Banking has
moved from deposit and lending tomoved from deposit and lending to Merchant banking and underwritingMerchant banking and underwriting Mutual fundsMutual funds Retail bankingRetail banking ATMsATMs Anywhere bankingAnywhere banking Internet bankingInternet banking Venture capital fundsVenture capital funds Factoring-Factoring-
Profitability of Profitability of Banks(1)Banks(1)
Reforms has shifted the focus of Reforms has shifted the focus of banks from being development banks from being development oriented to being commercially oriented to being commercially viableviable
Prior to reforms, banks were not Prior to reforms, banks were not profitable and in fact made losses for profitable and in fact made losses for the following reasons:the following reasons:
Declining interest incomeDeclining interest income Increasing cost of operationsIncreasing cost of operations
Profitability of banks (2)Profitability of banks (2)
Declining interest income was for the Declining interest income was for the following reasons:following reasons:
High proportion of deposits impounded for High proportion of deposits impounded for CRR and SLR, earning relatively low CRR and SLR, earning relatively low interest ratesinterest rates
System of directed lendingSystem of directed lending Political interference- leading to huge NPAsPolitical interference- leading to huge NPAs
Rising costs of operations for banks was Rising costs of operations for banks was because of several reasons: economic because of several reasons: economic and politicaland political
Profitability of Banks (3)Profitability of Banks (3)
As per the Narasimham Committee (1991), As per the Narasimham Committee (1991), the reasons for rising costs of banks were:the reasons for rising costs of banks were:
Uneconomic branch expansionUneconomic branch expansion Heavy recruitment of employeesHeavy recruitment of employees Growing indiscipline and inefficiency of staff due Growing indiscipline and inefficiency of staff due
to trade union activitiesto trade union activities Low productivityLow productivity
Declining interest income and rising cost of Declining interest income and rising cost of operations of banks led to low profitability in operations of banks led to low profitability in the 90sthe 90s
Bank profitability: Bank profitability: SuggestionsSuggestions Some suggestions made by Narasimham Some suggestions made by Narasimham
Committee are:Committee are: Set up an Asset Reconstruction Fund to Set up an Asset Reconstruction Fund to
take over doubtful debtstake over doubtful debts SLR to be reduced to 25% of total depositsSLR to be reduced to 25% of total deposits CRR to be reduced to 3 to 5% of total CRR to be reduced to 3 to 5% of total
depositsdeposits Banks to get more freedom to set Banks to get more freedom to set
minimum lending ratesminimum lending rates Share of priority sector credit be reduced Share of priority sector credit be reduced
to 10% from 40%to 10% from 40%
Suggestions (cont’d)Suggestions (cont’d)
All concessional rates of interest should be All concessional rates of interest should be removedremoved
Banks should go for new sources of funds such Banks should go for new sources of funds such as Certificates of Depositsas Certificates of Deposits
Branch expansion should be carried out strictly Branch expansion should be carried out strictly on commercial principleson commercial principles
Diversification of banking activitiesDiversification of banking activities Almost all suggestions of the Narasimham Almost all suggestions of the Narasimham
Committee have been accepted and Committee have been accepted and implemented in a phased manner since the implemented in a phased manner since the onset of Reformsonset of Reforms
NPA ManagementNPA Management
The Narasimham Committee The Narasimham Committee recommendations were made, among recommendations were made, among other things, to reduce the Non-other things, to reduce the Non-Performing Assets (NPAs) of banksPerforming Assets (NPAs) of banks
To tackle this, the government enacted To tackle this, the government enacted the Securitization and Reconstruction the Securitization and Reconstruction of Financial Assets and Enforcement of of Financial Assets and Enforcement of Security Act (SARFAESI) Act, 2002Security Act (SARFAESI) Act, 2002
Enabled banks to realise their dues Enabled banks to realise their dues without intervention of courtswithout intervention of courts
SARFAESI ActSARFAESI Act Enables setting up of Asset Management Companies Enables setting up of Asset Management Companies
to acquire NPAs of any bank or FI (SASF, ARCIL are to acquire NPAs of any bank or FI (SASF, ARCIL are examples)examples)
NPAs are acquired by issuing debentures, bonds or NPAs are acquired by issuing debentures, bonds or any other securityany other security
As a second creditor can serve notice to the As a second creditor can serve notice to the defaulting borrower to discharge his/her liabilities in defaulting borrower to discharge his/her liabilities in 60 days60 days
Failing which the company can take possession of Failing which the company can take possession of assets, takeover the management of assets and assets, takeover the management of assets and appoint any person to manage the secured assetsappoint any person to manage the secured assets
Borrowers have the right to appeal to the Debts Borrowers have the right to appeal to the Debts Tribunal after depositing 50% of the amount Tribunal after depositing 50% of the amount claimed by the second creditorclaimed by the second creditor
The Indian Capital Market The Indian Capital Market (1)(1) Market for long-term capital. Demand Market for long-term capital. Demand
comes from the industrial, service sector comes from the industrial, service sector and governmentand government
Supply comes from individuals, Supply comes from individuals, corporates, banks, financial institutions, corporates, banks, financial institutions, etc.etc.
Can be classified into:Can be classified into: Gilt-edged marketGilt-edged market Industrial securities market (new issues Industrial securities market (new issues
and stock market)and stock market)
The Indian Capital Market The Indian Capital Market (2)(2) Development Financial InstitutionsDevelopment Financial Institutions
Industrial Finance Corporation of India (IFCI)Industrial Finance Corporation of India (IFCI) State Finance Corporations (SFCs)State Finance Corporations (SFCs) Industrial Development Finance Corporation (IDFC)Industrial Development Finance Corporation (IDFC)
Financial IntermediariesFinancial Intermediaries Merchant BanksMerchant Banks Mutual FundsMutual Funds Leasing CompaniesLeasing Companies Venture Capital CompaniesVenture Capital Companies
Industrial Securities MarketIndustrial Securities Market
Refers to the market for shares and Refers to the market for shares and debentures of old and new companiesdebentures of old and new companies
New Issues Market- also known as the New Issues Market- also known as the primary market- refers to raising of new primary market- refers to raising of new capital in the form of shares and capital in the form of shares and debenturesdebentures
Stock Market- also known as the Stock Market- also known as the secondary market. Deals with securities secondary market. Deals with securities already issued by companiesalready issued by companies
Financial Intermediaries (1)Financial Intermediaries (1) Mutual Funds- Promote savings and Mutual Funds- Promote savings and
mobilise funds which are invested in the mobilise funds which are invested in the stock market and bond marketstock market and bond market
Indirect source of finance to companiesIndirect source of finance to companies Pool funds of savers and invest in the stock Pool funds of savers and invest in the stock
market/bond marketmarket/bond market Their instruments at saver’s end are called Their instruments at saver’s end are called
unitsunits Offer many types of schemes: growth fund, Offer many types of schemes: growth fund,
income fund, balanced fundincome fund, balanced fund Regulated by SEBIRegulated by SEBI
Financial Intermediaries (2)Financial Intermediaries (2)
Merchant banking- manage and underwrite new Merchant banking- manage and underwrite new issues, undertake syndication of credit, advise issues, undertake syndication of credit, advise corporate clients on fund raisingcorporate clients on fund raising
Subject to regulation by SEBI and RBISubject to regulation by SEBI and RBI SEBI regulates them on issue activity and SEBI regulates them on issue activity and
portfolio management of their business.portfolio management of their business. RBI supervises those merchant banks which are RBI supervises those merchant banks which are
subsidiaries or affiliates of commercial bankssubsidiaries or affiliates of commercial banks Have to adopt stipulated capital adequacy Have to adopt stipulated capital adequacy
norms and abide by a code of conductnorms and abide by a code of conduct
ConclusionConclusion
There are other financial intermediaries There are other financial intermediaries such as NBFCs, Venture Capital Funds, such as NBFCs, Venture Capital Funds, Hire and Leasing Companies, etc.Hire and Leasing Companies, etc.
India’s financial system is quite huge and India’s financial system is quite huge and caters to every kind of demand for fundscaters to every kind of demand for funds
Banks are at the core of our financial Banks are at the core of our financial system and therefore, there is greater system and therefore, there is greater expectation from them in terms of expectation from them in terms of reaching out to the vast populace as well reaching out to the vast populace as well as being competitive.as being competitive.
hank hank ouou
K ChockalingamK Chockalingam
TEL : 9322295394 TEL : 9322295394
e.mail: [email protected]: [email protected] [email protected]@iibf.org.in