BANKING & FINANCE

INTER INSTITUTE CREDIT

TRANSFER COURSE
Dr. Anusree Paul
 TOPICS
Structure of financial system
Structure of banking system
Money markets and Capital markets
Reserve Bank of India and its role
Commercial banking
Cooperative Banking
Non-Banking Financial Institutions and their role
Venture capital, Securitization of assets, portfolio management, risk and return.
Reforms in banking and finance
Banking Services: Remittances – Safe Custody – Safe Deposit Vaults – Collection
Facility – MICR Clearing ATMs – Credit cards and Debit Cards – Travellers’
Cheques – Gift Cheques – Ombudsman and Customer Services – Fraud Detection
and Control
Concept of Foreign Exchange (FE), FE transactions of Banks, Buying and Selling,
Spot and Forward, Role of EXIM Bank, Convertibility: Capital and Current
Accounts, RBI Mechanism for regulating foreign exchange markets

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 EXAM SCHEDULE
3 components of Exam:
project : 40 marks
Presentation: 10 marks
Written Examination: 50 marks

Date of written exam:

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 Indian Financial System
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.
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 Financial System
An institutional framework existing in a country to
enable financial transactions
Three main parts
Financial assets (loans, deposits, bonds, equities, etc.)
Financial institutions (banks, mutual funds, insurance
companies, etc.)
Financial markets (money market, capital market, forex
market, etc.)
Regulation is another aspect of the financial
system (RBI, SEBI, IRDA, FMC)

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Financial System

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 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.
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 Financial Market

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.
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Financial System

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 Financial Markets

Defined as the market in which financial

assets are created or transferred.

These assets represent 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.

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 Classification
Money Market- for short-term funds (less
than a year)
Organised (Banks)
Unorganised (money lenders, chit funds, etc.)

Capital Market- for long-term funds

Stock Market
Bond Market
Foreign Exchange Market
Credit Market
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 Money Market

The money market is 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.

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 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.

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 Foreign Exchange Market

The Forexh. 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.

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 Credit Market

Credit market is a place where banks, FIs

and NBFCs buy & sell short, medium and
long-term loans to corporate and
individuals.

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 FINANCIAL INTERMEDIATION
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.

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 FINANCIAL INTERMEDIATION
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.
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 Intermediary Market Role

Stock Exchange Capital Market Secondary Market to

securities
Investment Bankers Capital Market, Credit Corporate advisory
Market  services, Issue of securities

Underwriters Capital Market, Money Subscribe to unsubscribed

Market portion of securities
Registrars, Depositories, Capital Market Issue securities to the
Custodians investors on behalf of the
company and handle share
transfer activity
Primary Dealers Satellite Money Market Market making in
Dealers government securities

Forex Dealers Forex Market Ensure exchange ink

currencies
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 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 up to 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.

Instruments in Money Market

Call money market
Treasury bills market
Markets for commercial paper
Certificate of deposits
Bills of Exchange
Money market mutual funds
Promissory Note
Market Repos
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 Organised Money Market
Call money market
Bill Market
Treasury bills
Commercial bills
Bank loans (short-term)
Organised money market comprises RBI,
banks (commercial and co-operative)

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 Purpose of the Money Market
Banks borrow in the money market to:
Fill the gaps or temporary mismatch of funds
To meet the CRR and SLR mandatory
requirements as stipulated by the central bank
To meet sudden demand for funds arising out of
large outflows (like advance tax payments)

Call money market serves the role of

equilibrating the short-term liquidity
position of the banks
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 Call Money Market

Is an integral part of the Indian money market

where day-to-day surplus funds (mostly of
banks) are traded.
The loans are of short-term duration (1 to 14
days). Money lent for one day is called ‘call
money’; if it exceeds 1 day but is less than 15
days it is called ‘notice money’. Money lent for
more than 15 days is ‘term money’
The borrowing is exclusively limited to banks,
who are temporarily short of funds

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 Call Money Market
Call loans are generally made on a clean basis- i.e.
no collateral is required
The main function of the call money market is to
redistribute the pool of day-to-day surplus funds
of banks among other banks in temporary deficit
of funds
The call market helps banks economise their
cash and yet improve their liquidity
It is a highly competitive and sensitive market
It acts as a good indicator of the liquidity position
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Call Money Market Participants
Those who can both borrow and lend in
the market – RBI , banks and primary
dealers
Previously, selected financial institutions
viz., IDBI, UTI, Mutual funds were allowed
in the call money market only on the
lender’s side.
These were phased out and call money
market is now a pure inter-bank market
(since August 2005)
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 Commercial Papers
Commercial Paper (CP) is an unsecured money
market instrument issued in the form of a
promissory note.
Introduced in 1990
Corporates, primary dealers (PDs) and the All-India
Financial Institutions (FIs) are eligible to issue CP.
CP can be issued for maturities between a minimum
of 15 days and a maximum up to one year from the
date of issue.
Issued subject to minimum of Rs. 5 lacs and in the
multiple of Rs. 5 lacs after that.
Issued at discount to the face value

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 Treasury Bill Market
These bills are short-term liabilities (91-day, 182-day,
364-day) of the Government of India
It is an IOU of the government, a promise to pay the
stated amount after expiry of the stated period from the
date of issue
They are issued at discount to the face value and at the
end of maturity the face value is paid
The rate of discount and the corresponding issue price
are determined at each auction
RBI auctions 91-day T-Bills on a weekly basis, 182-day
T-Bills and 364-day T-Bills on a fortnightly basis on
behalf of the central government

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 Promissory Note
 Referred as note payable in accounting

 It is a contract detailing the terms of a promise by one

party (the maker) to pay a sum of money to the other (the
payee).

 The obligation may arise from the repayment of a loan

or from another form of debt.

 For example, in the sale of a business, the purchase price

might be a combination of an immediate cash payment
and one or more promissory notes for the balance.

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 Certificates of deposits
 Defined as short term deposit by way of usance
promissory notes.

 Greater flexibility to investors in the deployment of

surplus funds.

 Permitted by the RBI to banks

 Maturity of not less than 3 months and upto 1 year.

 Transferable in nature

 Free negotiability and limited flexibility

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 Money market mutual funds
 Invest primarily in money market instruments of very
high quality.

 RBI and public financial institution can set it either

directly or through its existing subsidiaries.

 MMMF
 Open Ended
 Close Ended

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 Market Repos
Repo (repurchase agreement) instruments enable
collateralised short-term borrowing through the
selling of debt instruments
A security is sold with an agreement to repurchase it at
a pre-determined date and rate
Reverse repo is a mirror image of repo and reflects the
acquisition of a security with a simultaneous
commitment to resell
Average daily turnover of repo transactions (other
than the Reserve Bank) increased from Rs.11,311 crore
during April 2001 to Rs. 42,252 crore in June 2006

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 Capital Market Instruments
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

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 Primary Markets Secondary Markets
When companies need financial resources for The place where such securities are traded by
its expansion, they borrow money from these investors is known as the secondary
investors through issue of securities. market.
Securities issued Securities like Preference Shares and
a) Preference Shares Debentures cannot be traded in the
b) Equity Shares secondary market.
c) Debentures
Equity shares is issued by the under writers Equity shares are tradable through a private
and merchant bankers on behalf of the broker or a brokerage house.
company.
People who apply for these securities are: Securities that are traded are traded by the
a) High networth individual retail investors.
b) Retail investors
c) Employees
d) Financial Institutions
e) Mutual Fund Houses
f) Banks

One time activity by the company. Helps in mobilising the funds for the
investors in the short run.

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 Financial Institutions
Includes institutions and mechanisms which
Affect generation of savings by the community
Mobilisation of savings
Effective distribution of savings
Institutions are banks, insurance
companies, mutual funds-
promote/mobilise savings
Individual investors, industrial and trading
companies- borrowers

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 Indian Banking System
Central Bank (Reserve Bank of India)
Commercial banks (222)
Co-operative banks
Banks can be classified as:
Scheduled (Second Schedule of RBI Act, 1934) - 218
Non-Scheduled - 4
Scheduled banks can be classified as:
Public Sector Banks (28)
Private Sector Banks (Old and New) (27)
Foreign Banks (29)
Regional Rural Banks (133)

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 Indigenous bankers
Individual bankers like Shroffs, Seths, Sahukars,
Mahajans, etc. combine trading and other business
with money lending.
Vary in size from petty lenders to substantial shroffs
Act as money changers and finance internal trade
through hundis (internal bills of exchange)
Indigenous banking is usually family owned
business employing own working capital
At one point it was estimated that IBs met about
90% of the financial requirements of rural India

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 RBI and indigenous bankers
Methods employed by the indigenous bankers are
traditional with vernacular system of accounting.
RBI suggested that bankers give up their trading
and commission business and switch over to the
western system of accounting.
It also suggested that these bankers should
develop the deposit side of their business
Ambiguous character of the hundi should stop
Some of them should play the role of discount
houses (buy and sell bills of exchange)

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 RBI and indigenous bankers
IB should have their accounts audited by certified
chartered accountants
Submit their accounts to RBI periodically
As against these obligations the RBI promised to
provide them with privileges offered to
commercial banks including
Being entitled to borrow from and rediscount bills with RBI
The IBs declined to accept the restrictions as well
as compensation from the RBI
Therefore, the IBs remain out of RBI’s purview

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Development Oriented Banking
Historically, close association between banks and
some traditional industries- cotton textiles in the
west, jute textiles in the east
Banking has not been mere acceptance of deposits
and lending money; included development banking
Lead Bank Scheme- opening bank offices in all
important localities
Providing credit for development of the district
Mobilising savings in the district. ‘Service area
approach’

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 Progress of banking in India
Nationalisation of banks in 1969: 14 banks were
nationalised
Branch expansion: Increased from 8260 in 1969
to 71177 in 2006
Population served per branch has come down
from 64000 to 16000
A rural branch office serves 15 to 25 villages
within a radius of 16 kms
However, at present only 32,180 villages out of 5
lakh have been covered
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