INDIAN FINANCIAL SYSTEM AND

SERVICES

LECTURE NOTES
BY
DR. SUDESHNA DUTTA
ASST.PROFESSOR
 MODULE I
PART-I-Syllabus
MODULE I-Syllabus:-:-Introduction , Components
Introduction , Components of Indian Financial
of Indian System
Financial ( Financial
System ServicesServices
( Financial , Financial,
Markets
Financial ,Financial
Markets Intermediaries
,Financial , Regulators
Intermediaries and Serviceand
, Regulators Providers
Service) ,Functions
Providers of Indian Financial
) ,Functions of Indian
System , Reforms
Financial System , Reforms in Indian Financial System.in Indian Financial System.

Introduction
In its simple meaning the term ‘finance’ refers to monetary resources & the term ‘financing’ refers
to the activity of providing required monetary resources to the needy persons and institutions. The
term ‘financial system’ refers to a system that is concerned with the mobilization of the savings of
the public and providing of necessary funds to the needy persons and institutions for enabling the
production of goods and/or for provision of services. Thus, a financial system can be understood
as a system that allows the exchange of funds between lenders, investors, and borrowers. In other
words, the system that facilitates the movement of finance from the persons who have surplus
funds to the persons who need it is called as financial system. It consists of complex, closely related
services, markets, and institutions used to provide an efficient and regular linkage between
investors and depositors.
Financial systems operate at national, global, and firm-specific levels. It includes the public,
private and government spaces and financial instruments which can relate to countless assets and
liabilities. Figure 1.1 shows a typical structure of financial system in any economy
What is the need of Financial System?

 Economic activities are facilitated by money and such activities generates income. At any
given time in the society we find two categories of people One group having some surplus
money after consumption ( surplus money holders or savers) and other group having
requirement for money for undertaking various developmental and economic activities
(called money seekers).

 The money-surplus holders have a need to safely invest their money to earn extra return.
The money seekers on the other hand need money to undertake various developmental
economic activity and are ready to return back the money taken with higher returns. There
is therefore requirement for a system which can take care of the needs of savers and money-
seekers and bring them together. The financial system provides a mechanism to satisfy
needs of these two groups.

 The financial system thus provides the mechanism and allows transfer of savings to
productive use safely and securely

Organised (Formal) and Unorganised (Informal) Financial Sector

The financial system of any country including India normally consist of two sectors i.e.
Unorganized or Informal Financial Sector and Organised or (formal ) Financial Sector.
(i) Unorganized or Informal Financial Sector. The informal financial sector is an unorganized,
non-institutional and non-regulated system dealing with the traditional and rural spheres of
economy. Not much formal rules or regulations or any regulators. Easy to transact. Risk is high.
The Money-Lenders or “lalas” at village level , chi funds are example of players in this informal
sector.
(ii) Formal Financial Sector: The formal financial sector is characterized by the presence of an
organized, institutional and regulated system which caters to the financial needs of the modern
spheres of economy. Indian banking system ,capital market (BSE , NSE etc) EBI, RBI etc are part
of such formal or organized sector of Indian financial system
WHAT ARE THE FUNCTIONS OF FINANCIAL SYSTEM

Financial system is the vital part of any economy or country. Financial system provides the
mechanism for channelization or circulation of money which facilitates all sort of economic
activities and development. The health of the economy is directly dependent on its financial
system. It deals with money which is the lifeblood of business or economy
Financial system plays many vital functions in relation to the economy. Some of these functions
are discussed as under.
1. Payment System: A payment system to enable exchange of goods and services for money.
Financial system provides a mechanism for such a payment system. Banks undertake this
responsibility by issue of cheques and drafts etc. Now a days innovations like online payment,
electronic fund transfer (ETF) ,NEFT ,RTGS ,payment through debit and credit cards has been
introduced.

2. Pooling of Funds: This means mobilizations of funds or savings .Financial system through its
vast network of institutions and branches is able to pool the savings small or large from all
sections of society thereby creating a large pool of funds for use in developmental and other
activities..

3. Transfer of resources: The savings mobilized are deployed in various economic activities
which help creation of assets and increase in GDP.The funds are given to all sectors business,
agriculture , household and government for undertaking developmental activities.

4. Risk Management: There is risk in investment. Without a safe a secure mechanism it would
have been very risky for saving holders to invest their money. However, the financial system
consists of such institutions that specialize in managing risk. These institutions collect savings
and invest .They assume all risk. They help manage the following types of risks associated with
lending or investment and hence the saving holder face very low risk.
a. Counter-party risk. Risk relating to the genuineness of the counter party to whom money is
lent.

b. Credit risk; Risk associated with the success of business and avoidance of default in
repayment.
c. Documentation risk: Lending or investment requires documentation. Any fault may seriously
affect recovery in case the borrower fails to repay. This is called documentation risk.

d. System risk. ;Risk of any mistake in the system through which lending or investment is made.

e. Country risk : Risk involved in overseas credit

f. Currency risk : Risk associated in increase or decrease in the value of currency.

g. Interest rate risk: Risk involved in re-investment and any decline in interest rates.
5.Price information for decentralized decision making: Financial system makes its possible that
price related data is disseminated among those who need them. This is done through various
publications and internet. As result one can take a decision about his funds staying at any place .
6. Price Discovery Process: Financial system also provides a platform to negotiate price is given
to buyers and sellers. For example for trading in shares one can use online trading plat form of
National Stock Exchange or Bombay Stock exchange systems.
7.Liquidity: The financial system also provides a way through which one can unlock one’s
investments in financial securities into cash. Investment in corporate shares and bonds can be sold
through stock exchange. Also, Banks, Financial institutions give scope of early withdrawal of
funds
Components/ Constituents of Indian Financial system:
The financial system consists of the Central Bank, as the apex financial institution, other regulatory
authorities, financial institutions, markets, instruments, a payment and settlement system, a legal
framework and regulations. The financial system carries out the vital financial
intermediation function of borrowing from surplus units and lending to deficit units. The legal
framework and regulators are needed to monitor and regulate the financial system. The payment
and settlement system is the mechanism through which transactions in the financial system are
cleared and settled.
The main components are;
 Regulatory Authorities
 Financial Institutions
 Financial Markets
 Financial Instruments
 Payment and Settlement Infrastructure
  Regulatory Authorities
The main component of any financial system is the regulatory system it has. In any economy,
the financial system is regulated by the central banking authority of that country. In India, the
central bank is named as the Reserve Bank of India.
The Reserve Bank of India
The regulation and supervision of banking institutions is mainly governed by the Companies
Act, 1956, Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970/1980,
Bankers' Books Evidence Act, Banking Secrecy Act and Negotiable Instruments Act, 1881
The regulation and supervision of finance companies is done by the Banking Regulation Act,
1949 which governs the financial sector.

Individual Institutions are regulated by Acts like:

 State Bank of India Act, 1954
 The Industrial Development Bank (Transfer of Undertaking and Repeal) Act, 2003
 The Industrial Finance Corporation (Transfer of Undertaking and Repeal) Act, 1993
 National Bank for Agriculture and Rural Development Act
 National Housing Bank Act
 Deposit Insurance and Credit Guarantee Corporation Act
Securities and Exchange Board of India
The Securities and Exchange Board of India was established on April 12, 1992 in accordance with
the provisions of the Securities and Exchange Board of India Act, 1992 to protect the interests of
investors in securities and to promote the development of, and to regulate the securities market
and for matters connected therewith or incidental thereto.
Insurance Regulatory and Development Authority
Insurance Regulatory and Development Authority regulates and supervises the insurance
industry - insurance companies and their agents and insurance brokers to protect the interests of
the policyholders, to regulate, promote and ensure orderly growth of the insurance industry
and for matters connected therewith or incidental thereto.
  Financial Institutions
The financial system consists of many financial institutions. While most of them are regulated
by the Reserve Bank, there are some which it manages just indirectly
Institutions Regulated by the Reserve Bank of India
The institutions regulated by the RBI are:
 Nationalised Commercial Banks
 Specialised Banks
 Registered Finance Companies
 Registered Finance Leasing Establishments
 Micro-Finance Institutions.
Institutions Not Regulated by the Reserve Bank of India
Certain financial institutions are not regulated by the Reserve Bank of India. These include
securities firms, investment banks and mutual funds which come under the purview of the SEBI,
Insurance Companies and Insurance Brokers which are regulated by the IRDA, etc.
 Financial Markets
The Financial Market, which is the market for credit and capital, can be divided into the Money
Market and the Capital Market.
The Money Market is the market for short-term interest- bearing assets.
Example:
1. Treasury bills
2. Commercial paper
3. Certificates of deposits

The major task of the Money Market is to facilitate the liquidity management in the economy.

The Capital Market is the market for trading in medium – long term assets.
The main purpose of the Capital Market is to facilitate the raising of long-term funds.

Example:
1. Treasury bonds
2. Private debt securities (bonds and debentures)
3. Equities (shares)
Did u know? The main issuers in the
1. Money Market are the Government, banks and private companies, while the main
investors are banks, insurance companies and pension and provident funds.
2. Capital Market are the Government, banks and private companies, while the main
investors are pension and provident funds and insurance companies.

The Financial Market can be also be classified according to instruments, such as the debt market
and the equity market.
The debt market is also known as the Fixed Income Securities Market and
its segments are the Government Securities Market (Treasury bills and bonds) and the Private
Debt Securities Market (commercial paper, private bonds and debentures). Another distinction
can also be drawn between primary and secondary markets. The Primary Market is the market for
new issues of shares and debt securities, while the Secondary Market is the market in which
existing securities are traded.
The Reserve Bank of India through its conduct of monetary policy influences the different
segments of the Financial Market in varying degrees. The Reserve Bank's policy interest rates
have the greatest impact on a segment of the Money Market called the inter-bank call money
market and a segment of the Fixed Income Securities Market, i.e. the Government Securities
Market.
 Financial Instruments
The main financial instruments can be categorized as under:
Deposits
Deposits are sums of money placed with a financial institution, for credit to a customer's account.
There are three types of deposits - demand deposits, savings deposits and fixed or time deposits.
Loans
A loan is a specified sum of money provided by a lender, usually a financial institution, to a
borrower on condition that it is repaid, either in instalments or all at once, on agreed dates and
at an agreed rate of interest. In most cases, financial institutions require some form of security
for loans.
Treasury Bills and Bonds
Treasury bills are government securities that have a maturity period of up to one year. Treasury
bills are issued by the central monetary authority (the RBI), on behalf of the Government of
India. Treasury bills are issued in maturities of 91 days, 182 days and 364 days.

REFORMS IN INDIAN FINANCIAL SYSTEM

BACKGROUND-
PHASE –I:-Weak Economy and weak financial system at the time of independence. Banks were
in private sector. Skewed distribution of banks and their branches. Bank finances were available
to only preferred clients.
PHASE –II :- The country nationalized banks and insurance companies in phases. Opened of large
number of branches and recruited large number of employees Controlled both deposits and loan
products of banks. Introduced credit control and ensured bank loans were available to agriculture
and other deserving small units. Banks grew in size and lots of loan distributed. However, banks
were not profitable resulting in large base of Non –Performing Assets (NPAs) or bad loans.
PHASE –III: Financial Crisis in 1991: The country witnessed payment crisis in foreign exchange.
Gold was mortgaged and loans taken from World Bank with the condition that the economy will
be reformed.
The Country overhauled the financial system and introduced major changes encompassing whole
economy including all segments of the financial system.
Reforms were moulded under three heads
1.Liberalization :Ensuring ease of doing business.
2.Privatization : Opening up sectors to private sector and
3.Globalisation : Permitting foreign competition.
BANKING SECTOR REFORMS:

1. Reduction in SLR and CRR limits. The statutory liquidity ratio (SLR) which was as high as 39
per cent of deposits with the banks has been reduced in a phased manner to 25 per cent.
2. Income recognition and asset classification norms introduced. Provisioning and Capital
adequacy standards specified. Indian Banks required to fulfill these norms by 1994 and 1996.
3. Guidelines for the establishment of private sector banks issued. This heralds a new policy
approach aimed at fostering greater competition.
4. Nationalised Banks allowed to tap the capital market to strengthen their capital base.
5. End of Administered Interest Rate Regime: Lending rates of commercial banks deregulated.
Banks required to declare their Prime Lending Rates (PLR). Banks are allowed to fix their own
interest rates on domestic term deposits with maturity of two years.
6. Computerisation of banking operations and Introduction of ATMs.
7. The Office of the Banking Ombudsman established for expeditious & inexpensive resolution.
of customer complaints related to Banking service
8. Digitalization of Banking Operations

CAPITAL MARKET REFORM:

 Establishment of SEBI- The Securities and Exchange Board of India was established on
April 12, 1992 in accordance with the provisions of the Securities and Exchange Board of
India Act, 1992. SEBI was established to protect the interests of investors in securities and
to promote the development of, and to regulate the securities market and for matters
connected therewith or incidental thereto.SEBI introduced regulations of Stock
Exchanges ,Initial Public Offerings, Insider trading ,Mutual Funds etc.
 National Stock Exchange commenced operations.For the first time online trading was
made possible.
 Derivative trading, primarily the exchange traded variety was started in India in June
2000 with introduction of index futures trading on NSE of India. This followed in July
2001 by introduction of index option, option on individual securities, and futures on
individual securities ( single stock futures).
  BSE also introduces online trading.
Insurance Sector Reform:
 'Committee on Reform of the Insurance Sector', RN Malhotra.
 Insurance Regulatory and Development Authority (IRDA) was incorporated in 1999 with
an objective to promote competition in insurance sector.
 License to Private Sector for opening insurance companies.
 FDI in insurance sector was introduced.
Foreign Exchange Market:
 Unified Exchange rate.
 Rupee made convertible on the Current Account
 Indian Banking Systems

BANKING : Meaning and business model

Banking is an intermediation activity between money-holders and money-seekers in the
financial system. The institution which provides such service is called a Bank. A bank collects
savings in the form of deposits from those having surplus money with a promise to pay interest
and to repay after maturity , on demand or order. The Bank then lends this money to those
seeking loans at higher rate of interest. The Bank works on its own account and assumes all
risk associated with lending. The differential between deposit rate and lending rate is the
income for the bank.
Importance of Banking:
The banking sector is the lifeline of any modern economy .It is one of the important financial
pillars of the financial system which plays a vital role in the success /failure of an economy.
The banking system is the fuel injection system which spurs economic efficiency by mobilizing
savings and allocating them to high return investment. Research confirms that countries with
a well developed banking system grow faster than those with a weaker one. The banking
system reflects the economic health of a country.

Growth of Indian Banking Sector

After the liberation and entry of foreign entities, there has been tremendous growth in the
Indian Retail banking scenario. According to a report by PWC (2018), it was revealed that by
the year 2050, India might become the third largest domestic banking sector after USA and
China. Harsh Bisht,(Expert in Banking and Capital market, PWC India) has confirmed that
“China and India could have a combined share of around 35% of global banking assets by
2050.The US, Japan, and Western Europe are projected to see a downfall in their share of
banking in the coming decades”.
 For the last five years, a report by Reserve Bank of India (2012) has claimed that in the case
of private banking there is a growth of approximately 24%in the net income. These figures and
facts prove that the growth rate in the Indian banking sector is tremendous.

The reasons for the growth are many. Rising per capita income is one the driving force for such
growth. This has given exposure to many expenditure and requirement of different banking
facilities. Moreover, retail banks are focusing on user friendly ways to attract customers.
Banking has been made very easy and hassle free. Internet banking and mobile banking has
become the second largest channel after ATM. Government is also focusing on including more
population under banking. Financial inclusion programme by Reserve Bank of India is
attempting to include the untapped population who are not banking. PradhanMantri Jan Dhan
Yogna, Atal Pension Yogna and Sukanya Samriddi Account have aided in attracting people
from all walks of life to start banking.

Definition of Banking :
Section 5 (1) (b) of the Banking Regulation Act 1949 defines banking as “the accepting ,for
the purpose of lending or investment of deposits of money from the public ,repayable on
demand or otherwise and withdrawable by cheque ,draft ,order or otherwise”
Section 5 (1) (c) defines a banking company as “any company which transacts the business of
banking in India.”

Types of banks

Reserve Bank of India is the central bank for India. It is otherwise recognized as banker’s bank. One of the
main function of the Reserve Bank of India is to direct the credit system of the country. Besides controlling
the credit system, it also carries out the monitory policy approved by the government. Primarily Reserve
Bank of India undertakes the major financial operations of the country. But for operation by public in
general different kinds of banks are working in the market.

1.1 Scheduled banks

Banks which are in accordance with the second schedule of the Reserve Bank of India Act, 1934 and listed
accordingly are considered as Schedule banks. It includes a wide range of banks working under the act.
Scheduled Banks incorporate State Bank of India and its tributaries banks (like State Bank of Hyderabad).
Previously there were seven subsidiaries to State Bank of India, but now there are five banks who work as
associate banks rather than subsidiary banks of State Bank of India. Scheduled Bank also broadly two types
of banks, one is commercial banks and second is cooperative banks. Public Sector, Private Sector, Foreign
Banks and Regional Rural Banks are included in Commercial Banks. On the other hand, Urban Cooperative
Banks and State Cooperative Banks are constituents of Cooperative banks.

1.1.2 Commercial Banks

The main motive of Commercial Banks is to generate profit from its operation. It is under the provision of
Banking Regulation Act, 1949. Principally it engages in accepting deposits and granting loans to the public,
corporate and sometimes Government also. Nowadays commercial banks are focusing on customer centric
approach for sustainable growth. Commercial banks are further divided into four streams.

1.2.1 Public Sector Banks

Banks whose majority of stake are when held by the Government, it is identified as Public Sector Bank.
These are also known as nationalized banks. There are 21 nationalized banks in India. The purpose of the
nationalized banks is to accommodate the requirement of priority sectors. However, it also aims to mobilize
savings from different parts of the country. State Bank of India claims to be the largest and oldest public
sector bank. In terms of asset, its market share is 23 % and 25% in terms of the deposit market. State Bank
of India is also listed in Fortune Global 500 list of the world’s biggest corporation of 2018.

1.2.2 Private Sector Banks

Banks in which the majority of stake is held by private owners are recognized as Private sector banks.
Currently, there are 21 private sectors banks operating in India. These banks are customer centric and
professionally managed. As mentioned earlier, private banks operate with a motive of profit maximization.
Mostly the private sector banks provide innovative products and comply with international standard. In
terms of asset ICICI bank is the largest private sector bank. However, it can be further dived into old private
sector banks and new private sectors banks. The present research is related to private sector banks in
Bhubaneswar.

1.2.3 Foreign Banks

Generally, banks where the bulk of the stake is owned and controlled by Foreign Institutional Investors
(FII) are recognized as foreign banks. Mostly, their head offices are located overseas, but they operate in
India with their branch offices. However, it should be noted that these banks are also under the guidelines
of the Reserve Bank of India. Apparently, the norms and guidelines for foreign banks are the same as public
and private sector banks. Standard Chartered and HSBC banks are examples of foreign banks functioning
in India.

1.2.4 Regional Rural Banks

Regional Rural Banks were opened with the motive to promote and provide easy banking facilities to
weaker sections of the society. It was established on 2nd October 1975 by the Government of India. Many
small farmers and agricultural laborers were trapped in the debt circle of Sahukar (local money
lenders).Similar was the case of small entrepreneurs who never had the opportunity to borrow a loan from
banks. Regional Rural banks made credit facility easy to these strata of society. Apart from credit facility,
it also provides other services like locker facility, credit & debit card facility, and disbursement of wages
and pensions by Government. Currently there are 56 Regional Rural Banks helping in the process of
economic growth of the country.

1..3 Co-operative Bank

Generally, Co-operative banks function without any profit motive. Co-operative Banks are indexed under
the Cooperative Societies Act, 1912. The basic function is no different from other retails banks and
accommodates the services like accepting and granting deposits. The banking facilities are carried out by
cooperatives like building societies, credit unions, and employment society. Further, it can be of two types
Urban Co-operative Banks and State Co-operative Banks

1.3.1 Urban Co-Operative Banks

Mainly Urban Co-Operative Banks cater to entrepreneurs, self employment and small business in urban
and semi urban areas. Initially, it was permitted to lend money only for non agricultural functions. But
nowadays the scope and horizon of its operation are wider and diversified.

1.3.2 State Co-Operative Banks

State Co-Operative Banks are primarily owned by the State Government and incorporated through the state
legislature. State Co-Operative Banks mainly focuses on the rural belt of the country. It provides credit
facility to different activities like hatcheries, irrigation, and farming.
 Reserve Bank of India

Scheduled Banks Non-Scheduled Banks

Commercial Banks Co-operative Bank

Public Sector Banks Urban Co-Operative Banks

Private Sector Banks State Co-Operative Banks

Foreign Banks

Regional Rural Banks

FUNCTIONS OF COMMERCIAL BANKS ( Also covers BANK PRODUCTS /SERVICES)

The Functions of a Commercial Banks can be categorized as under

1. Primary Function:

a. Accepting Deposits.

b. Lending and Deployment of Funds

i. Granting Loans and Advances

ii. Investment in Securities

2. Secondary Function :

a. Agency Functions

b. Utility Functions
(1) PRIMARY FUNCTIONS:
Commercial Banks are lifeline of any economy. With their vast network they reach out to nooks
and corner of the country .They mobilize savings in the form of deposits and channelize the funds
to its most productive use by lending and investments., there by boosing economic development
of the country. So accepting deposits and lending is the primary function of a commercial bank.
They carter to all sectors including households, corporate, agriculture business, government
sectors etc. They intermediate between surplus money-holders and money-seekers. In the process
they act on their own account and assume risk. They charge higher interest on funds deployments
9lending) than what they offer as interest to depositors. This difference called interest spread is the
income for the banks.

(i) Accepting Deposits:

They accept deposits for different maturities and also lend for different maturities.

Deposits are basically of two types

I. Savings Bank Account /Current Account Deposits: These are demand deposits.

II. Term Deposits : These deposits are for fixed term and normally withdrawn after maturity.
(ii)Lending and Deployment of Funds : The funds collected through deposits are deployed
profitably by lending or investments.

(i) Granting Loans and Advances

Loans and Advances are also different types catering to different needs

(a) Loans to Business:

(i) Cash Credit or Overdraft and Discounting of trade bills – Short term loans.

(ii) Term Loans – Long term loans

(b) Loans to Agriculture: Kissan Credit Card and other agriculture loans

(c) Loans to Individuals – Consumer Credit , Vehicle loan ,Education loans and Credit Card etc.

(ii) Investment in Securities:

(a) Investment in government securities as per SLR and CRR Norms

(b) Investment of Corporate Securities.

(c) Dealing in Foreign Exchange

(2) SECONDARY FUNCTIONS:

In addition to the primary functions commercial banks provide the following other functions called
secondary functions of banks. This includes Agency Functions where the banks renders some
functions as an agent of its customers. The Banks also renders certain utility functions to its
customers.

(a) Agency Functions: As per the instruction of the customers or on his behalf a Bank provides
following Agency functions:

I. Funds transfer facility at the instruction of the customer.

II. Collection of Cheques on behalf of customers
III. Periodic payments or Collections
IV. Managing Investment Portfolio of Customers.
(b) Utility Functions: For the benefits of its customers a bank also provides following utilities

Issue of Drafts ,Issue of Bank Guarantee, Issue of Letter of Credit ,Locker Facility ,
Currency Exchange ,Letter of Reference ,Issuing Travelers Cheque ,Electronic Fund
 Transfer (EFT) ,Automated Teller Machines ,Issuing Debit Card or Credit Card, Internet
payment facility , Phone pay facility etc.

BANKING PRODUCTS AND SERVICES:

Banking Products include

(1) Deposit Products – for mobilization of funds

(2) Loan Products – for deployment of funds
However banks also provide other services to its customers.

DIFFERENT TYPES OF DEPOSITS:-

Deposits of banks can be of two types

(a) Demand Deposits – In this case the depositor is allowed to withdraw on demand .The interest
is paid at a very low rate in these deposits. Demand Deposits include

(i) Saving banks deposits:-

This deposit is intended primarily for small scale savers. The primary objective of this
account is to develop the habits of savings among the small scale investors or individuals.
This account can be opened with the minimum balance, but it differs from bank to bank &
if cheque facilities are there minimum balance must be maintained otherwise the bank will
deduct some incidental charges.The depositor is supplied with a passbook. The nomination
facilities is available in savings bank accounts.

(ii) Current a/c deposits:-

A Current a/c is a account which is generally open by business people for their benefits &
convenience. Money can be deposited & withdraw anytime. Money can be withdrawn by
cheque. Usually banker does not allow any interest on this account. Basically this account
is meant for the business people to get the overdraft facilities

(iii)Term Deposits: In this type of deposit the funds is kept for a fixed term and the depositor is
not allowed to withdraw before maturity except on apecial cases. Banks pays higher rate of interest
on such term deposits. They include Fixed Deposits , Recurring deposit and Certificate of Deposits.
(i) Fixed deposit (FD):-
At the time of opening account the banker issue a receipt form for acknowledging the receipt of
money or deposit of account .It is popularly known as FDR(Fixed Deposit Receipt). It contains
the amount of deposit, name of the depositor ,date of maturity, rate of interest.
(ii) Recurring deposits (RD):-
It is one form of saving deposits. Depositors save money regularly in every month as a fixed
installment so that they are assured of the sizeable amount at a later period. This will enable the
depositors to meet contingent expenses.
(iii) Certificate of Deposits (CD) :- These are short term deposits of very high volume.

(2) DIFFERENT TYPES OF LOAN/ADVANCES:

1.LOAN:
In case of loan a banker advances a lump sum for a certain period at an agreed rate of interest. The
entire amount is paid either in cash or credit to his savings a/c. Loan may be demand or short term
loan
(A) SHORT TERM OR DEMAND LOAN: Demand loan is payable at demand at it is for a short
period of time. For 1 yr and usually granted to meet the working capital requirement & need of
borrower.
(i). CASH CREDIT:
A cash credit is an arrangement by which the customer is allowed to borrow up to a certain limit.
This is a permanent arrangement & the customer need not draw the sanctioned amount at once but
draw the amount as and when required.
Interest is charge only for the amount withdraw & not for the whole amount. Cash credit
arrangement usually meet against pledge or hypothecation of goods. This cash credit is the most
favourite mode of borrowings by large commercial & industrial concern.
(ii)OVERDRAFT:

Overdraft is an arrangement between a banker & his customer which the later is allowed to
withdraw over & above his credit balance in the current account up to an agreed limit. It is an
temporary arrangement granted against some security.
The borrowers is permitted to draw & repeat any number of times provided the total amount
overdrawn does not exceed the agreed limit. The interest is charged only for the amount drawn but
not the whole amount sanctioned.

A cash credit differs from an overdraft in one aspect. A cash credit is used for long term by
businessman, whereas is made occasionally for short duration in the current account only.

(iii)BILL DISCOUNTED & PURCHASED:

Bank grant advances to their customers by discounting bills of exchange. The amount after
deducting the interest from the amount of the instrument is credited in the accounts of a customer.
In this form of lending the interest is received in advance by the banker. Discounting of bill
constitute a clean advance & bank relay on the credit worthiness of the parties to the bills.

(B) LONG TERM LOAN: Term loan may be medium term or long term. Medium term loan
usually granted with in 5 yr & long term loan is for more than 5 yr. This loan is basically granted
to meet/acquire the capital assets or fixed assets such as purchase of land, building, plant,
machinery etc. These loans may be given to individuals , firms ,corporate etc.

FINANCIAL SERVICES PROVIDED BY BANK:

In addition to the fund based loans banks also provide certain non-fund based services to their
customers

(1) Safe-deposit lockers: For safe keeping of valuable banks provide safe deposit lockers to its
customers.

(2) Merchant Banking Services : Inorder to help its client raise money from public by issue of
shares or debentures banks works as bankers to issue and collect money on behalf of its client.

(3) Loan-syndication: When loan amount is very high or it contains foreign currency , banks may
play the role of a middlemen and help organize the loan from other banks.

(4) Project Consultancy: Banks also help business firm in preparation of project report and also
render consultancy.

(5) To work as trustees: banks offer to work as trustees in debenture issues.

(6) Portfolio Management Services: Some banks offer to work as portfolio managers of its high-
net-worth individual clients. They manage the whole portfolio of investments of the client on their
behalf for which the bank charges a fee.
 Indian Insurance System
Definition of Insurance
Insurance refers to a contractual arrangement in which one party, i.e. insurance company or the
insurer, agrees to compensate the loss or damage sustained to another party, i.e. the insured, by
paying a definite amount, in exchange for an adequate consideration called as premium.
It is often represented by an insurance policy, wherein the insured gets financial protection from
the insurer against losses due to the occurrence of any event which is not under the control of the
insured.
Insurance is a contract, represented by a policy, in which an individual or entity receives financial
protection or reimbursement against losses from an insurance company.

Principles of Insurance

1. Principle of Uberrimae fidei (Utmost Good Faith),

2. Principle of Insurable Interest,
3. Principle of Indemnity,
4. Principle of Contribution,
5. Principle of Subrogation,
6. Principle of Loss Minimization, and
7. Principle of Causa Proxima (Nearest Cause).

1. Principle of Uberrimae fidei (Utmost Good Faith)

Principle of Uberrimae fidei (a Latin phrase), or in simple english words, the Principle of Utmost
Good Faith, is a very basic and first primary principle of insurance. According to this principle,
the insurance contract must be signed by both parties (i.e insurer and insured) in an absolute good
faith or belief or trust.
The person getting insured must willingly disclose and surrender to the insurer his complete true
information regarding the subject matter of insurance. The insurer's liability gets void (i.e legally
revoked or cancelled) if any facts, about the subject matter of insurance are either omitted, hidden,
falsified or presented in a wrong manner by the insured
 2. Principle of Insurable Interest
The principle of insurable interest states that the person getting insured must have insurable interest
in the object of insurance. A person has an insurable interest when the physical existence of the
insured object gives him some gain but its non-existence will give him a loss. In simple words, the
insured person must suffer some financial loss by the damage of the insured object.

For example :- The owner of a taxicab has insurable interest in the taxicab because he is getting
income from it. But, if he sells it, he will not have an insurable interest left in that taxicab.
From above example, we can conclude that, ownership plays a very crucial role in evaluating
insurable interest. Every person has an insurable interest in his own life. A merchant has insurable
interest in his business of trading. Similarly, a creditor has insurable interest in his debtor.

3. Principle of Indemnity

Indemnity means security, protection and compensation given against damage, loss or injury.
According to the principle of indemnity, an insurance contract is signed only for getting protection
against unpredicted financial losses arising due to future uncertainties. Insurance contract is not made
for making profit else its sole purpose is to give compensation in case of any damage or loss.
In an insurance contract, the amount of compensations paid is in proportion to the incurred losses. The
amount of compensations is limited to the amount assured or the actual losses, whichever is less. The
compensation must not be less or more than the actual damage. Compensation is not paid if the
specified loss does not happen due to a particular reason during a specific time period. Thus, insurance
is only for giving protection against losses and not for making profit.
However, in case of life insurance, the principle of indemnity does not apply because the value of
human life cannot be measured in terms of money.

4. Principle of Contribution
Principle of Contribution is a corollary of the principle of indemnity. It applies to all contracts of
indemnity, if the insured has taken out more than one policy on the same subject matter. According
to this principle, the insured can claim the compensation only to the extent of actual loss either
from all insurers or from any one insurer. If one insurer pays full compensation then that insurer
can claim proportionate claim from the other insurers.
For example :- Mr. John insures his property worth $ 100,000 with two insurers "AIG Ltd." for $
90,000 and "MetLife Ltd." for $ 60,000. John's actual property destroyed is worth $ 60,000, then
Mr. John can claim the full loss of $ 60,000 either from AIG Ltd. or MetLife Ltd., or he can claim
$ 36,000 from AIG Ltd. and $ 24,000 from Metlife Ltd.
So, if the insured claims full amount of compensation from one insurer then he cannot claim the
same compensation from other insurer and make a profit. Secondly, if one insurance company
pays the full compensation then it can recover the proportionate contribution from the other
insurance company

5. Principle of Subrogation
Subrogation means substituting one creditor for another.
Principle of Subrogation is an extension and another corollary of the principle of indemnity. It also
applies to all contracts of indemnity.
According to the principle of subrogation, when the insured is compensated for the losses due to
damage to his insured property, then the ownership right of such property shifts to the insurer.
This principle is applicable only when the damaged property has any value after the event causing
the damage. The insurer can benefit out of subrogation rights only to the extent of the amount he
has paid to the insured as compensation.

For example :- Mr. John insures his house for $ 1 million. The house is totally destroyed by the
negligence of his neighbour Mr.Tom. The insurance company shall settle the claim of Mr. John
for $ 1 million. At the same time, it can file a law suit against Mr.Tom for $ 1.2 million, the market
value of the house. If insurance company wins the case and collects $ 1.2 million from Mr. Tom,
then the insurance company will retain $ 1 million (which it has already paid to Mr. John) plus
other expenses such as court fees. The balance amount, if any will be given to Mr. John, the insured

6. Principle of Loss Minimization

According to the Principle of Loss Minimization, insured must always try his level best to
minimize the loss of his insured property, in case of uncertain events like a fire outbreak or blast,
etc. The insured must take all possible measures and necessary steps to control and reduce the
losses in such a scenario. The insured must not neglect and behave irresponsibly during such events
just because the property is insured. Hence it is a responsibility of the insured to protect his insured
property and avoid further losses.
For example :- Assume, Mr. John's house is set on fire due to an electric short-circuit. In this tragic
scenario, Mr. John must try his level best to stop fire by all possible means, like first calling nearest
fire department office, asking neighbours for emergency fire extinguishers, etc. He must not
remain inactive and watch his house burning hoping, "Why should I worry? I've insured my
house."

7. Principle of Causa Proxima (Nearest Cause)

Principle of Causa Proxima (a Latin phrase), or in simple english words, the Principle of Proximate
(i.e Nearest) Cause, means when a loss is caused by more than one causes, the proximate or the
nearest or the closest cause should be taken into consideration to decide the liability of the insurer.
The principle states that to find out whether the insurer is liable for the loss or not, the proximate
(closest) and not the remote (farest) must be looked into.
For example :- A cargo ship's base was punctured due to rats and so sea water entered and cargo
was damaged. Here there are two causes for the damage of the cargo ship - (i) The cargo ship
getting punctured because of rats, and (ii) The sea water entering ship through puncture. The risk
of sea water is insured but the first cause is not. The nearest cause of damage is sea water which is
insured and therefore the insurer must pay the compensation. However, in case of life insurance,
the principle of Causa Proxima does not apply. Whatever may be the reason of death (whether a
natural death or an unnatural death) the insurer is liable to pay the amount of insurance.

Types of Insurance
Life and Nonlife insurance
Life Insurance
Life Insurance is different from other insurance in the sense that, here, the subject matter of
insurance is the life of a human being.
The insurer will pay the fixed amount of insurance at the time of death or at the expiry of a certain
period.
At present, life insurance enjoys maximum scope because life is the most important property of an
individual. Each and every person requires insurance.
This insurance provides protection to the family at the premature death or gives an adequate
amount at the old age when earning capacities are reduced.
Under personal insurance, a payment is made at the accident.
The insurance is not only a protection but is a sort of investment because a certain sum is returnable
to the insured at the death or the expiry of a period

Nonlife insurance/General Insurance

General insurance includes Property Insurance, Liability Insurance, and Other Forms of Insurance.
Fire and Marine Insurances are strictly called Property Insurance. Motor, Theft, Fidelity and
Machine Insurances include the extent of liability insurance to a certain extent The strictest form
of liability insurance is fidelity insurance, whereby the insurer compensates the loss to the insured
when he is under the liability of payment to the third party.
Property Insurance
Under the property insurance property of person/persons are insured against a certain specified
risk. The risk may be fire or marine perils, theft of property or goods damage to property at the
accident.
Marine Insurance
The marine perils are; collision with a rock or ship, attacks by enemies, fire, and captured by
pirates, etc. these perils cause damage, destruction or disappearance of the ship and cargo and non-
payment of freight.
So, marine insurance insures ship (Hull), cargo and freight. Previously only certain nominal risks
were insured but now the scope of marine insurance had been divided into two parts; Ocean Marine
Insurance and Inland Marine Insurance.
The former insures only the marine perils while the latter covers inland perils which may arise
with the delivery of cargo (gods) from the go-down of the insured and may extend up to the receipt
of the cargo by the buyer (importer) at his go down.

Fire Insurance
In the absence of fire insurance, the fire waste will increase not only to the individual but to the
society as well. With the help of fire insurance, the losses arising due to fire are compensated and
the society is not losing much.
The individual is preferred from such losses and his property or business or industry will remain
approximately in the same position in which it was before the loss.
The fire insurance does not protect only losses but it provides certain consequential losses also war
risk, turmoil, riots, etc. can be insured under this insurance, too.

Liability Insurance
The general Insurance also includes liability insurance whereby the insured is liable to pay the
damage of property or to compensate for the loss of persona; injury or death.
This insurance is seen in the form of fidelity insurance, automobile insurance, and machine
insurance, etc.

Social Insurance
The social insurance is to provide protection to the weaker sections of the society who are unable
to pay the premium for adequate insurance.
Pension plans, disability benefits, unemployment benefits, sickness insurance, and industrial
insurance are the various forms of social insurance.
Insurance can be classified into 4 categories from the risk point of view.

Personal Insurance
The personal insurance includes insurance of human life which may suffer a loss due to death,
accident, and disease. Therefore, personal insurance is further sub-classified into life insurance,
personal accident insurance, and health insurance.

Property Insurance
The property of an individual and of the society is insured against loss of fire and marine perils,
the crop is insured against an unexpected decline in deduction, unexpected death of the animals
engaged in business, break-down of machines and theft of the property and goods.

Guarantee Insurance
The guarantee insurance covers the loss arising due to dishonesty, disappearance, and disloyalty
of the employees or second party. The party must be a party to the contract. His failure causes loss
to the first party.
For example, in export insurance, the insurer will compensate the loss at the failure of the importers
to pay the amount of debt.

Other Forms of Insurance

Besides the property and liability insurances, there are other insurances that are included in general
Examples of such insurances are export-credit insurances, State employees’ insurance, etc.
whereby the insurer guarantees to pay a certain amount at certain events.This insurance is
extending rapidly these days.

Miscellaneous Insurance
The property, goods, machine, Furniture, automobiles, valuable articles, etc. can be insured against
the damage or destruction due to accident or disappearance due to theft.
There are different forms of insurances for each type of the said property whereby not only
property insurance exists but liability insurance and personal injuries are also the insurer.

Re-insurance
Reinsurance occurs when multiple insurance companies share risk by purchasing insurance
policies from other insurers to limit their own total loss in case of disaster. Described as "insurance
for insurance companies" by the Reinsurance Association of America, the idea is that no insurance
company has too much exposure to a particularly large event or disaster.
 Reinsurance occurs when multiple insurance companies share risk by purchasing insurance
policies from other insurers to limit their own total loss in case of disaster.
 By spreading risk, an insurance company takes on clients whose coverage would be too
great of a burden for the single insurance company to handle alone.
 Premiums paid by the insured is typically shared by all of the insurance companies
involved.
Insurers purchase reinsurance for four reasons: To limit liability on a specific risk, to stabilize loss
experience, to protect themselves and the insured against catastrophes, and to increase their
capacity. But reinsurance can help a company by providing the following:

1. Risk Transfer: Companies can share or transfer specific risks with other companies.
2. Arbitrage: Additional profits can be garnered by purchasing insurance elsewhere for less than
the premium the company collects from policyholders.
3. Capital Management: Companies can avoid having to absorb large losses by passing risk; this
frees up additional capital.
4. Solvency Margins: The purchase of surplus relief insurance allows companies to accept new
clients and avoid the need to raise additional capital.
5. Expertise: The expertise of another insurer can help a company obtain a higher rating and
premium.

It is a process whereby one entity (the reinsurer) takes on all or part of the risk covered under a
policy issued by an insurance company in consideration of a premium payment. In other words, it
is a form of an insurance cover for insurance companies.

Description: Unlike co-insurance where several insurance companies come together to issue one
single risk, reinsurers are typically the insurers of the last resort. The insurance business is based
on laws of probability which presupposes that only a fraction of the policies issued would result
in claims. As a result, the total sum insured by an insurance company would be several times its
net worth. It is based on this same probability of loss that insurance companies fix the insurance
premium. The premiums are fixed in such a manner that the total premium collected would be
enough to pay for the total claims incurred after providing for expenses. However, there is a
possibility that in a bad year, the total value of claims may be much more than the premium
collected. If the losses are of a very large magnitude, there is a chance that the net worth of the
company would be wiped out. It is to avoid such risks that insurance companies take out policies.
Secondly, insurance companies take the support of reinsurers when they do not have the capacity
to provide a cover on their own.

Micro Insurance
Micro insurance products offer coverage to low-income households or to individuals who have
little savings and is tailored specifically for lower valued assets and compensation for illness,
injury, or death.
Breaking Down Micro insurance
As a division of microfinance, micro insurance looks to aid low-income families by offering
insurance plans tailored to their needs. Micro insurance is often found in developing countries,
where the current insurance markets are inefficient or non-existent. Because the coverage value is
lower than the usual insurance plan, the insured people pay considerably smaller premiums.
Micro insurance, like regular insurance, is available for a wide variety of risks. These include both
health risks and property risks. Some of these risks include crop insurance, livestock/cattle
insurance, insurance for theft or fire, health insurance, term life insurance, death insurance,
disability insurance and insurance for natural disasters, etc.
Like traditional insurance, micro insurance functions based on the concept of risk pooling,
regardless of its small unit size and its activities at the level of single communities. Micro insurance
combines multiple small units into larger structures, creating networks of risk pools that enhance
both insurance functions and support structures.

Micro insurance Delivery Methods

Delivery of micro insurance is a challenge. Several methods and models exist, which can differ
according to the organization, institution, and provider involved. In general, there are four main
methods for delivering micro insurance to a client base: the partner-agent model, the provider-
driven model, the full-service model, and the community-based model:
• Partner-agent model: This model is based on a partnership between the micro insurance scheme
and an agent. In some cases a third-party healthcare provider. The micro insurance scheme is
responsible for the delivery and marketing of products to the clients, while the agent retains all
responsibility for design and development. In this model, Micro insurance schemes benefit from
limited risk but are also limited in their control.
• Full-service model: In this model, the Micro insurance scheme is in charge of everything; both
the design and delivery of products to the clients, working in conjunction with external healthcare
providers. While benefiting from full control, the disadvantage of the full-service model is the
higher risks.
• Provider-driven model: In this model, the healthcare provider is the Micro insurance scheme, and
similar to the full-service model, is responsible for all operations, delivery, design, and service.
This disadvantage of this method is the limitations of products and services that can be offered.
• Community-based/mutual model: In this method, policyholders or clients are run everything,
working with external healthcare providers to offer services. This model is advantageous for its
ability to design and market products more easily and effectively, but the small size and scope of
operations limits effectiveness.

POWERS OF IRDAI : Some of the powers include

1. All insurance companies have to register with IRDA compulsorily.

2. Companies can undertake only insurance busines

3. Accounts and balance sheets of companies have to be submitted to IRDA.

4. The nature of general insurance business will be prescribed by IRDA.

5. Statements of investment assets to be submitted to IRDA every financial year.

6. The appointment of chief executive officer requires prior permission of the IRDA.

7. All insurance agents must obtain license from IRDA.

8. IRDA has powers for levying penalty on companies which fail to comply with the rules and
regulations.

DUTIES OF IRDAI:
1. Regulates insurance companies The working of insurance companies will be regulated in
the following aspects
a) the persons to be employed,
b) the nature of business,
c) covering of risks,
d) terms and agreements for covering risks etc., will be prescribed by IRDA.

2. Promotes insurance companies

Corporate set-up is a must for establishing an insurance company and they have to submit
periodical reports to IRDA. Different kinds of policies and different types of insurance are
also suggested by IRDA to these insurance companies.

3. Ensures growth of insurance and reinsurance companies

Here, the promotion of new companies is encouraged. Even banks are also permitted to
promote insurance companies as a subsidiary.

FUNCTIONS OF IRDA:

1) Issuing certificate of registration.

2) protecting the interest of policy holders.
3) issuing license to agents.
4) Specifying code of conduct for surveyors and loss assessors.
5) Promoting efficiency in the insurance business.
6) Undertaking inspection, conducting enquiries etc., on insurance companies.
7) Control and regulations of rates, terms and conditions by insurance company to policy
holders.
8) Adjudication of disputes between insurance company and others in the insurance
business. Fixing the percentage of insurance business to rural and social sectors.

****