Financial Institutions

Financial Institutions are intermediaries that

mobilize the savings and facilitate the
allocation of funds in an efficient manner.

These are classified as:

Banking Institutions
Non-Banking Financial Institutions
Term Finance Institutions
Specialized Finance Institutions
Investment Institutions
State Level Financial Institutions
 Banking Institutions are creator of credit
while Non-Banking Financial Institutions
are Supplier/Spreader of credit.
In India, Non-Banking Financial Institutions
namely the
1.Development Financial Institutions (DFIs)
2.Non Banking Financial Companies (NBFCs)
3.Housing Finance Companies (HFCs) are the
major institutional purveyors of credit.
 Financial institutions are further classified
as
1. Term Finance Institutions such as
. Industrial Development Bank of India
(IDBI)
. Industrial Credit and Investment
Corporation of India (ICICI)
. Industrial Financial Corporation of India
(IFCI)
. Small Industries Development Bank of
India (SIDBI)
. Industrial Investment Bank of India (IIBI).
2. Specialized finance institutions like
Export Import Bank of India (EXIM)
Tourism Finance Corporation of India
(TFCI)
ICICI Venture
Infrastructure Development Finance
Company (IDFC) and
3. Sectoral financial institutions such as
National Bank for Agricultural and Rural
Development (NABARD)
National Housing Bank (NHB).
4.Investment institutions in the
business of mutual funds (UTI, Public
Sector and Private Sector Mutual
Funds) and insurance activity (LIC,
GIC and its subsidiaries) are also
classified as financial institutions.
5. State level financial institutions such
as
State Financial Corporation
State Industrial Development Corporation
(SIDCs) which are owned and managed by
the State Governments.

Financial Institutions act as Financial

Intermediary which performs the role of
efficient allocation of funds, when there are
conditions that make it difficult for lenders
or investors of funds to deal directly with
borrowers of funds in financial markets.
 The role of financial intermediaries is to
create more favourable transaction terms
than could be realized by lenders/investors
and borrowers dealing directly with each
other in the financial market.
Financial institutions are engaged in following
functions:
Risk reduction via diversification
Facilitating the trading of financial
assets for the financial intermediarys
customers through
brokeringarrangements.
Providing investment advice to
customers.
Manage the financial assets of
 Non banking financial
companies
Definition of Non-banking Finance
Company, A Non-Banking Financial
Company (NBFC) is a company
registered under the Companies Act,
1956 and is engaged in the business
of loans and advances, acquisition of
shares, securities, leasing, hire-
purchase, insurance business, and
chit business.
 A non banking institution which is a
company and which has its principal
business of receiving deposits under
any scheme or arrangement or any
other manner, or lending in any
manner is also a non-banking
financial company (residuary non
banking company).
 Type of NBFC
Equipment Leasing Companies
Hire Purchase Finance Companies
Loan Companies
Investment Companies
Residuary Non-Banking Companies
Miscellaneous Non-Banking Companies (Chit Fund)
Mutual Benefit Finance Companies (Nidhis )
Micro financial companies (equitas, bharat
financial,ujjivan)
Housing Finance Companies
Insurance Companies
Stock Broking Companies
Merchant Banking Companies
 Non-Banking Financial Companies - Principal Business

Non-Banking Financial Companies : Non-

Banking Financial Company In terms of
the Section 45-I(f) of the RBI Act, 1934 as
amended in 1997, their principal
business is that of a financial institution
as defined in Section 45 I(c) or that of
receiving deposits under any scheme or
lending in any manner.
Equipment leasing company (EL) :
Equipment leasing or financing of such
activity.
 Hire purchase finance company (HP)
: Hire purchase transaction or
financing of such transactions.
Investment company (IC): Acquisition
of securities and trading in such
securities to earn a profit.
Loan company (LC) : Providing
finance by making loans or
advances, or otherwise for any
activity other than its own; excludes
EL/HP/HFCs.
 Mutual benefit financial company
(MBFC) i.e. Nidhi Company Means any
company which is notified by the
Central Government under Section
620 A of the Companies Act 1956 (1 of
1956).
Housing finance company (HFC): The
financing of the acquisition or
construction of houses including the
acquisition or development of plots of
land. These companies are supervised
by the National Housing Bank.
 Residuary non-banking company
(RNBC) : Company which receives
deposits under any scheme or
arrangement, by whatever name
called, in one lump-sum or in
instalments by way of contributions
or subscriptions or by sale of units or
certificates or other instruments, or
in any manner. These companies are
NBFCs but do not belong to any of
the categories as stated above.
 Miscellaneous non-banking company
(MNBC) i.e. Chit Fund Company : Managing,
conducting or supervising as a promoter,
foreman or agent of any transaction or
arrangement by which the company enters
into an agreement with a specified number
of subscribers that every one of them shall
subscribe a certain sum in instalments over
a definite period and that every one of such
subscribers shall in turn, as determined by
lot or by auction or by tender or in such
manner as may be provided for in the
agreement, be entitled to the prize amount.
Difference between banks & NBFCs
NBFCs are doing functions similar to that of
banks, however there are a few differences:
1) a NBFC cannot accept demand deposits,
2) it is not a part of the payment and
settlement system and as such cannot
issue cheques to its customers, and
3) deposit insurance facility of DICGC(Deposit
Insurance and Credit Guarantee
Corporation) is not available for NBFC
depositors unlike in case of banks.
 Role of NBFCs
Development of sectors like transport
and infrastructure
Substantial employment generation
Help and increase wealth creation
Broad base economic development
Major thrust on semi-urban, rural
Areas and first time buyers/users
To finance economically weaker
sections
 Commercial banks
Meaning of Commercial Banks:
A commercial bank is a financial
institution which performs the functions
of accepting deposits from the general
public and giving loans for investment
with the aim of earning profit.
In fact, commercial banks, as their name
suggests, profit-seeking institutions, i.e.,
they do banking business to earn profit.
 They generally finance trade and
commerce with short-term loans. They
charge high rate of interest from the
borrowers but pay much less rate of
Interest to their depositors with the
result that the difference between the
two rates of interest becomes the main
source of profit of the banks. Most of the
Indian joint stock Banks are Commercial
Banks such as Punjab National Bank,
Allahabad Bank, Canara Bank, Andhra
Bank, Bank of Baroda, etc.
FUNCTIONS OF COMMERCIAL BANKS

Commercial banks have to perform a

variety of functions which are common to
both developed and developing countries.
These are known as General Banking
functions of the commercial banks. The
modern banks perform a variety of
functions. These can be broadly divided
into two categories:
(a) Primary functions and
(b) Secondary functions
 Primary banking functions of the
commercial banks include:
1. Acceptance of deposits
2. Advancing loans
3. Creation of credit
4. Clearing of cheques
5. Financing foreign trade
6. Remittance of funds
2. Advancing Loans:
The second primary function of a
commercial bank is to make loans
and advances to all types of persons,
particularly to businessmen and
entrepreneurs.
Loans are made against personal
security, gold and silver, stocks of
goods and other assets. The most
common way of lending is by:
(a)Overdraft Facilities:
In this case, the depositor in a current
account is allowed to draw over and above
his account up to a previously agreed limit.
Suppose a businessman has only Rs. 30,000/-
in his current account in a bank but requires
Rs. 60,000/- to meet his expenses. He may
approach his bank and borrow the additional
amount of Rs. 30,000/-. The bank allows the
customer to overdraw his account through
cheques. The bank, however, charges
interest only on the amount overdrawn from
the account. This type of loan is very popular
with the Indian businessmen.
 Cash Credit:
Under this account, the bank gives loans to
the borrowers against certain security. But the
entire loan is not given at one particular time,
instead the amount is credited into his
account in the bank; but under emergency
cash will be given. The borrower is required to
pay interest only on the amount of credit
availed to him. He will be allowed to withdraw
small sums of money according to his
requirements through cheques, but he cannot
exceed the credit limit allowed to him.
Besides, the bank can also give specified loan
to a person, for a firm against some collateral
security. The bank can recall such loans at its
option.
(c) Discounting Bills of Exchange:
This is another type of lending which is very
popular with the modern banks. The holder of a
bill can get it discounted by the bank, when he is
in need of money. After deducting its
commission, the bank 6 Banking pays the
present price of the bill to the holder. Such bills
form good investment for a bank. They provide a
very liquid asset which can be quickly turned
into cash. The commercial banks can rediscount,
the discounted bills with the central banks when
they are in need of money. These bills are safe
and secured bills. When the bill matures the
bank can secure its payment from the party
which had accepted the bill.
 Money at Call: Bank also grant loans
for a very short period, generally not
exceeding 7 days to the borrowers,
usually dealers or brokers in stock
exchange markets against collateral
securities like stock or equity shares,
debentures, etc., offered by them.
Such advances are repayable
immediately at short notice hence,
they are described as money at call
or call money
 Term Loans:
Banks give term loans to traders,
industrialists and now to agriculturists
also against some collateral securities.
Term loans are so-called because their
maturity period varies between 1 to 10
years. Term loans, as such provide
intermediate or working capital funds to
the borrowers. Sometimes, two or more
banks may jointly provide large term
loans to the borrower against a common
security. Such loans are called
participation loans or consortium finance.
(f) Consumer Credit:
Banks also grant credit to households in a
limited amount to buy some durable
consumer goods such as television sets,
refrigerators, etc., or to meet some
personal needs like payment of hospital
bills etc. Such consumer credit is made in
a lump sum and is repayable in
instalments in a short time. Under the 20-
point programme, the scope of consumer
credit has been extended to cover
expenses on marriage, funeral etc., as
well.
 Remittance of Funds:
Commercial banks, on account of their
network of branches throughout the
country, also provide facilities to remit
funds from one place to another for their
customers by issuing bank drafts, mail
transfers or telegraphic transfers on
nominal commission charges. As
compared to the postal money orders or
other instruments, bank drafts have
proved to be a much cheaper mode of
transferring money and has helped the
business community considerably
B.Secondary banking functions of the
commercial banks include:
1. Agency Services
2. General Utility Services
1. Agency Services: Banks also perform
certain agency functions for and on
behalf of their customers. The various
agency services rendered by banks are
as follows:
(a) Collection and Payment of Credit
Instruments: like cheques, bills of
exchange, promissory notes etc., on
behalf of their customers.
(b) Purchase and Sale of Securities: like
shares, stocks, bonds, debentures on
behalf of their customers.
(c) Collection of Dividends on Shares

(d)Acts as Correspondent: correspondents

of their customers. They get passports,
travellers tickets and even secure air
and sea passages for their customers.

(e) Income-tax Consultancy: prepare

income tax returns for their customers
and to help them to get refund of
income tax.
(f) Execution of Standing Orders: Banks
execute the standing instructions of
their customers for making various
periodic payments. They pay
subscriptions, rents, insurance premia
etc., on behalf of their customers.

(g) Acts as Trustee and Executor: Banks

preserve the Wills of their customers
and execute them after their death.
 General Utility Services: In addition to
agency services, the modern banks
provide many general utility services
for the community as given. 8 Banking
(a)Locker Facility
(b) Travellers Cheques and Credit Cards:
Banks issue travellers cheques to
help their customers to travel without
the fear of theft or loss of money. With
this facility, the customers need not
take the risk of carrying cash with
them during their travels.
(c) Letter of Credit: Letters of credit are
issued by the banks to their customers
certifying their credit worthiness.
Letters of credit are very useful in
foreign trade
(d) Collection of Statistics: Banks collect
statistics giving important information
relating to trade, commerce, industries,
money and banking. They also publish
valuable journals and bulletins
containing articles on economic and
financial matters.
(e) Underwriting Securities: Banks underwrite
the shares and debentures issued by the
Government, public or private companies.
(f) Accepting Bills of Exchange on Behalf of
Customers: Sometimes, banks accept bills
of exchange, internal as well as foreign, on
behalf of their customers. It enables
customers to import goods.
(g) Merchant Banking: Some commercial
banks have opened merchant banking
divisions to provide merchant banking
services.
 Difference between Overdraft facility
and Loan:

(i) Overdraft is made without security in current

account but loans are given against security.
(ii) In the case of loan, the borrower has to pay
interest on full amount sanctioned but in the
case of overdraft, the borrower is given the
facility of borrowing only as much as he
requires.
(iii) Whereas the borrower of loan pays Interest
on amount outstanding against him but
customer of overdraft pays interest on the
daily balance.
 MUTUAL FUNDS
A mutual fund is a company that pools money
from many investors and invest in well diversified
portfolio of sound investment
Issues securities (units) to the investors (unit
holders)on accordance with the quantum of
money invested by them.
Profit shared by the investors in proportion to
their investments
Set up in the form of trust and has a sponsor
trustee ,asset management company and
custodian
Advantages in terms of convenience , lower risk ,
expert management and reduced transaction
cost.
 Insurance organisations
They invest the savings of their policy
holders in exchange promise them a
specified sum at a later stage or upon
the happening of a certain event.
Provide the combination of savings
and protection
Through the contractual payment of
premium creates the desire in people
to save.
 Financial market
It is a place where funds from surplus units
are transferred to deficit units
It is a market for creation and exchange of
financial assets
They are not the source of finance but link
between savers and investors.
Corporations , financial institutions,
individuals and government trade in
financial products on this market either
directly or indirectly.
 Money market
Capital market
A market for long term funds
Focus on financing of fixed
investments
Main participants are mutual funds ,
insurance organisations , FIIs ,
corporate and individuals.
Two segments :
primary market
Secondary market
 Primary/new issue market
A market for new issues i.e. Market for fresh
capital
Provides the channel for sale of new
securities , not previously available.
Provides opportunity to issuers of securities;
government as well as corporates
To raise resources to meet their
requirements of investment and to
discharge some obligation
Does not have any organized setup
Performs triple service function :
origination, underwriting and distribution.
 Secondary/stock market
A market for old/existing securities
A place where buyers and sellers of securities
can enter into transactions to purchase and
sell shares, bonds , debentures etc.
Enables corporate , entrepreneurs to raise
resources for their companies and business
ventures through public issues.
Has physical existence
Vital functions are
Liquidity to investors
Continuous price formation
Link between savings and investments
 Functions/Role of Financial
Markets
Price Discovery
Transactions between buyers and sellers of
financial instruments in a financial market
determine the price of the traded asset
Liquidity
Provides an opportunity for investors to sell a
financial instrument at its fair market value at any
time
Without liquidity, an investor would be forced to
hold a financial instrument until conditions arise to
sell it or the issuer is contractually obligated to pay
it off.
 Reduction in Transaction Cost
Financial markets helps in reducing the cost
of trading a financial instrument on the
basis of asset, uncertainty etc.
Effective Mobilization of Savings
Organized market for individuals and
institutions provides Proper regulation for
interest of investors where Small savings of
large number of investors are utilized
Promoting Capital formation
Funds mobilized are provided to businesses
which leads to Capital formation and
development of national assets
 Wider Avenues of Investment
Different types of financial securities of
different firms to cater to different class
of investors
Investment Priorities
Exchanges facilitate investors to decide
their investment priorities by providing
different kinds of securities of different
companies
Manage investment portfolio to
maximize wealth by buying and selling
securities through exchange
 Investment Safety
SEBI regulates the financial markets - Transparent
procedures provide safety to the investment in
securities
Exchange authorities curb speculative practices
and minimize risk of common investor
Wide Marketability to Securities
Online price quoting system and online buying
and selling facility changed the nature and
working of stock exchanges
TV and internet provide information
Modern stock exchanges backed up with
information technology provide marketability to
securities Demat revolutionized the procedure of
transfer of securities
 Financial Resources for Public and Private Sectors
Markets provide financial resources to businesses in
public and private sector through various kinds of
securities as well as government for developmental
activities
Due to liquidity, marketing support, investment safety
assured through exchanges, public issue of securities
receive strong positive response
Indicator of Industrial Development and National
Economy
Price fluctuation of securities indicate the productivity,
efficiency and economic status of industries
At both national and international level, financial
markets represents the progress and conditions of
economy