Unit II

Financial Institutions
Introduction and Meaning
Financial institutions are entities that help individuals and businesses full fill their monetary or financial
requirements, either by depositing money, investing it, or managing it. Some of the institutions labelled under
this category include – banks, investment firms, trusts, brokerage ventures, insurance companies, etc.
As the financial institutions enable individuals and companies to save, manage, invest, and use the funds
productively, the administrative authorities of a nation take due care of their regulations. If not dealt with well,
these institutions might collapse, damaging the economy to a great extent. In short, a properly regulated
financial entity will mean a healthy economy.

Financial Institutions are businesses that offer various types of financial services to customers. These
organizations provide many services, such as accepting deposits, making investments, advancing loans, offering
foreign exchange services, etc.

Financial Institutes are not limited to banks, as credit unions, insurance companies, investment banks, and
brokerage firms are also part of FIs. These organizations play a crucial role within a capitalistic economic system,
as they regulate the economy, ensure fair financial practices, connect savers and spenders and facilitate
prosperity to facilitate transactions.

As financial institutions have an imperative role in our economy, regulating their activities has become a part of
governmental authorities. As a result, the government makes numerous laws and regulations to oversee and
regulate financial institutions’ activities.

A financial institution is an organization that facilitates financial transactions and is a key player in financial
intermediation. They are involved in handling transactions such as loans, deposits, and currency changes. The
method in which financial institutions work involve utilizing money from their clients and then allocate to people
and organizations that need it.

Financial institutions include varying areas of business operations, including banks, investment dealers, and
insurance companies. Business operations are integral in any economy as they handle different financial
activities. Therefore, people and businesses rely on financial institutions to handle their transactions and, at
times, investments. Due to their criticality, financial institutions need regulation mostly from a government since
their insolvencies can lead to a national fright.

Financial Institution Definition

Financial Institution - A "financial institution" includes any person doing business in one or more of the following
capacities:
(1) bank (except bank credit card systems);
(2) broker or dealer in securities;
(3) money services business;
(4) telegraph company;
(5) casino;
(6) card club;
(7) a person subject to supervision by any state or federal bank supervisory authority.
Roles Performed by Financial Institutions
1. Economic Growth of the Nation
At the national level, financial institutions are subject to government regulation. They serve as an agent of the
government and develop the country’s economy. For instance, following government regulations, financial
institutions may extend a selective credit line with lower interest rates to assist a struggling industry in resolving
its problems.
2. Capital Formation
Financial institutions offer financial services to investors who require external cash to raise their capital stocks
by accepting individual savings. Investors may want financial services to carry out development plans by setting
up new machinery, tools, and equipment; constructing a new facility; and purchasing new transport vehicles,
among other things. Financial institutions contribute to the creation of capital in this way.
3. Regulate Monetary Supply
The financial institution assists in controlling the amount of money in the economy. These organizations keep
the money supply stable and manage inflation. The Federal Reserve Bank regulates the nation’s liquidity in
several ways, including adjusting repo rates, participating in open markets, and setting cash reserve ratios. To
control liquidity, financial institutions participate in the purchasing and selling of government assets.
4. Banking Services
Commercial banks and other financial institutions assist their clients by offering savings and deposit services.
Additionally, they provide their clients with credit options, including overdraft facilities, to meet their short-term
funding needs. Additionally, commercial banks offer their clients loans such as house loans, mortgages, personal
loans, and loans for schooling.
5. Pension Fund Services
Financial institutions assist people in retirement planning through the different types of investment plans they
offer. A pension fund is one of these investing possibilities. Employers, banks, or other institutions contribute to
the investment pool on behalf of the individual, who then receives a lump sum or monthly income upon
retirement.

Functions of a Financial Institution

There are multiple functions of financial institutions. They include:

1. Banking services - Financial institutions, specifically commercial banks, assist their customers by giving
them banking services like deposit and saving services. These institutions also give out credit services
that assist their clients in catering to their immediate needs. The credit services could include
mortgages, personal or educational loans.
2. Capital formation - Financial institutions assist in the creation of capital by increasing capital stock.
Financial institutions can increase the stocks by organizing savings that are not in current use by
customers and giving them to investors.
3. Monetary supply regulation - Financial institutions control the supply of money in an economy. The
main objective of this control is to ensure that there is stability in an economy and limited chances of
inflation. The financial institution tasked with this responsibility is the central bank, and it completes
this task by transacting the government's securities to influence liquidity.
4. Pension fund services - Pension funds are made by financial institutions to assist people in preparation
for their retirement. These pension funds are investment means that these institutions create to ensure
individuals have money after their retirement, which could be issued on a monthly basis.
5. Ensure economic growth of a nation - Governments play a vital role in controlling financial institutions,
and the main objective is to help in the growth of an economy. When there are issues in an economy,
financial institutions are mandated to provide loans with low interest to assist in maintaining an
economy.
 6. Monetary supply regulation - Financial institutions control the supply of money in an economy. The
main objective of this control is to ensure that there is stability in an economy and limited chances of
inflation. The financial institution tasked with this responsibility is the central bank, and it completes
this task by transacting the government's securities to influence liquidity.
7. Easy fund transfer services -Transactions involving transfer of funds between any Accounts, or between
any Account and any other accounts of the Customer and/or third parties held within the Bank and/or
with other banks can only be accepted if the necessary arrangements have been established by the
Bank.
8. Ensure economic growth of a nation - Governments play a vital role in controlling financial institutions,
and the main objective is to help in the growth of an economy. When there are issues in an economy,
financial institutions are mandated to provide loans with low interest to assist in maintaining an
economy.
9. Manage financial risks -Financial risk management is the process of evaluating and managing current
and possible financial risk to decrease an organization's exposure to risk.

Central Bank
A central bank is an independent, non-political financial agency that supervises monetary policy. It is responsible
for maintaining cash and foreign currency reserves, thus stimulating the nation’s economic growth and
controlling inflation. Each country has its central bank to manage its financial and banking issues.

These banks perform the following operations:

• Maintaining monetary policy by regulating the money supply and interest rates
• Providing financial stability to the government and commercial institutions
• Safeguarding and managing the nation’s gold, foreign currency, and government bonds
• Overseeing the functioning of the banking sector and balancing the nation’s banking system
• Handling financial transactions; locally via clearing houses and globally via networks such as SWIFT
• Issuing new currency and coins inside a nation
• Providing financial advice to the government

Origin & History Of The Reserve Bank Of India

Origin Timeline
The origins of the Reserve Bank of India 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 for
India 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 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 and financial sector changed.

There were several causes for the creation of a central bank. Though the rupee was the common currency, there
were several species of rupee coins of different values in circulation. The authorities, however, endeavored to
evolve a standard coin. For many years, the Sicca of Murshidabad was, in theory, the standard coin, and the
rates of exchange of the various rupees in terms of the Sicca rupee varied, the discount being called the batta.

The Government received enquiries from the Collectors as to the batta they should charge on the different
species they received from zamindars and farmers. The proposed bank was to fix the value, in Sicca rupees, of
the bills it had to issue in return for the money received from the Collectors, on the basis of the same batta.
Thus, the bank was expected to assist in stabilizing inland exchange and in enforcing the Sicca coin as the
standard coin of the Provinces.
Functions of the Central Banks/RBI
1. Issue of Currency Notes
• Under section 22 of RBI Act, the bank has the sole right to issue currency notes of all denominations
except one-rupee coins and notes.
• The one-rupee notes and coins and small coins are issued by Central Government, and their distribution
is undertaken by RBI as the agent of the government.
• The RBI has a separate issue department which is entrusted with the issue of currency notes.
2. Banker to The Government
• The RBI acts as a banker agent and adviser to the government. It has an obligation to transact the
banking business of Central Government as well as State Governments.
• Example, RBI receives and makes all payments on behalf of the government, remits its funds, buys and
sells foreign currencies for it and gives it advice on all banking matters.
• RBI helps the Government – both Central and state – to float new loans and manage public debt.
• On behalf of the central government, it sells treasury bills and thereby provides short-term finance.
3. Banker’s bank And Lender of Last Resort
• RBI acts as a banker to other banks. It provides financial assistance to scheduled banks and state co-
operative banks in the form of rediscounting of eligible bills and loans and advances against approved
securities.
• RBI acts as a lender of last resort. It provides funds to the bank when they fail to get it from any other
source.
• It also acts as a clearing house. Through RBI, banks make inter-banks payments.
4. Controller of Credit
• RBI has the power to control the volume of credit created by banks. The RBI through its various
quantitative and qualitative measures regulates the money supply and bank credit in an economy.
• RBI pumps in money during recessions and slowdowns and withdraws money supply during an
inflationary period.
5. Manages Exchange Rate and Is Custodian of the Foreign Exchange Reserve
• RBI has the responsibility of removing fluctuations from the exchange rate market and maintaining a
competitive and stable exchange rate.
• RBI functions as custodian of nations foreign exchange reserves.
• It has to maintain a fair external value of Rupee.
• RBI achieves its objective through appropriate monetary and exchange rate policies.
6. Collection and Publication of Data
• The RBI collects and compiles statistical/data information on banking and financial operations, prices,
FDIs, FPIs, BOP, Exchange Rate and industries etc., of the economy.
• The Reserve Bank of India publishes a monthly Bulletin/publication for the same.
• It not only provides information but also highlights important studies and investigations conducted by
RBI.
7. Regulator and Supervisor of Commercial Banks
• The RBI has wide powers to supervise and regulate the commercial and co-operative banks in India.
• RBI issues licenses regulate branch expansion, manages liquidity and Assets, management and methods
of working of commercial banks and amalgamation, reconstruction and liquidation of the banks.
8. Clearing House Functions
• The RBI acts as a clearing house for all member banks. This avoids unnecessary transfer of funds
between the various banks.
9. Measures of Credit Control in India
• The management of the money supply and credit control is an important function of the Reserve Bank
of India. The money supply has an important bearing on the functioning of the economy
Commercial Banks
A commercial bank is a type of financial institution that provides services like accepting deposits, making
business loans, and offering basic investment products. The term commercial bank can also refer to a bank, or
a division of a large bank, which precisely deals with deposits and loan services provided to corporations or large
or middle-sized enterprises as opposed to individual members of the public or small enterprises. For example,
Retail banking, or Merchant banks.
A commercial bank can also be defined as a financial institution that is licensed by law to accept money from
different enterprises as well as individuals and lend money to them. These banks are open to the mass and assist
individuals, institutions, and enterprises.
Basically, a commercial bank is the type of bank people tend to use regularly. They are formulated by federal
and state laws on the basis of the coordination and the services they provide.

Role of Commercial Banks

1. Trade Development: Commercial banks provide capital, technical assistance, and other facilities to
traders as per their need which leads to growth in trade.
2. Agriculture Development: Commercial banks finance the most crucial sectors of the developing
economy, such as agriculture, short, medium, and long-term loans for seeds and fertilizers, tube wells
installation, warehouse construction, purchase of tractors and threshers.
3. Industrial Development: Countries that have focused on the industrial sectors have developed rapidly.
South Korea, Malaysia, Taiwan, Hong Kong, and Indonesia have recently developed their industrial
sectors with the help of commercial banks.
4. Capital Formation: Commercial banks help to increase the rate of capital formation in a country. Capital
formation means increasing the number of production units, technologies, plants, and equipment. They
fund projects responsible for increasing the rate of capital formation.
5. Development of Foreign Trade: Commercial banks assist businessmen in conducting business in two
different countries. Credit certificates are issued by the importer’s bank to the exporters to ensure
payment. Banks also provide foreign exchange.
6. Transfer to money: Commercial banks make it possible to transfer funds from one place to another
which leads to the growth of trade.
7. More production: A good banking system ensures greater productivity in all areas of the economy. It
increases the productive capacity of the economy by strengthening the capital structure and the
division of labor.
8. Trade Development: Commercial banks provide capital, technical assistance, and other facilities to
traders as per their need which leads to growth in trade.
9. Agriculture Development: Commercial banks finance the most crucial sectors of the developing
economy, such as agriculture, short, medium, and long-term loans for seeds and fertilizers, tube wells
installation, warehouse construction, purchase of tractors and threshers.
10. Industrial Development: Countries that have focused on the industrial sectors have developed rapidly.
South Korea, Malaysia, Taiwan, Hong Kong, and Indonesia have recently developed their industrial
sectors with the help of commercial banks.
11. Capital Formation: Commercial banks help to increase the rate of capital formation in a country. Capital
formation means increasing the number of production units, technologies, plants, and equipment. They
fund projects responsible for increasing the rate of capital formation.
12. Development of Foreign Trade: Commercial banks assist businessmen in conducting business in two
different countries. Credit certificates are issued by the importer’s bank to the exporters to ensure
payment. Banks also provide foreign exchange.
13. Transfer to money: Commercial banks make it possible to transfer funds from one place to another
which leads to the growth of trade.
 14. More production: A good banking system ensures greater productivity in all areas of the economy. It
increases the productive capacity of the economy by strengthening the capital structure and the
division of labor.
Functions of commercial bank
These banks are controlled by the Federal Reserve System. A commercial bank is licensed to assist the following
functions −

1. Primary functions
a. Accepting Deposits: The primary function for which the commercial banks were established is to
accept deposits from the general public, who possess surplus funds and are willing to deposit them
so as to earn interest on it.
b. Advancing Loans: Next important function performed by the commercial bank is lending money to
the individuals and companies. The banks make loans to the customers in the form of term loans,
cash credit, overdraft and discounting of bills of exchange.
2. Secondary functions
a. Agency Services: There are some facilities provided by the commercial banks in which they act as
an agent of the customers. Such services are:
i. Collection and payment of rent, interest and dividend.
ii. Collection and payment of cheques and bills.
iii. Buying and selling securities.
iv. Payment of insurance premium and subscriptions.
b. General Utility Services: Commercial banks provide general utility services to the customers and
charges a fee for the same. It covers services like:
i. Safekeeping of valuables, documents etc, in locker or vault.
ii. ATM card, credit card and debit card facility.
iii. Issue of demand draft, pay order and traveller’s cheque.
iv. Internet and mobile banking
v. Sale of application forms of competitive exams.
c. Transfer of funds: Banks assist in the transfer of funds from one person to another or from one
place to another through its credit instruments.
d. Credit Creation: The commercial banks are authorized to create credit, by granting more loans than
the amounts deposited by the customers.
Advantages of Commercial Bank
1. Confidentiality of Information: The banks when lends funds or accept deposits do not share the
information with anyone. Banks value the privacy of their customers by preserving the secrecy of
personal information of customers. The personal details of the customers or the account holders are
kept safe with the banks.
2. Economical: Commercial banks are widely regarded as the cheaper funding source. The reason for its
being an economical source is that it does not involves any cost for issuing of a prospectus, underwriting
fees or any other charges. Banking services under commercial banks are free from any sort of hidden
charges.
3. Flexible: Commercial banks are considered to be a flexible source of funding because the borrower can
easily borrow money from the banks whenever they are in urgent need of money or funds. The
borrowers can easily increase or reduce the amount of borrowings as per their convenience and
requirements. The banks make the funds available as and when needed by the borrowers. Also,
borrowers can repay the money when they don’t feel the requirement.
4. Lesser Formalities: It’s easy for borrowers to raise funds from commercial banks because it requires no
stringent formalities to follow up. As such no paperwork is involved in the whole borrowing process. It
 requires no formalities like looking for an underwriter or issuing of a prospectus. So, it makes the
process hassle-free and smooth.
5. Encourage Savings: Commercial Banks through their operations encourage savings among the general
public. With this facility, banks offer a safer way to collect money from individuals, which otherwise
they could have consumed impulsively. The amount of savings is subject to some fixed rate of interest.
So savings from individuals whether in small or big amount increases the capital accumulation with the
banks, which then can be used to invest or lend to the general public.
6. Facilitates Digital Transactions: With the growth of digitisation, commercial banks have emerged as
significant financial institution because it provides a technologically advanced platform for making
digital payments. Apart from basic facilities, it makes online transfers easy, use of cheques, ATMs, bank
drafts, etc. A very few and recent development of commercial banks is the facility of online wallet.
Earlier individuals and businessmen had to handle a lot of money which was subjected to theft, but
now they can keep their money safe in the wallets and can use to make digital payments.

Disadvantages of Commercial Bank

1. Procedural Difficulty: While lending funds to borrowers, it’s important for commercial banks to check
if the advances are being made to the right entity. The only way to check is to conduct a detailed
investigation of the firm’s background and its financial affairs. It follows stringent rules, so it makes the
procedure of borrowing very tricky and rigorous.
2. Difficulty in Renewal: Loans from Commercial Banks can be generally borrowed for a short period of
time only. It’s almost difficult to renew or extend the borrowings. Also, extending the tenure of
borrowed funds can be tough and only fresh loans can be borrowed.
3. Need for Security: Loans from commercial banks can’t be provided without any security. For any
amount of loan or advances, there is a requirement of any asset or personal guarantees from the
borrowers against which borrowings can be issued. Most of the time, the loan amount is lower than
the security’s value. So it has become disadvantageous for the public and firms.
4. Stringent Terms and Conditions: Commercial banks sometimes put forward a few challenging
conditions for borrowers before lending loans or funds. At times, terms and conditions are so difficult
to fulfil that it hampers the complete borrowing process. So, this restricts the borrowing decision of
firms that they even back out from this source of funds and shift to some other source of funds with
some feasible terms and conditions.
5. Bankruptcy: Sometimes, the banks may not be capable to provide the amount requested by the
borrowers even if that money belongs to the customers and they have only deposited those to their
savings account. This happens when the management of the banks does not take proper care of
depositors’ or investors’ finances and rather mismanages them. But sometimes, it could also happen
due to weaker economic health, like in times of recession when customers do more withdrawal than
borrowings.
6. Risk of Online Frauds: Growing digitisation has not only soothed operations but also has given rise to
online frauds. Cyber attacks have become more common and often nowadays, ATM cards are more
subjected to theft, hackers hack the accounts and passwords for digital payments, and steal money
online. There’s an urgent need to strengthen the game of internet banking.

Cooperative Banking
Meaning of Cooperative Bank:
Cooperative bank is an institution established on the cooperative basis and dealing in ordinary banking business.
Like other banks, the cooperative banks are founded by collecting funds through shares, accept deposits and
grant loans.
History of Cooperative Banking in India
Cooperative movement in India was started primarily for dealing with the problem of rural credit. The history of
Indian cooperative banking started with the passing of Cooperative Societies Act in 1904. The objective of this
Act was to establish cooperative credit societies “to encourage thrift, self-help and cooperation among
agriculturists, artisans and persons of limited means.”

Many cooperative credit societies were set up under this Act. The Cooperative Societies Act, 1912 recognised
the need for establishing new organisations for supervision, auditing and supply of cooperative credit. These
organisations were- (a) A union, consisting of primary societies; (b) the central banks; and (c) provincial banks.

Although beginning has been made in the direction of establishing cooperative societies and extending
cooperative credit, but the progress remained unsatisfactory in the pre-independence period. Even after being
in operation for half a century, the cooperative credit formed only 3.1 per cent of the total rural credit in 1951-
52.

Objectives of cooperative banks

1. Promote financial inclusion.

2. Providing rural financing and micro-financing.
3. Eliminating the influence of money lenders and intermediaries.
4. Empower members and foster a sense of ownership.
5. Provide affordable and accessible financial services.
6. Support local economic development.
7. Adhere to cooperative principles of trust and transparency.
8. Promote savings and financial education.
9. Strengthen social and community bonds.

Functions of cooperative banks

1. It provides financial assistance to people with small means and protects them from the latches of
money lenders providing loans and other services at a higher rate at the expense of the needy.
2. It supervises and guides affliated societies.
3. Rural financing: It provides financing to rural sectors like cattle farming, crop farming,hatching, etc. at
comparatively lower rates.
4. Urban financing- it provides financing for small scale industries, personal finance, home finance, etc.
5. It mobilises funds from its members and provides interest on the invested capital.

Features of Cooperative Banks

1. Voluntary Association: Cooperative banks are formed by a voluntary association of individuals or small
businesses who come together to meet their common financial needs.
2. Customer Ownership: Members of cooperative banks are both customers and owners of the bank. Each
member has an equal say in the decision-making process regardless of the size of their deposits.
3. Democratic Governance: Cooperative banks operate on the principles of democratic governance.
Members elect a board of directors who are responsible for managing the bank’s affairs and making
decisions on behalf of the members.
4. Limited Profit Motive: Cooperative banks aim to serve their members rather than maximize profits.
Their primary focus is on meeting the financial needs of their members at reasonable rates.
5. Social Objectives: Cooperative banks often have social objectives, such as promoting financial inclusion,
supporting agriculture, providing credit to small businesses, and uplifting the economically weaker
sections of society.
 6. Mutual Cooperation: Members of cooperative banks actively cooperate with each other and share
resources to meet their financial requirements. This mutual cooperation strengthens the collective
bargaining power of members.
7. Local Focus: Cooperative banks primarily serve a specific local community or region. They have a better
understanding of local needs and can tailor their products and services accordingly.
8. Credit and Savings Services: Cooperative banks provide a range of banking services, including accepting
deposits, granting loans, and offering various savings and investment products to their members.
9. Profit Distribution: Any surplus generated by the cooperative bank is distributed among the members
in proportion to their participation or usage of the bank’s services. This ensures equitable sharing of
profits.
10. Regulatory Oversight: Cooperative banks are regulated by the respective cooperative departments and
banking regulators of the country to ensure compliance with regulatory requirements and safeguard
the interests of members.

Types of Cooperative Banks

1. Primary Cooperative Banks

2. Urban Cooperative Banks
3. State Cooperative Banks
4. Central Cooperative Banks
5. Land Development Banks
6. Agricultural Cooperative Banks
7. Cooperative Rural Banks

Primary Co-operative Banks: These offer credit services in the urban and semi-urban regions. Thus, they are not
considered agricultural credit societies. Primary Co-Operative Banks receive concessional refinance services
from RBI and IDBI from time to time for them to offer housing loans and other types of loans that can be used
by small businesses. Multi-State Cooperative Banks.

Urban Co-operative Banks (UCBs): – The Urban Co-operative Banks (UCBs) are also known as the primary
cooperative banks, operate in urban and semi-urban areas. These are small-sized co-operatively organized
banking units to cater the needs of small borrowers viz. small scale business units, retail traders, professionals,
salaried classes, etc.

State Co-operative Banks: – These cooperative banks works at the apex level in states. They mobilize funds and
help in their proper channelization among various sectors. The money reaches the individual borrowers from
the State Co-operative Banks through Central Co-operative Banks and the Primary Credit Societies.

Central Co-operative Banks: – These banks works at the district level, provide loans to their members (i.e.
primary credit societies) and function as a link between the primary credit societies and state co-operative
banks.

The land development banks are divided into three tiers which are primary, state, and central. These offer credit
services to the farmers for developmental purposes. They used to be regulated by the RBI as well as the state
governments. However, this responsibility was recently transferred to the National Bank for Agricultural and
Rural Development (NABARD).
Primary Agricultural Credit Societies (PACS): -The PACS operate at the village or grass-root level. The operations
of each society are restricted to a small area so that the members know each other and are able to watch over
the activities of all members to prevent frauds.

Advantages of Cooperative Banks

1. Alternative Source of Credit: The rural population benefits from cooperative banking as they provide credit at
a lower rate as compared to the money lenders who tend to provide credit at a higher rate of interest. This
protects the rural population from the monopoly of the money lenders.

2. Encourages Savings and Investment: Cooperative banking has enabled the rural population to save more and
invest rather than hoard money. This will have a long-term benefit on the money management of the rural
population.

3. Improvement in Farming Methods: Due to the lower interest rates of the credits provided by the Cooperative
banks, the rural population can now utilise the same for better farming methods eg: purchasing seeds, chemical
fertilizers etc.

Limitations of Cooperative Banks

1. Inadequate Coverage: The membership of the rural population of cooperative banking is just 45%, hence the
inadequate coverage is a matter of concern. It is restricted only to a few states like Gujrat, Maharashtra, Punjab
etc.

2. Inefficient Societies: Since these banks are often run by the members themselves, they are not run efficiently
and hence lose out on alternate streams of revenue. For ex, It was observed that out of 94089 primary
agricultural credit societies in the country in the year1982-83, about 34000 societies were running at a loss.

3. Problem of Overdue: The overdue loans of the cooperative institutions have been increasing over the years.
The overdue in the short-term credit structure is most alarming in the North-Eastern States. In the long-term
loaning sector, the problem of overdue has almost crippled the land development banks in 9 states, viz.,
Maharashtra, Gujarat, Madhya Pradesh, Bihar, Karnataka, Assam, West Bengal, Orissa and Tamil Nadu.

4. Regional Disparities: The distribution of credit is not equally divided in these banks. According to an RBI report,
8 states account for about 80 per cent of the total credit whereas the credit disbursed varied from Rs. 4 in Assam
to Rs. 718 in Kerala.

Development bank
Meaning
Development banks are nothing but financial institutions providing long-term funds for capital-intensive
investments for a long period of time. Their lending yields low rates of returns, such as irrigation systems, urban
infrastructure, mining, and heavy industries, etc.
They are also known as development finance institutions (DFI) or long-term lending institutions.
These banks lend at low and stable interest rates so as to promote long-term investments along with social
benefits.
Development banks are not the same as commercial ones. Instead, development banks mobilize short to
medium-term deposits and lend for similar periods of tenure to avoid a maturity mismatch, which causes a
bank’s solvency and liquidity.

ROLE OF DEVELOPMENT BANKS

1. Providing Funds
The persons who have the capability of starting a business but does not have requisite help approach to financial
institutions for help. These institutions help a large number of persons for taking up some industrial activity.

2. Promotional activities
The promotional role of development banks is helpful in increasing the development of a country. They create
a new class of entrepreneurs and help the weaker sections of society to be a part of industrial culture. With a
view for a long term benefit to social development, banks have new capital schemes which provide financial
assistance to the novice entrepreneurs. They help in covering the expense and manpower resources for
undertaking the exercise of starting a new unit.

3. Assistance of Backward Units

The development bank encourages rustic and provincial development. They give money to beginning
organizations in reverse zones. Likewise, they help organizations which are in the venture in less-developed
regions.

4. Employment Generation
Financial institutions have helped both direct and indirect employment generation. They have employed many
people in their offices. These institutions help in creating employment by financing new and existing industrial
units.

5. Accelerating Industrialization
The setting up of more industrial units will generate direct and indirect employment, make available goods and
services in the country and help in increasing the standard of living. Financial institutions provide requisite
financial, managerial, technical help for setting up new units.

6. Development of Housing Sector

Development banks provide funding for the development of the housing sector. It refinances banks and financial
institutions which provide credit to the housing sector. It promotes and develops housing and financial
institutions.

7. Agriculture and Rural Development

It organizes the working of all monetary establishments that give credit to farming and rural development.
Development banks like the National Bank for Agriculture and Rural Development (NABARD) which give credit
to the agriculture and furthermore for country advancement exercises.

8. Improve Foreign Trade

It gives Overseas Buyers Credit to purchase Indian capital merchandise. Likewise, urges abroad banks to give
account to the purchasers in their nation to purchase capital products from India.

9. Revival of Sick Units

Development banks help to resuscitate (fix) wiped out units. It encourages modernization, rebuilding, and
broadening of wiped out units by giving credit and different administrations. The public authority of India (GOI)
began the Industrial Investment Bank of India (IIBI) to help wipe out units. IIBI is the principal credit and
recreation foundation for a restoration of wiped out units.

10. Contribution to Capital Markets

The development bank helps in the growth of capital markets. They invest in equity shares and debentures and
mutual funds of several companies listed in India.
Functions of development bank
Merchant Banking:
A merchant bank is a firm or the financial institution providing capital to the companies in the form of share
ownership instead of loan. Merchant bank also work as a consultancy and provide advisory on corporate matters
to firm in which they invest, these banks are experts in international trade, which makes them pundit in dealing
with multinational corporation. Merchant bankers helps firms or companies in raising finance by way of issue of
a share, bank loans, debenture etc. merchant bank do not provide financial service to normal public.

Services provided by merchant bankers:

1. Providing loans to companies
2. Raising funds from new instrument
3. Estimating the amount of funds required
4. Portfolio management
5. Loan syndicating
6. Project counselling
7. Market survey and forecasting
8. Fixed deposit management.
Features of merchant bank
1. These banks serve huge corporations and high net-worth individuals instead of the general public;
2. They are innovative and have a loose organizational structure;
3. Despite high liquidity
4. measures, their profit distribution is low;
5. Since they have many decision-makers, the decision-making process is prompt;
6. They offer services at domestic and international levels;
7. These banks possess strong databases and high-density information;
8. They make money in the form of fees and commissions.

Functions of merchant banker

1. Corporate counselling -Merchant bankers offer customized solutions to their clients’ financial
problems. Financial structuring includes determining the right debt-equity ratio and the framing of
appropriate capital structure theory
 2. Project counselling - Merchant bankers help their clients in various stages of the project undertaken by
the clients. They assist them in conceptualizing the project idea in the initial stage. Once the idea is
formed, they conduct feasibility studies to examine the viability of the proposed project.
3. Loan Syndication- Merchant bankers arrange to tie up loans for their clients. This takes place in a series
of steps. Firstly, they analyze the pattern of the client’s cash flows, based on which the terms of the
borrowings can be defined. Then the merchant banker prepares a detailed loan memorandum, which
is circulated to various banks and financial institutions and they are invited to participate in the
syndicate. The banks then negotiate the terms of lending on the basis of which the final allocation is
done.
4. Venture capital finance-Venture capital is money provided by professionals who invest alongside
management companies that have the potential to develop into significant economic contributors.
Venture capital funding may be by way of investment in the equity of the new enterprise or by way of
debt or a combination of both, though equity is the most preferred route. Venture capitalists generally
provide finance for promising start-ups. However, they also invest in companies at various stages of the
business life cycle viz
5. Portfolio management - Merchant banks provide portfolio management services to institutional
investors and other investors. They help in the management of securities to enhance the value of the
underlying investment. Merchant banks may assist their clients in purchasing and selling securities to
help them attain their investment objectives
6. Capital restructuring- Advisory service on examination of the corporation's capital structure to decide
the extent of capitalization , render advice on mergers, takeovers and amalgamations ,identify areas of
diversification of existing production systems.
7. Issue management-Merchant takes up the event of share issue of a company from-Preparation of
prospectus ▪ Preparation of a budget ▪ Preparation of (Controller of Capital Issues)CCI application ▪
Selection of issue house ▪ Appointment of registrar, broker and bankers to issue ▪ Advertising and
arranging publicity agency for post and pre-issue. ▪ Selection of institutional and broker underwriters .
▪ Compliance of listing requirements of stock exchange etc.
8. Lease finance- leasing is the arrangement that provides a firm with the use and control over assets
without buying and owning the same. Merchant bankers assist their clients by providing finance for the
acquisition of the asset taken on lease.
9. Working capital finance- Working Capital Financing is when a business borrows money to cover day-to-
day operations and payroll rather than purchasing equipment or investment. Merchant banker
provides such finance to entities.

Regulations by SEBI on Merchant Banking

Reforms for the merchant bankers
SEBI has made the following reforms for the merchant banker
1. Multiple categories of merchant banker will be abolished and there will be only one equity merchant
banker.
1. The merchant banker is allowed to perform underwriting activity. For performing portfolio
2. manager, the merchant banker has to seek separate registration from SEBI.
3. A merchant banker cannot undertake the function of a non banking financial company, such as
4. accepting deposits, financing others’ business, etc.
3. A merchant banker has to confine himself only to capital market activities.

Recognition by SEBI on merchant bankers

SEBI will grant recognition a merchant banker after taking into account the following aspects
1. Considering how much the merchant are professionally competent.
2. Whether they have adequate capital
 3. Track record, experience and general reputation of merchant bankers.
4. Quality of staff employed by merchant bankers, their adequacy and available
infrastructure are taken into account. After considering the above aspects, SEBI will grant
permission for the merchant banker to start functioning.

Features of Hire Purchase System

1. Act: It is regulated by the Hire Purchase Act, 1972.

2. Parties: It is an agreement amidst hirer and hire vendor for hiring an asset.
3. Claiming rights: In case hirer fails to make a payment, hire vendor can sue or claim only for the
return of the asset and not for the remaining due installment payments.
4. Selling Rights: Hirer cannot sell or mortgage the hired asset untill ownership gets transferred to the
them.
5. Loss bearer: Hire vendor remains liable for any loss of goods untill ownership gets transferred to
the hirer.

Types of Hire Purchase

• Consumer Hire Purchase: In this type, the goods are hired by the buyer for non-business purposes i.e.
for his personal use. This can also be for family or other household purposes apart from the business.
The hirer here is not the business but the natural person.
Example
Mr. Sen. and Mr. Gupta are friends, Mr. Gupta is planning to sell his car for $50,000, Mr. Sen wishes to
purchase the car for his personal use. However, he doesn’t have $50,000 in his hands, so, he entered
into an agreement with Mr. Gupta that he will make the down payment of $5,000 initially and the
balance of $45,000 will be paid in 5 equal installments of $9,000 each month with 10% interest charged
on balance. In case, Mr.Gupta fails to pay any instalments then the car will be taken back by Mr. Sen.
The ownership of the car will be transferred only after payment of the last installment.

• Industrial Hire Purchase: Contrary to the above, here, the hirer is not the natural personnel but the
companies or the industries that take the goods on hire for their business purposes. Example: the hire
purchase of machinery for use in industries.
Example
ABC Ltd. needs industrial equipment costing $70,000. Due to a shortage of funds, it decides to enter
into a hire purchase agreement with XYZ Ltd., whereby ABC acquires the equipment by paying $10,000
and agrees to pay the balance $60,000 in 6 equal installments of $10,000 each a month with an interest
rate equalling 5% per annum.

Advantages of Hire Purchase System:

(1) Convenience in Payment: The buyer is greatly benefited as he has to make the payment in installments. This
system is greatly advantageous to the people having limited income.

(2) Increased Volume Of Sales: This system attracts more customers as the payment is to be made in easy
installments. This leads to increased volume of sales.

(3) Increased Profits: Large volume of sales ensures increased profits to the seller.

(4) Encourages Savings: It encourages thrift among the buyers who are forced to save some portion of their
income for the payment of the installments. This inculcates the habit to save among the people.
(5) Helpful For Small Traders: This system is a blessing for the small manufacturers and traders. They can
purchase machinery and other equipment on installment basis and in turn sell to the buyer charging full price.

(6) Earning Of Interest: The seller gets the installment which includes original price and interest. The interest is
calculated in advance and added in total installments to be paid by the buyer.

(7) Lesser Risk: From the point of view of seller this system is greatly beneficial as he knows that if the buyer fails
to pay one installment, he can get the article back.

Disadvantages of Hire Purchase System:

(1) Higher Price: A buyer has to pay higher price for the article purchased which includes cost plus interest. The
rate of interest is quite high.

(2) Artificial Demand: Hire purchase system creates artificial demand for the product. The buyer is tempted to
purchase the products, even if he does not need or afford to buy the product.

(3) Heavy Risk: The seller runs a heavy risk under such system, though he has the right to take back the articles
from the defaulting customers. The second hand goods fetch little price.

(4) Difficulties in Recovery of Installments: It has been observed that the sellers do not get the installments from
the purchasers on time. They may choose wrong buyers which may put them in trouble. They have to waste
time and incur extra expenditure for the recovery of the installments. This sometimes led to serious conflicts
between the buyers and the sellers.

(5) Break Up Of Families: The system puts a great financial burden on the families which cannot afford to buy
costly and luxurious items. Recent studies in western countries have revealed that thousands of happy homes
and families have been broken by hire purchase buying’s.

Leasing companies
A financial institution predominantly engaged in the business of originating and underwriting lease transactions
is a leasing company. Leasing companies come in the form of bank lessors, captive lessors and independent
lessors and in all sizes – from small local rental stores to huge international finance companies and, together
with lease brokers, act as lease originators in the varied markets for lease assets. They provide leasing in the
form of short-term rentals to very long-term capital leasing of equipment and real estate, from the micro-ticket
leasing of hand tools and white goods to the syndicated big-ticket leasing of aircraft, marine vessels and plants.

Types of leases
1. Financial Lease: Financial leasing is a contract involving payment over a longer period. It is a
long-term lease and the lessee will be paying much more than the cost of the property or
equipment to the lessor in the form of lease charges. It is irrevocable. In this type of leasing
the lessee has to bear all costs and the lessor does not render any service.

2. Operating Lease: In an operating lease, the lessee uses the asset for a specific period. The
lessor bears the risk of obsolescence and incidental risks. There is an option to either party to
terminate the lease after giving notice. In this type of leasing:
• lessor bears all expenses
• lessor will not be able to realize the full cost of the asset
• specialized services are provided by the lessor.
This kind of lease is preferred where the equipment is likely to suffer obsolescence.

3. Leveraged and non-leveraged leases: In leveraged and non-leveraged leases, the value of the asset
leased may be of a huge amount which may not be possible for the lessor to finance. So, the lessor
involves one more financier who will have charge over the leased asset.

4. Conveyance type lease: In Conveyance type lease, the lease will be for a long-period with a clear
intention of conveying the ownership of title on the lessee.

5. Sale and leaseback: In a sale and leaseback, a company owning the asset sells it to the lessor. The
lessor pays immediately for the asset but leases the asset to the seller. Thus, the seller of the asset
becomes the lessee. The asset remains with the seller who is a lessee but the ownership is with the
lessor who is the buyer. This arrangement is done so that the selling company obtains finance for
running the business along with with the asset.

6. Full and non pay-out lease: A full pay-out lease is one in which the lessor recovers the full value of
the leased asset by way of leasing. In case of a non pay-out lease, the lessor leases out the same asset
over and over again.

7. Specialized service lease: The lessor or the owner of the asset is a specialist of the asset which he is
leasing out. He not only leases out but also gives specialized personal service to the lessee. Examples
are electronic goods, automobiles, air-conditioners, etc.

8. Net and non-net lease: In non-net lease, the lessor is in charge of maintenance insurance and other
incidental expenses. In a net lease, the lessor is not concerned with the above maintenance
expenditure. The lessor confines only to financial service.

9. Sales aid lease: In case, the lessor enters into any tie up arrangement with manufacturer for the
marketing, it is called sales aid lease.

10. Cross border lease: Lease across national frontiers are called cross border lease, Shipping, air
service, etc., will come under this category.

11. Tax oriented lease: Where the lease is not a loan on security but qualifies as a lease, it will be
considered a tax oriented lease.

12. Import Lease: In an Import lease, the company providing equipment for lease may be located in a
foreign country but the lessor and the lessee may belong to the same country. The equipment is more
or less imported.

13. International lease: Here, the parties to the lease transactions may belong to different countries
which is almost similar to cross border lease.
Advantages:
A. To Lessor: The following are the benefits of lease financing from the perspective of the lessor:

• Regularly Assured Income: Lessors receive lease rentals by leasing an asset for the duration of
the lease, which is a guaranteed and consistent source of income.
• Ownership Preservation: In a finance lease, the lessor transfers all risk and rewards associated
with ownership to the lessee without transferring asset’s ownership, so the lessor retains
ownership.
• Tax Advantage: Because the lessor owns the asset, the lessor receives a tax benefit in the form
of depreciation on the leased asset.
• Profitability is high: Leasing is a highly profitable business because the rate of return on lease
rentals is much higher than the interest paid on the asset’s financing.
• Growth Possibilities: There is a lot of room for growth here. Because leasing is one of the most
cost-effective forms of financing, demand for it is steadily increasing. Even amid a depression,
economic growth can be maintained. As a result, leasing has a much higher growth potential
than other types of businesses.
B. To Lessee: The following are the benefits of lease financing from the perspective of the lessee:

• Capital Goods Utilization: A business will not have to spend a lot of money to acquire an asset,
but it will have to pay small monthly or annual rentals to use it. The business can use its funds
for other productive purpose.
• Tax Advantages: Lease payments can be deducted as a business expense, allowing a company
to benefit from a tax advantage.
• Cheaper: Leasing is a form of financing that is less expensive than almost all other options.
• Technical Support: Regarding the leased asset, the lessee receives some form of technical
support from the lessor.
• Friendly to Inflation: Leasing is inflation-friendly because the lessee is required to pay a fixed
amount of rent each year, even if the asset’s cost rises.
• Ownership: After the primary period has expired, the lessor offers the lessee the opportunity
to purchase the assets for a small fee.
Disadvantages:
A. To Lessor: The following are the disadvantages of lease financing from the perspective of the
lessor:

• In the event of inflation, it is unprofitable: Every year, the lessee receives a fixed amount of
lease rental, which they cannot increase even if the asset’s cost rises. So, it is unprofitable
during inflation.
• Taxation twice: It is possible to be charged sales tax twice: The first is when the asset is
purchased, and the second is when the asset is leased.
• Greater Risk of Asset Damage: As the ownership is not transferred, the lessee treats the asset
carelessly, and there is a great chance that it will not be usable after the primary lease period
ends.
B. To Lessee: The following are the disadvantages of lease financing from the perspective of the
lessee:
 • Compulsion: Finance leases are non-cancellable, and lessees must pay lease rentals even if
they do not intend to use the asset.
• Ownership: Unless the lessee decides to purchase the asset at the end of the lease agreement,
the lessee will not become the owner of the asset.
• Costly: Lease financing is more expensive than other types of financing because the lessee is
responsible for both the lease rental and the expenses associated with asset ownership.
• Asset Understatement: As the lessee is not the owner of the asset, it cannot be included in
the balance sheet, resulting in an understatement of the lessee’s asset.

Underwriting
Underwriting is the process of determining and quantifying the financial risk of an individual
or institution. Typically, this risk usually involves loans, insurance or investments. Financial
institutions, such as banks, insurance agencies, investment firms and loan companies, employ
underwriters who conduct risk analysis to determine a potential borrower's creditworthiness.
Underwriting has an important function in the financial sector because it:

• Assesses the potential risk of the person or investment

• Establishes fair rates on loans
• Sets the correct premiums to cover the actual cost of insuring policyholders
• Prices investment risk accurately to establish a market for securities
• Ensures proper assessment and coverage
• Helps investors make sound investment decisions

Types of Underwriters
#1 – Insurance Underwriters
An underwriter for insurance determines whether an application from the potential client
needs further processing; whether they should take up the risk. Moreover, a critical analysis
reveals details about the level of risk, the amount of insurance, and whether the applicant
has to be granted an insurance policy. For example, individuals can take insurance for health,
life, rental or property, etc.
Examples
John is an insurance underwriter. His basic job is to determine if an applicant is eligible for
insurance. For example, suppose someone wants to take home insurance; John has to
evaluate the person’s credit history, the house value, and criminal records related to frauds
specifically associated with insurance if there is a need. This is because a person with an
unsatisfactory credit score will be a high-risk applicant. John can either reject it or provide the
applicant with an insurance cover with a high premium as a risk-reward.
#2 – Stock Market
An underwriter for securities determines the price and risk involved in security. Here,
individuals or institutions undertake to underwrite the public offerings. This process ensures
the issuing company’s full subscription (i.e., raising the full amount of capital).
The underwriting process provides major liquidity for the securities, aiding in their
distribution and price stabilization. In addition, investors use information analyzed from the
underwriting process to make informed choices.
Examples
Jack works in security underwriting. He has to keep an eye on the company’s performance
and analyze the demand their stocks will get. Various factors such as market share, profits, or
losses made the popularity of the products and services. Additionally, he has to check whether
the company has any defaults, scams, or scandals to its name, the reason for the IPO
, etc., and decide its price. If it goes unsold, he will lose his premium; therefore, Jack must do
a critical analysis.

Factoring
Factoring is a financing arrangement that is typically used by small and medium-sized
businesses to help them maintain a steady cash flow. As every business owner understands,
cash flow is important to ensure the successful, continuous operation of their business. This
is why it’s important to know the different types of factoring.

In general, factoring means a company is turning over their invoices to a third party in return
for receiving a portion of those invoices in cash within a few business days. Primarily, there
are two types of factoring, recourse factoring and non-recourse factoring.

Types of Factoring
1. Recourse and Non-recourse Factoring: In this type of arrangement, the financial
institution, can resort to the firm, when the debts are not recoverable. So, the credit
risk associated with the trade debts are not assumed by the factor.
2. On the other hand, in non-recourse factoring, the factor cannot recourse to the firm,
in case the debt turn out to be irrecoverable.
3. If the agreement between the borrower and lender calls for “no recourse” it means
the lender has no option to turn to the business owner for any shortfall between what
the company owed the lender, and what the liquidated assets provided.
4. Disclosed and Undisclosed Factoring: The factoring in which the factor’s name is
indicated in the invoice by the supplier of the goods or services asking the purchaser
to pay the factor, is called disclosed factoring.
5. Conversely, the form of factoring in which the name of the factor is not mentioned in
the invoice issued by the manufacturer. In such a case, the factor maintains sales
 ledger of the client and the debt is realized in the name of the firm. However, the
control is in the hands of the factor.
6. Domestic and Export Factoring: When the three parties to factoring, i.e. customer,
client, and factor, reside in the same country, then this is called as domestic factoring.
7. Export factoring, or otherwise known as cross-border factoring is one in which there
are four parties involved, i.e. exporter (client), the importer (customer), export factor
and import factor. This is also termed as the two-factor system.
8. Advance and Maturity Factoring: In advance factoring, the factor gives an advance to
the client, against the uncollected receivables.
9. In maturity factoring, the factoring agency does not provide any advance to the firm.
Instead, the bank collects the sum from the customer and pays to the firm, either on
the date on which the amount is collected from the customers or on a guaranteed
payment date.
Process

• The seller sells the goods to the buyer and raises the invoice on the customer.
• The seller then submits the invoice to the factor for funding. The factor verifies the
invoice.
• After verification, the factor pays 75 to 80 percent to the client/seller.
• The factor then waits for the customer to make the payment to him.
• On receiving the payment from the customer, the factor pays the remaining amount
to the client.
• Fees charged by factor or interest charged by a factor may be upfront i.e. in advance
or it may be in arrears. It depends upon the type of factoring agreement.
• In case of non — recourse factoring services factor bears the risk of bad debt so in
that case factoring commission rate would be comparatively higher.
• The rate of factoring commission, factor reserve, the rate of interest, all of them is
negotiable. These are decided depending upon the financial situation of the client.
Mutual Fund
Mutual Fund Meaning
A mutual fund is a professionally managed investment product in which a pool of money from
a group of investors is invested across assets such as equities, bonds, etc. Professionals handle
the investments on behalf of the investors who gain enhanced earnings based on their risk
appetite.

The portfolio of securities under the fund can be diversified into many types. For example,
there could be a combination of stocks and bonds or only equities/bonds. Securities could
also be segmented by industries such as tech or energy.

Types of Mutual Fund

1) Based on Structure
• Open-ended funds – They are very common and allow investors to trade units at any
point of time at the NAV.
• Close-ended funds – Involves issuing shares to the general public only once during the
IPO. Once listed on the exchange, they can be sold only to another investor and not to
the fund. Shares are traded at a premium or discount of the NAV.
• Unit Investment Funds – where trusts issue shares only once upon their creation with
the overall portfolio also remaining unchanged. They don’t come with the services of
a professional fund manager and have a restricted life span although investors can sell
anytime.

2) Based on Asset Type

• Money Market Funds: They pool money towards short-term low risk assets such as
certificates of deposits and treasury bills.
• Equity Funds: They could contain value stocks, growth equity, small-cap stocks, mid-
cap stocks, large-cap stocks, or a combination of all.
• Bonds Funds: These products are made of bonds giving interests as an income. Fixed
interest bonds are low risk, giving stable earnings. Those with floating interests allow
higher chances of profits but through greater risks.
• Balanced Funds: They are a combination of equities and bonds, usually in the 2:3
proportion, to balance the risk and return profile of the product.
• Index Funds: Such a fund traces the change in the value of its underlying market index
like S&P 500.
• Speciality Funds: Here, the securities belong to a specific segment like healthcare,
automobile, technology, energy, industrial or telecommunication.
An Introduction to the Basel Norms
Basel norms, also known as Basel accords, are the international banking regulations issued by the
Basel Committee. The Basel Committee was established in 1974. This Committee set standards
regarding various banking supervisory matters. The main aim of these standards is to ensure the
coordination of banking regulations worldwide. Read ahead to know about the three Basel norms and
how they affect Indian economy.

Basel Norms History for Banks

The Basel Norms are a set of international regulations for banks that aim to ensure the stability and
safety of the global banking system. The Basel Norms were developed by the Basel Committee on
Banking Supervision (BCBS), which is a committee of banking supervisory authorities that was
established by the central bank governors of the G10 countries in 1974. Here is a brief history of the
Basel Norms:

• The first Basel Accord, Basel I, was introduced in 1988 and focused mainly on credit risk. It
required banks to maintain a minimum level of capital, as a percentage of their risk-weighted
assets, to absorb losses and reduce the risk of insolvency.
• Basel II, introduced in 2004, expanded the scope of regulation to include operational risk and
introduced more sophisticated risk assessment methods. It also allowed banks to use internal
risk models to calculate their capital requirements.
• Basel III, introduced in response to the global financial crisis of 2008, further strengthened the
regulations by increasing the minimum capital requirements, introducing a leverage ratio to
limit excessive borrowing, and introducing new liquidity requirements.
• The latest version, Basel IV, is still being developed and is expected to introduce further
refinements to the risk assessment methods used by banks, as well as changes to the way that
capital requirements are calculated.
Types Of Basel Norms
Basel-I
Basel-1 was presented in 1988. It focussed essentially on layaway (default) hazard looked by the banks
According to Basel-1, all banks were needed to keep a capital sufficiency proportion of 8 %.
• The capital ampleness proportion is the base capital necessity of a bank and is characterized
as the proportion of money to chance weighted resources.
• The capital was grouped into Tier 1 and Tier 2 capital.
• Level 1 capital is the center capital of a bank that is lasting and solid. It incorporates value
capital and unveiled stores.
• Level 2 capital is the beneficial capital. It incorporates undisclosed stores, general
arrangements, arrangements against Non-performing Assets, combined non-redeemable
inclination shares, and so on.
• The danger weighted resource is the bank’s resources weighted by hazards.
• The resources of the bank were grouped into 5 danger classes of 0 % or 0, 10 % or 0.1, 20 %
or 0.2, 50 % or 0.5 and 100 % or 1. Model money into 0 % hazard classification, home loan into
20 % hazard class, and corporate obligation into 100 % hazard class.
 • Lets say-a bank has Rs.100 as money holds, Rs.200 as home loan and Rs.300 as credits offered
out to organizations. The danger weighted assets= (Rs.100 * 0 ) + (Rs.200 * o.2) + (Rs.300 * 1)
= 0 + 40 + 300 = Rs340
• Accordingly, this bank needs to keep 8 % of Rs.340 as the least capital. (in any event, 4 % in
level 1 capital)
India embraced Basel-1 out of 1999.

Basel-II
Basel-II was given in 2004.
This system depends on three boundaries.
• Least capital prerequisites: Banks should keep a base capital ampleness necessity of 8% of
hazard weighted resources. Additionally, Basel-II partitions the capital into 3 levels. Level 3
capital incorporates transient subject credits. (subject credits imply lower in the positioning.
It is reimbursed after different obligations in the event of bank liquidation.) In any case, the
meaning of capital sufficiency proportion was refined.
• Administrative oversight: According to this, banks were needed to create and utilize better
danger executive procedures in checking and dealing with every one of the three kinds of
dangers that a bank faces, viz. credit, market, and operational dangers
• Market Discipline: It expanded divulgence necessities. Banks need to compulsorily reveal their
CAR, hazard openness, and so forth to the national bank.
As of now, India follows Basel-II standards.

Basel-III
The monetary emergency of 2007-08 uncovered weaknesses in the Basel standards. Hence, the past
agreements were fortified.
• Basel-III was first given in late 2009. The rules mean to advance a stronger financial
framework.
• Capital: The capital ampleness proportion is to be kept up at 12.9 %. The base tier 1 capital
proportion and the base tier 2 capital proportion must be kept up at 10.5 % and 2 % of hazard
weighted resources separately.
• Banks need to keep a capital protection cushion of 2.5%.
• Counter-recurrent support is additionally to be kept up at 0-2.5%.
• The influence rate must be in any event 3 %. The influence rate is the proportion of a bank’s
level 1 cash flow to average absolute solidified resources.
• Liquidity: Basel-III made two liquidity proportions: LCR and NSFR. The liquidity inclusion ratio
(LCR) will expect banks to hold a cushion of excellent fluid resources adequate to manage the
money outpourings experienced in an intense momentary pressure situation as indicated by
administrators. The base LCR necessity will be to arrive at 100% on 1 January 2019. This is to
forestall circumstances like “Bank Run.” The objective is to guarantee that banks have
sufficient liquidity for a 30-days stress situation if it somehow managed to occur. Then again,
the Net Stable Funds Rate (NSFR) expects banks to keep a steady subsidizing profile
comparable to their reeling sheet resources and exercises. NSFR expects banks to subsidize
their exercises with stable wellsprings of money (solid over the one-year skyline). The base
 NSFR prerequisite is 100 %. Accordingly, LCR estimates present moment (30 days) versatility,
and NSFR estimates medium-term (1 year) strength.

NPA(Non Performing Asset)

NPA or Non-performing Assets are those types of loans in the banking sector for which the borrower
will not pay the interest amount or principal amount for more than 90 days. For this type of loan, the
banker thinks the loan agreement is broken, and the borrower cannot pay the loan amount. In easy
terms, if the clients will not pay the principal amount and interest for a particular period, then such
loans are known as Non Performing Assets. In India, the timeframe given for this asset as NPA is 90
days.
Non-Performing Assets Example
For example, Company ABC has taken credit of 5lakhs from Bank XYZ on which it has to repay 15000
of interest every month for one year. If the company ABC will not pay the interest amount or Principal
amount for three consecutive months, i.e., 90 days. Then the Bank XYZ has to consider the loan as
NPA in their balance sheet.
NPAs are classified into four types.
• Standard Assets: It is a performing asset that generates constant income and pays back the
loans before the due date. Therefore, these assets have a reasonable risk and are not
considered as NPAs.

• Sub-Standard Assets: NPAs that have been not paying the interest amount or principal amount
for upto 12 months or one year comes under sub-standard assets.

• Doubtful Assets: Non-performing assets are in the doubtful debts category, have not paid the
interest amount or principal amount for more than 12 months to 36 months. Lenders normally
have doubts that the borrower will pay back the full loan or not. Therefore, this NPA will
severely affect the bank’s profile.

• Loss Assets: These are non-performing assets that do not pay the interest amount or principal
amount for more than three years. With this class, the banks are unable to recover the
amount. Finally, banks will register this loan amount as a loss on their balance sheet. The
entire loan amount will close completely.

What can be the possible reasons for NPAs

• Diversification of funds to unrelated business/fraud.
• Lapses due to diligence.
• Business losses due to changes in business/regulatory environment. Lack of morale,
particularly after government schemes which had written off loans.
• Global, regional or national financial crisis which results in erosion of margins and profits of
companies, therefore, stressing their balance sheet which finally results into non-servicing of
interest and loan payments. (For example, the 2008 global financial crisis).
• The general slowdown of entire economy for example after 2011 there was a slowdown in the
Indian economy which resulted in the faster growth of NPAs.
 • The slowdown in a specific industrial segment, therefore, companies in that area bear the
heat and some may become NPAs.
• Unplanned expansion of corporate houses during the boom period and loan taken at low rates
later being serviced at high rates, therefore, resulting in NPAs.
• Due to mal-administration by the corporates, for example, willful defaulters.
• Due to mis governance and policy paralysis which hampers the timeline and speed of projects,
therefore, loans become NPAs. For example the Infrastructure Sector.
• Severe competition in any particular market segment. For example the Telecom sector in
India.
• Delay in land acquisition due to social, political, cultural and environmental reasons.
• A bad lending practice which is a non-transparent way of giving loans. Due to natural reasons
such as floods, droughts, disease outbreak, earthquakes, tsunami etc.
• Cheap import due to dumping leads to business loss of domestic companies. For example the
Steel sector in India

six-point strategy that could help solve the problem

• Accountability: Junior executives are often made accountable for lapses, however, major
decisions are made by the Credit Sanction Committee consisting of senior-level executives.
Hence it’s important to make senior executives accountable, if PSBs need to tackle NPAs.
• Corporate Governance: Even though, the government had set up Banks Board Bureau in April
2016 to attract talent, corporate governance hasn’t improved to the desired level with certain
issues persisting and need to be resolved urgently.
• Stricter NPA Recovery: The government needs to amend the laws and give more powers to
banks to recover NPAs. The Insolvency and Bankruptcy Code has brought in discipline because
of fear of losing the asset. Since debtor control amendments to the Banking Regulation Act,
the present scenario allows the RBI to conduct an inspection of a lender but doesn’t give them
power to set up an oversight committee. The RBI has asked for nine additional powers under
the Banking Regulation Act with regards to PSBs including the ability to remove CMDs and
appoint them, the power to supersede the Board of Directors and make application for
winding up errant banks, sanction scheme of voluntary amalgamation etc.
• Credit Risk Management: Proper credit appraisal of the project, creditworthiness of clients
and their skill and experience should be carried out. While conducting these analyses, banks
should also do a sensitivity analysis and should build safeguards against external factors.
Effective Management Information System (MIS) needs to be implemented to monitor early
warning signals about the projects. The MIS should ideally detect issues and set off timely
alerts to management so that necessary action is taken.
• Asset Reconstruction Company: There’s a need to set up an ARC or an Asset Management
Company to fast track resolution of stressed assets of PSBs. The government should initiate
necessary steps to explore the feasibility after thorough discussions on pricing and capital
issues.
• Fraud Management: Frauds in PSBs rose both in number and value over the last three years

Insolvency and Bankruptcy Code (IBC)

Introduction:

The Prime Minister mentioned the Insolvency and Bankruptcy Code (IBC 2016) as one of the key
legislative reforms that would help aid India’s path to self-reliance on a high growth trajectory.
The IBC, along with the Goods and Services Tax regime, among other key reforms, were helping in
significantly improving the ease of doing business in India and enabling it to emerge as a ‘Make for
World’ platform. PM Modi also credited these reforms for a surge in Foreign Direct Investment into
India in 2019-2020, to the tune of nearly $74.5 billion, or a significant increase of 20 per cent from the
previous year.

About Insolvency and Bankruptcy Code IBC:

• Insolvency and Bankruptcy Code, 2016 is considered as one of the biggest insolvency reforms
in the economic history of India.
• This was enacted for reorganization and insolvency resolution of corporate persons,
partnership firms and individuals in a time bound manner for maximization of the value of
assets of such persons.
• Insolvency and Bankruptcy Code, 2016 provides a time-bound process for resolving insolvency
in companies and among individuals.
• The Government implemented the Insolvency and Bankruptcy Code (IBC) to consolidate all
laws related to insolvency and bankruptcy and to tackle Non-Performing Assets (NPA), a
problem that has been pulling the Indian economy down for years.
• Establishment of an Insolvency and Bankruptcy Board of India to exercise regulatory oversight
over insolvency professionals, insolvency professional agencies and information utilities.
• Insolvency professionals handle the commercial aspects of insolvency resolution process.
• Insolvency professional agencies develop professional standards, code of ethics and be first
level regulator for insolvency professionals members leading to development of a competitive
industry for such professionals.
Objectives achieved so far by IBC

• Two key drivers for the IBC are relatively short time-bound processes, and the focus on
prioritising resolution rather than liquidation to support companies falling within its ambit.
• Its core implication has been to allow credit to flow more freely to and within India while
promoting investor and investee confidence.
• It has successfully instilled confidence in the corporate resolution methodology as IBC has
streamlined insolvency processes in a sustainable, efficient, and value retaining manner.
• Improvement in India’s Ease of Doing Business Rankings to 63 rd place.
• According to the Resolving Insolvency Index (component of Ease of Doing Business), India’s
ranking improved to 52 in 2019 from 108 in 2018, which is a leap of 56 places.
• The Recovery Rate improved nearly threefold from 26.5% in 2018 to 71.6% in 2019. And the
overall time taken in recovery also improved nearly three times, coming down from 4.3 years
in 2018 to 1.6 years in 2019.
Limitations that need to be addressed:
 • According to the data from the Insolvency and Bankruptcy Board of India (IBBI), of the 2,542
corporate insolvency cases filed between December 1, 2016 and September 30, 2019, about
156 have ended in approval of resolution plans — a mere 15%.
• High number of liquidations is a cause for major worry as it violates IBC’s principal objective
of resolving bankruptcy.
• Slow judicial process in India allows the resolution processes to drag on, this was the same
reason for slow recovery under SICA or RBBD.

Financial Inclusion Meaning

Financial inclusion refers to providing good quality financial products and services everyone can access
and afford. Such provision should be irrespective of company size or an individual’s financial condition.
It aims at providing an equal economic opportunity for sustainable growth.
Objectives
The main objectives of financial inclusions are as follows:

1. Provide financial service to all – The process aims to provide accessible and affordable
financial services and products.
2. Set up financial institutions – Financial inclusion also aims to set up more institutions that
would cater to the financial needs of the people.
3. Strong economy – As the finance of an economy becomes more robust, the economy grows
through growth in trade and commerce.
4. Better options – It will provide more investment opportunities.
5. Create financial awareness – Financial education is essential for economic growth. Financial
inclusion will promote financial education.
6. Reach maximum market – Financial inclusion means bringing all under one umbrella. In
finance, it will help bring people and corporates from different sources under one roof.
7. Globalize digital solutions – Financial inclusion will lead to globalizing any digital methods
adopted to promote and grow the financial sector.
8. Provide customized solutions – Banks and financial institutions will take more interest in
innovation and designing customized solutions to attract clients.
Why Financial inclusion is important in India
• Creating a platform for inculcating the habit to save money- The lower income
• category has been living under the constant shadow of financial duress mainly because of
• the absence of savings.
• Providing formal credit avenues - availability of adequate and transparent credit from
• formal banking channels shall allow the entrepreneurial spirit of the masses to increase
• outputs and prosperity in the countryside.
• Plug gaps and leaks in public subsidies and welfare programmes- A considerable sum
• of money that is meant for the poorest of poor does not actually reach them
Opportunities of financial inclusion
• Balanced growth - People had vast resources in their hands by availing banking services.
• Increase financial strength of banks- people from even the remote areas open bank
• accounts. The business of bank flourish due to good mobilization of funds.
 • Removes poverty- everybody will be given access to formal financial services the individual
can borrow loans for business of education or any other purpose.
• Financial transaction made easy- using the option of electronic fund transfer helps in
• easy and speedy way to fund transfer.
• Safe savings- people will have savings along with other allied services like insurance cover,
entrepreneurial loans, safety lockers, payment and settlement facility.
• Increase in GDP - Boosting up business opportunities will increase gross domestic product
which will inflate the national income.

Financial Crime
Financial crime is an illegal activity by organizations or individuals for monetary benefit. In the process,
one party gains, and another party suffers a loss. Therefore, it is a significant threat to a country’s
economy, society, and global financial system, affecting its growth and stability.
Types of financial crime
1. Money laundering – Money laundering refers to illegally earning or transferring vast sums of
money from a source to a destination for personal gain without informing the concerned
parties.
2. Bribery – Bribery offers vast sums of money or valuable items to a party on duty to achieve
the desired result.
3. Tax evasion – An individual or entity deliberately skips tax payments against the earned
income to save more money.
4. Financial market manipulation – The financial markets are often manipulated by spreading
false rumors to influence prices, insider trading, or devising methods to deceive investors.
5. Cyber crime – Cyber financial crime committed through email, the internet, or the use of
specially designed software for a fraudulent purpose is on a steady rise in today’s world.
6. Terrorist financing – In this type of fraud, some groups create funds or provisions to help carry
out terrorism-related activities in a region.

Who commits Financial Crime

• Criminal groups, including terrorist groups, increasingly perpetrate large-scale frauds to fund
their activities and operations.

• Corrupt heads of state may use their position and powers to loot the coffers of their (often
impoverished) countries.

• Business leaders or senior executives manipulate or misreport financial data to misrepresent

a company’s true financial position.

• Employees from the most senior to the most junior steal company funds and other assets.

• From outside the company, a customer, supplier, contractor, or a person without connection
to the organization can perpetrate fraud.
 • Increasingly, the external fraudster colludes with an employee to more easily achieve bigger
and better results.

• The successful individual criminal, serial, or opportunist fraudsters in possession of their

proceeds are a different group of people who have committed a financial crime.
Prevention
There are ways and means to prevent financial crime as follows:

1. Confirming customer’s identity – Whenever any customer does a financial transaction

with any entity, it is necessary to ask for proper identity-related documents through
updated software.
2. Document verification – It is also necessary to verify the documents taken from the
customer.
3. Establish due diligence regarding money transfers – There should be a rule regarding
how much money to transfer at a time. The organization should block any transfer
above that amount.
4. Designing software to identify risk – The software designs should be such that they
can identify any suspicious activity.
5. Continuous risk monitoring – An entity should have a department for constant risk
monitoring in different functional areas.
6. Immediate action – It is crucial to take immediate action once there is fraud to keep
the damage under control.