INDIAN FINANCIAL

SYSTEM
-DEEPAK BANSAL
UNIT-1
OVERVIEW OF INDIAN FINANCIAL
SYSTEM
AGENDA

 Role of Financial Markets in capital formation and

economic development.
 Commercial Banks and industrial finance-evolving role.

 Reserve Bank of India as a regulator of Banking systems

and its other functions.
 Securities & Exchange Board of India as a regulator of
Indian capital market
FINANCIAL SYSTEM AND ECONOMIC
DEVELOPMENT
 The growth of output in any economy depends on the
increase in the proportion of savings/investment to a
nation’s output of goods and services.
 The financial system and financial institutions help in the
diversion of rising current income into savings/investments.
 The financial system is possibly the most important
institutional and functional vehicle for economic
transformation. Finance is a bridge between the present and
the future and whether it be the mobilisation of savings or
their efficient, effective and equitable allocation for
investment, it is the success with which the financial
system performs its functions that sets the pace for the
achievement of broader national objectives.
SIGNIFICANCE & DEFINITION
 The term financial system is a set of inter-related
activities/services working together to achieve some
predetermined purpose or goal. It includes different
markets, the institutions, instruments, services and
mechanisms which influence the generation of savings,
investment capital formation and growth.
 Van Horne defined the financial system as the purpose of
financial markets to allocate savings efficiently in an
economy to ultimate users either for investment in real
assets or for consumption.
 According to Robinson, the primary function of the
system is "to provide a link between savings and
investment for the creation of new wealth and to permit
portfolio adjustment in the composition of the existing
wealth.“
 From the above definitions, it may be said that the
primary function of the financial system is the
mobilisation of savings, their distribution for industrial
investment and stimulating capital formation to
accelerate the process of economic growth.
TYPES OF MARKET
 Well-developed financial markets are required for
creating a balanced financial system in which both
financial markets and financial institutions play
important roles.
 The primary function of the financial markets is to
facilitate the transfer of funds from surplus sectors
(lenders) to deficit sectors (borrowers).
 Normally households have excess of funds or savings
which they lend to borrowers in the corporate and public
sectors, whose requirement of funds exceed their
savings.
 A financial Market consists of investors or buyers,
sellers, dealers and brokers and does not refer to a
physical location.
 The participants in the market are linked by formal
trading rules and communication networks for
originating and trading financial securities.
 The primary market in which the public issue of
securities is made through a prospectus is a retail market
and there is no physical location.
 The investors are reached by direct mailing or invitation
to bid within a price band.
 On the other hand, the secondary market or stock
exchange where existing securities are traded, is an
auction market and may have a physical location such as
the rotunda of the Bombay Stock Exchange or the
trading floor of Delhi, Ahmadabad and other exchanges
where the exchange members meet to trade securities
face-to-face.
MONEY MARKET
 The money or credit market is the centre for dealings in
monetary assets of short-term nature generally below
one year.
 The instruments are call money/notice money, term
money, treasury bills, commercial paper, certificates of
deposits, participation certificates and forward rate
agreements/interest rate swaps.
 The money market has organised and unorganised
components.
 The organised credit market is dominated by commercial
banks.
 The other major players are the Reserve bank of India,
Life Insurance corporation, General Insurance
corporation, Unit Trust of India, Securities Trading
corporation of India Ltd. And Discount and finance
house of India.
 Unorganised Market consists of indigenous bankers and
money lenders.
 There is no clear demarcation between short-term and
long-term finance in as much as there is nothing on a
hundi to indicate accommodation.
 Hundi is the indigenous bill of exchange.

 Hundis are usually accommodation bills.

CAPITAL MARKET
 The capital market consists of primary and secondary
markets.
 The primary market deals with the issue of new
instruments by corporate sector such as equity shares,
preference shares and debentures.
 The secondary market consists of 24 stock exchanges,
(out of which 5 has been de-recognized) including the
national stock exchange, the over the counter exchange
of India and interconnected stock exchange of India Ltd.
Where existing instruments including negotiable debts
are traded.
 Capital formation occurs in the primary market while the
secondary market provides a continuous market for the
securities already issued to be bought and sold in volume
with little variation in the current market price.
 The major player in the primary market are the merchant
banker, mutual funds, financial institutions, foreign
institutional investors and the anchor of the market, the
individual investor.
 In the secondary market, the stockbrokers who are
members of the stock exchanges, the mutual funds,
financial institutions, foreign institutional investors and
individual investors.
FOREIGN EXCHANGE MARKET
 The foreign exchange market encompasses all transactions
involving the exchange of different monetary units for each
other.
 Every sovereign nation has its own currency. The monetary
unit of a country can be exchanged with any other currency
of any other country in the foreign exchange market.
 The foreign exchange market is not a physical place. It is a
network of banks’ dealers and brokers who are dispersed
throughout the leading financial sectors of the world.
 It acts as an intermediary for individual buyers and sellers.
The foreign exchange market links financial activities in
different currencies.
 FEM in India comprises of authorized dealers consisting
mainly of commercial banks, customers and Reserve
Bank of India.
 There are seven major centres in Mumbai, Delhi,
Calcutta, Chennai, Bangalore, Kochi and Ahmadabad
with Mumbai accounting for the major portion of the
transactions.
 The Foreign Exchange Dealers Association of
India(FEDAI) plays an important role by laying down
the rules for commission and other charges.
FOREIGN EXCHANGE RATES
 The foreign exchange rates govern the rate at which one
currency can be exchanged for another.
 An exchange rate may be defined as the amount of
currency that one requires to buy one unit of another
currency or is the amount of a currency one receives
when selling one unit of another currency.
RESERVE BANK OF INDIA
 The Reserve Bank of India as the central bank of the
country, is at the head of this group.
 Commercial banks themselves may be divided into two
groups, the scheduled and the non scheduled.
 The commercial banking system may be distinguished
into:
 A. Public Sector Banks

 B. Private Sector Banks

A. Public Sector Banks
 i) State Bank of India

 ii) Associate Bank

 iii) 14 Nationalized Banks (1969)

 iv) 6 Nationalized Banks (1980)

 v) Regional Rural Banks

B. Private Sector Banks

 Other Private Banks;

 ii) New sophisticated Private Banks;

 iii) Cooperative Banks included in the second schedule;

 iv) Foreign banks in India, representative offices, and

 v) One non-scheduled banks

RBI
 The Reserve Bank of India (RBI) is the apex financial
institution of the country‘s financial system entrusted
with the task of control, supervision, promotion,
development and planning.
 RBI is the queen bee of the Indian financial system
which influences the commercial banks' management in
more than one way.
 RBI performs the four basic functions of management,
viz., planning, organising, directing and controlling in
laying a strong foundation for the functioning of
commercial bank
FUNCTIONS
 Issuing currency notes, to act as a currency authority.
 Banker, Agent and Financial Advisor to the State

 Banker to the Banks

 Custodian of Foreign Exchange Reserves

 Lender of the Last Resort

 Banks of Central Clearance, Settlement and Transfer

 Controller of Credit

 Supervisory Functions
COMMERCIAL BANKS
 In India there are 88 commercial banks which account
for about 82 %of the total assets of the financial sector,
over 2000 cooperative banks accounting for about 5%
and 133 regional Rural Banks, which account for about
3% of the total assets of the financial sector.
 Commercial banks are business enterprises which deal in
finances, financial instruments and provide various
financial services for a price known as interest, discount,
commission, fee etc.
 According to the Banking Regulation Act, 1949,
Banking means, “accepting, deposit of money from the
public, for the purpose of lending or investment.”
 These deposits may be repayable on demand or
otherwise and may be withdrawn by cheque, draft, order
or otherwise.
 Accepting deposits and lending these resources to
business houses and individuals are the main function of
commercial banks.
 Commercial banks also involve into various financial
services.
FUNCTIONS OF COMMERCIAL BANKS
 Accepting deposits
 Loans and advances

 Agency functions

 Dealings in foreign exchange

 Credit creation

 Popularising cheque system

 Transfer of funds

 Other functions

 Function under innovative banking

 Insurance business
SECURITY & EXCHANGE BOARD OF
INDIA
 The SEBI Act was passed on 4th April, 1992 which
empowered SEBI to regulate entire gamut of activities in
primary and secondary market.
 SEBI exercises control over new issues registration and
regulation of market intermediaries, regulation of mutual
funds, regulating listing of securities, imposing a code of
conduct on merchant bankers, underwriter, brokers.
 SEBI protects the interests of investors in securities and
promote the development and regulation of the securities
market.
 The Board consists of a chairman, two members from
the Government of India, ministries of Law and Finance,
one member from the RBI and two other members.
 The SEBI prohibits unfair trade practices and insider
trading, regulation of take-overs etc.
FUNCTIONS OF SEBI
 Regulating the business in stock exchanges and any
other securities market.
 Registering and regulating the working of stock brokers,
sub-brokers, share transfer agents, bankers to an issue,
merchant bankers, underwriters, portfolio managers,
investment advisers and such other intermediaries who
may be associated with securities markets in any manner.
 Registering and regulating the working of collective
investment schemes including mutual fund.
 Promoting and regulating self-regulatory organisation.
 Prohibiting fraudulent and unfair trade practices relating
to securities market.
 Promoting investors’ education and training of
intermediaries of securities market.
 Prohibiting insider trading in securities.

 Levying fees or other charges for carrying out the above

purposes and
 Conducting research for the above purposes.
UNIT- II
FINANCIAL MARKET
Agenda
 Money Market: Organisation, Constituents and
Instruments
 Capital Market: New Issue Market & Stock Exchanges-
Differences & Similarities, Functions, Methods of New
Issues, Regulatory framework.
MONEY MARKET
 Money Market is a very important segment of the Indian
financial system.
 Money Market is basically over-the-phone market. The
transactions are conducted through oral communications.
 It is the market for dealing in monetary assets of short-
term nature. Short-term funds up to one year.
 Money market instruments have the characteristics of
liquidity, minimum transaction cost and no loss in value.
 Money market provides access to providers and users of
short term funds to fulfill their borrowings and
investment requirements.
 The Money Market is the major mechanism through
which the Reserve Bank influences liquidity and the
general level of interest rates.
 There are a large number of participants in the money
market: Commercial Banks, Mutual funds, investment
institutions, financial institutions and finally the Reserve
Bank of India.
 The money market can obtain funds from the central
bank either by borrowing or through sale of securities.
ORGANISATION OF MONEY MARKET
 Organised
 Reserve Bank of India
 Public Sector Banks
 Private Sector Banks-
 Non-Scheduled Banks
 Scheduled Banks-

Foreign Banks


 Indian Banks

 Development Banks and other Financial Institutions like LIC,

UTI, IFC, IDBI etc.
 DFHI Ltd.
 Unorganised
 Indigenous bankers
 Money Lenders
 Traders
 Commission Agents
 Chit Funds
 Nidhis
MONEY MARKET INSTRUMENTS
 Money at call and short notice (Call Loans)
 Treasury Bills

 Bills Rediscounting Scheme (BRS)

 Certificates of Deposits (CDs)

 Commercial Papers (CPs)

 Repurchase Options

 Inter-Bank Participation Certificates on a risk sharing

basis or without risk sharing basis
 Options

 Swaps
CAPITAL MARKET
New Issue Market
New Issues Market comprises all people, institutions,
methods, services and practices involved in raising fresh
capital for both new and existing companies. This
Market is also called Primary Market. PM deals in only
new securities which acquire form for the first time, i.e.
which were not available previously.
On the other hand, secondary market or stock market or
stock exchange deal in existing securities, i.e. securities
which have already been issued by companies and are
listed with the stock exchanges.
FUNCTIONS OF NIM
 Facilitates transfer of resources from savers to
entrepreneurs establishing new companies.
 Helps raising resources for expansion and/or
diversification of activities of existing companies
 Helps selling existing enterprises to the public as going
concerns through conversion of existing
proprietorship/partnership/private limited concerns into
public limited companies.
PLAYERS IN THE NEW ISSUE MARKET
 Merchant Bankers
 Registrars

 Collecting and co-ordinating Bankers

 Underwriters

 Brokers, Agents

 Printers

 Advertising Agencies

 Mailing Agencies

 SEBI
DIFFERENCES BETWEEN NIM AND
STOCK EXCHANGES
NIM Stock Exchanges
1. Market for new securities 1. Market for existing securities
2. No fixed geographical location 2. Located at a fixed place
3. Results in raising fresh resources 3. Facilitates transfer of securities
for the corporate sector from one corporate investor to
another.
4. All companies enter NIM 4. Securities of only listed companies
can be traded at stock exchanges
5. No tangible form or administrative 5. Has a definite administrative set-up
set-up and a tangible form.
6. Subjected to outside control by 6. Subjected to control both from
SEBI, Stock Exchanges and the within and outside.
companies Act.
SIMILARITIES BETWEEN NIM & STOCK
EXCHANGES
 Securities traded at stock exchanges are those which
have first been issued by the companies.
 While issuing prospectus, the companies stipulate in the
prospectus that application has been made or will be
made in due course for listing of shares with the stock
exchange.
 Stock exchange exercise control over the organisation of
new issues as a precondition for listing of shares.
 Stock exchanges provide liquidity to the securities which
have passed through NIM.
METHODS OF NEW ISSUES
 Public issue through prospectus
 Through offer for sale

 Through placement of securities- private placement and

stock exchange placing
 Rights issue

 Issue of Bonus shares

 Book-building

 Stock option or Employees Stock Option Scheme

UNIT-III
BANKING INSTITUTIONS
Agenda

 Commercial Banks
 Co-operative Banks
COMMERCIAL BANKS
 Commercial Banks are business enterprises which deal
in finances, financial instruments and provide various
financial services for a price known as interest, discount,
commission, fee etc.
 According to the Banking Regulation Act, 1949, banking
means, “Accepting deposits of money from the public,
for the purpose of lending or investment”.
 These deposit may be repayable on demand or otherwise
and may be withdrawn by cheques, draft, order or
otherwise.
 Accepting deposits and lending these resources to
business houses and individuals are the main function of
commercial banks.
FUNCTIONS OF COMMERCIAL BANKS
 Accepting Deposits
 Demand deposits or current accounts

 Savings deposits

 Time deposits or fixed deposits

 Loans and Advances

 Cash Credits

 Overdrafts

 Discounting of bills

 Short-term, Medium-term or Long-term loans

 Agency function
 Dealings in foreign exchange

 Credit Creation

 Popularising Cheque System

 Transfer of funds

 Other functions

 Insurance Business
SOURCES & APPLICATION OF FUNDS
Sources
 Paid-up Capital

 Reserves and Surpluses

 Deposits

Application
 Buildings, furniture, office equipment etc. for conducting
business
 Money at call and short notice

 Bills discounted and purchased

 Treasury bills etc.

ASSET STRUCTURE OF COMMERCIAL
BANKS
 Cash Balances
 Money at call and short notice

 Short-term Bills

 Loans and advances

 Investments
NON-PERFORMING ASSETS
 A non-performing Asset in India represents an advance
that has not been serviced as a result of past dues
accumulating for 90 days and over.

 NPAs consist of assets under three categories:-

 Sub-standard

 Doubtful and

 Loss
 A non-performing asset is an advance where:
 Interest and/or installment of principal remain overdue
for a period of more than 90 days in respect of term
loan.
 The account remains our of order for a period of more

than 90 days in respect of an overdraft/cash credit.

 The bill remains overdue for a period of more than 90

days in case of the bills purchased and discounted.

 Interest and/or installment of principal remain overdue

for two harvest seasons but for a period of not exceeding

180 days in the case of an advance granted for
agricultural purposes.
 And amount to be received for a period of more than 90

days in respect of other accounts.

BANK RATE, LENDING RATES AND
CREDIT-OFF TAKE
 Bank rate is the rate of interest at which Reserve Bank of
India lends money to banks.
 Its is the rate at which the central bank rediscounts
certain defined bills and other eligible papers.
 Prime Lending rate is the rate of interest at which banks
lend to the borrowers with highest credit-worthiness.
 Credit-off take occurs when the demand for money at
lower rate (bank rate and various interest rate) is
promoted.
REPO AND REVERSE REPO RATE
 Repo rate is the rate at which banks borrow short-term
funds from RBI.
 Reverse repo rate is the rate at which banks park their
short-term surplus funds in the RBI.
 Commercial Banks

Scheduled Banks non-scheduled banks

(i) Public Sector (28) (i) Local Area Banks
(ii) Private Sector (60) SBI Group (8)
(iii) Regional Rural (231) Nationalised Bank(19)
Indian
(29)
Foreign (31)
ORGANISATIONAL STRUCTURE OF CO-
OPERATIVE CREDIT INSTITUTIONS
 Urban Co-operative Banks
 Rural Co-operative Credit Institutions
 Short Term Credit
 State Co-operative Banks
 District/Central Banks

 Primary Agricultural Credit Societies

 Long Term Credit

 State Co-operative Agricultural & Rural
Development Banks
 Primary Co-operative Agricultural & Rural
Development Banks
CO-OPERATIVE BANKS
 Co-operative Banks undertake the business of banking
both in urban and rural areas on the principle of co-
operation.
 They have served a useful role in spreading the banking
habit throughout the country.
 The co-operative banks have been set up under the
various Co-operative Societies Acts enacted by the State
Governments.
 The State Governments regulate/monitor these banks.

 Certain provisions of the Banking Regulation Act 1949

were made applicable to co-operative banks as well.
 The State Co-operative Banks and Urban Co-operative
Banks are eligible to be granted the status of scheduled
banks by the Reserve Bank of India.
 All Co-operative banks are eligible for being registered
as insured banks.
URBAN CO-OPERATIVE BANKS
 These banks are required to obtain a license from the
Reserve Bank of India under section 22 of the Banking
Regulation Act, 1949.
 Recently the Reserve Bank of India has revised the
licensing policy of new banks.
 According the this, a new bank should have share capital
of Rs. 4 Crore and membership of at least 3000 if the
population is over 10 lakhs.
 A share capital of Rs. 2 Crore and membership of at least
2000 are required for population of 5 to 10 lakhs.
 Share capital of Rs. 1 Crore and membership of at least
1500 are required for population of 1 to 5 lakhs.
 Share capital of Rs. 25 lakhs and membership of at least
500 for population of less than 1 lakh.
 The new bank should have at least 2 directors with
suitable banking experience or relevant professional
qualifications.
 An urban co-operative bank is allowed to become a
schedule bank if its net demand and time liabilities are at
least Rs. 100 Crore and its overall functioning in terms
of select parameters is satisfactory.
 All categories of scheduled banks including co-operative
banks are now subject to the same cash reserve
requirement as applicable to Scheduled Commercial
Banks.
STATE CO-OPERATIVE BANKS
 These are the important banks in the field of short-term
co-operative credit in rural areas.
 The scheduled co-operative banks are eligible for loans
and advances from RBI and have to make cash reserve
ratio with the RBI.
 The non-scheduled state co-operative banks have to
comply with the requirement of making deposit with
RBI.
 State co-operative banks are also required to seek licence
from RBI for carrying on of Banking business under
section 22 of the Banking Regulation Act, 1949.
 State Co-operative banks are eligible for obtaining credit
from NABARD on the basis of short-term and medium-
term credit granted by them.
 State co-operative banks grant loans and advances to the
central/district co-operative banks.
UNIT-IV
NON-BANKING FINANCIAL INTERMEDIARIES
Agenda
 Investment Policy and performance appraisal of Unit
Trust of India and other mutual funds
 Non-Banking Financial Companies

 Insurance Companies
NON-BANKING FINANCIAL COMPANIES
 Non-banking Financial Institutions carry out financing
activities but their resources are not directly obtained
from the savers as debt. Instead, these Institutions
mobilize the public savings for rendering other financial
services including investment. All such Institutions are
financial intermediaries and when they lend, they are
known as Non-Banking Financial Intermediaries
(NBFIs) or Investment Institutions.
 The principal business of NBFCs is to accept deposits
under various schemes or arrangements like regulated
deposits and exempted deposits and to lend in various
ways.
 NBFCs except HFCs are regulated by the RBI.

 HFCs are regulated by NHB.

 NBFCs were allowed to enter into credit card business

on their own or in association with another NBFC or a
scheduled commercial bank.
 Loan Companies
 Investment Companies

 Hire-purchase Finance

 Housing finance

 Lease Finance

 Mutual Benefit Financial Companies

 Residuary Non-Banking Companies

 Merchant Banks

 Venture Capital Funds

 Factors
 Apart from these NBFIs, another part of Indian financial
system consists of a large number of privately owned,
decentralised, and relatively small-sized financial
intermediaries. Most work in different, miniscule niches
and make the market more broad-based and competitive.
While some of them restrict themselves to fund-based
business, many others provide financial services of
various types. The entities of the former type are termed
as "non-bank financial companies (NBFCs)". The latter
type are called "non-bank financial services companies
(NBFCs)".
 Non-bank financial intermediaries (NBFIs) comprise a
mixed bag of institutions, ranging from leasing,
factoring, and venture capital companies to various types
of contractual savings and institutional investors
(pension funds, insurance companies, and mutual funds).
The common characteristic of these institutions is that
they mobilize savings and facilitate the financing of
different activities, but they do not accept deposits from
the public. NBFIs play an important dual role in the
financial system.
MUTUAL FUNDS

 Mutual Funds are financial intermediaries which collect

the savings of investors and invest them in a large and
well diversified portfolio of securities such as money
market instruments, corporate and Government bonds
and equity shares of joint stock companies.
 A Mutual Fund is a pool of mix funds invested by
different investors, who have no contact with each other.
 Mutual funds helps the investors who generally don’t
have adequate time, knowledge, experience and
resources for directly accessing the capital market.
 The first mutual fund was the Unit Trust of India in 1964
under an act of Parliament.
 During the years 1987-1992, seven new mutual funds
were established in the public sector.
 In 1993, the Government changed its policy to allow the
entry of private corporate and foreign institutional
investor into the mutual fund segment.
 There are two types of Mutual Funds :
 Open-ended funds
 Closed-ended funds
ORGANIZATION
 The Sponsor
 The Board of Trustee or Trust Company

 The Asset Management Company

 The Custodian

 The Unit-holders
INVESTMENT POLICY & PERFORMANCE
APPRAISAL OF UTI
 The MFs invest their resources in different type of
financial assets subject to the guidelines form the
government and the SEBI.
 The government directs that investment by the UTI in
anyone company should not exceed five percent of its
total investible fund, or 10 percent of the value of the
outstanding securities of that company, whichever is
lower.
 It is further laid down that UTI should not invest more
than 5 percent of its funds in the initial issues of any new
industrial concern.
 The objective of government regulations are to minimize
risk and avoid concentration of investments in a few
large companies.
 In view of the requirement of safe provision of a stable,
regular and growing income to its unit-holders, the
portfolio of its assets has to be composed of fixed-
income securities and ordinary shares.
 The SEBI requires other mutual funds to invest not more
than 5 percent of the outstanding equity capital of any
company.
DETERMINANTS OF MUTUAL FUND
PERFORMANCE
 Factors affecting expected returns include asset
allocation and systematic risk, while transaction costs
include explicit and implicit ones, which can be
measured by expense ratios, age of the funds, fund fees,
management structure, management tenure, macro
economics variables like inflation, growth rate of GDP,
development of capital market, and size of funds
respectively.
 In order to judge the performance of MF schemes in an
objective manner and offer investors an easy way to
identify funds that have performed better in relation to
their peer, a number of….
 Entities are evaluating and ranking their performance.
 The most popular of them are rankings/evaluations by
CRISIL, Value Research India and Credence Analytics.
INSURANCE COMPANIES
 The Insurance companies are financial intermediaries as
they collect and invest large amounts of premiums.
 They offer protection to the investors, provide means for
accumulating savings and channelise funds to the
government and other sectors.
 The insurance industry has both economic and social
purpose. It provides social security and promotes
individual welfare.
 The actual premium of insurance companies comprises
the pure premium and administrative as well as
marketing cost.
 The pure premium is the present value of the expected
cost of an insurance claim.
 Since there is a lag between payment of premiums and
payment of claims, there is generation of investible
funds known as insurance reserves.
 Insurance companies may be organised as either
corporations or mutual associations.
 There are various parts of insurance industry: life
insurance, health insurance, general insurance, etc.
INSURANCE INDUSTRY IN INDIA
 Public Sector
 Life– LIC, Post Office Insurance
 General – GIC and its four subsidiaries

 Private Sector
 Life
 General
INVESTMENT PATTERN AND POLICY
 The pattern of investment of LIC funds has been
governed by the provisions of the Insurance Act 1938.
 Till very recently, it had to invest at least 50 percent of
its controlled funds in government and other approved
securities, 15 percent in “other” investments which
included loans to state government for housing and water
supply schemes, municipal securities not included in
category one, government guaranteed loans to municipal
committees and co-operative sugar factories, and upto
35 percent in “approved” …..
 investments which included shares and debentures of
public and private limited companies, of co-operative
societies, immovable property, loans to its policy-holders
and fixed deposits with scheduled banks and co-
operative societies.
UNIT-V
DEVELOPMENT, MERCHANT & INVESTMENT
BANKING

Agenda

 Development Banking
 Merchant Banking

 Investment Banking
DEVELOPMENT BANKING
 Development Banking is the financing of projects
assessed on the basis of their viability to generate cash
flows to meet the interest and repayment obligation.
 They have an in-built promotional aspect because
projects have to fall within the overall national industrial
priorities, located preferably in backward areas and
promoted by entrepreneurs.
Development banking is different: Loans are made not to
those who have accumulated wealth in the past but to
those who show promise to become wealthy in the
future. Normal banking looks for safety in assets
accumulated from the past; in development banking,
possible accumulation of assets in the future is the true
collateral. Thus, while in normal banking, the collateral
is real and tangible, in development banking, the
collateral is a dream; it is intangible. In normal banking,
an interest default of more than 90 days becomes a non-
performing asset. In the case of development, growth is
rarely smooth; development happens in fits and starts;
cash flows are subject to wild fluctuations and become
negative at times.
development banks need to have a longer perspective
than three months; they should show patience for years.
Normal banks can afford to be myopic; development
banks should take the long view. For development banks,
it is the trend line and not the current surplus that is
important. As one development banker blithely
explained: "When I see any risk, I take my money and
run away." But that is not development banking;
development banks take risks that ordinary banks will
not.
MERCHANT BANKING
 Merchant banking activity was formally initiated into the
Indian Capital markets when Grindlays bank in 1967
received the license from Reserve Bank of India in
1967.
 Apart from meeting specially, the needs of small scale
units, it provided management consultancy services to
large and medium sized companies.
 Following Grindlays Bank, Citibank set up its merchant
banking division in 1970. The division took up the task
of assisting new entrepreneurs and existing units in the
evaluation of new projects and raising funds through
borrowing and equity issues.
 Merchant Bankers are permitted to carry on activities of
primary dealers in government securities.
 On the recommendations of Banking Commission in 1972,
Indian banks should offer merchant banking services as part
of the multiple services they could provide their clients.
 State Bank of India started the merchant Banking division
in 1972. In the initial years the SBIs objective was to render
corporate advice and assistance to small and medium
entrepreneurs.
 The commercial banks that followed SBI were Central Bank
of India, Bank of India and syndicate Bank in 1977; Bank of
Baroda, Standard Chartered Bank and Mercantile Bank in
1978 and United Bank of India, United Commercial Bank,
PNB, Canara Bank and IOB in late 1970s and early 1980s.
 Among the development banks ICICI started merchant
banking activities in 1973, followed by IFCI(1986) and
IDBI (1991).
 The notification of the Ministry of Finance defines a
merchant banker as, “any person who is engaged in the
business of issue management either by making
arrangements regarding selling, buying or subscribing to
securities as manager, consultant, advisor or rendering
corporate advisory service in relation to such issue
management.”
 Merchant bankers have to be organized as body
corporates. They are governed by the merchant bankers
rules issued by the Ministry of Finance and merchant
bankers regulations issued by SEBI.
SERVICES RENDERED BY MERCHANT
BANKS
 Organizing and extending finance for investment in
projects,
 Assistance in financial management,

 Acceptance of house business,

 Raising Eurodollar loans and issue of foreign currency

bonds,
 Financing local authorities

 Financing export of capital goods, ships, hydropower

installation, railways.
 Financing of hire-purchase transactions, equipment
leasing, mergers and take-overs
 Valuation of Assets,
 Investment management and promotion of investment
trusts.
 All merchant banks don’t offer all these services.

 Different merchant bankers specialize in different

services.
 Merchant banking is a skill based activity and involves
servicing of any financial need of the client.
 Merchant banking activities are regulated by (1)
Guidelines of SEBI and Ministry of Finance, (2)
Companies act 1956 (3) Listing guidelines of Stock
Exchanges and (4) Securities Contracts (Regulation) Act
1956.
INVESTMENT BANKING
UNIT-VI
FDI AND ISSUES RELATED THEREIN
Agenda
 Foreign Investment and its regulation

 Accessing International Capital Market

FOREIGN DIRECT INVESTMENT