602: FINANCIAL INSTITUTIONS AND MARKETS

TY BBA SEM VI

2022-23

1. FINANCIAL INSTITUTIONS

Sr.No. Content Page No.

1 Financial System

(a) Introduction 2

(b) Meaning 2

(c) Definitions 2

(d) The Indian Financial System 3

1.1 Financial Institutions 5

(a) Regulatory & Promotional Institutions 5

(b) Banking Institutions 6

(c) Non-Banking Institutions 6

1.2 Financial Markets 7

(a) Money Market 7

(b) Capital Market

Primary 7

Secondary 8

Derivative 8

1.3 Financial Instrument / Assets 8

1.4 Financial Services 9

2 Financial System and Economic Development 9

3 Financial Sector Reforms (Brief Overview) 12

(a) Banking 12
 (b) Government Securities Market 13

(c) Capital Market 14

(d) Forex 16

4 Financial Inclusion

Introduction 16

Definition 16

Objectives 17

Initiatives taken for promoting financial inclusion 17

Prime Minister’s Jan Dhan Yojana 18

Challenges of financial inclusion 18

5 Regulatory and Promotional Institutions 18

5.1 Functions and Role of RBI 19

(a) Main/Traditional Functions 19

(b) Developmental/Promotional Functions 20

(c) Supervisory Functions 21

5.2 Role and Functions of SEBI 21

Objective 22

Role 22

Functions

(a) Protective 22

(b) Developmental 23

(c) Regulatory 23
1. Financial System

a) Introduction
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. 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. Financial system comprises of set of subsystems of financial institutions, financial markets,
financial instruments and services which helps in the formation of capital. It provides a mechanism
by which savings are transformed to investment.

b) Meaning of Financial System

Financial system is a set of complex and closely interlinked financial institutions, financial markets,
financial instruments and services which facilitate the transfer of funds.

c) Definitions of Financial System

1. A financial system may be defined as a set of institutions, instruments and markets which
promotes savings and channels them to their most efficient use. It consists of individuals (savers),
intermediaries, markets and users of savings (investors).

2. According to Prasanna Chandra, “financial system consists of a variety of institutions, markets and
instruments related in a systematic manner and provide the principal means by which savings are
transformed into investments”.

3. A financial system consists of institutional units and markets that interact, typically in a complex
manner, for the purpose of mobilizing funds for investment, and providing facilities, including
payment systems, for the financing of commercial activity.-OECD

d) THE INDIAN FINANCIAL SYSTEM

The Indian financial system can be broadly classified into formal (organised) financial sector and
informal (unorganised) financial sector.

Formal financial system

The formal financial system is characterized by the presence of an organized, institutional and
regulated system which caters to the financial needs of the modern spheres of economy.
The formal financial system comprises of Ministry of Finance ((MoF), RBI, SEBI and other regulatory
and promotional bodies as well financial institutions.

Informal financial system

The informal financial system is an unorganized, non-institutional and non-regulated system dealing
with traditional and rural spheres of the economy.
The informal financial system consists of individual money lenders, local bankers, Traders, landlords,
and chit funds.
Structure/constituents/components of Indian formal financial system
The formal financial system comprises financial institutions, financial markets, financial instruments
and financial services.
1.1 Financial Institutions

These are intermediaries that mobilise savings and facilitate the allocation of funds in an efficient
manner.

On the basis of the nature of activities, financial institutions may be classified as:
(a) Regulatory and promotional institutions
(b) Banking institutions (creators and purveyors of credit)
(c) Non-banking institutions (purveyors of credit)

(a) Regulatory and Promotional Institutions

Regulatory and promotional bodies are those financial institutions which regulate, control, supervise
and promote the financial system. Financial institutions, financial markets, financial instruments and
financial services are all regulated by regulators like Ministry of Finance (MoF), RBI, SEBI, IRDA, AMFI,
PFRDA etc.

1. RBI:
The RBI as the apex institution controls, supervises, regulates and develops the monetary system
and the financial system of the country.

Established in April, 1935 in Calcutta, the Reserve Bank of India (RBI) later moved to Mumbai in
1937. After its nationalization in 1949, RBI is presently owned by the Govt. of India. It has 19 regional
offices, majorly in state capitals, and 9 sub-offices. It is the issuer of the Indian Rupee.

RBI regulates the banking and financial system of the country by issuing broad guidelines and
instructions. The objectives are twofold: a) to secure monetary stability within the country b) to
operate the currency and credit system to the advantage of the country.

2. SEBI:
The Securities and Exchange Board of India was established on April 12, 1992 in accordance with the
provisions of the Securities and Exchange Board of India Act, 1992 to regulate the functions of
securities market to keep a check on malpractices and protect the investors. Headquartered in
Mumbai, SEBI has its regional offices in New Delhi, Kolkata, Chennai and Ahmedabad.

3. AMFI:
The Association of Mutual Funds in India (AMFI) is a self-regulatory body formed by the fund houses
and asset management companies (AMCs) in India. AMFI, the association of all the Asset
Management Companies of SEBI registered mutual funds in India, was incorporated on August 22,
1995 as a non-profit organisation. As of now, 45 Asset Management Companies that are registered
with SEBI, are its members. It is a non-profit government organisation and a regulator under the
purview of SEBI.
The Association of Mutual Funds in India (AMFI) is dedicated to developing the Indian Mutual Fund
Industry on professional, healthy and ethical lines and to enhance and maintain standards in all
areas with a view to protecting and promoting the interests of mutual funds and their unit holders.
4. IRDAI:
Insurance Regulatory and Development Authority of India (IRDAI) is an autonomous apex statutory
body for regulating and developing the insurance industry in India. It was established in 1999
through an act passed by the Indian Parliament. Headquartered in Hyderabad, Telangana, IRDA
regulates and promotes insurance business in India.

5. PFRDA:
Pension Fund Regulatory and Development Authority (PFRDA), Established in October 2003 by the
Government of India, PFRDA develops and regulates the pension sector in India. The National
Pension System (NPS) was launched in January 2004 with an aim to provide retirement income to all
the citizens. The objective of NPS is to set up pension reforms and inculcate the habit of saving for
retirement amongst the citizens.

Financial institutions also act as the intermediaries who facilitate the smooth functioning of the
financial system by making investors and borrowers meet. They collect resources by accepting
deposits from individuals and institutions and lend them to trade, industry and others. They buy and
sell financial instruments. They generate financial instruments as well. They deal in financial assets.
They accept deposits, grant loans and invest in securities. They are classified as under.

(b) Banking Institutions

Banking institutions mobilize the savings of the people. They provide a mechanism for the smooth
exchange of goods and services. They extend credit while lending money. They not only supply credit
but also create credit. There are four categories of banking institutions. They are commercial banks,
Small finance banks, payment banks and co-operative banks.

(c) Non-banking Institutions:

The non-banking financial institutions also mobilize financial resources directly or indirectly from the
people. They lend the financial resources mobilized. They lend funds but do not create credit.

In India, non-banking financial institutions, namely, the developmental financial institutions (DFIs),
and non-banking financial companies (NBFCs) as well as housing finance companies (HFCs) are the
major institutional purveyors of credit.

Financial institutions can also be classified as term-finance institutions such as the Industrial
Development Bank of India (IDBI), the Industrial Credit and Investment Corporation of India (ICICI),
the Industrial Financial Corporation of India (IFCI), the Small Industries Development Bank of India
(SIDBI), and the Industrial Investment Bank of India (IIBI).

Financial institutions can be specialised finance institutions like the Export Import Bank of India
(EXIM), the Tourism Finance Corporation of India (TFCI), ICICI Venture, the Infrastructure
Development Finance Company (IDFC), and sectoral financial institutions such as the National Bank
for Agricultural and Rural Development (NABARD) and the National Housing Bank (NHB).
Investment institutions in the business of mutual funds Unit Trust of India (UTI), public sector and
private sector mutual funds and insurance activity of Life Insurance Corporation (LIC), General
Insurance Corporation (GIC) and its subsidiaries are classified as financial institutions.

There are state-level financial institutions such as the State Financial Corporations (SFCs) and State
Industrial Development Corporations (SIDCs) which are owned and managed by the State
governments.

1.2 Financial Markets

Financial markets are a mechanism enabling participants to deal in financial claims. The markets also
provide a facility in which their demands and requirements interact to set a price for such claims.

Financial markets refer to the institutional arrangements for dealing in financial assets and credit
instruments of different types such as currency, cheques, bank deposits, bills, bonds etc.
Financial markets can be referred to as those centres and arrangements which facilitate buying and
selling of financial assets, claims and services.

The main organised financial markets in India are the money market and the capital market.

(a) Money market

Money market is a market for dealing with financial assets and securities which have a maturity
period of upto one year. In other words, it is a market for purely short term funds. The money
market may deal with different instruments like, Call money, Commercial bills, Treasury bills, Short
term loan market etc.

(b) Capital Market

The capital market is a market for financial assets which have a long or indefinite maturity.
Generally, it deals with long term securities which have a maturity period of above one year.

Capital market deals with (i) Industrial securities market, (ii) Government securities market, and (iii)
Long-term loans market.

Capital market may be further divided into three namely:

(i) Primary market or New issue market
(ii) Secondary market or Stock exchange
(iii) Derivatives market

(i) Primary Market

Primary market is a market for new issues or new financial claims. Hence, it is also called New Issue
market. The primary market deals with those securities which are issued to the public for the first
time. In the primary market, borrowers exchange new financial securities for long term funds.
(ii) Secondary Market
Secondary market is a market for secondary sale of securities i.e. trading in outstanding or existing
securities. In other words, securities which have already passed through the new issue market are
traded in this market. Generally, such securities are quoted the Stock Exchange and it provides a
continuous and regular market to buying and selling of securities.
There are two components of the secondary market: over-the-counter (OTC) market and the
exchange traded market. The government securities market is an OTC market. In an OTC market,
spot trades are negotiated and traded for immediate delivery and payment while in the exchange-
traded market, trading takes place over a trading cycle in stock exchanges.

(iii) Derivatives market

The derivatives are most modern financial instruments in hedging risk. The individuals and firms who
wish to avoid or reduce risk can deal with the others who are willing to accept the risk for a price. A
common place where such transactions take place is called the derivative market. It is a market in
which derivatives are traded. The important types of derivatives are forwards, futures, options,
swaps, etc.

On the basis of financial claims, financial markets may also be classified into debt and equity market.
Debt market: This is the financial market for fixed claims like debt instruments.
Equity market: This is the financial market for residual claims, i.e., equity instruments.

1.3 Financial Instruments/assets

A financial instrument is a claim against a person or an institution for payment, at a future date, of a
sum of money and/or a periodic payment in the form of interest or dividend. The term ‘and/or’
implies that either of the payments will be sufficient but both of them may be promised.

Financial securities may be primary or secondary securities. Primary securities are also termed as
direct securities as they are directly issued by the ultimate borrowers of funds to the ultimate savers.
Examples of primary or direct securities include equity shares and debentures. Secondary securities
are also referred to as indirect securities, as they are issued by the financial intermediaries to the
ultimate savers. Bank deposits, mutual fund units, and insurance policies are secondary securities

On the basis of marketability, financial assets can be classified as under:

(a) Marketable assets
(b) Non-marketable assets

(a) Marketable assets:

Marketable assets are those which can be easily transferred from one person to another without
much hindrance. Examples: Shares of Listed Companies, Government Securities, Bonds of Public
Sector Undertakings, etc.
(b) Non-marketable assets
On the other hand, if the assets cannot be transferred easily, they come under this category.
Examples: Bank Deposits, Provident Funds, Pension Funds, National Savings Certificates, Insurance
Policies, etc.

Financial instruments differ in terms of marketability, liquidity, reversibility, type of options, return,
risk and transaction costs. Financial instruments help the financial markets and the financial
intermediaries to perform the important role of channelizing funds from lenders to borrowers.

1.4 Financial Services

The term financial services can be defined as “activities, benefits, and satisfactions, connected with
the sale of money, that offers to users and customers, financial related value.

Financial services rendered by the financial intermediaries bridge the gap between lack of
knowledge on the part of investors and increasing sophistication of financial instruments and
markets. These financial services are vital for creation of firms, industrial expansion and economic
growth.

Financial services provided by various financial institutions, commercial banks and merchant bankers
can be broadly classified into two categories.

(a) Asset based/fund based services.

Leasing, Hire purchase, venture capital, insurance services, factoring services etc

(b) Fee based/advisory services

Merchant banking, credit rating, stock broking, investment banking etc

2. FINANCIAL SYSTEM AND ECONOMIC DEVELOPMENT

The financial system plays a crucial role in the economic development of a country. Businesses and
industries are financed by the financial systems which lead to growth in employment and in turn
increase economic activity and domestic trade. Financial intermediaries help improve investment
efficiency, leading to higher economic growth. It is explained that how financial systems play an
important role in the economic development of a nation.

1. Savings-Investment Relationship:
The Financial system helps efficiently direct the flow of savings and investments in the economy.
Here financial institutions like banks play a major role. They allow depositors to invest money in
various deposits like FDs and RDs by offering attractive rates of interest. These savings are then
channelized by the banks to provide credit to different business entities, which are involved in
production and distribution. Banks help in the allocation of resources across different sectors of
the economy.
2. Growth of Capital Markets:
Business entities require capital for funding business activities and production. Businesses
require two kinds of capital: Working capital and Fixed capital. Therefore, various business
entities use the financial system to raise funds for both short term and long term money
requirements. Stable financial markets raise investor confidence. As a result, investors from
domestic as well as international markets start investing in the capital markets. As a result, more
capital becomes available to domestic companies. They can then use this capital to increase
economies of scale, which makes them more competitive in the international market. If these
financial institutions and markets were not present, foreign investors would find it very difficult
to locate investment opportunities and follow through with them.

3. Government Securities:
The financial system enables the government raise funds, helping them borrow at a lower rate of
interest. The state and the central government can raise short term and long term funds from
the government securities market, to finance capital requirements by issuing bills and bonds.
The government can also borrow funds from the money market by issuing treasury bills. These
instruments offer attractive rates of interest. Therefore, the money market, the capital market
and the foreign exchange market help in the development of trade, industry and commerce
within and outside India, ensuring the development of the economy.

4. Foreign Exchange Markets:

The foreign exchange market helps exporters and importers raise and receive funds for settling
transactions. It also enables banks borrow money and provides funds to different types of
customers in various foreign currencies like Dollars or the Euro.

5. Infrastructure and Growth:

The financial infrastructure has a strong financial bearing on economic growth. The financial
infrastructure signifies the financial assets, the financial market and the financial intermediaries
which are the three main pillars of the economy. Financial markets play a vital role in
infrastructure development, as well. This is because the private sector may face great difficulties
in raising large amounts of funds for projects with a high gestation period. It is the financial
markets that provide the liquidity required by investors. Investors can sell their securities and
cash out whenever they want. It is not important for the same investor to hold on to the security
for the entire tenure of the loan. Key sectors like power generation, oil, and gas, transport,
telecommunication, and railways receive a lot of funding at concessional rates thanks to the
financial markets.

6. Trade and commerce Development:

The financial system helps in the development of both domestic as well as foreign trade and also
industry and commerce. The financial system facilitates the exchange of documents between
sellers and buyers through banks. The buyer does not need to meet the seller to complete
negotiations. These transactions help the economy grow faster. With the advent of latest
technology, it is now possible to remit money to any part of the world within a few seconds.
Hence, financial markets and institutions aid in trade and commerce and even improve the gross
domestic product of a country.
7. Employment growth:
A properly functioning financial system helps generate more employment opportunities within
the economy. The financial system helps provide funds to the growing business houses and
industries, which results in an increase in production. Consequently, it generates more
employment opportunity for both the organized sector as well as the unorganised sector.
Increase in business and industrial activity leads to various employment opportunities like sales,
marketing, advertisement and so on. Funding availed by startups helps create additional
employment opportunities.

8. Venture Capital:
Startups have grown big time in India. However, securing funds for growth is one of the major
challenges faced by startups. The main reason is lack of sufficient venture capital in India. The
economic development of the country will be faster when more business ventures are funded
and promoted. This capital deficit can be solved when more financial institutions contribute a
part of their funds for the promotion of new ventures. In this way the financial system allows the
creation of venture capital.

9. Balances Economic Growth:

Economic development needs balanced growth which can be attained by propelling growth in all
sectors, simultaneously. The financial system helps allocate savings into investment channels. It
helps in mobilizing savings and make better use of these funds by allowing investments in
various sectors of the economy. The financial system helps channelize available funds, thus
leading to productive use of money by distributing it across sectors in such a manner, that there
is balanced growth in industries, agriculture and service sector.

10. Interest Rates Stabilization:

The financial system ensures that all the organizations and institutions which it is composed of,
behave as one unified system. Generally, healthy competition is promoted between the
members of the system. This means that members have to compete with each other by lowering
their costs. As a result, the benefits of lower interest rates are passed on to the consumers. It is
the existence of the financial system, which ensures that interest rates remain stable across the
country. The banking system led by a central bank makes this possible. In the absence of a
financial system, each region would have its own interest rate based on the availability of
capital. However, with the financial system in place, interest rates remain the same across the
entire country. As a result, businessmen and entrepreneurs throughout the country are on an
equal footing.

11. Aids International Trade:

The financial institutions provide funds to traders through the financial market, which issue
financial instruments like treasury bills and commercial papers. Pre-shipment and post-shipment
finance by commercial banks helps foreign trade. Letter of credit (LCs) is issued in favour of
importers. The risks inherent in trade and commerce get multiplied several times when it comes
to international trade. This is because firstly, the seller and buyer are in different legal
jurisdictions. Hence, the enforceability of contracts is reduced. Secondly, the quantity of goods
 involved in import and export transactions is extremely large. Hence, the outstanding amounts
also become large, and this ends up increasing the overall risk in the transaction.

3. FINANCIAL SECTOR REFORMS IN INDIA

Introduction

The financial sector reforms refer to steps taken to reform the banking system, capital market,
government debt market, foreign exchange market etc. An efficient financial sector is necessary for
the mobilization of households savings and to ensure their proper utilisation in productive sectors.
Before 1991, the Indian financial sector was suffering from several lacunae and deficiencies which
had reduced their quality and efficiency of operations. Therefore, financial sector reforms had
become essential at that time.

Financial sector reforms in India introduced as a part of the structural adjustment and economic
reforms programme in the early 1990s have had a profound impact on the functioning of the
financial institutions, especially banks. The Narasimham committee was established in August 1991
to give comprehensive recommendations on the financial sector of India including the capital market
and banking sector. The main objectives, therefore, of the financial sector reform process in India
initiated were to:
 Remove financial repression that existed earlier;
 Create an efficient, productive and profitable financial sector industry;
 Enable price discovery, particularly, by the market determination of interest rates that then
helps in efficient allocation of resources;
 Provide operational and functional autonomy to institutions;
 Prepare the financial system for increasing international competition;
 Open the external sector in a deliberated fashion;
 Maintenance of financial stability even in the face of domestic and external shocks.

1. Banking sector reforms

Changes in CRR and SLR: One of the most important reforms includes the reduction in cash reserve
ratio (CRR) and statutory liquidity ratio (SLR). The SLR has been reduced from 39% to the current
value of 18 %. The cash reserve ratio has been reduced from 15 % to 4.5%. This reduction in the SLR
and CRR has given banks more financial resources for lending to the agriculture, industry and other
sectors of the economy.

Changes in administered interest rates: Earlier, the system of administered interest rate structure
was prevalent in which RBI decided the interest rate charged by the banks. The main purpose was to
provide credit to the government and certain priority sectors at concessional rates of interest. The
system has been done away and RBI no longer decides interest rates on deposits paid by the banks.
However, RBI regulates interest on smaller loans up to Rs 2 lakhs on which the interest rate should
not be more than the prime lending rates.
Capital Adequacy Ratio: The capital adequacy ratio is the ratio of paid-up capital and the reserves to
the deposits of banks. The capital adequacy ratio of Indian banks had not been as per the
international standards. The capital adequacy of 8% on the risk-weighted asset ratio system was
introduced in India. The Indian banks had to achieve this target by March 31, 1994, while the foreign
Bank had to achieve this norm by 31st March 1993. Now, Basel 3 norms are introduced in India.

Allowing private sector banks: after the financial reforms, private banks we are given life and HDFC
Bank, ICICI Bank, IDBI Bank, Corporation Bank etc. were established in India. This has brought much
needed competition in the Indian money market which was essential for the improvement of its
efficiency. Foreign banks have also been allowed to open branches in India and banks like Bank of
America, Citibank, American Express opened many new branches in India.

Reforms related to non performing assets (NPA):

Non-performing assets are those loans on which the loan installments have not been paid up for 90
days. RBI introduced the recognition income recognition norm. According to this norm, if the income
on the assets of the bank is not received in two quarters after the last date, the income is not
recognised. Recovery of bad debt was ensured through Lok Adalats, civil courts, Tribunals etc. The
Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest
(SARFAESI) Act was brought to handle the problem of bad debts.

Elimination of direct or selective credit controls:

Earlier, under the system of selective or direct credit control, RBI controlled the credit supply using
the system of changes in the margin for providing a loan to traders against the stocks of sensitive
commodities and to the stockbrokers against the shares. This system of direct credit control was
abolished and now the banks have greater freedom in providing credit to their customers.
Promotion of microfinance for financial inclusion: for the promotion of financial inclusion,
microfinance scheme was introduced by the government, and RBI gave guidelines for it. The most
important model for microfinance has been the Self Help Group Bank linkage programme. It is being
implemented by the regional rural banks, cooperative banks, and Scheduled commercial banks.

Technology Related Measures:

Some of these measures are setting up of INFINET as the communication backbone for the financial
sector, introduction of National Electronic Fund Transfer (NEFT) and Real Time Gross Settlement
(RTGS) System.

2. Reforms in the government security market

Automatic monetization:
The policy of automatic monetization of the fiscal deficit of government was phased out in 1997
through an agreement between the government and RBI. Now the government borrows money
from the market through the auction of government securities.
Abolition of tax deduction at source:
Tax deduction at source (TDS) used to be major impediment to the development of the government
securities market. This not only distorted the pricing mechanism, but also rendered trading in
Government securities cumbersome. Recognizing this, the RBI convinced the Government to abolish
it. The removal of TDS on Government securities was apparently a small but a major reform in
removing pricing distortions for Government securities.

Banks investments in Government securities valuation/accounting norms:

Concomitantly, regulatory initiatives in introducing international best practices in
valuation/accounting norms for the banks’ investment portfolios (comprising mainly government
securities) also necessitated the banks to mark to market their investment portfolios and forced
them to actively trade. This gave an added impetus to the incipient trading activity.

Retail interest in Government securities:

The retail interest in Government securities has been lukewarm mainly on account of competing
small savings instruments and also due to the difficulties faced by a small investor in
accessing/exiting the Government securities market. With the rationalization of interest rates on
small savings instruments, some amount of parity could be brought between the returns on
Government securities and small savings instruments. Further in developing and under developed
economies, individuals show preference for more liquid bank deposits. Amongst the efforts to
promote retail interest in government securities and thereby to widen the investor base, promotion
of Gilt funds and trading of Government securities on stock exchanges are worth mentioning.
However, poor liquidity in the order driven trading systems for government securities in the stock
exchanges implies that much needs to be done to get the gilts to the retail investor.

Others:
The government introduced treasury bills for 91 days for ensuring liquidity and meeting short-term
financial needs and for benchmarking. Foreign institutional investors were now allowed to invest
their funds in the government securities. The government introduced the system of delivery versus
payment settlement for ensuring transparency in the system.

3. Reforms in the capital market

Establishment of SEBI: The Securities and Exchange Board of India (SEBI) was established in 1988. It
got a legal status in 1992. SEBI was primarily set up to regulate the activities of the merchant banks,
to control the operations of mutual funds, to work as a promoter of the stock exchange activities
and to act as a regulatory authority of new issue activities of companies. The SEBI was set up with
the fundamental objective, "to protect the interest of investors in securities market and for matters
connected therewith or incidental thereto."

Establishment of Creditors Rating Agencies: Three creditors rating agencies viz. The Credit Rating
Information Services of India Limited (CRISIL - 1988), the Investment Information and Credit Rating
Agency of India Limited (ICRA - 1991) and Credit Analysis and Research Limited (CARE) were set up in
order to assess the financial health of different financial institutions and agencies related to the
stock market activities. It is a guide for the investors also in evaluating the risk of their investments.
Increasing of Merchant Banking Activities: Many Indian and foreign commercial banks have set up
their merchant banking divisions in the last few years. These divisions provide financial services such
as underwriting facilities, issue organising, consultancy services, etc. It has proved as a helping hand
to factors related to the capital market.

Candid Performance of Indian Economy: In the last few years, Indian economy is growing at a good
speed. It has attracted a huge inflow of Foreign Institutional Investments (FII). The massive entry of
FIIs in the Indian capital market has given good appreciation for the Indian investors in recent times.
Similarly many new companies are emerging on the horizon of the Indian capital market to raise
capital for their expansions.

Rising Electronic Transactions: Due to technological development in the last few years, The physical
transaction with more paper work is reduced. Now paperless transactions are increasing at a rapid
rate. It saves money, time and energy of investors. Thus it has made investing safer and hassle free
encouraging more people to join the capital market. The Securities and Exchange Board of India
(SEBI) had on September 7 permitted the exchanges to introduce the T+1 settlement cycle from
January 1 on any security available in the equity segment on an optional basis.

Growing Mutual Fund Industry: The growing of mutual funds in India has certainly helped the
capital market to grow. Public sector banks, foreign banks, financial institutions and joint mutual
funds between the Indian and foreign firms have launched many new funds. A big diversification in
terms of schemes, maturity, etc. has taken place in mutual funds in India. It has given a wide choice
for the common investors to enter the capital market.

Growing Stock Exchanges: The numbers of various Stock Exchanges in India are increasing. Initially
the BSE was the main exchange, but now after the setting up of the NSE and the OTCEI, stock
exchanges have spread across the country. Recently a new Inter-connected Stock Exchange of India
has joined the existing stock exchanges.

Investor's Protection: Under the purview of the SEBI the Central Government of India has set up the
Investors Education and Protection Fund (IEPF) in 2001. It works in educating and guiding investors.
It tries to protect the interest of the small investors from frauds and malpractices in the capital
market.

Growth of Derivative Transactions: Since June 2000, the NSE has introduced the derivatives trading
in the equities. In November 2001 it also introduced the future and options transactions. These
innovative products have given variety for the investment leading to the expansion of the capital
market.

Commodity Trading: Along with the trading of ordinary securities, the trading in commodities is also
recently encouraged. The Multi Commodity Exchange (MCX) is set up. The volume of such
transactions is growing at a splendid rate.
4. Reforms in the foreign exchange market
Managed floating exchange rate system: There was an evolution of exchange rate regime from a
single currency fixed-exchange rate system to fixing the value of rupee against a basket of currencies
and further to market-determined floating exchange rate regime.
Commercial banks deals: In 1993, India moved towards market based exchange rates, and the
current account convertibility was now allowed. The commercial banks were allowed to undertake
operations in foreign exchange.

Swap transactions: The Rupee foreign currency swap market has been developed. New players are
now allowed to enter this market and undertake currency swap transactions subject to certain
limitations.

Authorised dealers: The authorized dealers of foreign exchange were now given the permission for
activities such as initiating trading positions, borrowing and investing in foreign markets etc. subject
to certain limitations and regulations.

FEMA: The foreign exchange Regulation Act, 1973 was replaced by the foreign exchange
management Act, 1999 for providing greater freedom to the exchange markets.

FII and NRI: The foreign institutional investors and non-resident Indians were allowed to trade in the
exchange-traded derivatives contracts subject to certain regulations and limitations.

4.FINANCIAL INCLUSION

Introduction
When bankers do not give the desired attention to certain areas, the regulators have to step in to
remedy the situation. This is the reason why the Reserve Bank of India places a lot of emphasis on
financial inclusion. Thus, the Government of India and the Reserve Bank of India have been making
concerted efforts to promote financial inclusion as one of the important national objectives of the
country. In simple words, it is the process of ensuring access to financial services and timely and
adequate credit where needed by vulnerable groups such as weaker sections and low-income
groups at an affordable cost. The essence of financial inclusion is to ensure delivery of financial
services, like - bank accounts for savings and transactional purposes, low cost credit for productive,
personal and other purposes, financial advisory services, insurance facilities (life and non-life) etc.
Some of the major efforts made in the last five decades include - nationalization of banks, building
up of robust branch network of scheduled commercial banks, co-operatives and regional rural banks,
introduction of mandated priority sector lending targets, lead bank scheme, formation of self-help
groups, permitting BCs/BFs to be appointed by banks to provide door step delivery of banking
services, zero balance BSBD accounts, etc. The fundamental objective of all these initiatives is to
reach the large sections of the hitherto financially excluded Indian population.
Definitions of financial inclusion
Financial inclusion may be defined as the process of ensuring access to financial services and timely
and adequate credit where needed by vulnerable groups such as weaker sections and low income
groups at an affordable cost (The Committee on Financial Inclusion, Chairman: Dr. C. Rangarajan).

Financial Inclusion, broadly defined, refers to universal access to a wide range of financial services at
a reasonable cost. These include not only banking products but also other financial services such as
insurance and equity products (The Committee on Financial Sector Reforms, Chairman: Dr.Raghuram
G. Rajan). Household access to financial services is depicted in the following figure.

Financial inclusion may be defined as the delivery of banking services at an affordable cost,
especially to the vast sections of disadvantaged and low-income group.

Objectives of Financial Inclusion

 Financial inclusion intends to help people secure financial services and products at
economical prices such as deposits, fund transfer services, loans, insurance, payment
services, etc.
 It aims to establish proper financial institutions to cater to the needs of the poor people.
 Financial inclusion aims to build and maintain financial sustainability so that the less
fortunate people have a certainty of funds which they struggle to have.
 Financial inclusion intends to increase awareness about the benefits of financial services
among the economically underprivileged sections of the society.
 Financial inclusion intends to improve financial literacy and financial awareness in the
nation.
 Financial inclusion aims to bring in digital financial solutions for the economically
underprivileged people of the nation.
 It also intends to bring in mobile banking or financial services in order to reach the poorest
people living in extremely remote areas of the country.

Initiatives taken for promoting Financial Inclusion

In the recent years, GOI and RBI have undertaken several initiatives to expand the financial outreach
to the unbanked people of India. Both the institutions have endeavoured to introduce so many
schemes to meet the goal of universal financial inclusion.
1. Priority Sector Lending: It is an important role given by the Reserve Bank of India (RBI) to the
banks for providing a specified portion of the bank lending to few specific sectors like agriculture or
small scale industries. This is essentially meant for an all round development of the economy as
opposed to focusing only on the financial sector.

2. Setting up of the ‘Ultra Small Branches’: These are non brick-mortar branches. The purpose of
which is to reduce the infrastructural costs in setting up branches in rural areas. Under this initiative,
the banks will appoint banking correspondent who will deal with all cash transactions and other
routine work in that area. A bank officer will visit this ultra small branch once a week and connect
this business correspondent to the banks’ core banking solution (CBS) through a secured network
enabling data access and transfer between the small branch and the bank.
3. Opening of no-frills accounts: Basic banking no-frills account is with nil or very low minimum
balance as well as charges that make such accounts accessible to vast sections of the population.
Banks have been advised to provide small overdrafts in such accounts.

4. Relaxation on know-your-customer (KYC) norms: KYC requirements for opening bank accounts
were relaxed for small accounts in August 2005; thereby simplifying procedures by stipulating that
introduction by an account holder who has been subjected to the full KYC drill would suffice for
opening such accounts. It has now been further relaxed to include the letters issued by the Unique
Identification Authority of India containing details of name, address and Aadhaar number.

5. Engaging business correspondents (BCs): In January 2006, RBI has permitted banks to engage
business facilitators (BFs) and BCs as intermediaries for providing financial and banking services. The
BC model allows banks to provide doorstep delivery of services, especially cash in-cash out
transactions, thus addressing the last-mile problem.

6. Use of technology: Recognizing that technology has the potential to address the issues of
outreach and credit delivery in rural and remote areas in a viable manner, banks have been advised
to make effective use of information and communications technology (ICT), to provide doorstep
banking services through the BC model where the accounts can be operated by even illiterate
customers by using biometrics, thus ensuring the security of transactions and enhancing confidence
in the banking system.

PMJDY: Around 192.1 million accounts have been opened under the Pradhan Mantri Jan Dhan
Yojana (PMJDY). These zero-balance bank accounts have been accompanied by 165.1 million debit
cards, a life insurance cover of Rs 30,000 and an accidental insurance cover of Rs 1 lakh.
Other than PMJDY, there are several other financial inclusion schemes in India — Jeevan Suraksha
Bandhan Yojana, Pradhan Mantri Vaya Vandana Yojana, Pradhan Mantri Mudra Yojana, Stand Up
India scheme, Venture Capital Fund for Scheduled Castes under the social- sector initiatives, Pradhan
Mantri Suraksha Bima Yojana (PMSBY), Atal Pension Yojana (APY), Varishtha Pension Bima Yojana
(VPBY), Credit Enhancement Guarantee Scheme (CEGS) for scheduled castes, and Sukanya Samriddhi
Yojana
Challenges of Financial Inclusion
 Bank services do not have enough support for scalability.
 The technology adoption is limited.
 The lack of the availability of documents for the purposes of banking activities.
 Almost minimal financial literacy.
 In the case of rural areas, telecom connectivity and infrastructure are poor

5. REGULATORY AND PROMOTIONAL INSTITUTIONS

5.1 THE RESERVE BANK OF INDIA (RBI)
The origin of the Reserve Bank can be traced to 1926, when the Royal Commission on Indian
Currency and Finance—also known as the Hilton-Young Commission— recommended the creation of
a central bank to separate the control of currency and credit from the government and to augment
banking facilities throughout the country. The Reserve Bank of India Act of 1934 established the
Reserve Bank as the banker to the central government and set in motion a series of actions
culminating in the start of operations in 1935. Since then, the Reserve Bank’s role and functions have
undergone numerous changes—as the nature of the Indian economy has changed.
Reserve Bank of India being an apex body enjoys enormous power and functions under banking
system in India. It has monopoly over the issue of bank-notes and monetary system of the country.
These power and functions as to issue of bank notes and currency system are governed by the
Reserve Bank of India Act, 1934. Besides it the Banking Regulation Act, 1949 also empowers certain
power and Function of the Reserve Bank.

ROLE AND FUNCTIONS OF RBI

A. Main/Traditional Functions
Main functions are those functions which every central bank of each nation performs all over the
world. Basically, these functions are in line with the objectives with which the bank is set up. It
includes fundamental functions of the Central Bank. They comprise the following tasks.

1. Issue of Currency Notes: The RBI has the sole right or authority or monopoly of issuing currency
notes except one rupee note and coins of smaller denomination. These currency notes are legal
tender issued by the RBI. Currently it is in denominations of Rs. 2, 5, 10, 20, 50, 100, 500, and 2,000.
The RBI has powers not only to issue and withdraw but even to exchange these currency notes for
other denominations. It issues these notes against the security of gold bullion, foreign securities,
rupee coins, exchange bills and promissory notes and government of India bonds.
Four printing presses actively print notes: Dewas in Madhya Pradesh, Nasik in Maharashtra, Mysore
in Karnataka, and Salboni in West Bengal.
Coins are minted by the Government of India. RBI is the agent of the Government for distribution,
issue and handling of coins. Four mints are in operation: Mumbai, Noida in Uttar Pradesh, Kolkata,
and Hyderabad.

2. Banker to other Banks: The RBI being an apex monitory institution has obligatory powers to
guide, help and direct other commercial banks in the country. The RBI can control the volumes of
banks reserves and allow other banks to create credit in that proportion. Every commercial bank has
to maintain a part of their reserves with its parent's viz. the RBI. Similarly, in need or in urgency
these banks approach the RBI for fund. Thus, it is called as the lender of the last resort.

3. Banker to the Government: The RBI being the apex monitory body has to work as an agent of the
central and state governments. It performs various banking function such as to accept deposits,
taxes and make payments on behalf of the government. It works as a representative of the
government even at the international level. It maintains government accounts, provides financial
advice to the government. It manages government public debts and maintains foreign exchange
reserves on behalf of the government. It provides overdraft facility to the government when it faces
financial crunch.
As a banker to the central government, the Reserve Bank maintains its accounts, receives money
into and makes payments out of these accounts and facilitates the transfer of government funds. It
also acts as the banker to those state governments that have entered into an agreement with us.

4. Exchange Rate Management: It is an essential function of the RBI. In order to maintain stability in
the external value of rupee, it has to prepare domestic policies in that direction. Also, it needs to
prepare and implement the foreign exchange rate policy which will help in attaining the exchange
rate stability. In order to maintain the exchange rate stability, it has to bring demand and supply of
the foreign currency (U.S Dollar) close to each other.

5. Credit Control Function: Commercial bank in the country creates credit according to the demand
in the economy. But if this credit creation is unchecked or unregulated then it leads the economy
into inflationary cycles. On the other credit creation is below the required limit then it harms the
growth of the economy. As a central bank of the nation the RBI has to look for growth with price
stability. Thus, it regulates the credit creation capacity of commercial banks by using various credit
control tools.

B. Developmental/Promotional Functions
Along with the routine traditional functions, central banks especially in the developing country like
India have to perform numerous functions. These functions are country specific functions and can
change according to the requirements of that country. The RBI has been performing as a promoter
of the financial system since its inception. Some of the major development functions of the RBI are
maintained below.

1. Development of the Financial System: The financial system comprises the financial institutions,
financial markets and financial instruments. The sound and efficient financial system is a
precondition of the rapid economic development of the nation. The RBI has encouraged
establishment of main banking and non-banking institutions to cater to the credit requirements of
diverse sectors of the economy.

2. Development of Agriculture: In an agrarian economy like ours, the RBI has to provide special
attention for the credit need of agriculture and allied activities. It has successfully rendered service in
this direction by increasing the flow of credit to this sector. It has earlier the Agriculture Refinance
and Development Corporation (ARDC) to look after the credit, National Bank for Agriculture and
Rural Development (NABARD) and Regional Rural Banks (RRBs).

3. Provision of Industrial Finance: Rapid industrial growth is the key to faster economic
development. In this regard, the adequate and timely availability of credit to small, medium and
large industry is very significant. In this regard the RBI has always been instrumental in setting up
special financial institutions such as ICICI Ltd. IDBI, SIDBI and EXIM BANK etc.

4. Provisions of Training: The RBI has always tried to provide essential training to the staff of the
banking industry. The RBI has set up the bankers' training colleges at several places. National
Institute of Bank Management i.e NIBM, Bankers Staff College i.e BSC and College of Agriculture
Banking i.e CAB are few to mention.

5. Collection of Data: Being the apex monetary authority of the country, the RBI collects process and
disseminates statistical data on several topics. It includes interest rate, inflation, savings and
investments etc. This data proves to be quite useful for researchers and policy makers.

6. Publication of the Reports: The Reserve Bank has its separate publication division. This division
collects and publishes data on several sectors of the economy. The reports and bulletins are
regularly published by the RBI. It includes RBI weekly reports, RBI Annual Report, Report on Trend
and Progress of Commercial Banks India., etc. This information is made available to the public also at
cheaper rates.

7. Promotion of Banking Habits: As an apex organization, the RBI always tries to promote the
banking habits in the country. It institutionalizes savings and takes measures for an expansion of the
banking network. It has set up many institutions such as the Deposit Insurance Corporation- 1962,
UTI-1964, IDBI-1964, NABARD-1982, NHB-1988, etc. These organizations develop and promote
banking habits among the people. During economic reforms it has taken many initiatives for
encouraging and promoting banking in India.

8. Promotion of Export through Refinance: The RBI always tries to encourage the facilities for
providing finance for foreign trade especially exports from India. The Export-Import Bank of India
(EXIM Bank India) and the Export Credit Guarantee Corporation of India (ECGC) are supported by
refinancing their lending for export purpose.

C. Supervisory Functions
The reserve bank also performs many supervisory functions. It has authority to regulate and
administer the entire banking and financial system. Banks are fundamental to the nation’s financial
system. The central bank has a critical role to play in ensuring the safety and soundness of the
banking system—and in maintaining financial stability and public confidence in this system. As the
regulator and supervisor of the banking system, the Reserve Bank protects the interests of
depositors, ensures a framework for orderly development and maintains overall financial stability
through preventive and corrective measures. Some of its supervisory functions are given below.
1. Granting license to banks: The RBI grants license to banks for carrying its business. License is also
given for opening extension counters, new branches, even to close down existing branches.
2. Bank Inspection: The RBI grants license to banks working as per the directives and in a prudent
manner without undue risk. In addition to this it can ask for periodical information from banks on
various components of assets and liabilities.
3. Control over NBFIs: The Non-Bank Financial Institutions are not influenced by the working of a
monetary policy. However, RBI has a right to issue directives to the NBFIs from time to time
regarding their functioning. Through periodic inspection, it can control the NBFIs.
4. Implementation of the Deposit Insurance Scheme: The RBI has set up the Deposit Insurance
Guarantee Corporation in order to protect the deposits of small depositors. All bank deposits below
Rs. Five lakh are insured with this corporation. The RBI has implemented the Deposit Insurance
Scheme in case of a bank failure.

5.2.SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI)

Securities and Exchange Board of India (SEBI) is a statutory regulatory body entrusted with the
responsibility to regulate the Indian capital markets. It monitors and regulates the securities market
and protects the interests of the investors by enforcing certain rules and regulations.
SEBI was founded on April 12, 1992, under the SEBI Act, 1992. Headquartered in Mumbai, India, SEBI
has regional offices in New Delhi, Chennai, Kolkata and Ahmedabad along with other local regional
offices across prominent cities in India.
Objectives of SEBI:
The overall objectives of SEBI are to protect the interest of investors and to promote the
development of stock exchange and to regulate the activities of stock market. The objectives of SEBI
are:
 To regulate the activities of stock exchange
 To protect the rights of investors and ensuring safety to their investment
 To prevent fraudulent and malpractices by having balance between self regulation of
business and its statutory regulations
 To regulate and develop a code of conduct for intermediaries such as brokers, underwriters,
etc

Role of SEBI:
This regulatory authority acts as a watchdog for all the capital market participants and its main
purpose is to provide such an environment for the financial market enthusiasts that facilitate the
efficient and smooth working of the securities market. SEBI also plays an important role in the
economy.
To make this happen, it ensures that the three main participants of the financial market are taken
care of, i.e. issuers of securities, investors, and financial intermediaries.
1. Issuers of securities: These are entities in the corporate field that raise funds from various sources
in the market. This organization makes sure that they get a healthy and transparent environment for
their needs.
2. Investors: Investors are the ones who keep the markets active. This regulatory authority is
responsible for maintaining an environment that is free from malpractices to restore the confidence
of the general public who invest their hard-earned money in the markets.
3. Financial Intermediaries: These are the people who act as middlemen between the issuers and
investors. They make the financial transactions smooth and safe.

Functions of SEBI
The SEBI performs functions to meet its objectives. To meet three objectives SEBI has three
important functions. These are:

(a) Protective Functions:

These functions are performed by SEBI to protect the interest of investor and provide safety of
investment. As protective functions SEBI performs following functions:
(i) It Checks Price Rigging:
Price rigging refers to manipulating the prices of securities with the main objective of
inflating or depressing the market price of securities. SEBI prohibits such practice because
this can defraud and cheat the investors.
(ii) It Prohibits Insider trading:
Insider is any person connected with the company such as directors, promoters etc. These
insiders have sensitive information which affects the prices of the securities. This
information is not available to people at large but the insiders get this privileged information
by working inside the company and if they use this information to make profit, then it is
known as insider trading, e.g., the directors of a company may know that company will issue
Bonus shares to its shareholders at the end of year and they purchase shares from market to
 make profit with bonus issue. This is known as insider trading. SEBI keeps a strict check when
insiders are buying securities of the company and takes strict action on insider trading.
(iii) SEBI prohibits fraudulent and Unfair Trade Practices:
SEBI does not allow the companies to make misleading statements which are likely to induce
the sale or purchase of securities by any other person.
(iv) SEBI undertakes steps to educate investors so that they are able to evaluate the securities of
various companies and select the most profitable securities.
(v) SEBI promotes fair practices and code of conduct in security market by taking following steps:

 SEBI has issued guidelines to protect the interest of debenture-holders wherein companies
cannot change terms in midterm.
 SEBI is empowered to investigate cases of insider trading and has provisions for stiff fine and
imprisonment.
 SEBI has stopped the practice of making preferential allotment of shares unrelated to
market prices.

(b) Developmental Functions:

These functions are performed by the SEBI to promote and develop activities in stock exchange and
increase the business in stock exchange. Under developmental categories following functions are
performed by SEBI:
(i) SEBI promotes training of intermediaries of the securities market.
(ii) SEBI tries to promote activities of stock exchange by adopting flexible and adoptable approach in
following way:
 SEBI has permitted internet trading through registered stock brokers.
 SEBI has made underwriting optional to reduce the cost of issue.
 Even initial public offer of primary market is permitted through stock exchange.
(iii) Carry out research work
(iv) Encouraging self-regulating organizations
(v) Promotion of fair trading and reduction of malpractices

(c) Regulatory Functions:

These functions are performed by SEBI to regulate the business in stock exchange. To regulate the
activities of stock exchange following functions are performed:
i. SEBI has framed rules and regulations and a code of conduct to regulate the intermediaries
such as merchant bankers, brokers, underwriters, etc.
ii. These intermediaries have been brought under the regulatory purview and private
placement has been made more restrictive.
iii. SEBI registers and regulates the working of stock brokers, sub-brokers, share transfer agents,
trustees, merchant bankers and all those who are associated with stock exchange in any
manner.
iv. SEBI registers and regulates the working of mutual funds etc.
v. SEBI regulates takeover of the companies.
vi. SEBI conducts inquiries and audit of stock exchanges.
vii. Register and regulate credit rating agencies
viii. Levying fees and other charges as per act