FINANCIAL SYSTEM FY.B.F.

FINANCIAL SYSTEM

The term "finance" in our simple understanding it is perceived as equivalent to 'Money'. We read
about Money and banking in Economics, about Monetary Theory and Practice and about "Public
Finance". But finance exactly is not money, it is the source of providing funds for a particular
activity. Thus public finance does not mean the money with the Government, but it refers to
sources of raising revenue for the activities and functions of a Government. Here some of the
definitions of the word 'finance', both as a source and as an activity i.e. as a noun and a verb.

The American Heritage® Dictionary of the English Language, Fourth Edition defines the term as
under-

1:"The science of the management of money and other assets.";

2: "The management of money, banking, investments, and credit. ";
3: "finances Monetary resources; funds, especially those of a government or corporatebody"
4: "The supplying of funds or capital."

Finance as a function (i.e. verb) is defined by the same dictionary as under-

1:"To provide or raise the funds or capital for": financed a new car
2: "To supply funds to": financing a daughter through law school.
3: "To furnish credit to".

Another English Dictionary, "WordNet ® 1.6, © 1997Princeton University " defines the term as
under-

1:"the commercial activity of providing funds and capital"

2: "the branch of economics that studies the management of money and other assets"
3: "the management of money and credit and banking and investments"

The same dictionary also defines the term as a function in similar words as under-

1: "obtain or provide money for;" " Can we finance the addition to our home?"
2:"sell or provide on credit "

All definitions listed above refer to finance as a source of funding an activity. In this respect
providing or securing finance by itself is a distinct activity or function, which results in Financial
Management, Financial Services and Financial Institutions. Finance therefore represents the
resources by way funds needed for a particular activity. We thus speak of 'finance' only in
relation to a proposed activity. Finance goes with commerce, business, banking etc. Finance is
also referred to as "Funds" or "Capital", when referring to the financial needs of a corporate
body. When we study finance as a subject for generalising its profile and attributes, we
distinguish between 'personal finance" and "corporate finance" i.e. resources needed personally
by an individual for his family and individual needs and resources needed by a business
organization to carry on its functions intended for the achievement of its corporate goals.
FINANCIAL SYSTEM FY.B.F.M

India's Financial System

One of the major economic developments of this decade has been the recent takeoff
of India, with growth rates averaging in excess of 8% for the last four years, a stock
market that has risen over three-fold in as many years with a rising inflow of foreign
investment. In 2006, total equity issuance reached $19.2bn in India, up 22 per cent.
Merger and acquisition volume was a record $27.8bn, up 38 per cent, driven by a 371 per
cent increase in outbound acquisitions exceeding for the first time inbound deal volumes.
Debt issuance reached an all-time high of $13.7bn, up 28 per cent from a year earlier.
Indian companies were also among the world's most active issuers of depositary receipts
in the first half of 2006, accounting for one in three new issues globally, according to the
Bank of New York.
The questions and challenges that India faces in the first decade of the new
millennium are therefore fundamentally different from those that it has wrestled with for
decades after independence. Liberalization and globalization have breathed new life into
the foreign exchange markets while simultaneously besetting them with new challenges.
Commodity trading, particularly trade in commodity futures, have practically started
from scratch to attain scale and attention. The banking industry has moved from an era of
rigid controls and government interference to a more market-governed system. New
private banks have made their presence felt in a very strong way and several foreign
banks have entered the country. Over the years, microfinance has emerged as an
important element of the Indian financial system increasing its outreach and providing

much-needed financial services to millions of poor Indian households.

The economic development of a nation is reflected by the progress of the various economic units,
broadly classified into corporate sector, government and household sector. While performing
their activities these units will be placed in a surplus/deficit/balanced budgetary situations.

There are areas or people with surplus funds and there are those with a deficit. A financial
system or financial sector functions as an intermediary and facilitates the flow of funds from the
areas of surplus to the areas of deficit. A Financial System is a composition of various
institutions, markets, regulations and laws, practices, money manager, analysts, transactions and
claims and liabilities.
FINANCIAL SYSTEM FY.B.F.M

Financial System;

The word "system", in the term "financial system", implies a set of complex and closely
connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities
in the economy. The financial system is concerned about money, credit and finance-the three
terms are intimately related yet are somewhat different from each other. Indian financial system
consists of financial market,
financial instruments and financial intermediation. These are briefly discussed below;

FINANCIAL MARKETS:

A Financial Market can be defined as the market in which financial assets are created or
transferred. As against a real transaction that involves exchange of money for real goods or
services, a financial transaction involves creation or transfer of a financial asset. Financial Assets
or Financial Instruments represents a claim to the payment of a sum of money sometime in the
future and /or periodic payment in the form of interest or dividend.

Money Market- The money market ifs a wholesale debt market for low-risk, highly-liquid, short-
term instrument. Funds are available in this market for periods ranging from a single day up to a
year. This market is dominated mostly by government, banks and financial institutions.

Capital Market - The capital market is designed to finance the long-term investments. The
transactions taking place in this market will be for periods over a year.

Forex Market - The Forex market deals with the multicurrency requirements, which are met by
the exchange of currencies. Depending on the exchange rate that is applicable, the transfer of
funds takes place in this market. This is one of the most developed and integrated market across
the globe.

Credit Market- Credit market is a place where banks, FIs and NBFCs purvey short, medium and
long-term loans to corporate and individuals.
FINANCIAL SYSTEM FY.B.F.M

Constituents of a Financial System

FINANCIAL INTERMEDIARIES:

Having designed the instrument, the issuer should then ensure that these financial assets reach
the ultimate investor in order to garner the requisite amount. When the borrower of funds
approaches the financial market to raise funds, mere issue of securities will not suffice.
Adequate information of the issue, issuer and the security should be passed on to take place.
There should be a proper channel within the financial system to ensure such transfer. To serve
this purpose, Financial intermediaries came into existence. Financial intermediation in the
organized sector is conducted by a wide range of institutions functioning under the overall
surveillance of the Reserve Bank of India. In the initial stages, the role of the intermediary was
mostly related to ensure transfer of funds from the lender to the borrower. This service was
offered by banks, FIs, brokers, and dealers. However, as the financial system widened along
with the developments taking place in the financial markets, the scope of its operations also
widened. Some of the important intermediaries operating ink the financial markets include;
investment bankers, underwriters, stock exchanges, registrars, depositories, custodians, portfolio
managers, mutual funds, financial advertisers financial consultants, primary dealers, satellite
dealers, self regulatory organizations, etc. Though the markets are different, there may be a few
intermediaries offering their services in move than one market e.g. underwriter. However, the
services offered by them vary from one market to another.
 FINANCIAL SYSTEM FY.B.F.M

Intermediary Market Role

Stock Exchange Capital Market Secondary Market to securities

Corporate advisory services,

Investment Bankers Capital Market, Credit Market
Issue of securities
Subscribe to unsubscribed
Underwriters Capital Market, Money Market
portion of securities

Issue securities to the investors

Registrars, Depositories,
Capital Market on behalf of the company and
Custodians
handle share transfer activity

Primary Dealers Satellite Market making in government

Money Market
Dealers securities

Forex Dealers Forex Market Ensure exchange ink currencies

ROLE OF FINANCIAL INTERMEDIARIES

Financial Intermediaries are performing various roles in addition to what they used to do earlier
by innovating and upgrading themselves in many ways. Some of the important roles they are
expected to perform in the 21st century is to help in the reduction of Poverty, Restructuring of
firms in distress, Markets for firm's Assets and so on.

Introduction

The term financial intermediary may refer to an institution, firm or individual who performs
intermediation between two or more parties in a financial context. Typically the first party is a
provider of a product or service and the second party is a consumer or customer.

Financial intermediaries are banking and non-banking institutions which transfer funds from
economic agents with surplus funds (surplus units) to economic agents (deficit units) that would
like to utilize those funds. FIs are basically two types: Bank Financial Intermediaries, BFIs
(Central banks and Commercial banks) and Non-Bank Financial Intermediaries, NBFIs
(insurance companies, mutual trust funds, investment companies, pensions funds, discount
houses and bureaux de change).
FINANCIAL SYSTEM FY.B.F.M

Financial intermediaries can be:

 Banks;
 Building Societies;
 Credit Unions;
 Financial adviser or broker;
 Insurance Companies;
 Life Insurance Companies;
 Mutual Funds; or
 Pension Funds.

The borrower who borrows money from the Financial Intermediaries/Institutions pays higher
amount of interest than that received by the actual lender and the difference between the Interest
paid and Interest earned is the Financial Intermediaries/Institutions profit.

Financial Intermediaries are broadly classified into two major categories:

1) Fee-based or Advisory Financial Intermediaries

2) Asset Based Financial Intermediaries.

Fee Based/Advisory Financial Intermediaries: These Financial Intermediaries/ Institutions

offer advisory financial services and charge a fee accordingly for the services rendered.

Their services include:

i. Issue Management
ii. Underwriting
iii. Portfolio Management
iv. Corporate Counseling
v. Stock Broking
vi. Syndicated Credit
vii. Arranging Foreign Collaboration Services
viii. Mergers and Acquisitions
ix. Debentive Trusteeship
x. Capital Restructuring

ASSET-BASED Financial Intermediaries: These Financial Intermediaries/Institutions finance

the specific requirements of their clientele. The required infra-structure, in the form of required
asset or finance is provided for rent or interest respectively. Such companies earn their incomes
from the interest spread, namely the difference between interest paid and interest earned.

The financial institutions may be regulated by various regulatory authorities, or may be required
to disclose the qualifications of the person to potential clients. In addition, regulatory authorities
may impose specific standards of conduct requirements on financial intermediaries when
providing services to investors.
FINANCIAL SYSTEM FY.B.F.M

Role of Financial Intermediaries for Poverty Reduction

Finding innovative ways to provide financial services to the poor so that they can improve their
productive capacity and quality of life is the role of the financial intermediaries in the
21st century.

Most of the poor live in the rural areas, and are engaged in agricultural activities or a variety of
micro-enterprises.

 The poor are vulnerable to income fluctuations and hence are exposed to risk.
 They are unable to access conventional credit and insurance markets to offset this.

Most formal financial institutions do not serve the poor because of perceived high risks, high
costs involved in small transactions, perceived low profitability, and most importantly, inability
to provide the physical collateral generally required by such institutions. About 95 percent of
poor households still have little access to institutional financial services. Most poor and low-
income households continue to rely on meager self-finance or informal sources of finance.

Providing efficient micro-finance to the poor is important for many reasons:

 Efficient provision of savings, credit and insurance facilities can enable the poor to
smoothen their consumption, manage risks better, gradually build assets, develop micro-
enterprises, enhance income earning capacity, and generally enjoy an improved quality of
life.
 Efficient micro-finance services can also contribute to improvement of resource
allocation, development of financial markets and system, and ultimately economic
growth and development.
 With improved access to institutional micro-finance, the poor can actively participate in
and benefit from development opportunities.
 The latent capacity of the poor for entrepreneurship would be encouraged with the
availability of small-scale loans and would introduce them to the small-enterprise sector.
 This could allow them to be more self-reliant, create employment opportunities, and, not
least, engage women in economically productive activities.
 Micro-finance activities prove that poor households can and do save rather than borrow,
and it is possible to successfully mobilize funds from poor households.
 Another important fact is that contrary to expectations, the poor are creditworthy and
financial services can be provided to the poor on a profitable basis at low transaction
costs without having to rely on physical collateral.
 Finally, micro-finance services contribute to the development of rural financial markets
and to strengthening the social and human capital of the poor.
FINANCIAL SYSTEM FY.B.F.M

There are many problems that should be resolved for the further development of micro-finance in
Poverty Reduction:

 Policy environments in many developing countries are not favorable for the sustainable
growth of micro-finance. In particular, interest rate ceilings and subsidized credit limit
the ability of micro-finance institutions to provide services to the poor.
 Inappropriate and extensive intervention by governments in micro-finance undermines its
efficient operation.
 Inadequate financial infrastructure is another major problem in the region. Financial
infrastructure includes legal, information, and regulatory and supervision systems.
 In addition, most microfinance institutions do not have adequate capacity to expand the
scope and outreach of services on a sustainable basis to potential clients. Specifically,
they lack the ability to leverage funds, provide services compatible with the potential
clients' characteristics, adequate network and delivery mechanisms, and so forth.

Financial Intermediaries as Markets for Firm's Assets

 Financial intermediaries appear to have a key role in the restructuring and liquidation of
firms in distress. In particular, there is rich evidence that financial intermediaries play an
active role in the reallocation of displaced capital, meant both as the piece-meal
reallocation of assets (such as the redeployment of individual plants) and, more broadly,
as the sale of entire bankrupt corporations to healthy ones. A key part of reorganization
under main bank supervision or management is the implementation of a plan of asset
sales with proceeds typically used to recover bank loans. In Germany a function of banks
during reorganizations is to "use bank contacts to facilitate a merger with another firm as
a means of resolving the crisis". Knowing possible synergies among firms, banks can
suggest solutions for the efficient reallocation of assets and of corporate control and that
in several countries there is widespread anecdotal evidence, though not quantitative one,
on this role of banks. Healthy firms search around for the displaced capital of bankrupt
firms but matching is imperfect and firms can end up with machines unsuitable for them.

 Financial intermediaries arise as internal, centralized markets where information on

machines and buyers is readily available, allowing displaced capital to migrate towards
its most productive uses. Financial intermediaries can perform this role by aggregating
the information on firms collected in the credit market. The function of intermediaries as
matchmakers between savers and firms in the credit market can support their function as
internal markets for assets. Intuitively, by increasing the number of highly productive
matches in the credit market, intermediaries increase the share of highly productive
second hand users in the decentralized resale market. This improvement in the quality of
the decentralized secondary market reduces the incentive of firms to address financial
intermediaries for their ability as re-deployers. However, by increasing the number of
highly productive matches in the credit market, intermediaries create also wealthy buyers
without assets and contribute to decrease the thickness of the decentralized resale market.
This makes the decentralized market less appealing and increases the incentive of firms
to use intermediaries as resale markets. When the quality improvement in the
FINANCIAL SYSTEM FY.B.F.M

decentralized market is not too big and the second effect prevails, better matchmaking in
the credit market supports the function of intermediaries as internal markets for assets.

Role of Pension Funds as Financial Intermediaries

Pension funds may be defined as forms of institutional investor, which collect pool and invest
funds contributed by sponsors and beneficiaries to provide for the future pension entitlements of
beneficiaries. They thus provide means for individuals to accumulate saving over their working
life so as to finance their consumption needs in retirement, either by means of a lump sum or by
provision of an annuity, while also supplying funds to end-users such as corporations, other
households (via securitized loans) or governments for investment or consumption.

We now assess pension funds relative to the various financial functions one by one, in order
correctly to identify the role funds play in stimulating change in the financial landscape.

 Clearing and settling payments: Pension funds have had an important indirect role in
boosting the efficiency of the financial systems, by influencing the structure of securities
markets. By demanding liquidity, pension funds help to generate it, firstly by their own
activity in arbitrage, trading and diversification, secondly via the fact that liquidity is a
form of increasing return to scale, as larger markets in which pension funds are active
attract more trading, reducing costs and improving liquidity further. A third effect arises
from funds' countervailing power as they press for improvements in market structure and
regulation. These include deregulation and reduction in commissions, advanced
communication and information systems, reliable clearing and settlements systems, and
efficient trading systems, all of which help to ensure that there is efficient arbitrage
between securities and scope for diversification.

 Provision of a mechanism for pooling of funds and subdivision of shares: Pension

funds offer much lower costs of diversification by proportional ownership. Pension funds
can also offer the possibility of investing in large denomination and indivisible assets
such as property which are unavailable to small investors. Furthermore, pension funds
reduce the cost of transacting by negotiating lower transactions costs and custodial fees.
The direct participation costs to households of acquiring information and knowledge
needed to invest in a range of assets, as well as in undertaking complex risk trading and
risk management are reduced (although costs of monitoring the asset manager remain).
The net effect is that individuals are likely to switch to pension funds from direct
holdings of securities and from bank deposits.

 Provision of ways to transfer economic resources: Pension funds act in an unusual

manner in this regard, in that they may increase the volume of saving besides the
disposition of household funds. At a micro level, company or other obligatory pension
funds can implement enforced saving by deferring wages and salaries, thereby reducing
risk of a low replacement ratio. At a macro level, the increase in saving is not usually
one-to-one, as increased contractual saving via pension funds is typically partly or wholly
FINANCIAL SYSTEM FY.B.F.M

offset by declining discretionary

saving. Pension funds
increase the supply of long term funds to capital markets, and reduce bank deposits, even
abstracting from changes in aggregate saving, so long as households do not increase the
liquidity of the remainder of their portfolios fully to offset growth of pension assets.

 Provision of ways to manage uncertainty and control risk: Pension funds provide risk
control directly to households via the forms of retirement income insurance they provide,
an advantage which largely reflects the unusual (among financial intermediaries) link of
pension funds to employers. To assist in undertaking this risk control function they
diversify assets as noted above and also act in securities and derivatives markets to hedge
and control risk.

 Providing price information: pension funds seek publication of information from

companies directly, and press for market-value based accounting systems. This is of
benefit to all users of the market - although it disadvantages banks, which in making
loans tend to rely on private information not available to other investors.

 Providing ways to deal with incentive problems: Dealing with incentive problems in
equity finance is one of the most crucial aspects of pension funds' activities as financial
intermediaries. The basic issue in corporate governance is simply stated. Given the
divorce of ownership and control in the modern corporation, principal-agent problems
arise, as shareholders cannot perfectly control managers acting on their behalf. Managers,
who have superior information about the firm and its prospects and at most a partial link
of their compensation to the firms' profitability, may divert funds in various ways away
from those who sink equity capital in the firm, notably expropriation or diversion to
unattractive projects from a shareholder's point of view. Principal-agent problems in
equity finance imply a need for shareholders such as pension funds to exert control over
management, while also remaining sufficiently distinct to let them buy and sell shares
freely without breaking insider trading rules. If difficulties of corporate governance are
not resolved, these market failures in turn also have implications for corporate finance in
that equity will be costly and often subject to quantitative restrictions. Effectiveness of
corporate governance is typically enhanced by presence of large investors, such as
pension funds. They will have the leverage to oblige managers to distribute profits to
providers of external finance either directly or via the threat to sell to takeover raiders.
They are needed because individual investors may find it difficult to enforce their rights,
owing to difficulty of acting in a concerted manner against management and related free
rider problems which make it not worthwhile for an individual to collect information and
monitor management. Since pension fund stakes are typically limited to 5% of a
company, they also avoid the "downside" to dominant investors, who if they own a large
proportion of the company may override the interests of minority shareholders and could
even reduce measured profitability.
FINANCIAL SYSTEM FY.B.F.M

FINANCIAL INSTRUMENTS

Money Market Instruments

The money market can be defined as a market for short-term money and financial assets that are
near substitutes for money. The term short-term means generally a period upto one year and near
substitutes to money is used to denote any financial asset which can be quickly converted into
money with minimum transaction cost.

Some of the important money market

instruments are briefly discussed below;
1. Call/Notice Money
2. Treasury Bills
3. Term Money
4. Certificate of Deposit
5. Commercial Papers

1. Call /Notice-Money Market

Call/Notice money is the money borrowed

or lent on demand for a very short period. When money is borrowed or lent for a day, it is known
as Call (Overnight) Money. Intervening holidays and/or Sunday are excluded for this purpose.
Thus money, borrowed on a day and repaid on the next working day, (irrespective of the number
of intervening holidays) is "Call Money". When money is borrowed or lent for more than a day
and up to 14 days, it is "Notice Money". No collateral security is required to cover these
transactions.

2. Inter-Bank Term Money

Inter-bank market for deposits of maturity beyond 14 days is referred to as the term money
market. The entry restrictions are the same as those for Call/Notice Money except that, as per
existing regulations, the specified entities are not allowed to lend beyond 14 days.

3. Treasury Bills.

Treasury Bills are short term (up to one year) borrowing instruments of the union government. It
is an IOU of the Government. It is a promise by the Government to pay a stated sum after expiry
of the stated period from the date of issue (14/91/182/364 days i.e. less than one year). They are
issued at a discount to the face value, and on maturity the face value is paid to the holder. The
rate of discount and the corresponding issue price are determined at each auction.
FINANCIAL SYSTEM FY.B.F.M

4. Certificate of Deposits

Certificates of Deposit (CDs) is a negotiable money market instrument nd issued in

dematerialized form or as a Usance Promissory Note, for funds deposited at a bank or other
eligible financial institution for a specified time period. Guidelines for issue of CDs are presently
governed by various directives issued by the Reserve Bank of India, as amended from time to
time. CDs can be issued by (i) scheduled commercial banks excluding Regional Rural Banks
(RRBs) and Local Area Banks (LABs); and (ii) select all-India Financial Institutions that have
been permitted by RBI to raise short-term resources within the umbrella limit fixed by RBI.
Banks have the freedom to issue CDs depending on their requirements. An FI may issue CDs
within the overall umbrella limit fixed by RBI, i.e., issue of CD together with other instruments
viz., term money, term deposits, commercial papers and intercorporate deposits should not
exceed 100 per cent of its net owned funds, as per the latest audited balance sheet.

5. Commercial Paper

CP is a note in evidence of the debt obligation of the issuer. On issuing commercial paper the
debt obligation is transformed into an instrument. CP is thus an unsecured promissory note
privately placed with investors at a discount rate to face value determined by market forces. CP
is freely negotiable by endorsement and delivery. A company shall be eligible to issue CP
provided - (a) the tangible net worth of the company, as per the latest audited balance sheet, is
not less than Rs. 4 crore; (b) the working capital (fund-based) limit of the company from the
banking system is not less than Rs.4 crore and (c) the borrowal account of the company is
classified as a Standard Asset by the financing bank/s. The minimum maturity period of CP is 7
days. The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other
agencies. (for more details visit www.indianmba.com faculty column)

Capital Market Instruments

The capital market generally consists of the following long term period i.e., more than one year
period, financial instruments; In the equity segment Equity shares, preference shares, convertible
preference shares, non-convertible preference shares etc and in the debt segment debentures, zero
coupon bonds, deep discount bonds etc.

Hybrid Instruments

Hybrid instruments have both the features of equity and debenture. This kind of instruments is
called as hybrid instruments. Examples are convertible debentures, warrants etc.

FINANCIAL SERVICES:

Service sector in general is emerging as the largest contributing forces to the growth of economy.
With opening up of the economy at global level the switch over from manufacturing to service
sector has experienced intense attraction and interest the world over in general and I giant Asian
FINANCIAL SYSTEM FY.B.F.M

Economy like India in particular. "TRIMS" – Trade related investment measures have played
key role in spurring the growth of service sector. The traditional saying is that "Everything in

excess is poison". It could have been a true principle in the traditional dormant economy but the
existing scenario – the prevailing trends suggest otherwise. Presently there does no exist any
validity to hear that "Enough of bull". The experts in financial markets firmly express the
opinion that, "If you have heard it on the streets, turns a deaf ear to it". This in respect reminds us
of very know old statement from John F Kennedy that "The one unchangeable certainty is that
nothing is unchangeable and certain".

Since 1990s the Indian Financial Services has comparatively undergone to complete and a new
face of change as compared to other early days by which it was exactly controlled by commercial
banks and other financial institutions which are the main source of funds for the priority sectors.

However, before the liberalization of the Indian economy was engulfed with retarded growth due
to: too much regulations of the interest rates, price of securities, lack of enough financial
instruments in the required large scale, poor credit rating, too much regulation of foreign
exchange market, mitigated or lack of reliable information about international financial sectors
development, under developed government securities market and finally poor debt instruments.
Besides the above, due to the comprehensive step taken by the Indian government in the
economic liberation, we have equally to accept that the entire financial sector has undergone a
wide and vast change.

In addition to the above we have to take into account the following sources of revenue as [a]
Fund based source & [b] Fee based source

The fund based income is that revenue gained from interest, lease rental, and as well as income
from capital market investments. Also on the other side we have to know that fee-based income
is that source gained from banking, advisory services, custodial services and many more.

The financial intermediaries have to took various innovation in the financial services are to poor
and comparatively low profitability, keen competitions, liberalization of the Indian economy.
The advancement of the communication technology, leads to more demand on customer service,
globalization of the world economy and many more.

Merchant Banking:

The merchant banker are those financial intermediary involved with the activity of transferring
capital funds to those borrowers who are interested in borrowing.

The activities of the merchant banking in India is very vast in nature of which includes the
following

a) The management of the customers securities

b) The management of the portfolio,
FINANCIAL SYSTEM FY.B.F.M

c) The management of projects and counseling as well as appraisal

d) The management of underwriting of shares and debentures

e) The circumvention of the syndication of loans

f) Management of the interest and dividend etc

Factors responsible for the Changes:

Globalization of Indian Economy has made the whole economy open, which has more
multinational player in the era of the financial services? This has resulted in to the emergence of
the global investment in financial sector. Government has now open up the doors of investments
especially in the area of banks and insurance, which leads to competitive environment for the
present players. Now they have to bring something new which is efficient and best services to
live in the competitive environment.

Competition arising out of Private Company Participation is due to the liberalization of the
economy. Now along with the public/government players, private players are also offering
financial services and instruments, which are more innovative and different than the earlier
offering. All around, there is a fresh thinking on the financial products, structure of banking and
insurance instruments with value creation. Financial markets are being redefined, reinvented and
reconfigured on a persistent basis.

Changing Customer Demographics:

If we look at the all-growing economies like China, Germany and Brazil, India has 35% of the
population in the age group of 15years to 34 years. It is estimated that by 130mn plus people get
added to working population by 2009 with 55 million families (320 million people) will be
added in the middle-income group (0.1 to 0.3 Million Rs). The demographic change leads to the
change in the need of the customer.

Changing Customer Needs customers have larger segment in corporate decision-making they
are the final judges of the every single activity offered by the marketer. Banks in India have
traditionally offered mass banking products. Financial market has turned into a buyer's market.
Market focus is shifting from mass banking products to class banking with introduction of value
added products. Today, financial institutions are co-designing the products/services with their
customers and striving to provide them with global solutions

Technology Improvements Technology is also helping market players redefine the way they
have been operating in the market. In today's time it becomes vary easy for a customer to transfer
a fund from one location to another location with CLICK of Mouse. Availability of the concepts
like phone banking, anytime banking etc. has become possible because of the technological
developments only.
FINANCIAL SYSTEM FY.B.F.M

Government Reforms Government is major decision player in the financial market. It decides
the proportion of the investment limits as well as the regulation and control. In last ten years
government is designing its policy with more liberal and competitive content. Which it are
welcome trends for the emerging financial services.

Heightened focus on customer relations the bank of the future has to be essentially a marketing
organization that also sells banking products. New distribution channels are being used; more &
more banks are outsourcing services like disbursement and servicing of consumer loans, Credit
card business. Direct Selling Agents (DSAs) of various Banks go out and sell their products.
They make house calls to get the application form filled in properly and also take your passport-
sized photo.

Revolution in Banking Sector:

Banking in India originated in the first decade of 18th century with the General Bank coming into
existence in 1786. Bank of Hindustan followed this. Both these banks are now defunct. The
oldest bank in existence in India is the State Bank of India being established as the Bank of
Calcutta in Calcutta in June 1806.

In the early 1990s the then Narasimha Rao government embarked on the policy of liberalization
and gave license to small number of private banks, which came to be known as new generation
tech-savvy banks such as ICICI Bank and HDFC Bank. Currently in 2005, banking in India is
considered fairly matured in terms of supply, product range and reach-even though reach in rural
India still remains a challenge for the private sector and foreign banks. With the growth of Indian
economy expected to be strong for quite some time especially in its service sector, the demand
for banking services specially retail banking, mortgage and investment services are expected to
be strong.

The emerging areas in banking services are;

 2 in 1 Accounts
 Overdrafts (OD)
 ATMs
 Net Banking
 Credit Card

2 in 1 Accounts

2 in 1 accounts are available at many of the foreign and private banks. It amalgamates the
features of a savings or a current account and a fixed deposit account. As soon as one opens 2 in
1 accounts with the bank, deposit starts earning a rate of interest higher than that of a plain
savings account. The rate of interest can be equivalent to prevailing rates for Fixed Deposit.
Customers can choose the sweep option – Term Deposit or Mutual Fund, based on their
requirements.
FINANCIAL SYSTEM FY.B.F.M

Overdraft [OD]

Overdraft is the agreed amount by which a bank account can be overdrawn. When the amount of
money withdrawn from the bank account is greater than the amount actually available in the
account the excess is known as the overdraft and the account is said to be overdrawn. If agreed
by the bank in advance this is essentially a form of loan facility and there is a particular interest
rate attached with the overdrawn amount.

ATMs

Automated Teller Machines has revolutionary's entire banking sector. Currently there are more
than 16000 ATMs in India fulfilling the daily requirement of money to a common man. The
story of the humble cash-dispensing machine started around three decades back. Since then they
have become common site in metros and semi metro cities. ATM allows a customer to do
number of banking functions like withdrawing cash, making balance inquiries, transferring
money from one account to another account, request for a Cheque book and statements, Utility
Bill Payment – like electricity bills, Credit Card payments etc by using a plastic, magnetic strip
card and personal identification number issued by financial institution.

Net Banking

Internet technology has invaded the portal of our banking institutions. No doubt innovation like
ATM have considerably put customer at ease in the recent past, but with net banking the
customer will be able to transact with the help of the mouse. The services offered enable one to
check credit card transactions, paying bills, transferring fund between accounts in two different
banks, and scheduling future payments and transfers. A gradual increase in net banking is logical
as the need to minimize costs catches attention. A North American Internet Banking survey done
by management consultancy Booz Allen & Hamilton in 2000 revealed that the cheapest way of
banking is internet banking.

Credit Cards

It is estimated in the year 2004; the total credit card market in the country was at 17 million
cards. The credit card industry is growing at 30 – 35 % per annum at present. The size of Indian
credit card market is estimated to be around $4bn by end of 2010.

Four banks have now crossed the 2 million card base, with ICICI bank leading the pack at 4
million cards followed by Citi bank at 2.8 million, HDFC bank at 2.2 million and SBI card just
over 2 million. Industry average for spends on credit a card two years ago was just around Rs
16,000 per card that has now increased to around 20,000 per card. Rapid Advancement in
Technology, Easier access to knowledge and globalization have changed entire banking sector.
FINANCIAL SYSTEM FY.B.F.M

Because of these factors today customer is sophisticated and well aware about the financial
needs.

Leasing Services

The Indian company investors must be acknowledged that lease is that agreement under which
the company or Indian firm acquire the exact right and make use of certain capital asset on the
consideration of payment of rental charges. The Indian corporate company must equally known
that it cannot equally know that it cannot acquire any kind of ownership to such an asset apart
from making use of it. The user comparatively pays all the expected operating costs and also the
maintenance expenses.

The main corporate companies must equally take into the consideration that developed countries
like America, United Kingdom the companies of such a countries are commonly depending on
the leasing factor. In India since the era of liberalization, many of the Indian companies have
equally been involved in the leasing transactions. On the other side, many financial institutions
and even the commercial banks in the Indian financial sector have comparatively been accepted
over the same transactions.

Mutual Funds Services

The Indian corporate companies must equally be informed that the mutual funds comprises of the
exact funds gained by pooling all the public savings. The mutual funds are comparatively
invested in those portfolios, which are commonly diversified in nature with the main objectives
of sharing the risk. The Indian small-scale investors cannot be able to get their funds from the
comparative big corporate companies can equally gain there working funds from the mutual
funds.However, the modern concept of the mutual funds was developed in1968 in London by the
foreign and colonial government trust of London.

By which it gained its invention in India in early 1980, even if it was exactly started in 1964 by
the unit trust of India.

In addition to the above, the mutual funds can be grouped into [a] Close ended funds & [b] Open
ended funds. The Indian corporate companies can only benefits from the mutual funds on
gaining savings for investment, better yield low cost on investment, tax benefits, flexible on
investment, promoting industrial development reducing the cost of new issue and many more
other advantages.

On the other side, Indian corporate companies must be informed on the kind of risks involved
with the mutual funds like market risks, scheme risks, business risk, investment risks and even
the political nature of risks. While the investors are selecting the funds must take into account the
objectives of the fund, consistency of performance of the funds. Historical background of the
funds, cost of operation, capacity for innovation, the investors servicing, market trends, and even
the transparence of the fund management. For the Indian mutual funds to have good future there
must be full support of SEBI better control of capital issue, better interest rate, good PE ratio,
investors must have good choice, tax concessions, and many more.
FINANCIAL SYSTEM FY.B.F.M

Hire Purchase Services

In the hire purchase kind of transaction is that method of selling by which goods are left out on
hiring by the Indian corporate company to the purchaser by which the hirer is comparatively
required to the payment on an agreed sum of amount in the system of periodical installments. In
the hire purchase the Indian corporate companies must know that the ownership of such kind of
the property exactly remain under the control of the creditor who normally passes the right to
hirer on the condition of payment of the last agreed sum of money in installment.

The Indian corporate company must know that legally, payment is made in installment over the
agreed specified period, possession of the same right is delivered to the purchaser during the time
of agreement, the property passes to the exact purchaser on the agreed last installment, and the
hirer has a right to return the property without further installment. In addition to the above, the
Indian corporate company must know that the agreement must comparatively contain the nature
of the goods as described in manner so that to identify them easily, the nature of the hire
purchase price, the date of commencement and finally the extend or number of installments.

Venture Capital Services

The venture capital is that investment in the new Indian enterprises without stability in growth.
It's that environment of capital, shareholding and even the setting up of small firms, which are
comparatively specializing, in same new technological ideas in the commercial sectors.

The venture capital is equity participation, it's of high risk in nature, it's also available only for
commercialization of new technologies and it's the exact promoter of the projects, and it's
continuous in nature and input of the firm. The Indian corporate companies must equally know
that venture capital involves the development of project idea, implementation, fledging or
additional financing, and establishment stage.

The main importance of venture capital to Indian, corporate companies are the reduction of risk,
easy to analyze the business prospects and to assume the investors on affairs of the business. The
Indian methods of venture financing are equity participation, income notes, the conventional
loans and even the conditional loans. In order to promote the venture capital growth in India,
there must be tax concessions for capital gains, high level development of capital market, giving
of fiscal incentives to Indian corporate companies, high level participation of the private sectors
the improving and reviewing of the existing laws and limited partnership and many more.

Discounting, factoring and forfeiting services

Due to the exact trade transaction the trade bill comparatively arises, the Indian corporate
companies must take into consideration that the supplier of the exact goods draws bill which is
based on the purchase for the invoice price of goods sold on credit method of which is drawn on
the short period of time. The buyer pays the amount on the exact date by which the supplier of
goods has to await until the expiry of the exact bill. However, the banks provides the cash
FINANCIAL SYSTEM FY.B.F.M

discounting based on the exact trade bills by which they deduct certain charges as discount based
on the amount of the bill and credit balance of the customers account.

Factoring

Factoring is to get thing being done. The ward factor means to mark or to do according to R.W.
Johnson factoring is a service involving the purchase by financial organization, called a factor of
receivables owned by manufacturers and distributors by the customers with the factor assuming
full credit and collection responsibilities.

The main conditions of factoring that the Indian corporate companies must know are these must
be assignment of debt that has to be in favour of the factor. The selling limits for the client, the
factor must have recourse to the client in the case of non-payment by the customer; the factor
will equally have recourse in case of non-payment, details on payment for the services, interest
and limit of any overdraft facility charged. The Indian corporate companies must be well
informed about the types of factoring as full service, recourse factoring, maturity, bulk, invoice,
agency and also international factoring. At the same time the exact cost of factoring like the
pricing, fee, discount, accounting system must be taken into consideration.

Forfeiting

Forfeiting is the French term means "to give something" or "give one's right". Generally the term
forfeit is non-recourse purchase by the commercial bank or any other financial intermediaries or
institutions receivables that equally arises from the export of the goods.

Securitization of Debt Services

The securitization is that process by which the liquidating of the liquid and the long term assets
of the Indian corporate companies like the loans and receivables by the issuing marketable
securities against the same. However, the Indian corporate companies must know that
securitization is that technique by which the exact long term, non-negotiable instruments are
equally converted into securities of such kind of small value in nature which can be easily
transacted in the commercial capital market.

In India, apart from the above, there is low and unpopularity of securitization due to introduction
of it as it's a new idea or concept to India, heavy stamp duty and comparative registration fees
imposed by the Indian government, complicated and also legal transfer procedure the difficulty
in the assignment of debts. Also there is poor standard of loan documentation, problem of
inadequate credit rating system, poor accounting procedure and lack of comprehensive guidance.
FINANCIAL SYSTEM FY.B.F.M

Derivatives

The derivatives are those instruments, which are commonly used to derive therein-exact value of
underlying asset of the financial institutional corporate companies. The derivatives
comparatively may involve the payment or receipt of the value or income created by the
underlying assets. The main factors that are responsible for the slow growth of derivatives in
India and high level of misconception of the derivatives, the derivatives lends themselves to
leveraging, the nature of the off balance sheet, items, poor accounting system, speculative
mechanism and finally poor infrastructure system.

Credit Rating Services

According to Moody's Rating are designed exclusively for the purpose of grading bonds
according to their investments qualities". Also according to the Australian Ratings "A corporate
credit rating provides lenders with a simple system of gradation by which the relative capacity of
companies to make timely repayment of interest and principal on a particular type of debt can be
noted".

The main credit ratings in India are credit rating information service ltd (CRISIL), investment
information and credit rating agency of India (ICRA), Credit Analysis and Research (CARE),
and Duff Phelps Credit Rating Pvt. Ltd (DCR India).

FINANCIAL SERVICES RISK:

Today financial services companies operate in increasingly complex, competitive and global
markets. The ability to manage risks across geographies, products, asset classes, customer
segments and functional departments is of paramount importance and inability to manage the
risk can cause the irreparable damage and financial risks are increasing day by day especially in
insurance, commercial banking and investment banking. The objective of this paper is to give the
overview if risk in financial services.

The art of managing risk is more challenging than ever. Risk managers face a wide range of
demands, from working with multiple variables to finding technology solutions that generate
comprehensive risk analysis. Now question arises

What is risk.

Risk is exposure to uncertainty.

FINANCIAL SYSTEM FY.B.F.M

Thus, risk has two components: Uncertainty and Exposure to that uncertainty. In financial
services a spectator is like a person who is going to jumps out of an airplane with a parachute on
his back, he may be uncertain as to whether or not the chute will open. He is taking a risk
because he is exposed to that uncertainty. If the chute fails to open, he will suffer personally. The
financial services industry is primarily concerned with financial risk which is financial exposure
to uncertainty Types of financial risk

Main types of risk are:

Credit risk : Credit risk is risk resulting from uncertainty in a counterparty's ability or
willingness to meet its contractual obligations. A housing finance company extends a housing
loan to a client. Because the client could fail to make timely principal or interest payments, the
housing finance company faces a credit risk.

Operational risks: During the 1990s, financial institutions started to focus attention on the risks
associated with their back office operations— what came to be called operational risks or
operational risk are all risks other than market or credit risks. A broker's back office fails to catch
a discrepancy between a reported trade and a confirmation from the counterparty. Ultimately, the
trade could be disputed, causing a loss.

Market risks : Market risk is the financial risk of uncertainty in the future market value of a
portfolio of assets and/or liabilities. Institutions can actually reduce these risks simply by
researching them. A brokerage firm can reduce market risk by being knowledgeable about the
FINANCIAL SYSTEM FY.B.F.M

markets it operates in.

Market risk exist in many forms.

Financial Institutions : Risks arises from financial transactions entered into for the purpose of
facilitating a client's requirements.

Investor : the exposure arises from the risk of loss in value of investments (directly or indirectly
through derivative products) from adverse movements in the value of asset.

Manufacturing Companies : the risk relates to the financial attributes of business transactions.

Liquidity risk : is financial risk from a possible loss of liquidity. There are two types of liquidity
risk:

Specific liquidity risk is the risk that a particular institution will lose liquidity. This might
happen if the institution's credit rating fell or something else happened which might cause
counterparties to avoid trading with or lending to the institution.

Systemic liquidity risk :affects all participants in a market. It is the risk that an entire market
will lose liquidity. Financial markets tend to lose liquidity during periods of crisis or high
volatility.