Jaiib Indian Financial System Module A Paper 1 PDF
Jaiib Indian Financial System Module A Paper 1 PDF
Jaiib Indian Financial System Module A Paper 1 PDF
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FINANCIAL SYSTEM:
•It is a system for the efficient management and creation of finance. According
to Robinson, financial system provides a link between savings and investment for the
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creation of new wealth and to permit portfolio adjustment in the composition of the
existing wealth. According to Van Horne, financial system is defined as the purpose of
financial markets to allocate savings efficiently in an economy to ultimate users –either for
investment in real assets or for consumption. Thus the financial system mainly stands on
three factors
Ø Money
Ø Credit
Ø Finance
1.Money‘s the unit of exchange or medium of payment. It represents the value of financial
transactions in qualitative terms.
2. Credit’, on the other hand, is a debt or loan which is to be returned normally with
interest.
3. Finance‘ is monetary wealth of the state, an institution or a person. Comprising these
factors in a systematic order forms a financial system.
Objectives
The objectives of the financial system are
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The functions of financial system can be classified into two broad categories:
1. Controlling functions
2. Promotional functions.
Financial Institutions:
Ø Banking
Ø Non Banking
Ø Companies
Ø Non Banking
Ø Financial companies
Ø Central Bank
Ø Commercial
Ø Banks
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Ø Co-Operative
Ø Banks
Ø Non Banking
Ø Financial
Ø Intermediaries
The following are the limitations of the Indian financial system. • The Indian Financial
system has failed to meet the financial needs of small scale Industries. It has rather
patroned the big industrial houses who are already well off. • The mushrooming of
financial institutions has deteriorated the quality and effectiveness of the sector to some
extent. • In many cases, it could not impose adequate control towards financial
irregularities and frauds, often influenced by politically and economically organized
pressure groups. • The Indian financial system fails to create a well defined and organized
capital market. • It fails to motivate economically marginal or small entrepreneurs by
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providing micro credit to them. • The Indian financial system is not flexible at the desired
level. It takes abnormal time to cope with the changing situation.
Ø Factoring Asset Liability Management
Objectives
Ø Channelizing the financial surplus of the general public into productive investments
avenues
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Ø Ensuring the compliance with rules and regulations governing the securities market.
Ø Project Counseling
Ø Capita l Structuring
Ø Portfolio Management
Ø Issue Management
Ø Credit Syndication
Ø Working capital
Ø Venture Capital
Ø Lease Finance
Ø Fixed Deposits
(ii) Project counseling Project counseling is a part of corporate counseling and relates to
project finance. It broadly covers the study of the project, offering advisory assistance on
the viability and procedural steps for its implementation.
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(iii) Capital Structure Here the Capital Structure is worked out i.e., the capital required,
raising of the capital, debt-equity ratio, issue of shares and debentures, working capital,
fixed capital requirements, etc.,
(iv) Portfolio Management It refers to the effective management of Securities i.e., the
merchant banker helps the investor in matters pertaining to investment decisions.
Taxation and inflation are taken into account while advising on investment in different
securities. The merchant banker also undertakes the function of buying and selling of
securities on behalf of their client companies. Investments are done in such a way that it
ensures maximum returns and minimum risks.
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in identifying which financial institution should be approached for term loans. The
merchant bankers follow certain steps before assisting the clients approach the
appropriate financial institutions. a.
Merchant banker first makes an appraisal of the project to satisfy that it is viable b. He
ensures that the project adheres to the guidelines for financing industrial projects. c. It
helps in designing capital structure, determining the promoter‗s amount of term loan to be
raised. d. After verifications of the project, the Merchant Banker arranges for a preliminary
meeting with financial institution. e. If the financial institution agrees to consider the
proposal, the application is filled and submitted along with other documents.
(vii) Working Capital: The Companies are given Working Capital finance, depending
upon their earning capacities in relation to the interest rate prevailing in the market.
(viii)Venture Capital: Venture Capital is a kind of capital requirement which carries more
risks and hence only few institutions come forward to finance. The merchant banker looks
in to the technical competency of the entrepreneur for venture capital finance.
(ix). Fixed Deposit: Merchant bankers assist the companies to raise finance by way of
fixed deposits from the public. However such companies should fulfill credit rating
requirements.
(x)Other Functions
•Small Scale industry counseling- counseling SSI units on marketing and finance
•Equity research and investment counseling –merchant banker plays an important role
in providing equity research and investment counseling because the investor is not in a
position to take appropriate investment decision.
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•Assistance to NRI investors - the NRI investors are brought to the notice of the various
investment opportunities in the country.
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3. Banker’s Bank:- The Reserve Bank performs the same functions for the
other commercial banks as the other banks ordinarily perform for their customers. RBI
lends money to all the commercial banks of the country.
Structure of Banking Sector in India
4. Controller of the Credit:- The RBI undertakes the responsibility of controlling credit
created by the commercial banks. RBI uses two methods to control the extra flow of money
in the economy. These methods are quantitative and qualitative techniques to control and
regulate the credit flow in the country. When RBI observes that the economy has
sufficient money supply and it may cause inflationary situation in the country then it
squeezes the money supply through its tight monetary policy and vice versa.
Where do Printing of Security Papers, Notes and Minting take Place in India?
5. Custodian of Foreign Reserves:-For the purpose of keeping the foreign exchange rates
stable, the Reserve Bank buys and sells the foreign currencies and also protects the
country's foreign exchange funds. RBI sells the foreign currency in the foreign exchange
market when its supply decreases in the economy and vice-versa. Currently India has
Foreign Exchange Reserve of around US$ 417bn.
6. Other Functions:-The Reserve Bank performs a number of other developmental works.
These works include the function of clearing house arranging credit for agriculture (which
has been transferred to NABARD) collecting and publishing the economic data, buying and
selling of Government securities (gilt edge, treasury bills etc)and trade bills, giving loans to
the Government buying and selling of valuable commodities etc. It also acts as the
representative of Government in International Monetary Fund (I.M.F.) and represents the
membership of India.
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New department constituted in RBI:- On July 6, 2005 a new department, named financial
market department in reserve bank of India was constituted for surveillance on financial
markets.
This newly constituted dept. will separate the activities of debt management and monetary
operations in future. This department will also perform the duties of developing and
monitoring the instruments of the money market and also monitoring the government
securities and foreign money markets.
So it can be concluded that as soon as the our country is growing the role of RBI is going to
be very crucial in the upcoming years.
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NBFC
Banking sector throughout the world constitutes a large number of financial operations
such as deposits, loans etc. Most nations have a centralized bank that regulates all the other
banks that operates in that nation. There are various types of financial companies that exist
which indulge in financial businesses. A Non-Banking financial company is one such type of
a financial company with a difference from banks.
The Reserve Bank of India (RBI) defines a Non-Banking Financial Company as,
It is of prime importance to understand the basic difference between a bank and a Non-
Banking Financial Company (NBFC). The basic differences from a bank are:
Demand deposits are those that can be by anyone into the financial institution and can be
withdrawn at any time as per the wish of the depositor without any prior notice to the
institution eg. current accounts in banks. These deposits are restricted to NBFCs by the RBI.
Unlike banks, NBFC is not a part of payments and settlements system regulated by
RBI
Payment and settlement systems in India include credit cards, debit cards, Real Time Gross
Settlement (RTGS), National Electronic Fund Transfer (NEFT) and few others. NBFC cannot
do these operations as per RBI regulations.
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As the NBFCs are restricted to be a part of payments and settlement system by the RBI,
issuing cheques by NBFC cannot be done.
For the depositors in NBFC the deposit insurance facility and credit guarantee corporation
is not available.
Deposit Insurance and Credit Guarantee Corporation (DICGC) is a subsidiary of RBI that
insures all the deposits such as savings, fixed, recurring etc. upto a limit of ₹1,00,000 for
each deposit and provides a guarantee for credit facilities. This facility is not extended to
NBFC by the RBI.
Asset Finance companies are those that are involved in the financing of physical assets for
an economic activity. The physical assets may be automobiles, generator sets, earth movers
etc.
Investment Company involves its business activity to the acquisition of securities such as
shares, debentures, equity etc.
Loan Companies are those that are into proving finances such as loans or advances for an
activity or a business.
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This type of company carries out business in the acquisition of securities, shares. And also
following conditions should be satisfied:
It is a company that facilitates the long-term flow of long-term debt into infrastructure
projects. It raises finances through the issue of Rupee or Dollar bonds with the minimum
maturity period of 5 years. IDF-NBFC is liable to get sponsor only from IFC companies.
It is a non-deposit accepting NBFC having the minimum of 85% of its assets satisfying
following criteria:
1. Loans are given to people from a rural background with income not
exceeding ₹1,00,000 or an urban person with income not exceeding ₹1,60,000.
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2. The loan should not exceed ₹50,000 in the first cycle and ₹1,00,000 in
consecutive cycles.
3. Total debt of a person should not exceed ₹1,00,000.
4. The tenure of loan for the amount more than ₹15,000 should not be less than 24
months if prepaid should be with the penalty.
5. Loans can be expanded without collateral.
6. Loans can be repaid in instalments on weekly, monthly or fortnightly basis left to
borrower’s choice.
7. Total aggregate loans given for income generation by the company should not be
less than 50% of total loans given.
This type of company involves itself in the business of factoring. It should the
minimum of 50% of its total assets through factoring and should constitute more
than 50% of its gross income from factoring.
It is a company having a net fund ₹100 crore and having at least 90% of its income
from mortgage guarantee.
No, it is not necessary for every NBFC to be registered with the Reserve bank of India
(RBI). Though the question is binary, it has to have a brief explanation for this. A
Non-Banking Financial Company can operate without registering itself with RBI and
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also without having the net fund of ₹2,00,00,000 in its company. However since
there are many types of NBFCs there are certain other bodies that come into picture
for regulating, other than RBI. In order to avoid dual regulation, certain types of
NBFC’s are exempted from registering with the RBI and are in turn controlled by
concern regulating bodies connected with the business type of the company. Below
table gives few types of companies and its respective regulatory body of that type
company:
Owing to the scope and the diversification of NBFCs, any person with an idea of venturing
into a new business having funds would be tempted into financing sector. Though there are
a lot of financing individuals who can be found in every area of a place mostly using undue
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standards in financing there are many who would like to venture into financing complying
with legal formalities.
Below is an example of how to register an NBFC (in this case, a Microfinance institution)
Firstly a name for the company has to be decided and has to be registered with the ROC.
Also, it has to be registered as either a private limited or a public limited company.
After the capital requirement is achieved it is necessary to deposit this amount in a bank
account on a fixed deposit and obtain the certificate for the same from the bank.
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With all the documents mentioned above-prepared application with those documents can
be applied to the RBI for approval. Online application with all the required documents can
be submitted in RBI online portal [https://cosmos.rbi.org.in]. Also, all the documents have
to be physically submitted to the regional office of RBI in the respective region of the
company.
Registration charges
The professional fee charged by RBI for registration of a new Micro Finance Institution is
₹4 to ₹4.5 lakh since this is a tedious, time consuming and a complicated process. The total
registration charges will be up to ₹8.5 lakh.
It is to be noted that the registration process is complicated, time-consuming and costly but
on the other side it is also worth it and has a great scope.
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What is SLR?
SLR is Statutory Liquidity Ratio which is calculated by RBI, this is the ratio of compulsory
ratio of deposit that bank has to maintain in form of cash, gold, other securities prescribe
by RBI. In short, it is kept by the bank in for of liquid assets. The purpose of maintaining
SLR is that bank will have an amount in the form of liquid assets which can be used to
handle a sudden increase in demand of amount from the depositor. It is used by RBI to limit
credit facility offered by the bank to borrowers which maintain the stability of the bank.
SLR can be said as a percentage of net time and demand liability kept by the bank. Here,
time liability the amount which is payable to the customer after interval and demand
liability means the amount which is payable to the customer when he is demanding for the
same. SLR also protect the bank from bank run situation and provide confidence to the
customer in the banking system.
SLR Example
Let SLR is 20% then bank have to keep INR 20 from the deposit of INR 100, that means if
the bank has a deposit of INR 200 Million then bank have to keep 40 Million i.e. 20% of
total 200 Million and a bank can use rest 160 Million for banking purpose.
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returned to shareholders. The equity holder may also profit from the sale of the stock if the
market price should increase in the marketplace.
The owner of an equity stake can also lose money. In the case of bankruptcy, they may lose
the entire stake.
The equity market is volatile by nature. Shares of equity can experience substantial price
swings, sometimes having little to do with the stability and good name of the corporation
that issued them.
Volatility can be caused by social, political, governmental, or economic events. A large
financial industry exists to research, analyze, and predict the direction of individual stocks,
stock sectors, and the equity market in general.
The equity market is viewed as inherently risky while having the potential to deliver a
higher return than other investments. One of the best things an investor in either equity or
debt can do is to educate themselves and speak to a trusted financial advisor.
Money Market: Money market refers to the market where the requirement or
arrangement of funds is for a period of less than one year. Calls and Inter Bank Term
Money, repo transactions (i.e. banks' borrowing window from the RBI), Certificate of
Deposits, Commercial Papers, Treasury Bills, Bill Rediscounting, etc. are some of the money
market instruments through which short term requirement of funds are met by banks,
institutions and the State and Central Government.
Bank and Corporate Deposits: While bank fixed deposits (FDs) are very common
amongst the investors as a traditional investment avenue for decades, corporate deposits
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are nothing but fixed deposits where the issuer is a company or an institution other than a
bank.
Government Securities: G-Secs or Government Securities are Sovereign rated debt papers
issued by the Government with a face value of a fixed denomination. In India, G-secs are
issued by Government of India and State Government at face value of Rupees One Hundred
in lieu of their borrowings from the market.
Corporate & PSU Bond Market: Corporate Bonds are issued by Public Sector
Undertakings (PSUs) and private corporations. These bonds are issued for a wide range of
tenor normally; say for a period of 1 year to 15 years or even more. As compared to
Government Securities which are nearly free of default risk; corporate bonds may turn out
to be risky.
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Regulating rates, advantages, terms and conditions which may be offered by insurers not
covered by the Tariff Advisory Committee under section 64U of the Insurance Act, 1938 (4
of 1938)
Specifying how books should be kept
Regulating company investment of funds
Regulating a margin of solvency
Adjudicating disputes between insurers and intermediaries or insurance intermediaries
Supervising the Tariff Advisory Committee
Specifying the percentage of premium income to finance schemes for promoting and
regulating professional organisations
Specifying the percentage of life- and general-insurance business undertaken in the rural or
social sector
Specifying the form and the manner in which books of accounts shall be maintained, and
statement of accounts shall be rendered by insurers and other insurer intermediaries.
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Banking Regulation
THE ESTABLISHMENT OF RBI
The establishment of RBI was based on the recommendations of a Royal Commission on
Indian Currency and Finance known as the Hilton Young Commission after which it was on
1st April 1935 that the Reserve Bank of India was established as the central banking
authority in India and was nationalized on 1st January 1948.
Subsequently, in 1949, the Banking Regulations Act was passed which empowered the
Reserve Bank to regulate, control and inspects the banks in India.
The outlook and guidelines of the RBI were conceptualized by Dr B.R. Ambedkar in his
book “ The Problem of the Rupee- Its origin and its solutions “
RBI was established with the aim to regulate the issue of bank notes, to maintain reserves,
secure monetary stability and to operate the credit and currency system of the country.
The RBI actually took over from the government the functions so far being performed by
the Controller of Currency and Imperial Bank of India.
Currently, the Governor of RBI is Mr Urjit Patel and is headquartered at Mumbai. It has four
zonal offices at Chennai, Delhi, Kolkata and Mumbai.
THE NEED TO NATIONALIZE BANKS IN INDIA
Despite the presence of a central regulatory authority i.e., the RBI which could control the
banks, except for the State Bank Of India, other banks were owned by private individuals. It
was in the 1960s that Mrs Indira Gandhi; the then Prime Minister initiated the process of
Bank Nationalization. She summed up the objectives of nationalization as “The present
decision to nationalize major banks is to accelerate the achievements of our objectives “..
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i)Controlling private monopolies of the banks that were owned by private business houses
and corporate families and to ensure supply of credit to socially desirable sections.
ii) Reducing regional imbalance as there was a large rural-urban divide it was necessary
for banking to seep into rural areas also.
iii) Lending credit to priority sectors like agriculture, which was the largest contributor to
national income.
iv) Developing banking habits in India as the maximum population lived in rural areas and
for the development of the national banking, habits were necessary among such a huge
population.
THE REGULATIONS OVER BANKS IN INDIA
The Banking Regulation Act of 1949 and the RBI Act 1953 has given the RBI the power to
regulate the banking system. The Indian banking sector is broadly classified into scheduled
banks and non-scheduled banks. All banks included in the Second Schedule to the Reserve
Bank of India Act, 1934 are Scheduled Banks. Some of the regulatory functions of RBI are :
RBI issues license to commence new banking operations or to open new branches of the
existing banks through the power given to the RBI under the Banking Regulation Act 1949.
RBI controls the appointment of the chairman, directors and additional directors of banks
in India.
RBI ensures banks maintain transparency in disclosing any charges that they levy on their
customers and also ensures that money laundering is curbed through its KNOW YOUR
CUSTOMER guidelines that need to be ensured when anyone opens an account with them.
RBI has its own monitoring procedure and system for audit and inspection on the basis of
“CAMELS” that stands for Capital adequacy, Asset quality, Management, Earning, Liquidity,
System and Control.
The BANKING REGULATIONS ACT 1949 was passed with the aim of having a specific Act
for Banking companies. Prior to this act, the banking companies were regulated by the
Indian Companies Act, 1913. This comprehensive legislation ensured a minimum capital
requirement to prevent bank failures and it also eliminated cut-throat competition by
regulation the opening of branches and deciding the location of banks. The BR Act has thus
helped in the balanced growth of banks in India and their working also. It has ensured that
the interests of the depositors are safeguarded.
ARE THERE BANKS WHICH DO NOT COME UNDER RBI?
Yes. There are some banks which do not come under the regulations of the RBI. They are :
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Monetary Policy
The objective of monetary policy is to achieve the desired expansion of economy by
facilitating the availability of money supply needed for the expansion. The role of
formulating monetary policy in India is performed by Reserve Bank of India. It is aimed at
ensuring the availability required money supply for all the legitimate economic activities
while it should not be available so as to create inflationary pressure.The primary aim of
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monetary policy in India is to maintain price stability while keeping in mind the objective
of economic growth.
Types of Monetary Policy
There are three common types of monetary policy. These are:
Expansionary Monetary Policy
Contractionary Monetary Policy
Unconventional Monetary Policy
Expansionary Monetary Policy
Expansionary monetary policy is the monetary policy which seeks to increase aggregate
demand and economic growth in the economy. It involves increasing the money supply and
lowering the interest rates. The lower interest rate encourages the borrowers to buy more
which increases the economic activity. The increased economic activity leads to more
employment opportunities thus decreasing unemployment. It also increases the inflation as
more money is available to buy goods and services. It is also known as Easy Money Policy
or Loose Money Policy as central banks seeks to increase the money supply by lowering the
interest rates.
Contractionary Monetary Policy
Contraction monetary policy is the monetary policy which is used to fight the inflation in
economy. It involves decreasing the money supply and increasing the interest rates. As
reduction in money supply increases the interest rates, the borrowers will be reluctant to
borrow the money due to higher borrowing cost which ultimately reduces the economic
activity. It leads to decrease in inflation, increase in unemployment and slowdown in
economy. It is also known as tight money policy as central banks seeks to reduce the money
supply by restricting credit by increasing interest rates.
Unconventional Monetary Policy
Unconventional monetary policy is pursued by central banks when their traditional
instruments of monetary policy cease to achieve their goals. The one such unconventional
monetary policy was employed us United States after the financial crisis of 2007 in the
form Quantitative Easing (QE).
Instruments of Monetary Policy in India
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The Reserve Bank of India employs various instruments of monetary policy in India to
achieve the objectives of price stability and higher economic growth. Some of the important
instrument or tools of monetary policy in India are:
Open Market Operations (OMO)
Cash Reserve Ration (CRR)
Statutory Liquidity Ratio (SLR)
Liquidity Adjustment Facility (LAF)
Selective Credit Control
Moral Suasion
Open Market Operations (OMO)
It is the process of buying and selling of government securities, bond or Treasury Bills (T-
Bills) to regulate the money supply in economy. If government wants to reduce money
supply, it issues these bonds. The money is consumed to buy these bonds thus it reduced
the monetary base of the economy. Similarly to increase the money supply, the government
sells these bonds thereby increasing the monetary base of the economy. In India, the open
market operations are conducted by Reserve Bank of India through its core banking
solution e-Kuber.
Cash Reserve Ratio (CRR)
It refers to the cash which banks have to maintain with the Reserve Bank of India as
percentage of Net Demand and Time Liabilities (NDTL). An increase in CRR makes it
mandatory for banks to hold large portion of their deposits with the RBI. Therefore it
reduces their deposit available for credit and they lend less which affect their profitability
and also reduces the money supply in economy.
Statutory Liquidity Ratio (SLR)
Apart from CRR, the banks in India are required to maintain liquid assets in the form of
gold, cash and approved securities. The increase/decrease in SLR affects the availability of
money for credit with banks.
Liquidity Adjustment Facility (LAF)
Under Liquidity Adjustment Facility (LAF) the banks purchase money from RBI on
repurchase agreements.
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Repo Rate: It is the interest rate at which the Reserve Bank provides overnight liquidity to
banks against the collateral of government and other approved securities under the
liquidity adjustment facility (LAF)
Reverse Repo Rate: The (fixed) interest rate at which the Reserve Bank absorbs liquidity,
on an overnight basis, from banks against the collateral of eligible government securities
under the LAF
Marginal Standing Facility
Under SF, the scheduled commercial banks can borrow additional amount of overnight
money from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR)
portfolio up to a limit at a penal rate of interest. This provides a safety valve against
unanticipated liquidity shocks to the banking system.
Bank Rate
It is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or
other commercial papers.
Selective Credit Control
Under this method, the central influence the credit growth in country through following
techniques:
Specifying the margin requirements and differential rate of interests
Regulating the credit for consumer durables
Moral Suasion
The central persuades the commercial banks to regulate the credit growth through oral and
verbal communication.
Why monetary policy is ineffective in India?
There are many reasons for monetary policy not able to achieve its intended objectives.
Some of the reasons are:
Higher proportion of Non-Bank Credit
The credit market in India is largely occupied by non-bank credit providing institutions like
money lenders, cooperatives, relatives, friends etc. This large segment is not affected by
monetary policy instrument.
Introduction of new financial instruments
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Mutual Fund, Venture Capital, IPO etc. have influence on overall liquidity in the economy.
The monetary policy intervention by Reserve Bank of India is insignificant in these
segments of financial system.
High currency-deposit ratio
The rural economy in India has more inclination towards the usage of cash. Thus there is
high currency-deposit ratio. The monetary policy only touches the deposit section. Thus
any intervention by way of monetary policy has meager effect on economy.
Retail Banking
The issue of retail banking is extremely important and topical. Across the globe, retail
lending has been a spectacular innovation in the commercial banking sector in recent
years. The growth of retail lending, especially, in emerging economies, is attributable to the
rapid advances in information technology, the evolving macroeconomic environment,
financial market reform, and several micro-level demand and supply side factors.
India too experienced a surge in retail banking. There are various pointers towards this.
Retail loan is estimated to have accounted for nearly one-fifth of all bank credit. Housing
sector is experiencing a boom in its credit. The retail loan market has decisively got
transformed from a sellers’ market to a buyers’ market. Gone are the days where getting a
retail loan was somewhat cumbersome. All these emphasise the momentum that retail
banking is experiencing in the Indian economy in recent years.
Retail banking is, however, quite broad in nature - it refers to the dealing of commercial
banks with individual customers, both on liabilities and assets sides of the balance sheet.
Fixed, current / savings accounts on the liabilities side; and mortgages, loans (e.g.,
personal, housing, auto, and educational) on the assets side, are the more important of the
products offered by banks. Related ancillary services include credit cards, or depository
services. Today’s retail banking sector is characterized by three basic characteristics:
What is the nature of retail banking? In a recent book, retail banking has been described as
"hotter than vindaloo". Considering the fact that vindaloo, the Indian-English innovative
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curry available in umpteen numbers of restaurants of London, is indeed very hot and spicy,
it seems that retail banking is perceived to be the in-thing in today’s world of banking.
Retail banking in India is not a new phenomenon. It has always been prevalent in India in
various forms. For the last few years it has become synonymous with mainstream banking
for many banks.
The typical products offered in the Indian retail banking segment are housing loans,
consumption loans for purchase of durables, auto loans, credit cards and educational loans.
The loans are marketed under attractive brand names to differentiate the products offered
by different banks. As the Report on Trend and Progress of India, 2003-04 has shown that
the loan values of these retail lending typically range between Rs.20,000 to Rs.100 lakh.
The loans are generally for duration of five to seven years with housing loans granted for a
longer duration of 15 years. Credit card is another rapidly growing sub-segment of this
product group.
In recent past retail lending has turned out to be a key profit driver for banks with retail
portfolio constituting 21.5 per cent of total outstanding advances as on March 2004. The
overall impairment of the retail loan portfolio worked out much less then the Gross NPA
ratio for the entire loan portfolio. Within the retail segment, the housing loans had the least
gross asset impairment. In fact, retailing make ample business sense in the banking sector.
While new generation private sector banks have been able to create a niche in this regard,
the public sector banks have not lagged behind. Leveraging their vast branch network and
outreach, public sector banks have aggressively forayed to garner a larger slice of the retail
pie. By international standards, however, there is still much scope for retail banking in
India. After all, retail loans constitute less than seven per cent of GDP in India vis-à-
vis about 35 per cent for other Asian economies — South Korea (55 per cent), Taiwan (52
per cent), Malaysia (33 per cent) and Thailand (18 per cent). As retail banking in India is
still growing from modest base, there is a likelihood that the growth numbers seem to get
somewhat exaggerated. One, thus, has to exercise caution is interpreting the growth of
retail banking in India.
What has contributed to this retail growth? Let me briefly highlight some of the basic
reasons.
First, economic prosperity and the consequent increase in purchasing power has given a
fillip to a consumer boom. Note that during the 10 years after 1992, India's economy grew
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at an average rate of 6.8 percent and continues to grow at the almost the same rate – not
many countries in the world match this performance.
Third, technological factors played a major role. Convenience banking in the form of debit
cards, internet and phone-banking, anywhere and anytime banking has attracted many
new customers into the banking field. Technological innovations relating to increasing use
of credit / debit cards, ATMs, direct debits and phone banking has contributed to the
growth of retail banking in India.
Fourth, the Treasury income of the banks, which had strengthened the bottom lines of
banks for the past few years, has been on the decline during the last two years. In such a
scenario, retail business provides a good vehicle of profit maximisation. Considering the
fact that retail’s share in impaired assets is far lower than the overall bank loans and
advances, retail loans have put comparatively less provisioning burden on banks apart
from diversifying their income streams.
Fifth, decline in interest rates have also contributed to the growth of retail credit by
generating the demand for such credit.
In this backdrop let me now come two specific domains of retail lending in India, viz., (a)
credit cards and (b) housing.
While usage of cards by customers of banks in India has been in vogue since the mid-1980s,
it is only since the early 1990s that the market had witnessed a quantum jump. The total
number of cards issued by 42 banks and outstanding, increased from 2.69 crore as on end
December 2003 to 4.33 crore as on end December 2004. The actual usage too has
registered increases both in terms of volume and value. Almost all the categories of banks
issue credit cards. Credit cards have found greater acceptance in terms of usage in the
major cities of the country, with the four major metropolitan cities accounting for the bulk
of the transactions.
In view of this ever increasing role of credit cards a Working Group was set up for
regulatory mechanism for cards. The terms of reference of the Working Group were fairly
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broad and the Group was to look into the type of regulatory measures that are to be
introduced for plastic cards (credit, debit and smart cards) for encouraging their growth in
a safe, secure and efficient manner, as also to take care of the best customer practices and
grievances redressal mechanism for the card users. The Reserve Bank has been receiving a
number of complaints regarding various undesirable practices by credit card issuing
institutions and their agents. Some of them are:
• Unsolicited calls to members of the public by card issuing banks/ direct selling
agents pressurising them to apply for credit card.
• Communicating misleading / wrong information regarding credit cards regarding
conditions for issue, amount of service charges/ waiver of fees, gifts/prizes.
• Sending credit cards to persons who have not applied for them / activating
unsolicited cards without the approval of the recipient.
• Charging very high interest rates /service charges.
• Lack of transparency in disclosing fees/charges/penalties. Non-disclosure of
detailed billing procedure.
The Working Group deliberated a number of major issues relating to: a) to customer
grievances and rights: a) Transparency and Disclosure, b) Customer Rights Protection, and
c) Code of Conduct. The Group recommended that the Most Important Terms and
Conditions should be highlighted and advertised and sent separately to the prospective
customer. These terms and conditions include various issues relating to: a) fees and
charges, (b) drawal limits, (c) billing, (d) default, (e) termination / revocation of card
membership, (f) loss / theft / misuse of card, and (g) disclosure.
These recommendations are being processed within the RBI and a set of guidelines would
be issued which are going to pave the path of a healthy growth in the development of
plastic money in India. The RBI is also considering bringing credit card disputes within the
ambit of the Banking Ombudsman scheme. While building a regulatory oversight in this
regard we need to ensure that neither does it reduce the efficiency of the system nor does it
hamper the credit card usage.
In view of its backward and forward linkages with other sectors of the economy, housing
finance in developing countries is seen as a social good. In India, growth of housing finance
segment has accelerated in recent years. Several supporting policy measures (like tax
benefits) and the supervisory incentives instituted had played a major role in this market.
Housing credit has increased substantially over last few years, but from a very low base.
During the period 1993-2004, outstanding housing loans by scheduled commercial banks
and housing finance companies grew at a trend rate of 23 per cent. The share of housing
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loans in total non-food credit of scheduled commercial banks has increased from about 3
per cent in 1992-93 to about 7 per cent in 2003-04. Recent data reveal that non-priority
sector housing loans outstanding as on February 18, 2005 were around Rs. 74 thousand
crore, which is, however, only 8.0 per cent of the gross bank credit. As already pointed out,
direct housing loans up to Rs. 15 lakh irrespective of the location now qualify as priority
sector lending; housing loans are understood to form a large component of such lending. In
addition, housing credit is also being provided by housing finance companies, which in turn
are also receiving some bank finance.
Thus, from miniscule amounts, the exposure of the banking sector to housing loans has
gone up. Unlike many other countries, asset impairment on account of housing finance
constitutes a very small portion. However, with growing competition in the housing finance
market, there has been a growing concern over its likely impact on the asset quality. While
no immediate financial stability concerns exist, there is a need to put in place appropriate
risk management systems, strengthen internal control procedures and also improve
regulatory oversight in this area. Banks also need to monitor their exposure and the credit
quality. In a fiercely competitive market, there may be some temptation to slacken the loan
scrutiny procedures and this needs to be severely checked.
Having delineated the broad contours of retail banking in India let me now come to its
opportunities and challenges.
Retail banking has immense opportunities in a growing economy like India. As the growth
story gets unfolded in India, retail banking is going to emerge a major driver. How does the
world view us? I have already referred to the BRIC Report talking India as an economic
superpower. A. T. Kearney, a global management consulting firm, recently identified India
as the "second most attractive retail destination" of 30 emergent markets.
The rise of the Indian middle class is an important contributory factor in this regard. The
percentage of middle to high income Indian households is expected to continue rising. The
younger population not only wields increasing purchasing power, but as far as acquiring
personal debt is concerned, they are perhaps more comfortable than previous generations.
Improving consumer purchasing power, coupled with more liberal attitudes toward
personal debt, is contributing to India's retail banking segment.
The combination of the above factors promises substantial growth in the retail sector,
which at present is in the nascent stage. Due to bundling of services and delivery channels,
the areas of potential conflicts of interest tend to increase in universal banks and financial
conglomerates. Some of the key policy issues relevant to the retail banking sector are:
financial inclusion, responsible lending, access to finance, long-term savings, financial
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capability, consumer protection, regulation and financial crime prevention. What are the
challenges for the industry and its stakeholders?
Second, rising indebtedness could turn out to be a cause for concern in the future. India's
position, of course, is not comparable to that of the developed world where household debt
as a proportion of disposable income is much higher. Such a scenario creates high
uncertainty. Expressing concerns about the high growth witnessed in the consumer credit
segments the Reserve Bank has, as a temporary measure, put in place risk containment
measures and increased the risk weight from 100 per cent to 125 per cent in the case of
consumer credit including personal loans and credit cards (Mid-term Review of Annual
Policy, 2004-05).
Third, information technology poses both opportunities and challenges. Even with ATM
machines and Internet Banking, many consumers still prefer the personal touch of their
neighbourhood branch bank. Technology has made it possible to deliver services
throughout the branch bank network, providing instant updates to checking accounts and
rapid movement of money for stock transfers. However, this dependency on the network
has brought IT departments additional responsibilities and challenges in managing,
maintaining and optimizing the performance of retail banking networks. Illustratively,
ensuring that all bank products and services are available, at all times, and across the entire
organization is essential for today’s retails banks to generate revenues and remain
competitive. Besides, there are network management challenges, whereby keeping these
complex, distributed networks and applications operating properly in support of business
objectives becomes essential. Specific challenges include ensuring that account transaction
applications run efficiently between the branch offices and data centres.
Fourth, KYC Issues and money laundering risks in retail banking is yet another important
issue. Retail lending is often regarded as a low risk area for money laundering because of
the perception of the sums involved. However, competition for clients may also lead to KYC
procedures being waived in the bid for new business. Banks must also consider seriously
the type of identification documents they will accept and other processes to be completed.
The Reserve Bank has issued details guidelines on application of KYC norms in November
2004.
Wholesale Banking
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Wholesale banking refers to the complete banking solution provided by the merchant
banks to the large scale business organizations and the government agencies or
institutions. To avail the facility of wholesale banking, the companies need to possess a
strong financial statement and operate on a large scale. Usually, multinational companies
are the clients of wholesale banking.
Features of Wholesale Banking
As the name signifies, wholesale banking operates to serve the large scale business
objectives.
To know more about the concept, let us understand its various characteristics:
• Large Scale Operations: Wholesale banking majorly meets the enormous financial
requirements of the large scale companies and the government.
• Low Operational Cost: The cost of carrying out transactions and other banking
operations is quite low due to a limited customer base and few numbers of
transactions.
• High Risk Involved: The risk level involved in wholesale banking is very high. T the
failure of the borrower company can lead to the collapse of all the parties associated
with it.
• Control Over Financial Transaction Monitoring and Recovery: Due to limited
customers, it becomes convenient for the banks to monitor the financial transactions
and recover the loans and advances.
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Primary Functions
Secondary Functions
The banks have some additional responsibilities which hare mentioned below:
• Underwriting: The wholesale bank raises capital for the projects of large business
organizations by issuing debt or equity shares to the investors on behalf of the
respective companies.
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• Global Expansion: Wholesale banks expand to the places where the multinational
client companies have branches.
• Wholesale Credit Transformation: A wholesale bank focus on consistent client’s
experience, processes, roles and technology used in the credit product and bank’s
operations.
• Client Onboarding: The primary concern is enhancing the information,
transparency, service speed and experience of the client companies.
• Data Management: The banks control and enhance the security, governance and
quality of the confidential data.
• Monetize Mobile Capabilities: These banks facilitate customers with self-service
operations and information related to various products and services through mobile
channels.
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We can now say that wholesale banking is a suitable option for the companies which need
substantial financial assistance from time to time. ANd also for the ones looking forward to
availing the opportunities for growth and development.
• Provides Extra Safety to Depositors: In wholesale banking, the banks treat the
deposited funds with a high level of safety and put the amount in comparatively
secured investment opportunities.
• Low Transaction Fees: The banks charge the transaction fees at a discounted rate
for the customers of wholesale banking.
• Facilitates Large Trade Transactions: It supports the high-value transactions of
the companies operating on a large scale.
• Fulfils Huge Working Capital Requirements: Large business associations require
a considerable amount of funds to carry out day to day operations. Thus, wholesale
banking accomplishes this need by providing funds for working capital.
• Lending to Government: These banks even lend funds to the government of the
country for carrying out various long-term projects.
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The transactions of wholesale banking involve a high amount of funds which makes it a
complicated affair.
• High Risk: As we know that the lumpsum transactions take place in wholesale
banking, there is a high level of risk involved.
• Expensive Business Accounts: Maintaining accounts and records is a costly affair
in wholesale banking when compared to traditional bank accounts.
• High-Interest Rates and Processing Fees: The borrower company is liable to pay
off high interest and processing fees on loans and advances to the banks.
• Relies on Stability of Location: When the company deposits a large amount at a
single location, i.e. the wholesale bank, there is a risk of loss if the bank faces a
situation of downfall.
• Payment for Unused Services: In wholesale banking, there is always a complaint
that the client companies have to pay even for those services which are not used by
them.
• May Lead to Client’s Exploitation: When the borrowed sum is of high value, there
are chances that the borrower company may be exploited by the bank.
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We know that India is a developing country, and with the increasing globalization, Indian
firms are converting into multinational companies. These companies operate across the
globe and therefore requires enormous funds to serve the working capital requirements,
investment needs and other financial obligations.
Even the Indian government promotes medium scale industries to build a reliable
infrastructure, facilitate sound market conditions, minimize deficits and for overall
economic development. All these factors result in the need for business finance.
In fact, in India, the revenue generated from the banking industry comprises majorly of
wholesale banking services. Since, these banks fulfil major corporate requirements such as
merchant banking services, project finance, working capital needs, investment banking
services, leasing finance, facilitates mergers and acquisitions, etc.
Wholesale banking is a whole sole solution to all the banking requirements of the
companies with huge turnover and high net worth facilitating the smooth transfer of funds,
proper allocation and investment of excess capital, internal stock transfer, etc.
There is a vast scope for wholesale banking in the Indian banking industry, and it is
flourishing rapidly with the increase in globalization and industrialization.
International Banking
International banking is just like any other banking service, but it takes place across
different nations or internationally. To put in another way, international banking is an
arrangement of financial service by a residential bank of one country to the residents of
another country. Mostly multinational companies and individuals use this banking facility
for transacting.
EXAMPLE OF INTERNATIONAL BANKING
Suppose Microsoft, an American company is functioning in London. It is in need of funds to
meet its working capital requirements. In such scenario, Microsoft can avail the banking
services in form of loans, overdraft or any other financial service through banks in London.
Here, the residential bank of London shall be giving its services to an American company.
Therefore, the transaction between them can be said to be part of international banking
facility.
FEATURES AND BENEFITS OF INTERNATIONAL BANKING
FLEXIBILITY
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Participatory notes
What are participatory notes?
Foreign investment in India can broadly be classified into two categories—Foreign direct
investment (FDI) and investment made by foreign institutional investors (FIIs). In both of
these cases, foreign money enters the Indian markets and fuels growth of economy,
industries and capital market.
However, with the number of increasing regulations in India, it is not easy for foreign
money to enter the markets.
There are strict guidelines laid down by market regulator SEBI (Securities and Exchange
Board of India) for seeking approvals and documentation for FDI. Also, there are several
restrictions laid down on the exit of this money.
On the other hand, FII is mainly characterised as portfolio investment i.e. quick money
entering the Indian capital market for short-term. Due to its short-term nature, the
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regulators have laid down fewer guidelines on FII than on FDI. But, the fact remains that
foreign money cannot enter Indian markets without regulatory approvals.
So, what happens to all those overseas investors, who want to invest in the Indian stock
markets without getting into the regulatory approval process and other hassles? Well, the
answer is participatory notes.
P-notes: Offshore derivative instruments
Participatory notes also called P-Notes are offshore derivative instruments with Indian
shares as underlying assets. These instruments are used for making investments in the
stock markets. However, they are not used within the country. They are used outside India
for making investments in shares listed in the Indian stock market. That is why they are
also called offshore derivative instruments.
Participatory notes are issued by brokers and FIIs registered with SEBI. The investment is
made on behalf of these foreign investors by the already registered brokers in India. For
example, Indian-based brokerages buy India-based securities and then issue participatory
notes to foreign investors. Any dividends or capital gains collected from the underlying
securities go back to the investors.
The brokers that issue these notes or trades in Indian securities have to mandatorily report
their PN issuance status to SEBI for each quarter. These notes allow foreign high networth
individuals, hedge funds and other investors to put money in Indian markets without being
registered with SEBI, thus making their participation easy and smooth. P-Notes also aid in
saving time and costs associated with direct registrations.
Why are participatory notes used?
Investing through P-Notes is very simple and hence very popular amongst FIIs. Overseas
investors who are not registered with SEBI have to go through a lot of scrutiny, such as
know-your-customer norms, before investing in Indian shares. To avoid these hurdles,
foreign investors take this route. Also, since the end beneficiary of these notes is not
disclosed, many investors who want to remain anonymous use it. These instruments aid
investors who do not want to register with SEBI and reveal their identities to take positions
in the Indian market.
Advantages of participatory notes
Anonymity: Any entity investing in participatory notes is not required to register with
SEBI, whereas all FIIs have to compulsorily get registered. It enables large hedge funds to
carry out their operations without disclosing their identity.
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Ease of trading: Trading through participatory notes is easy because they are like contract
notes transferable by endorsement and delivery.
Tax saving: Some of the entities route their investment through participatory notes to take
advantage of the tax laws of certain preferred countries.
Disadvantages of P-notes
Indian regulators are not very happy about participatory notes because they have no way
to know who owns the underlying securities. It is alleged that a lot of unaccounted money
made its way to the country through the participatory note route.’
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• To enable the Central Bank to influence and regulate liquidity in the economy
through its intervention in this market.
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Treasury bills
The Bill market is a sub-market of this market in India. There are two types of the bill in
the money market. They are treasury bills and commercial bill. The treasury bills are also
known as T-Bills, T-bills are issued by the Central bank on behalf of Government, whereas
Commercial Bills are issued by Financial Institutions.
Treasury bills do not yield any interest, but it is issued at discount and repaid at par at the
time of maturity. In T-bills there is no risk of default; it is a safe investment instrument.
Commercial bills
Commercial bill is a money market instrument which is similar to the bill of exchange; it is
issued by a Commercial organization to raise money for short-term needs. In India, the
participants of the commercial bill market are banks and financial institutions.
Certificate of deposits
In general institutions issue certificate of deposit at discount on its face value. The banks
and financial institutions can issue CDs on a floating rate basis.
Commercial paper
The commercial paper is another money market instrument in India. We also call
commercial paper as CP. CP refers to a short-term unsecured money market instrument.
Big corporations with good credit rating issue commercial paper as a promissory note.
There is no collateral support for CPs. Hence, only large firms with considerable financial
strength can issue the instrument.
The money-market mutual funds were introduced by RBI in 1992 and since 2000 they are
brought under the regulation of SEBI. It is an open-ended mutual fund which invests in
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short-term debt securities. This kind of mutual fund solely invests in instruments of the
money market.
Repo means “Repurchase Agreement”. It exists in India since December 1992. REPO means
selling a security under an agreement to repurchase it at a predetermined date and rate.
Those who deal in government securities they use the repo as an overnight borrowings.
The following are the important features of the money market in India –
The money market is purely for short-term funds or assets called near money.
All the instruments of the money market deal only with financial assets that are financial in
nature. Also, such instruments have maturity period up to one year.
It deals assets that can convert into cash readily without much loss and with minimum
transaction cost.
Generally, transactions take place through oral communication (for eg. phone or mobile).
The exchange of relevant documents and written communications take place subsequently.
There is no formal place for the trading ( like a stock exchange).
The components of a money market are the Central Bank, Commercial Banks, Non-banking
financial companies, discount houses, and acceptance house. Commercial banks are
dominant player of this market.
The instruments of this market are liquid when we compare it with other financial
instruments. We can convert these instruments into cash easily. Thus, they are able to
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address the need for the short-term surplus funds of the lenders and short-term fund
requirements of the borrowers.
The major functions of such market instrument are to cater to the short-term financial
needs of the economy. Some other functions are as following:
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These bonds come from PSUs and private corporations and are offered for an extensive
range of tenures up to 15 years. There are also some perpetual bonds. Comparing to G-Secs,
corporate bonds carry higher risks, which depend upon the corporation, the industry
where the corporation is currently operating, the current market conditions, and the rating
of the corporation. However, these bonds also give higher returns than the G-Secs.
Certificate of Deposit
These are negotiable money market instruments. Certificate of Deposits (CDs), which
usually offer higher returns than Bank term deposits, are issued in demat form and also as
a Usance Promissory Notes. There are several institutions that can issue CDs. Banks can
offer CDs which have maturity between 7 days and 1 year. CDs from financial institutions
have maturity between 1 and 3 years. There are some agencies like ICRA, FITCH, CARE,
CRISIL etc. that offer ratings of CDs. CDs are available in the denominations of ` 1 Lac and in
multiple of that.
Commercial Papers
There are short term securities with maturity of 7 to 365 days. CPs are issued by corporate
entities at a discount to face value.
Forex Market
What Is Foreign Exchange Market?
The foreign exchange market, also referred to as the forex market, is a decentralized global
marker for trading currencies. Forex market is an over the counter (OTC) market. The forex
market determines the foreign exchange rates. It involves selling, buying and exchanging
currencies at the current market price. Forex market is the largest market in the world in
terms of trade volume.
Foreign Exchange Market In India
Features Of Foreign Exchange Market
Lower trading cost has enabled even small investors to earn good profits. Forex traders
charge a minimal fee towards commission, unlike other investment options. The forex
commission is restricted to the spread or the difference between buying and selling prices
for a currency pair.
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The foreign exchange market is open 24 hours from Monday to Friday. With a 24 hours
market, you have more opportunities to execute trades. Foreign exchange market opens at
Sunday 22:05 GMT and closes at Friday 21:50 GMT.
3) High Leverage
You can trade on margins which are technically on borrowed money in forex market. The
value for your investment is high as the returns can be seen increasing exponentially. As
forex market is highly volatile, you can suffer huge losses by trading with leverage
(borrowed money) if the market works against you. Forex market is a double-edged sword.
If the market plays in your favor, you make good profits. If the market plays against your
bet, you suffer huge losses.
4) Highly Transparent
Foreign exchange market is a transparent market in which the traders have full access to
market related data and information that are required to place successful transactions.
With transparent markets, traders have good control over their investments and can
decide on their further steps on the basis of information available.
You can access your forex market account from anywhere, provided you have an internet
connection. You can trade from anywhere at any time. The accessibility enables forex
market to score over other markets as it is convenient for the traders to place trade
transactions at leisure.
6) High Liquidity
Traders are free to buy and sell currencies of their own choice in forex market. This facility
allows traders exchange currencies without affecting the prices of the currency pair being
traded.
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1) Spot Market
The transactions involving currency pairs in this market happen swiftly. Transactions
made in spot market include instant payment at the present exchange rate which is also
called as the ‘spot rate’. Spot market does not expose the traders to the volatility of the
forex market which raises or lowers the price between the trade and agreement.
2) Futures Market
As the name suggests, transactions in future market involve future payment and future
delivery at a previously agreed exchange rate, which is also called as the future rate. These
deals and contracts are standardized which means that the elements of the deal or
agreement are fixed and cannot be negotiated. Future market transactions are popular
amongst those traders who perform large forex transactions and seek a steady return on
their investments.
3) Forward Market
Forward market transactions work on the similar lines of future market. The major
difference is that the terms are negotiable by the parties under forward market. The terms
can be negotiated and tailored as per the needs of the parties involved in the agreement.
Forward market allows flexibility.
1) Transfer Function:
The most basic function of the forex market is to transfer purchasing power across
countries. Forex market enables the conversion of one currency into another. The currency
conversion is enabled through financial instruments like foreign bills of exchange, bank
drafts, and telephonic transfers among others.
2) Credit Function:
Forex market offers both national and international credits to promote foreign trades. The
bill of exchange used in the international payments usually matures in three months.
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3) Hedging Function:
In risky situations, the forex market operates as a hedge. Hedging is an act of equating
assets and liabilities in foreign currency to avoid the risk due to future changes in the value
of foreign currency.
• Highly flexible
• Can trade on the currency pair of your choice
• Highly leveraged
• Low cost transactions
• Highly transparent
The Foreign Exchange Management Act (FEMA) was an official Act that consolidated and amended
laws governing foreign exchange in India. The primary objective of FEMA act was “facilitating
external trade and payments and...promoting the orderly development and maintenance of foreign
exchange market in India”. FEMA was enacted by the Parliament of India in the winter session of
1999 to replace the Foreign Exchange Regulation Act (FERA) of 1973.
When FERA was introduced in 1973, the Indian economy was suffering from an all-time low of
foreign exchange (forex) reserves. To rebuild these reserves, the government took a stance that all
forex earned by Indian residents -- living within India or abroad -- belonged to the Government of
India and had to be surrendered to the Reserve Bank of India (RBI). FERA, thus, severely regulated
all forex transactions that had a direct or indirect impact on India’s forex reserves, which included
the import and/or export of currency.
However, FERA did not quite have the effect that was envisioned and the Indian economy
continued to decline. To compound matters, the strict regulatory environment created under the
‘License Raj’ dampened the Indian economy further. To mitigate the downturn, then-Finance
Minister Manmohan Singh unleashed economic liberalization in 1991 and as a result, the
government had to make a series of concessions to FERA’s stipulations under the new rules. These
concessions made FERA largely irrelevant under the new economic regime. Eventually, the
government decided to move from “currency regulation” to “currency management”, and set up
FEMA.
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The RBI proposed FEMA in 1999 to administrate foreign trade and exchange transactions.
According to the official order, FEMA would “consolidate and amend the law relating to foreign
exchange (forex) with the objective of facilitating external trade and payments and for promoting
the orderly development and maintenance of foreign exchange market in India”.
The The Foreign Exchange Management Act officially came into existence on 1st June 2000 and its
arrival paved the way for the introduction of the Prevention of Money Laundering Act (PMLA) of
2002.
Most significantly, FEMA regarded all forex-related offences as civil offences, whereas FERA
regarded them as criminal offences. Additionally, there were other important guidelines such as:
• FEMA did not apply to Indian citizens who resided outside India. This criterion was
checked by calculating the number of days a person resided in India during the previous
financial year (182 days or more to be a resident). It was noted that even an office, a branch,
or an agency could be a ‘person’ for the purpose of checking residency.
• FEMA authorized the central government to impose restrictions on and supervise three
things – payments made to any person outside India or receipts from them, forex, and
foreign security deals.
• It specified the areas around acquisition/holding of forex that required specific permission
of the Reserve Bank of India (RBI) or the government.
• FEMA put foreign exchange transactions into two categories – capital account and current
account. A capital account transaction altered the assets and liabilities outside India or
inside India but of a person resident outside India. Thus, any transaction that changed
overseas assets and liabilities for an Indian resident in a foreign country, or vice versa, was
classified as a capital account transaction. Any other transaction fell into the current
account category.
FEMA also gave the RBI the authority to regulate capital account transactions. As per the Foreign
Exchange Management (Permissible Capital Account Transactions) Regulations of 2000, “no
person shall undertake or sell or draw foreign exchange to or from an authorised person for any
capital account transaction”. The Regulations prohibited any person resident outside India from
investing in Indian firms or organisations in the business of chit funds such as a Nidhi company,
agricultural or plantation activities, real estate (excluding development of townships, construction
of residential/commercial premises, roads or bridges), or construction of farm houses, and/or in
trading in Transferable Development Rights (TDRs).
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It did allow for transactions carried out by Indian residents that included investments in foreign
securities, foreign currency loans raised in and out of India, transfer of immovable property outside
India, the issue of guarantees in favour of anybody living outside India, and the export/import and
holding of currency/currency notes.
Under The Foreign Exchange Management Act, the central government issued the Foreign
Exchange Management (Current Account Transaction) Rules of 2000 which restricted forex deals
made by authorised persons under their current account. Under the FEMA rules, current account
transactions that were prohibited, not prohibited, and permitted, required the prior approval of
the central government and/or RBI.
Prohibited transactions included the remittance of lottery winnings, income from racing/riding,
purchase of lottery tickets, banned/proscribed magazines, football pools, sweepstakes,
commission on exports made towards equity investment in JVs/wholly owned subsidiaries of
Indian companies abroad, amongst others. Additionally, Nepal and Bhutan allowed the use of
Indian currency for local transactions, and the citizens of these countries were considered at par
with Indian citizens from a legal standpoint. Because of these provisions allowing for a common
currency market in India, Nepal and Bhutan, use of forex for transactions in – or with the residents
of – Nepal and Bhutan was also prohibited.
Moreover, FEMA recognized the growing international presence of Indians as well as the rising
contribution of Non Resident Indians (NRIs) to the Indian economy. Thus, it allowed individuals to
avail forex facility (up to a limit of US$250,000) for a variety of purposes that included international
travel to any country (except Nepal and Bhutan), gifts, donations, travel for overseas employment,
emigration and maintenance of close relatives living abroad.
The RBI was the overall controlling authority as far as FEMA was concerned. It worked with and
empowered the central bank to specify the different classes of capital account transactions along
with the exchange rate admissible for each such transaction.
• Authorised persons could withdraw or sell forex; however, the Act empowered the RBI to
put several restrictions on their capital account. Authorized persons were expected to
provide details and information regarding forex transactions to the RBI on a regular basis.
• FEMA allowed Indian residents to carry out transactions in forex, foreign security, or to
own immovable property abroad. This was permitted if the currency, security, or property
was owned or acquired when he/she was living outside India, or if it was inherited by
him/her from someone living outside India.
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• FEMA regulations covered forex transactions and remittances which included individuals
or entrepreneurs moving money in or out of India, or exchanging foreign currency in India
for travel purposes.
• There were many subsequent regulations and notifications issued under the Act
addressing specific issues such as authentication of documents, current account
transactions, adjudication proceedings and appeal, compounding proceedings, permissible
capital account transactions and borrowing or lending in forex, amongst others.
Indeed, FEMA was drafted to create a more liberal foreign exchange market in India. The Act
encouraged deregulation of foreign exchange and smooth international trade. FEMA also has a
distinct administrative difference from FERA, which sought to impose sweeping regulations on
every aspect of India forex transactions. On the other hand, FEMA aimed to manage only certain
forex transactions that might have an impact on national security and the wider national economy,
and opened up individual forex transactions to the free market.
With Drip Capital’s expert guidance and consulting, entities can better comply with FEMA. This
includes specific guidance on FEMA-applicable areas and export businesses within India as well as
all branches, offices, and agencies located outside India that are owned or controlled by a resident
of India.
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The combination of five currencies and seven maturities leads to a total of 35 different
LIBOR rates calculated and reported each business day. The most commonly quoted rate is
the three-month U.S. dollar rate, usually referred to as the current LIBOR rate.
Each day, ICE asks major global banks how much they would charge other banks for short-
term loans. The association takes out the highest and lowest figures, then calculates the
average from the remaining numbers. This is known as the trimmed average. This rate is
posted each morning as the daily rate, so it's not a static figure. Once the rates for each
maturity and currency are calculated and finalized, they are announced/published once a
day at around 11:55 am London time by IBA.
LIBOR is also the basis for consumer loans in countries around the world, so it impacts
consumers just as much as it does financial institutions. The interest rates on various credit
products such as credit cards, car loans, and adjustable rate mortgages fluctuate based on
the interbank rate. This change in rate helps determine the ease of borrowing between
banks and consumers.
But there is a downside to using the LIBOR rate. Even though lower borrowing costs may
be attractive to consumers, it does also affect the returns on certain securities. Some
mutual funds may be attached to LIBOR, so their yields may drop as LIBOR fluctuates.
Important Point
LIBOR is the benchmark interest rate at which major global lend to one another.
LIBOR is administered by the Intercontinental Exchange which asks major global banks
how much they would charge other banks for short-term loans.
The rate is calculated using the Waterfall Methodology, a standardized, transaction-based,
data-driven, layered method.
How Is LIBOR Calculated?
The ICE Benchmark Administration (IBA) has constituted a designated panel of global
banks for each currency and tenor pair. For example, 16 major banks, including Bank of
America, Barclays, Citibank, Deutsche Bank, JPMorgan Chase, and UBS constitute the panel
for US dollar LIBOR. Only those banks that have a significant role in the London market are
considered eligible for membership on the ICE LIBOR panel, and the selection process is
held annually.
As of April 2018, the IBA submitted a new proposal to strengthen the LIBOR calculation
methodology. It suggested using a standardized, transaction-based, data-driven, layered
method called the Waterfall Methodology for determining LIBOR.
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The first transaction-based level involves taking a volume-weighted average price (VWAP)
of all eligible transactions a panel bank may have assigned a higher weighting for
transactions booked closer to 11:00 a.m. London time.
The second transaction-derived level involved taking submissions based on transaction-
derived data from a panel bank if it does not have a sufficient number of eligible
transactions to make a Level 1 submission.
The third level—expert judgment—comes into play when a panel bank fails to make a
Level 1 or a Level 2 submission. It submits the rate at which it could finance itself at 11:00
a.m. London time with reference to the unsecured, wholesale funding market.
Uses of LIBOR
LIBOR is used worldwide in a wide variety of financial products. They include the
following:
Standard interbank products like the forward rate agreements (FRA), interest rate swaps,
interest rate futures/options, and swaptions
Commercial products like floating rate certificate of deposits and notes, syndicated loans,
and variable rate mortgages
Hybrid products like collateralized debt obligations (CDO), collateralized mortgage
obligations (CMO), and a wide variety of accrual notes, callable notes, and perpetual notes
Consumer loan-related products like individual mortgages and student loans
LIBOR is also used as a standard gauge of market expectation for interest rates finalized by
central banks. It accounts for the liquidity premiums for various instruments traded in the
money markets, as well as an indicator of the health of the overall banking system. A lot of
derivative products are created, launched and traded in reference to LIBOR. LIBOR is also
used as a reference rate for other standard processes like clearing, price discovery, and
product valuation.
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Banks borrow and lend money to one another on the interbank market in order to maintain
appropriate, legal liquidity levels, and to meet reserve requirements placed on them by
regulators. Interbank rates are made available only to the largest and most creditworthy
financial institutions.
What Does the Mumbai Interbank Offered Rate (MIBOR) Tell You?
MIBOR is calculated every day by the National Stock Exchange of India (NSEIL) as a
weighted average of lending rates of a group of major banks throughout India, on funds
lent to first-class borrowers. This is the interest rate at which banks can borrow funds from
other banks in the Indian interbank market.
The Mumbai Interbank Offer Rate (MIBOR) is modeled closely on LIBOR. The rate is used
currently for forward contracts and floating-rate debentures. Over time and with more use,
MIBOR may become more significant.
MIBOR is calculated based on input from a panel of 30 banks and primary dealers, and it
represents India's interbank borrowing rate.
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Objectives of SEBI
The objectives of SEBI are:
To regulate activities in stock exchange and ensure safe investments
To prevent fraudulent practices by striking a balance between business and its statutory
regulations
Functions of SEBI
The three main functions of SEBI are as follows:
Protective function
Developmental function
Regulatory function
Protective functions are performed by SEBI to protect interest of investors and provide
safe investments. This entails:
Checks on prices rigging: Price rigging refers to manipulating the prices of securities.
Prevents insider trading: Insider refers to directors, promoters of the company. These
people have sensitive information which they can use to make profit. SEBI keeps a
stringent check whether insiders are buying securities of the company.
Prohibits fraudulent and unfair practices: SEBI does not allow companies to make
misleading statements.
Developmental functions are performed by the SEBI to develop activities in stock
exchange to increase the business in stock exchange. Under this category, following
functions are performed by SEBI:
Promoting training of intermediaries of the securities market
Promote activities of stock exchange by adopting flexible methods such as internet trading
Initial public offer of primary market is permitted through stock exchange.
Regulatory functions are performed by SEBI to regulate the business in stock exchange.
SEBI registers and regulates the working of mutual funds and other investment options.
SEBI regulates takeover of the companies.
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Organizations
Organizations include various entities such as MCX-SX, BSE, NSE, other regional stock
exchanges, and the two depositories National Securities Depository Limited (NSDL) and
Central Securities Depository Limited (CSDL).
Market Regulators
Market Regulators include the Securities and Exchange Board of India (SEBI), the Reserve
Bank of India (RBI), and the Department of Company Affairs (DCA).
Role Of Capital Market In India
The capital market has a crucial significance to capital formation. For a speedy economic
development, the adequate capital formation is necessary. The significance of capital
market in economic development is explained below:
Mobilization Of Savings And Acceleration Of Capital Formation:
In developing countries like India, the importance of capital market is self-evident. In this
market, various types of securities help to mobilize savings from various sectors of the
population. The twin features of reasonable return and liquidity in stock exchange are
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definite incentives to the people to invest in securities. This accelerates the capital
formation in the country.
Raising Long-Term Capital
The existence of a stock exchange enables companies to raise permanent capital. The
investors cannot commit their funds for a permanent period but companies require funds
permanently. The stock exchange resolves this dash of interests by offering an opportunity
to investors to buy or sell their securities, while permanent capital with the company
remains unaffected.
Promotion Of Industrial Growth
The stock exchange is a central market through which resources are transferred to the
industrial sector of the economy. The existence of such an institution encourages people to
invest in productive channels. Thus it stimulates industrial growth and economic
development of the country by mobilizing funds for investment in the corporate securities.
Ready And Continuous Market
The stock exchange provides a central convenient place where buyers and sellers can easily
purchase and sell securities. Easy marketability makes an investment in securities more
liquid as compared to other assets.
Technical Assistance
An important shortage faced by entrepreneurs in developing countries is technical
assistance. By offering advisory services relating to the preparation of feasibility reports,
identifying growth potential and training entrepreneurs in project management, the
financial intermediaries in capital market play an important role.
Reliable Guide To Performance
The capital market serves as a reliable guide to the performance and financial position of
corporate, and thereby promotes efficiency.
Proper Channelization Of Funds
The prevailing market price of a security and relative yield are the guiding factors for the
people to channelize their funds in a particular company. This ensures effective utilization
of funds in the public interest.
Provision Of Variety Of Services:
The financial institutions functioning in the capital market provide a variety of services
such as a grant of long-term and medium-term loans to entrepreneurs, provision of
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Stock Exchange
What is an exchange?
Put simply, an exchange is an institution, organization, or association which hosts a market
where stocks, bonds, options, futures, and commodities are traded. Buyers and sellers
come together to trade during specific hours on business days. Exchanges impose rules and
regulations on the firms and brokers that are involved with them. If a particular company is
traded on an exchange, it is referred to as "listed."
Securities that are not listed on a stock exchange are sold OTC, which stands for Over-The-
Counter. Companies that have shares traded OTC are usually smaller and riskier because
they do not meet the requirements to be listed on a stock exchange. Many giant blue-chip
stocks, such as Berkshire Hathaway, at one time traded on the over-the-counter market
before migrating to the so-called "Big Board," or New York Stock Exchange.
What Is the Purpose of a Stock Exchange?
When a business raises capital by issuing shares, the owners of those new shares are likely
going to want to sell their stake someday. Maybe they have a child going to college and
need to cover the tuition bill. Perhaps they pass away, and their estate is subject to some
hefty estate taxes. They may even leave it to their grandchildren, who get to enjoy the
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stepped-up basis loophole, but the heirs want to liquidate to buy a house. Whatever is
driving their decision, they aren't likely to tie up their funds unless they know somehow,
someway, at some point in the future, they'll be able to find a buyer for their holdings
without too much trouble in what is known as "the secondary market."
Without a stock exchange, these owners would have to go around to friends, family
members, and community members, hoping to find someone to whom they could sell their
shares. (Technically, you can do this. You don't have to sell your shares on a stock
exchange. You can take physical possession of your stocks in certificate form, endorse
them, and sign them over to someone in exchange for payment in your lawyer's office, or at
your dining room table if you are so inclined. When the stock exchange was closed during
World War I, many people did just that, creating a secondary shadow market.
The downside is that there is no transparency. Nobody knows what the best price is for a
given stock at any given moment in time. You could be selling your shares for $50 while the
guy two towns over is getting $70.) With a stock exchange, you will never know the person
on the other end of the trade. He, she, or it could be halfway around the world. It could be a
retired teacher. It could be a multi-billion dollar insurance group. It could be a publicly
traded mutual fund or hedge fund.
The need for convenience is what led to the establishment of the biggest stock exchange in
the world. In the United States, a group of stockbrokers met under a buttonwood tree in
New York City. On May 17th, 1792, twenty-four of these stockbrokers got together outside
of 68 Wall Street to sign the now-famous Buttonwood Agreement, which effectively created
the New York Stock & Exchange Board. Almost three-quarters of a century later, in 1863, it
was officially renamed the New York Stock Exchange. These days, most people refer to it as
the NYSE.
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The New York Stock Exchange - Located in New York City; $22.923 trillion in listed
market capitalization.
NASDAQ - Short for the "National Association of Securities Dealers Automated Quotation,"
this electronic stock exchange is located in New York City; $10.857 trillion in listed market
capitalization.
Tokyo Stock Exchange - Formally known as the Japan Exchange Group, located in Tokyo,
Japan; $4.485 trillion in listed market capitalization.
Shanghai Stock Exchange - Located in Shanghai, China; $3.986 trillion in listed market
capitalization.
Hong Kong Stock Exchange - Located in Hong Kong, Hong Kong; $3.936 trillion in listed
market capitalization.
Euronext - Located throughout Europe (France, Portugal, The Netherlands, and Belgium);
$3.927 trillion in listed market capitalization.
London Stock Exchange - Located in London, England; $3.767 trillion in listed market
capitalization.
Shenzhen Stock Exchange - Located in Shenzhen, China; $2.504 trillion in listed market
capitalization.
TMX Group - The Canadian stock exchange is located in Toronto, Canada; $2.095 trillion in
market capitalization.
Bombay Stock Exchange - Located in Mumbai, India; $2.056 trillion in market
capitalization.
National Stock Exchange of India - Located in Mumbai, India; $2.030 trillion in market
capitalization.
Deutsche Börse - The German stock exchange, located in Frankfurt, Germany; $1.864
trillion in market capitalization.
SIX Swiss Exchange - The Zurich stock exchange, located in Zurich, Switzerland; $1.523
trillion in listed market capitalization.
Korea Exchange - The South Korean stock exchange located in Seoul, South Korea; $1.463
trillion in listed market capitalization.
Nasdaq Nordic - Located in Stockholm, Sweden; $1.372 trillion in listed market
capitalization.
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Provided that a person buying or selling securities or otherwise dealing with the securities
market as a depository, 3[participant,] custodian of securities, foreign institutional investor
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or credit rating agency immediately before the commencement of the Securities Laws
(Amendment) Act, 1995, for which no certificate of registration was required prior to such
commencement, may continue to buy or sell securities or otherwise deal with the securities
market until such time regulations are made under clause (d) of sub-section (2) of section
30.
(1B) No person shall sponsor or cause to be sponsored or carry on or caused to be carried
on any venture capital funds or collective investment schemes including mutual funds,
unless he obtains a certificate of registration from the Board in accordance with the
regulations :
Provided that any person sponsoring or causing to be sponsored, carrying or causing to be
carried on any venture capital funds or collective investment schemes operating in the
securities market immediately before the commencement of the Securities Laws
(Amendment) Act, 1995, for which no certificate of registration was required prior to such
commencement, may continue to operate till such time regulations are made under clause
(d) of sub-section (2) of section 30.]
[Explanation.—For the removal of doubts, it is hereby declared that, for the purposes of
this section, a collective investment scheme or mutual fund shall not include any unit
linked insurance policy or scrips or any such instrument or unit, by whatever name called,
which provides a component of investment besides the component of insurance issued by
an insurer.]
(2) Every application for registration shall be in such manner and on payment of such fees
as may be determined by regulations.
(3) The Board may, by order, suspend or cancel a certificate of registration in such manner
as may be determined by regulations :
Provided that no order under this sub-section shall be made unless the person concerned
has been given a reasonable opportunity of being heard.
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they undertake lower risk, debt funds in India yield returns which though higher than
returns offered by fixed return investments, tend to be lower than those provided by equity
funds in the long term. As per SEBI classification, there are as many as 16 types of debt
funds.
The most popular type of debt fund in terms of AUM (Assets Under Management) is liquid
fund as they are often used by corporations to park their excess cash for short periods. A
liquid fund predominantly invests in debt and money market securities with maturities of
up to 91 days. Due to the shorter maturity period, liquid funds feature the least amount of
risk among all debt funds. Liquid funds generally give returns that are higher than savings
accounts and at par with fixed deposits while being a lot more liquid than the latter.
Hybrid Funds: As the name suggests, a hybrid fund is a mutual fund which invests its assets
in two or more asset classes including equities, debt, money market instruments, gold,
overseas securities, etc. A hybrid fund generally invests in only two asset classes namely
equity and debt. The blend of equity and debt enables a hybrid fund to give returns similar
to those generated by equity funds while undertaking relatively lower risk levels like debt
funds. As per SEBI classification, there are 7 types of hybrid funds.
The most popular type of scheme in this category is the Dynamic Asset Allocation Fund. A
Dynamic Asset Allocation Fund has the flexibility to invest any amount between 0%-100%
of its assets in either equity or debt. Typically this type of fund aims to sell equities and
book profits in overvalued equity market conditions while doing the reverse when equity
market valuations are attractive. A Dynamic Asset Allocation Fund decreases its debt
exposure in undervalued markets and increases its debt holding during a bull run.
Benefits of Mutual Fund Investments
The following are the benefits of investing in mutual funds:
Flexible Investment Amounts
A mutual fund investment can be started with an amount as low as Rs. 500 while there is
no limit on the maximum amount you can invest. But do keep in mind that in case of ELSS
investments, you get the tax benefit only up to the Rs. 1.5 lakh 80C limit in a financial year.
Professional Management of Funds
With mutual fund, an investor can benefit from the professional management of his/her
funds by an expert fund manager. Fund houses charge a nominal fee for the administration
and management of a mutual fund scheme called Expense Ratio. The expense ratio of a
mutual fund generally ranges between 0.5% to 1.5% and cannot exceed the limit of 2.5%
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set by SEBI. Fund houses always mention the returns generated by a mutual fund scheme
after deducting the applicable expense ratio.
High Returns
Mutual funds offer long term returns that range from 7% (in lowest risk carrying liquid
funds) and 15% or higher in case of most equity funds over a 5 year period. These inflation
beating returns provided by mutual funds are one of the key reasons why many are
choosing these market-linked investments over fixed income instruments such as fixed
deposits.
Diversification
Mutual funds allow investors to access a wide and diversified investment portfolio that can
include equities of varying market capitalisations as well as debt and money market
instruments for an investment amount which can be as low as Rs. 500. The diversified
investment portfolio allows a mutual fund to provide an unmatched balance between risk
and return.
Systematic Investment Option
A systematic investment plan (SIP) is a method of investing in mutual funds which allows
investors to invest a fixed sum in a mutual fund scheme at predetermined intervals (daily,
weekly, monthly, bi-annual or annual). SIP investments reduce the potential financial risk
associated with a lump sum investment. It also enables an investor to increase/decrease
the investment in line with the current financial situation of the investor.
Tax Benefit
An Equity Linked Savings Scheme (ELSS) is a type of mutual fund which helps an investor
in getting a tax benefit in addition to the above-mentioned benefits. An ELSS comes with a
lock-in period of 3 years and every ELSS investment qualifies for a tax deduction of up to
Rs. 1.5 lakh under Section 80C of the Income Tax Act. Even in the case of other (non-ELSS)
equity schemes, capital gains from unit redemption up to Rs. 1 lakh in a fiscal are exempt
from tax.
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The basic principle of insurance is that an entity will choose to spend small periodic
amounts of money against a possibility of a huge unexpected loss. Basically, all the
policyholder pool their risks together. Any loss that they suffer will be paid out of their
premiums which they pay.
Functions of an Insurance Company
Provides Reliability
The main function of insurance is that eliminates the uncertainty of an unexpected and
sudden financial loss. This is one of the biggest worries of a business. Instead of this
uncertainty, it provides the certainty of regular payment i.e. the premium to be paid.
Protection
Insurance does not reduce the risk of loss or damage that a company may suffer. But it
provides a protection against such loss that a company may suffer. So at least the
organisation does not suffer financial losses that debilitate their daily functioning.
Pooling of Risk
In insurance, all the policyholders pool their risks together. They all pay their premiums
and if one of them suffers financial losses, then the payout comes from this fund. So the risk
is shared between all of them.
Legal Requirements
In a lot of cases getting some form of insurance is actually required by the law of the land.
Like for example when goods are in freight, or when you open a public space getting fire
insurance may be a mandatory requirement. So an insurance company will help us fulfil
these requirements.
Capital Formation
The pooled premiums of the policyholders help create a capital for the insurance company.
This capital can then be invested in productive purposes that generate income for the
company.
Principles of Insurance
As we discussed before, insurance is actually a form of contract. Hence there are certain
principles that are important to ensure the validity of the contract. Both parties must abide
by these principles.
Utmost Good Faith
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Bancassurance
What Is Bancassurance?
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In a factoring arrangement, first of all, the borrower sells trade receivables to the factor and
receives an advance against it. The advance provided to the borrower is the remaining
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amount, i.e. a certain percentage of the receivable is deducted as the margin or reserve, the
factor’s commission is retained by him and interest on the advance. After that, the
borrower forwards collections from the debtor to the factor to settle down the advances
received.
Forfaiting
Forfaiting is a mechanism, in which an exporter surrenders his rights to receive payment
against the goods delivered or services rendered to the importer, in exchange for the
instant cash payment from a forfaiter. In this way, an exporter can easily turn a credit sale
into cash sale, without recourse to him or his forfaiter.
The major differences between factoring and forfaiting are described below:
1. Factoring refers to a financial arrangement whereby the business sells its trade
receivables to the factor (bank) and receives the cash payment. Forfaiting is a form
of export financing in which the exporter sells the claim of trade receivables to the
forfaiter and gets an immediate cash payment.
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2. Factoring deals in the receivable that falls due within 90 days. On the other hand,
Forfaiting deals in the accounts receivables whose maturity ranges from medium to
long term.
3. Factoring involves the sale of receivables on ordinary goods. Conversely, the sale of
receivables on capital goods are made in forfaiting.
4. Factoring provides 80-90% finance while forfaiting provides 100% financing of the
value of export.
5. Factoring can be recourse or non-recourse. On the other hand, forfaiting is always
non-recourse.
6. Factoring cost is incurred by the seller or client. Forfaiting cost is incurred by the
overseas buyer.
7. Forfaiting involves dealing with negotiable instruments like bills of exchange and
promissory note which is not in the case of Factoring.
8. In factoring, there is no secondary market, whereas in the forfaiting secondary
market exists, which increases the liquidity in forfaiting.
Comparison Chart
BASIS FOR
FACTORING FORFAITING
COMPARISON
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BASIS FOR
FACTORING FORFAITING
COMPARISON
Cost Cost of factoring borne by the seller Cost of forfaiting borne by the
(client). overseas buyer.
Secondary No Yes
market
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An OBS operating lease is one in which the lessor retains the leased asset on its balance
sheet. The company leasing the asset only accounts for the monthly rental payments and
other fees associated with the rental rather than listing the asset and corresponding
liability on its own balance sheet.At the end of the lease term, the lessee generally has the
opportunity to purchase the asset at a drastically reduced price.
Leaseback Agreements
Under a leaseback agreement, a company can sell an asset, such as a piece of property, to
another entity. They may then lease that same property back from the new owner.
Like an operating lease, the company only lists the rental expenses on its balance sheet,
while the asset itself is listed on the balance sheet of the owning business.
Accounts Receivables
Accounts receivable (AR) represents a considerable liability for many companies. This
asset category is reserved for funds that have not yet been received from customers, so the
possibility of default is high. Instead of listing this risk-laden asset on its own balance sheet,
companies can essentially sell this asset to another company, called a factor, which then
acquires the risk associated with the asset. The factor pays the company a percentage of the
total value of all AR upfront and takes care of collection. Once customers have paid up, the
factor pays the company the balance due minus a fee for services rendered. In this way, a
business can collect what is owed while outsourcing the risk of default.
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discipline and encourage sound banking practices including supervisory review. Together,
these areas of focus are known as the three pillars.
Basel III
In the wake of the Lehman Brothers collapse of 2008 and the ensuing financial crisis, the
BCBS decided to update and strengthen the Accords. The BCBS considered poor
governance and risk management, inappropriate incentive structures, and an
overleveraged banking industry as reasons for the collapse. In November 2010, an
agreement was reached regarding the overall design of the capital and liquidity reform
package. This agreement is now known as Basel III.
Basel III is a continuation of the three pillars along with additional requirements and
safeguards. For example, Basel III requires banks to have a minimum amount of common
equity and a minimum liquidity ratio. Basel III also includes additional requirements for
what the Accord calls "systemically important banks" or those financial institutions that are
considered "too big to fail."
The Basel Committee on Banking Supervision greed on the terms of Basel III in November
2010, and it was scheduled to be introduced from 2013 until 2015. Basel III
implementation has been extended repeatedly, and the latest completion date is expected
to be January 2022.
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• Wide gamut solutions were developed diligently for helping our customers in
making intelligent decision in entire stage of customer life cycle.
Evolution of CIBIL
Apr 2011: individuals were able to avail CIBIL TransUnion Score
Sep 2010: First centralized database on Mortgages in India- CIBIL Mortgage Check was
launched
Jul 2010: CIBIL Detect - India's first repository for information on high-risk activity was
initiated
Apr 2004: CIBIL Launched Credit Bureau services in India (Consumer Bureau)
Aug 2000: CIBIL was Incorporated basis the recommendations made by the Siddiqui
Committee
Nov 1999: CIBIL is also Report submitted by Siddiqui Committee for setting up India's first
Credit Information Bureau
Functions of CIBIL
• The Consumer Bureau of CIBIL keep its dynamic information repository of India for
providing its member comprehensive risk management tools
• Consumer Credit Information is important tool used by credit grantor at the time of
new customer acquisition.
• Portfolio Review provides the credit grantor with a comprehensive view of their
borrower’s credit relationships across multiple lenders.
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A Credit Score plays a critical role in the loan and credit card approval process. This is the
first screening criterion applied by banks and financial institutions when reviewing your
loan application.
In the illustration below, two individuals with Credit Scores of 810 and 620 respectively
apply for a home loan. Depending on the credit policy of the bank, it is more likely that the
bank will screen the individual with an 810 Credit Score for further evaluation, while the
application with the Credit Score of 620 may not be processed.
How does the CIBIL Score affect me as an individual?
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ii)You have a credit history but no credit activity or transactions in the last two years.
iii) You only have add-on credit cards and have no direct credit exposure.
Debt Collection
Goals and Objectives
To create a network of Debt Collection Professionals for Indian Market
To share best practices of collection of Debts in India
To suggest policy to Government of India/ Reserve Bank of India (RBI) based on Fair Debt
Collection Practices across the Globe
To Carry out Networking Events for Debt Collection Professionals in India.
To Carry out Education among Law Students and Professionals on best practices for
Collection of Debts in India.
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Taking a cue from the developments in the finance sector taking place globally, India
undertook structural changes by way of these reforms and successfully relaxed the external
constraints in its operation i.e. reduction in Cash Reserve Ratio and Statutory Liquidity
Ratio, capital adequacy reforms, restructuring and recapitulation of banks and
enhancement in the competitive element in the market through the entry of new banks.
Banks in India had to give a go-by to their traditional operational methods of directed
credit, fixed interest rates and directed investments, all of which, had the effect of
deteriorating the quality of loan portfolios and inadequacy of capital and erosion of
profitability.
Another prominent consequence of the reforms was the sprouting up of a number of banks
due to the entry of new private and foreign banks, increased transparency in the banking
system through the introduction of prudential norms and increase in the role of the market
forces due to the deregulated interest rates. All these measures lead to major changes in
the operational environment of the finance sector.
The objective of this paper is to analyse the financial sector reforms that have been carried
out in India since the 1990s. The first chapter analyses the objectives of the reforms in the
financial sector. Chapter II goes on explain in detail the policy reforms undertaken in this
sector and puts forth a four-pronged approach to understand the various elements within
the financial sector which have undergone changes. This is followed by Chapter IV which
essentially recognises the elements integral to the reformation process. It includes the
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suggestions made by Y.V. Reddy. Finally, the penultimate chapter concludes the
submissions and the analysis made in this research paper.
Objectives of Reforms in the Financial Sector
The primary objective of financial sector reforms in the 1990s was to “create an efficient,
competitive and stable that could contribute in greater measure to stimulate growth”.
Economic reform process took place amidst two serious crises involving the financial
sector:
The crisis involving the balance of payments that had threatened the international
credibility of the country and dragged it towards the brink of default.
The crisis involving the grave threat of insolvency threatening the banking system which
had concealed its problems for years with the aid of defective accounting policies.
Apart from the above two dilemmas, there were many deeply rooted problems of the
Indian economy in the early 1990s which were strongly related to the finance sector.
Prevalent amoung these were:
As mentioned by McKinnon and Shaw, till the early 1990s, the Indian financial sector could
be described as an example of financial repression. The sector was characterised by
administered interest rates fixed at unrealistically low levels, large pre-emption of
resources by authorities and micro regulations which direct the major flow of funds back
and forth from the financial intermediaries.
The act of the government involving large scale pre-emption of resources from the banking
system to finance its fiscal deficit.
More than necessary structural and micro-regulation that inhibited financial innovation
and increased transaction costs.
Relatively inadequate level of prudential regulation in the financial sector.
Inadequately developed debt and money markets.
Obsolete and out-dated technological and institutional structures that lead to the
consequent inefficiency of the capital markets and the rest of the financial system.
Till the early 1990s, the Indian financial system was characterised by extensive regulations
viz. administered interest rates, weak banking structure, directed credit programmes, lack
of proper accounting, risk management systems and lack of transparency in operations of
major financial market participants. [15] Furthermore, this period was characterised by the
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restrictive entry of foreign banks since after the nationalisation of banks in 1969 and 1980,
almost 90 per cent of the banking assets were under the control of government owned
banks and financial institutions. [16] The financial reforms initiated in this era attempted
to overcome these weaknesses with the view of enhancing efficient allocation of resources
in the Indian economy.
The Reserve Bank of India had been making efforts since 1986 to develop efficient and
healthy financial markets which were accelerated after 1991. RBI focused on the
development of financial markets especially the money market, government securities
market and the forex markets. Financial markets also benefited from close coordination
between the Central Government and the RBI as also between the other regulators.
Major contours of the financial sector reforms in India
On a general understanding, there are three groups of reform measures that are used to
handle the problems faced by the financial sector. These are that of removal of financial
repression, rehabilitation of the banking system and lastly, deepening and development of
capital markets.
The focal issues addressed by financial sector reforms in India have primarily aimed
to include the following:
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The financial reforms since the 1990s can be classified into two phases. The first phase,
also known as the first generation reforms, was aimed at the creation of an efficient,
productive, profitable and healthy financial sector which would function in an environment
of functional autonomy and operational flexibility. The first phase was initiated in 1992
based on the recommendations of the Committee on Financial System. While the early
phase of reforms was being implemented, the global economy was also witnessing
prominent changes coinciding with the movement towards global integration of financial
services. Narasimhan Committee I noted that the objective of Financial Sector Reforms in
India should not focus on correcting the present financial weaknesses but should strive to
eliminate the roots of the cause of the present challenges being faced by the Indian market
economy.
The second generation reforms or the second phase commenced in the mid-1990s and laid
greater emphasis on strengthening the financial system and on the introduction of
structural improvements. Narasimhan Committee II was to look into the extent of the
effectiveness of the implementation of reforms suggested by Narasimhan Committee I and
was entrusted with the responsibility to lay down a course of future reforms for the growth
and integration of the Indian banking sector with international standards.
Principles of Financial Sector Reforms in India
Dr. Y.V. Reddy has stated that the financial sector reforms in India are based on Punch-
sutra or five principles which are explained as follows:
Introduction of various measures by cautious and gradual phasing thus giving time to
various agents to carry out the necessary norms. For instance, the gradual introduction of
prudential norms.
Mutually reinforcing measures, that would serve as enabling reforms which would not in
anyway disrupt the confidence in the system. E.g. Improvement in the profitability of banks
by the combined reduction in refinance and Cash Reserve Ratio.
Complementary nature of the reforms in the banking sector with other commensurate
changes in fiscal, external and monetary policies.
Development of the financial infrastructure in terms of technology, changing legal
framework, setting up of a supervisory body, and laying down of audit standards.
Introducing initiatives to nurture, integrate and develop money, forex and debt market so
as to give an equal opportunity to all major banks to develop skills and to participate.
Policy Reforms in the Financial Sector
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Indian financial reforms can be explained by way of a four-pronged approach viz. (a)
banking reforms, (b) debt market, (c) forex market reforms, and (d) reforms in other
segments of the financial sector. These are explained in detail in the subsequent sub-
headings.
Banking Reforms
Despite the general approach of the financial sector reform process, many of the regulatory
and supervisory norms were started out first for commercial banks and thereafter were
expanded to other financial intermediaries. Banking reforms consisted of a two-fold
process. Firstly, the process involved recapitaltiation of banks from government resources
to bring them at par with appropriate capitalisation standards. On a second level, an
approach was adopted replacing privatisation. Under this, increase in capitalisation has
been brought about through diversification of ownership to private investors up to a cap of
49 per cent and thus keeping majority ownership and control with the government.
The main idea was to increase the competition in the banking system by a gradual process
and unlike other countries, banking reform in India, did not involve large-scale
privatisation. Due to such widening of ownership, majority of these banks have been
publicly listed which in turn has brought about greater transparency through enhanced
disclosure norms. The phased introduction of new banks in the private sector and
expansion in the number of foreign banks provided for a new level of competition.
Furthermore, increasingly tight capital adequacy norms, prudential and supervision norms
were to apply equally across all banks, regardless of their ownership.
Government Debt Market Reforms
A myriad of reforms have been introduced in the government securities debt market. Only
in the 1990s a proper G-Sec debt market had been initiated which had progress from
strategy of pre-emption of resources from banks at administered rates of interest to a
system that is more market oriented. The main instrument of pre-emption of bank
resources in the pre-reform period was through the prescription of a Statutory Liquidity
Ratio i.e. the ratio at which banks are required to invest in approved securities. It was
initially introduced as a prudential measure. The high SLR reserve requirements lead to
the creation of a captive market for government securities which were issued at low
administered interest rates. After the introduction of reforms, the SLR ratio has been
brought down to a statutory minimum level of 25 per cent. Numerous measure have been
taken to broaden the G-Sec market and to increase the transparency. Automatic
monetisation of the government’s deficit has been given a go-by. At present, the market
borrowings of the central government are undertaken through a system of auctions at
market-related rates.
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Another important step has been the setting of the Securities and Exchange Board of India
as a regulator for equity markets and to improve market efficiency and integration of
national markets and to prevent unfair practices regarding trading. The reform measures
in the equity market since 1992 have laid emphasis mainly on regulatory effectiveness,
enhancement of competitive conditions, reduction of information asymmetries,
development of modern technological infrastructure, mitigation of transaction costs and
lastly, controlling of speculation in the securities market. Furthermore, the reform process
had the effect of putting an end to the monopoly of the United Trust of India by opening up
of mutual funds to the private sector in 1992. Mutual funds have been permitted to open
offshore funds for the purpose of investing in equities in other jurisdictions. Another
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development which took place in 1992 was the opening up of the Indian capital market for
foreign institutional investors. The Indian corporate sector has been granted permission to
tap international capital markets through American Depository Receipts, Foreign Currency
Convertible Bonds, Global Depository Receipts and External Commercial Borrowings.
`Moreover, now Overseas Corporate Bodies and non-resident are allowed to invest in
Indian companies.
Integral aspects of future reform policies
Though it is quite impossible to prioritize the various aspects which are relevant for
reform, the author has mentioned a few critical elements which have been highlighted by
Y.V. Reddy in a lecture delivered by him.
Need for greater legislative measures
It is mandatory that financial reforms are accompanied by legislative measure
commensurate with these reforms to enable further progress. These are required mainly
with regard to ownership, development of financial markets, regulatory focus, and
bankruptcy procedures. Shortcomings in benefits of reforms such as in credit delivery
require changes in the legal framework. Furthermore, it is required to concentrate in
reduction of transaction costs in economic activity and to enhance economic incentives.
Increased enforceability cannot be substituted by the increase in the severity of penalties
in criminal proceedings. Lastly, in the institutional element, there is an increasing need to
clearly demarcate the roles and functions of the owner, financial intermediary and market
participant so as to “replace the joint-family approach that is a legacy of the pre-reform
framework”.
Fiscal Empowerment
Notwithstanding the existing level of fiscal deficit, which appears to be manageable, the
cushion available for meeting unforeseen circumstances is limited. This problem is acute
especially in regard to finances of states which have major structural problems and are in
constant need of fiscal support from the Central Government. Y.V. Reddy remarks that the
nature of fiscal dominance constrains the effectiveness of the monetary policy to meet
unforeseen contingencies as well as to main price stability and contain inflationary
expectations.
Reforms in the real sector
Reforms in the real sector would be necessary to bring about structural changes in the
Indian economy, particularly in domestic trade. Further growth can be successfully
achieved by liberalisation of the financial and external sector.
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The Board for Regulation and Supervision of Payment and Settlement Systems (BPSS), a
sub-committee of the RBI is the highest policy making body on payment systems in the
country. In India, the payment and settlement systems are regulated by the Payment and
Settlement Systems Act, 2007 (PSS Act).
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Electronic Payments
The initiatives taken by the RBI in the early-nineties focused on technology-based solutions
for the improvement of the payment and settlement system in the country.
In 2008, the RBI launched a new service known as National Electronic Clearing Service
(NECS). NECS (Credit) facilitates multiple credits to beneficiary accounts with destination
branches across the country against a single debit of the account of the sponsor bank.
Regional ECS (RECS)
Next to NECS, RECS has been launched during the year 2009.RECS, a miniature of the NECS
is confined to the bank branches within the jurisdiction of a Regional office of RBI.
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RTGS is a funds transfer systems where transfer of money takes place from one bank to
another on a "real time" and on "gross" basis. Settlement in "real time" means payment
transaction is not subjected to any waiting period. "Gross settlement" means the
transaction is settled on one to one basis without bunching or netting with any other
transaction. Once processed, payments are final and irrevocable. This was introduced in
2004.
The POS terminals help in carrying out cashless transactions at merchant outlets by
swiping credit/ debit cards on the POS machine.
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