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 Indian
Financial System

RAHUL B. CHAUHAN, MBA., M.Com., PhD

ANDINO MASELENO, S.T., M.Eng., Ph.D
Dr. FAUZI, S.E., M.Kom, M.E, Akt., CA., CMA.

Editor:
Citrawati Jatiningrum, S.E., M.Si., Ph.D
 INDIAN FINANCIAL SYSTEM
Indramayu © 2022, Penerbit Adab

Penulis: Rahul B. Chauhan, MBA., M.Com., PhD., Andino Maseleno, S.T., M.Eng., Ph.D.,
dan Dr. Fauzi, S.E, M.Kom, M.E, Akt., CA., CMA.
Editor: Citrawati Jatiningrum, S.E., M.Si., Ph.D
Desain Cover: Nurul Musyafak
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vi + 162 hlm. ; 15,5 x 23 cm
No ISBN: 978-623-497-004-3

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 INTRODUCTION

The capital market encourages economic growth. The various

institutions which operate in the capital market give quantities and
qualitative direction to the flow of funds and bring rational allocation
of resources. A well-developed capital market comprising expert
banking and non-banking intermediaries brings stability to the value
of stocks and securities.
A financial system is a composition of various institutions,
markets, regulations and laws, practices, money managers, analysts,
transactions, and liabilities. This book thoroughly describes the Indian
Five parts consist of: Financial System, The Indian Financial System
is organized in five parts, consist of: The Indian Financial System,
Indian Money Market, Indian Capital Market, and Fee-Based Financial
Services.
In addition, important topic and depth discussion of the Indian
Financial System includes the following:
• Constituents of financial system
• Functions of the Indian financial system
• Role of the money market in economy
• Producing information and allocating capital
• Capital market in India

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 Indian Financial SystemCMA.

This book offers a comprehensive and well-crafted topic the

Indian Financial System. This book is also suitable for readers
interested in learning about money, banking, and the financial
system in the context of contemporary events, policy, and business.
Researcher and students can selectively read this book for their
references and studies.

v
 TABLE OF CONTENTS

INTRODUCTION............................................................................................... iii
TABLE OF CONTENTS...................................................................................... v

CH. 1 FINANCIAL SYSTEM.......................................................................... 1

1.1. INDIAN FINANCIAL SYSTEM..................................................... 2
1.2. FINANCIAL MARKETS............................................................... 3
1.3. FINANCIAL INTERMEDIATION.................................................. 4
1.4. FINANCIAL INSTRUMENTS...................................................... 5
1.5. PLAYERS OF MONEY MARKET ................................................. 10
1.6. FUNCTIONS OF MONEY MARKET ........................................... 11
1.7. STRUCTURE OF INDIAN MONEY MARKET............................... 12
1.8. FEATURES I DEFICIENCIES OF INDIAN MONEY MARKET........ 17
1.9. CAPITAL MARKET IN INDIA:-.................................................... 20
1.10.FACTORS CONTRIBUTING TO THE GROWTH AND
. DEVELOPMENT OF CAPITAL MARKET .................................... 26
1.11.REFORMS I DEVELOPMENTS IN CAPITAL MARKET
. SINCE 1991:-............................................................................ 29
1.12.SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI):-......... 33

CH. 2 INDIAN FINANCIAL SYSTEM-OVERVIEW.......................................... 39

2.1. CONSTITUENTS OF FINANCIAL SYSTEM................................. 41
2.2. FUNCTIONS OF INDIAN FINANCIAL SYSTEM........................... 46
2.3. ROLE OF MONEY MARKET IN ECONOMY ................................ 48
2.4. PRODUCING INFORMATION AND ALLOCATING CAPITAL ...... 48
2.5. CAPITAL MARKET IN INDIA: MEANING, FEATURES
. AND IMPORTANCE OF CAPITAL MARKET................................ 53

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 Indian Financial SystemCMA.

CH. 3 MONEY MARKET............................................................................... 59

3.1. MONEY MARKET INSTRUMENT............................................... 62
3.2. STRUCTURE OF INDIAN MONEY MARKET............................... 68
3.3. MEASURES TO IMPROVE INDIAN MONEY MARKET................. 70
3.4. CAPITAL MARKET..................................................................... 71
3.5. INDUSTRIAL DEVELOPMENTBANK OF INDIA (IDBI)................ 82
3.6. ADVANTAGES OF MUTUAL FUNDS: The advantages
. of investing in a Mutual funds are:......................................... 92
3.7. INDUSTRIAL CREDIT AND INVESTMENT CORPORATION
. OF INDIA (ICICI)........................................................................ 94
3.8. ORGANIZED MONEY MARKET.................................................. 106
3.9. UN-ORGANIZED MONEY MARKET........................................... 108

CH. 4 CAPITAL MARKET............................................................................. 109

4.1. REFORMS IN PRIMARY MARKET.............................................. 111
4.2. REFORMS IN THE SECONDARY MARKET................................. 113
4.3. SEBI IN CAPITAL MARKET ISSUES .......................................... 116
4.4. OBJECTIVES OF THE SEBI....................................................... 116
4.5. ORGANISATIONAL GRID OF THE SEBI..................................... 116
4.6. POWERS AND FUNCTIONS OF SEBI........................................ 117
4.7. ROLE OF SEBI........................................................................... 117
4.8. ORGANISED CAPITAL MARKET................................................ 121
4.9. UN-ORGANIZED CAPITAL MARKET......................................... 122

CH. 5 FEE BASED FINANCIAL SERVICES.................................................... 123

5.1.. VENTURE CAPITAL FINANCING............................................... 124
5.2..FACTORING.............................................................................. 129
5.3..LEASING:.................................................................................. 132
5.4..UNDERWRITING....................................................................... 138
5.5.. CREDIT RATING........................................................................ 143
5.6.. OTHER FINANCIAL SERVICES ................................................. 147

AUTHORS PROFILE.......................................................................................... 157

vii
 CH. 1

FINANCIAL SYSTEM

1
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

An Overview of Indian Financial System

Financial System of any country consists of financial markets,
financial intermediation and financial instruments or financial
products. We discuss the meaning of finance and Indian Financial
System and focus on the financial markets, financial intermediaries
and financial instruments. The brief review on various money market
instruments

1.1 INDIAN FINANCIAL SYSTEM

The economic development of a nation is reflected by the progress
of the various economic units, broadly classified into corporate sector,
government and household sector. While performing their activities
these units will be placed in a surplus/deficit/balanced budgetary
situations.
There are areas or people with surplus funds and there are those
with a deficit. A financial system or financial sector functions as an
intermediary and facilitates the flow of funds from the areas of surplus
to the areas of deficit. A Financial System is a composition of various
institutions, markets, regulations and laws, practices, money manager,
analysts, transactions and claims and liabilities.

Financial System;

The word “system”, in the term “financial system”, implies a set

of complex and closely connected or interlined institutions, agents,
practices, markets, transactions, claims, and liabilities in the economy.

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 Indian Financial SystemCMA.

The financial system is concerned about money, credit and finance-

the three terms are intimately related yet are somewhat different
from each other. Indian financial system consists of financial market,
financial instruments and financial intermediation. These are briefly
discussed below;

1.2 FINANCIAL MARKETS

A Financial Market can be defined as the market in which financial
assets are created or transferred. As against a real transaction that
involves exchange of money for real goods or services, a financial
transaction involves creation or transfer of a financial asset. Financial
Assets or Financial Instruments represents a claim to the payment of
a sum of money sometime in the future and/or periodic payment in
the form of interest or dividend.

Money Market- The money market ifs a wholesale debt market

for low-risk, highly-liquid, short-term instrument.
Funds are available in this market for periods
ranging from a single day up to a year. This market
is dominated mostly by government, banks and
financial institutions.

Capital Market- The capital market is designed to finance the long-

term investments. The transactions taking place in
this market will be for periods over a year.

Forex Market- The Forex market deals with the multicurrency

requirements, which are met by the exchange of
currencies. Depending on the exchange rate that
is applicable, the transfer of funds takes place in
this market. This is one of the most developed and
integrated market across the globe.

3
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

Credit Market- Credit market is a place where banks, FIs and NBFCs
purvey short, medium and long-term loans to
corporate and individuals.

Constituents of a Financial System

1.3 FINANCIAL INTERMEDIATION

Having designed the instrument, the issuer should then ensure
that these financial assets reach the ultimate investor in order to
garner the requisite amount. When the borrower of funds approaches
the financial market to raise funds, mere issue of securities will not
suffice. Adequate information of the issue, issuer and the security
should be passed on to take place. There should be a proper channel
within the financial system to ensure such transfer. To serve this
purpose,
Financial intermediaries came into existence. Financial
intermediation in the organized sector is conducted by a wide
range of institutions functioning under the overall surveillance
of the Reserve Bank of India. In the initial stages, the role of the

4
 Indian Financial SystemCMA.

intermediary was mostly related to ensure transfer of funds from

the lender to the borrower. This service was offered by banks, FIs,
brokers, and dealers. However, as the financial system widened
along with the developments taking place in the financial markets,
the scope of its operations also widened. Some of the important
intermediaries operating in the financial markets include; investment
bankers, underwriters, stock exchanges, registrars, depositories,
custodians, portfolio managers, mutual funds, financial advertisers
financial consultants, primary dealers, satellite dealers, self regulatory
organizations, etc. Though the markets are different, there may be
a few intermediaries offering their services in more than one market
e.g. underwriter. However, the services offered by them vary from
one market to another.
Intermediary Market Role
Stock Exchange Capital Market Secondary Market to securities
Capital Market, Corporate advisory services, Issue of
Investment Bankers
Credit Market securities
Capital Market, Subscribe to unsubscribed portion of
Underwriters
Money Market securities
Registrars, Issue securities to the investors on
Depositories, Capital Market behalf of the company and handle
Custodians share transfer activity
Primary Dealers Market making in government
Money Market
Satellite Dealers securities
Forex Dealers Forex Market Ensure exchange ink currencies

1.4 FINANCIAL INSTRUMENTS

A. Money Market Instruments

The money market can be defined as a market for short-term

money and financial assets that are near substitutes for money.
The term short-term means generally a period upto one year
and near substitutes to money is used to denote any financial
asset which can be quickly converted into money with minimum
transaction cost.

5
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

Some of the important money market instruments are briefly

discussed below;
1. Call/Notice Money
2. Treasury Bills
3. Term Money
4. Certificate of Deposit
5. Commercial Papers

1. Call/Notice-Money Market: Call/Notice money is the

money borrowed or lent on demand for a very short period.
When money is borrowed or lent for a day, it is known as
Call (Overnight) Money. Intervening holidays and/or Sunday
are excluded for this purpose. Thus money, borrowed on
a day and repaid on the next working day, (irrespective of
the number of intervening holidays) is “Call Money”. When
money is borrowed or lent for more than a day and up to 14
days, it is “Notice Money”. No collateral security is required
to cover these transactions.

2. Inter-Bank Term Money: Inter-bank market for deposits of

maturity beyond 14 days is referred to as the term money
market. The entry restrictions are the same as those for Call/
Notice Money except that, as per existing regulations, the
specified entities are not allowed to lend beyond 14 days.

3. Treasury Bills.: Treasury Bills are short term (up to one year)
borrowing instruments of the union government. It is an IOU
of the Government. It is a promise by the Government to pay
a stated sum after expiry of the stated period from the date
of issue (14/91/182/364 days i.e. less than one year). They are
issued at a discount to the face value, and on maturity the
face value is paid to the holder. The rate of discount and the
corresponding issue price are determined at each auction.

6
 Indian Financial SystemCMA.

4. Certificate of Deposits: Certificates of Deposit (CDs)

is a negotiable money market instrument nod issued in
dematerialized form or as a Usance Promissory Note,
for funds deposited at a bank or other eligible financial
institution for a specified time period. Guidelines for issue
of CDs are presently governed by various directives issued
by the Reserve Bank of India, as amended from time to
time. CDs can be issued by (i) scheduled commercial banks
excluding Regional Rural Banks (RRBs) and Local Area Banks
(LABs); and (ii) select all-India Financial Institutions that have
been permitted by RBI to raise short-term resources within
the umbrella limit fixed by RBI. Banks have the freedom to
issue CDs depending on their requirements. An FI may issue
CDs within the overall umbrella limit fixed by RBI, i.e., issue
of CD together with other instruments viz., term money,
term deposits, commercial papers and interoperate deposits
should not exceed 100 per cent of its net owned funds, as
per the latest audited balance sheet.

5. Commercial Paper: CP is a note in evidence of the debt

obligation of the issuer. On issuing commercial paper the
debt obligation is transformed into an instrument. CP is
thus an unsecured promissory note privately placed with
investors at a discount rate to face value determined by
market forces. CP is freely negotiable by endorsement and
delivery. A company shall be eligible to issue CP provided-
(a) the tangible net worth of the company, as per the latest
audited balance sheet, is not less than Rs. 4 crore; (b) the
working capital (fund-based) limit of the company from the
banking system is not less than Rs.4 crore and (c) the borrowal
account of the company is classified as a Standard Asset by
the financing bank/s. The minimum maturity period of CP is
7 days. The minimum credit rating shall be P-2 of CRISIL or

7
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

such equivalent rating by other agencies. (for more details

visit www.indianmba.com faculty column)

B. Capital Market Instruments

The capital market generally consists of the following long

term period i.e., more than one year period, financial instruments;
In the equity segment Equity shares, preference shares,
convertible preference shares, non-convertible preference shares
etc and in the debt segment debentures, zero coupon bonds,
deep discount bonds etc.

C. Hybrid Instruments

Hybrid instruments have both the features of equity and

debenture. This kind of instruments is called as hybrid instruments.
Examples are convertible debentures, warrants etc.

Money Market Concept, Meaning

There are two types of financial markets viz., the money

market and the capital market. The money market in that part
of a financial market which deals in the borrowing and lending
of short term loans generally for a period of less than or equal
to 365 days. It is a mechanism to clear short term monetary
transactions in an economy.

Definitions of Money Market

Following definitions will help us to understand the concept

of money market.
According to Crowther, “The money market is a name given
to the various firms and institutions that deal in the various grades
of near money.”
According to the RBI, “The money market is the centre for
dealing mainly of short character, in monetary assets; it meets

8
 Indian Financial SystemCMA.

the short term requirements of borrowers and provides liquidity

or cash to the lenders. It is a place where short term surplus
investible funds at the disposal of financial and other institutions
and individuals are bid by borrowers, again comprising institutions
and individuals and also by the government.”
According to Nadler and Shipman, “A money market is a
mechanical device through which short term funds are loaned and
borrowed through which a large part of the financial transactions
of a particular country or world are degraded. A money market
is distinct from but supplementary to the commercial banking
system.”
These definitions help us to identify the basic characteristics
of a money market. A money market comprises of a well
organized banking system. Various financial instruments are used
for transactions in a money market. There is perfect mobility of
funds in a money market. The transactions in a money market
are of short term nature.

Functions of Money Market

Money market is an important part of the economy. It plays

very significant functions. As mentioned above it is basically
a market for short term monetary transactions. Thus it has to
provide facility for adjusting liquidity to the banks, business
corporations, non-banking financial institutions (NBFs) and other
financial institutions along with investors.
The major functions of money market are given below:-
1. To maintain monetary equilibrium. It means to keep a balance
between the demand for and supply of money for short term
monetary transactions.
2. To promote economic growth. Money market can do this by
making funds available to various units in the economy such
as agriculture, small scale industries, etc.

9
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

3. To provide help to Trade and Industry. Money market provides

adequate finance to trade and industry. Similarly it also
provides facility of discounting bills of exchange for trade
and industry.
4. To help in implementing Monetary Policy. It provides a
mechanism for an effective implementation of the monetary
policy.
5. To help in Capital Formation. Money market makes available
investment avenues for short term period. It helps in
generating savings and investments in the economy.
6. Money market provides non-inflationary sources of finance
to government. It is possible by issuing treasury bills in order
to raise short loans. However this dose not leads to increases
in the prices.

Apart from those, money market is an arrangement which

accommodates banks and financial institutions dealing in short
term monetary activities such as the demand for and supply of
money

1.5 PLAYERS OF MONEY MARKET

In money market transactions of large amount and high volume
take place. It is dominated by small number of large players. In money
market the players are:-Government, RBI, DFHI (Discount and finance
House of India) Banks, Mutual Funds, Corporate Investors, Provident
Funds, PSUs (Public Sector Undertakings), NBFCs (Non-Banking
Finance Companies) etc.
The role and level of participation by each type of player differs
from that of others.

10
 Indian Financial SystemCMA.

1.6 FUNCTIONS OF MONEY MARKET

1. To maintain monetary equilibrium. It means to keep a balance
between the demand for and supply of money for short term
monetary transactions.

2. To promote economic growth. Money market can do this by

making funds available to various units in the economy such as
agriculture, small scale industries, etc.

3. To provide help to Trade and Industry. Money market provides

adequate finance to trade and industry. Similarly it also provides
facility of discounting bills of exchange for trade and industry.

4. To help in implementing Monetary Policy. It provides a mechanism

for an effective implementation of the monetary policy.

5. To help in Capital Formation. Money market makes available

investment avenues for short term period. It helps in generating
savings and investments in the economy.

6. Money market provides non-inflationary sources of finance to

government. It is possible by issuing treasury bills in order to
raise short loans. However this dose not leads to increases in the
prices.

7. To caters to the short-term financial needs of the economy.

8. To helps the RBI in effective implementation of monetary policy.

9. To helps in allocation of short term funds through inter-bank

transactions and money market Instruments.

10. Provides funds in non-inflationary way to the government to

meet its deficits.

11
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

1.7 STRUCTURE OF INDIAN MONEY MARKET

Organized Sector Unorganized Sector
Call and Notice Money Market Indigenous Bankers
Treasury bill Market Money Lenders
Commercial Bills NBFI
Certificate of Deposits
Commercial Papers
Money Market Mutual Funds
The REPO Market
DFHI

I. Organized Sector of Money Market:-Organized Money Market

is not a single market, it consist of number of markets. The most
important feature of money market instrument is that it is liquid.
It is characterized by high degree of safety of principal. Following
are the instruments which are traded in money market

1) Call and Notice Money Market:-The market for extremely

short-period is referred as call money market. Under call
money market, funds are transacted on overnight basis. The
participants are mostly banks. Therefore, it is also called Inter-
Bank Money Market. Under notice money market funds are
transacted for 2 days and 14 days’ period. The lender issues
a notice to the borrower 2 to 3 days before the funds are to
be paid. On receipt of notice, borrowers have to repay the
funds.
In this market the rate at which funds are borrowed and
lent is called the call money rate. The call money rate is
determined by demand and supply of short term funds. In call
money market the main participants are commercial banks,
co-operative banks and primary dealers. They participate
as borrowers and lenders. Discount and Finance House of
India (DFHI), Non-banking financial institutions like LIC, GIC,

12
 Indian Financial SystemCMA.

UTI, NABARD etc. are allowed to participate in call money

market as lenders.
Call money markets are located in big commercial centers
like Mumbai, Kolkata, Chennai, Delhi etc. Call money market
is the indicator of liquidity position of money market. RBI
intervenes in call money market as there is close link between
the call money market and other segments of money market.

2) Treasury Bill Market (T-Bills):-This market deals in Treasury

Bills of short term duration issued by RBI on behalf of
Government of India. At present three types of treasury
bills are issued through auctions, namely 91 day, 182 day
and364day treasury bills. State government does not issue
any treasury bills. Interest is determined by market forces.
Treasury bills are available for a minimum amount of Rs.
25,000 and in multiples of Rs. 25,000. Periodic auctions are
held for their Issue.
T-bills are highly liquid, readily available; there is absence of
risk of default. In India T-bills have narrow market and are
undeveloped. Commercial Banks, Primary Dealers, Mutual
Funds, Corporate, Financial Institutions, Provident or Pension
Funds and Insurance Companies can participate in T-bills
market.

3) Commercial Bills:-Commercial bills are short term,

negotiable and self-liquidating money market instruments
with low risk. A bill of exchange is drawn by a seller on the
buyer to make payment within a certain period of time.
Generally, the maturity period is of three months. Commercial
bill can be resold a number of times during the usance period
of bill. The commercial bills are purchased and discounted
by commercial banks and are rediscounted by financial
institutions like EXIM banks, SIDBI, IDBI etc.

13
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

In India, the commercial bill market is very much under­

developed. RBI is trying to develop the bill market in our
country. RBI has introduced an innovative instrument known
as “Derivative. Usance Promissory Notes, with a view to
eliminate movement of papers and to facilitate multiple
rediscounting.

4) Certificate Of Deposits (CDs):-CDs are issued by Commercial

banks and development financial institutions. CDs are
unsecured, negotiable promissory notes issued at a discount
to the face value. The scheme of CDs was introduced in 1989
by RBI. The main purpose was to enable the commercial
banks to raise funds from market. At present, the maturity
period of CDs ranges from 3 months to 1 year. They are
issued in multiples of Rs. 25 lakh subject to a minimum size
of Rs. 1 crore. CDs can be issued at discount to face value.
They are freely transferable but only after the lock-in-period
of 45 days after the date of issue.
In India the size of CDs market is quite small. In 1992, RBI
allowed four financial institutions ICICI, IDBI, IFCI and IRBI to
issue CDs with a maturity period of. one year to three years.

5) Commercial Papers (CP):-Commercial Papers were

introduced in January 1990. The Commercial Papers can be
issued by listed companies which have working capital of
not less than Rs. 5 crores. They could be issued in multiple
of Rs. 25 lakhs. The minimum size of issue being Rs. 1 crore.
At present the maturity period of CPs ranges between 7 days
to 1 year. CPs are issued at a discount to its face value and
redeemed at its face value.

6) Money Market Mutual Funds (MMMFs):-A Scheme of

MMMFs was introduced by RBI in 1992. The goal was to
provide an additional short-term avenue to individual

14
 Indian Financial SystemCMA.

investors. In November 1995 RBI made the scheme more

flexible. The existing guidelines allow banks, public financial
institutions and also private sector institutions to set up
MMMFs. The ceiling of Rs. 50 crores on the size of MMMFs
stipulated earlier, has been withdrawn. MMMFs are allowed
to issue units to corporate enterprises and others on par with
other mutual funds. Resources mobilised by MMMFs are now
required to be invested in call money, CD, CPs, Commercial
Bills arising out of genuine trade transactions, treasury
bills and government dated securities having an unexpired
maturity upto one year. Since March 7, 2000 MMMFs have
been brought under the purview of SEBI regulations. At
present there are 3 MMMFs in operation.

7) The Repo Market:-Repo was introduced in December 1992.

Repo is a repurchase agreement. It means selling a security
under an agreement to repurchase it at a predetermined date
and rate. Repo transactions are affected between banks and
financial institutions and among bank themselves, RBI also
undertake Repo.
In November 1996, RBI introduced Reverse Repo. It means
buying a security on a spot basis with a commitment to resell
on a forward basis. Reverse Repo transactions are affected
with scheduled commercial banks and primary dealers.
In March 2003, to broaden the Repo market, RBI allowed
NBFCs, Mutual Funds, Housing Finance and Companies and
Insurance Companies to undertake REPO transactions.

8) Discount And Finance House Of India (DFHI) In 1988,

DFHI was set up by RBI. It is jointly owned by RBI, public
sector banks and all India financial institutions which have
contributed to its paid up capital.It is playing an important
role in developing an active secondary market in Money
Market Instruments. In February 1996, it was accredited

15
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

as a Primary Dealer (PD). The DFHI deals in treasury bills,

commercial bills, CDs, CPs, short term deposits, call money
market and government securities.
II. Unorganized Sector of Money Market:-The economy on one
hand performs through organized sector and on other hand
in rural areas there is continuance of unorganized, informal
and indigenous sector. The unorganized money market mostly
finances short-term financial needs of farmers and small
businessmen. The main constituents of unorganized money
market are:-
1) Indigenous Bankers (IBs) Indigenous bankers are individuals
or private firms who receive deposits and give loans and
thereby operate as banks. IBs accept deposits as well as
lend money. They mostly operate in urban areas, especially
in western and southern regions of the country. The volume
of their credit operations is however not known. Further
their lending operations are completely unsupervised and
unregulated. Over the years, the significance of IBs has
declined due to growing organized banking sector.
2) Money Lenders (MLs) they are those whose primary business
is money lending. Money lending in India is very popular both
in urban and rural areas. Interest rates are generally high.
Large amount of loans are given for unproductive purposes.
The operations of money lenders are prompt, informal and
flexible. The borrowers are mostly poor farmers, artisans,
petty traders and manual workers. Over the years the role of
money lenders has declined due to the growing importance
of organized banking sector.
3) Non-Banking Financial Companies (NBFCs)
They consist of:-
1. Chit Funds: Chit funds are savings institutions. It has
regular members who make periodic subscriptions to the

16
 Indian Financial SystemCMA.

fund. The beneficiary may be selected by drawing of lots.

Chit fund is more popular in Kerala and Tamilnadu. Rbi
has no control over the lending activities of chit funds.
2. Nidhis:-Nidhis operate as a kind of mutual benefit for
their members only. The loans are given to members at
a reasonable rate of interest. Nidhis operate particularly
in South India.
3. Loan Or Finance Companies: Loan companies are found
in all parts of the country. Their total capital consists of
borrowings, deposits and owned funds. They give loans
to retailers, wholesalers, artisans and self-employed
persons. They offer a high rate of interest along with
other incentives to attract deposits. They charge high
rate of interest varying from 36% to 48% p.a.
4. Finance Brokers: They are found in all major urban
markets specially in cloth, grain and commodity markets.
They act as middlemen between lenders and borrowers.
They charge commission for their services.

1.8 FEATURES I DEFICIENCIES OF INDIAN MONEY MARKET

Indian money market is relatively underdeveloped when
compared with advanced markets like New York and London Money
Markets. Its’ main features/defects are as follows

1. Dichotomy:

A major feature of Indian Money Market is the existence

of dichotomy i.e. existence of two markets:-Organized Money
Market and Unorganized Money Market. Organized Sector
consist of RBI, Commercial Banks, Financial Institutions etc. The
Unorganized Sector consist of IBs, MLs, Chit Funds, Nidhis etc. It
is difficult for RBI to integrate the Organized and Unorganized

17
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

Money Markets. Several segments are loosely connected with

each other. Thus there is dichotomy in Indian Money Market.

2. Lack Of Co-ordination and Integration:

It is difficult for RBI to integrate the organized and

unorganized sector of money market. RBT is fully effective in
organized sector but unorganized market is out of RBI’s control.
Thus there is lack of integration between various sub-markets
as well as various institutions and agencies. There is less co-
ordination between co-operative and commercial banks as well
as State and Foreign banks. The indigenous bankers have their
own ways of doing business.

3. Diversity In Interest Rates:

There are different rates of interest existing in different

segments of money market. In rural unorganized sectors the rate
of interest are high and they differ with the purpose and borrower.
There are differences in the interest rates within the organized
sector also. Although wide differences have been narrowed down,
yet the existing differences do hamper the efficiency of money
market.

4. Seasonality Of Money Market:-

Indian agriculture is busy during the period November to

June resulting in heavy demand for funds. During this period
money market suffers from Monetary Shortage resulting in high
rate of interest. During slack season rate of interest falls &s there
are plenty of funds available. RBI has taken steps to reduce the
seasonal fluctuations, but still the variations exist.

5. Shortage Of Funds:-

In Indian Money Market demand for funds exceeds the

supply. There is shortage of funds in Indian Money Market an

18
 Indian Financial SystemCMA.

account of various factors like inadequate banking facilities, low

savings, lack of banking habits, existence of parallel economy
etc. There is also vast amount of black money in the country
which has caused shortage of funds. However, in recent years
development of banking has improved the mobilization of funds
to some extent.

6. Absence Of Organized Bill Market:-

A bill market refers to a mechanism where bills of exchange

are purchased and discounted by banks in India. A bill market
provides short term funds to businessmen. The bill market in India
is not popular due to overdependence of cash transactions, high
discounting rates, problem of dishonor of bills etc.

7. Inadequate Banking Facilities:-

Though the commercial banks, have been opened on a

large scale, yet banking facilities are inadequate in our country.
The rural areas are not covered due to poverty. Their savings
are very small and mobilization of small savings is difficult. The
involvement of banking system in different scams and the failure
of RBI to prevent these abuses of banking system shows that
Indian banking system is not yet a well organized sector.

8. Inefficient And Corrupt Management:-

One of the major problem of Indian Money Market is its

inefficient and corrupt management. Inefficiency is due to faulty
selection, lack of training, poor performance appraisal, faulty
promotions etc. For the growth and success of money market,
there is need for well trained and dedicated workforce in banks.
However, in India some of the bank officials are inefficient and
corrupt.

19
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

1.9 CAPITAL MARKET IN INDIA:-

Capital market deals with medium term and long term funds. It
refers to all facilities and the institutional arrangements for borrowing
and lending term funds (medium term and long term). The demand
for long term funds comes from private business corporations, public
corporations and the government. The supply of funds comes largely
from individual and institutional investors, banks and special industrial
financial institutions and Government.

STRUCTURE I CONSTITUENTS I CLASSIFICATION OF CAPITAL

MARKET
Capital market is classified in two ways
CAPITAL MARKET IN INDIA
Gild–Edged Industrial Development Financial
Market Securities Financial intermediaries
Market Institutions (DFIs)

a) Gilt-Edged Market:-
Gilt-Edged market refers to the market for government and
semi-government securities, which carry fixed rates of interest.
RBI plays an important role in this market.
b) Industrial Securities Market:-
It deals with equities and debentures in which shares and
debentures of existing companies are traded and shares and
debentures of new companies are bought and sold.
c) Development Financial Institutions:-
Development financial institutions were set up to meet the
medium and long-term requirements of industry, trade and
agriculture. These are IFCI, ICICI, IDBI, SIDBI, IRBI, UTI, LIC, GIC
etc. All These institutions have been called Public Sector Financial
Institutions.

20
 Indian Financial SystemCMA.

d) Financial Intermediaries:-
Financial Intermediaries include merchant banks, Mutual Fund,
Leasing companies etc. they help in mobilizing savings and
supplying funds to capital market.

The Second way in which capital market is classified is as follows:-

a) Primary Market:-
Primary market is the new issue market of shares, preference
shares and debentures of non-government public limited
companies and issue of public sector bonds.
b) Secondary Market
This refers to old or already issued securities. It is composed of
industrial security market or stock exchange market and gilt-
edged market.

ROLE AND IMPORTANCE OF CAPITAL MARKET IN INDIA

Capital market has a crucial significance to capital formation.
For a speedy economic development adequate capital formation
is necessary. The significance of capital market in economic
development is explained below:-
1. Mobilisation Of Savings And Acceleration Of Capital Formation:-
In developing countries like India the importance of capital
market is self evident. In this market, various types of securities
helps to mobilise savings from various sectors of population. The
twin features of reasonable return and liquidity in stock exchange
are definite incentives to the people to invest in securities. This
accelerates the capital formation in the country.
2. Raising Long-Term Capital:-
The existence of a stock exchange enables companies to raise
permanent capital. The investors cannot commit their funds for
a permanent period but companies require funds permanently.
The stock exchange resolves this dash of interests by offering

21
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

an opportunity to investors to buy or sell their securities, while

permanent capital with the company remains unaffected.
3. Promotion Of Industrial Growth:-
The stock exchange is a central market through which resources
are transferred to the industrial sector of the economy. The
existence of such an institution encourages people to invest in
productive channels. Thus it stimulates industrial growth and
economic development of the country by mobilising funds for
investment in the corporate securities.
4. Ready And Continuous Market:-
The stock exchange provides a central convenient place where
buyers and sellers can easily purchase and sell securities. Easy
marketability makes investment in securities more liquid as
compared to other assets.
5. Technical Assistance:-
An important shortage faced by entrepreneurs in developing
countries is technical assistance. By offering advisory services
relating to preparation of feasibility reports, identifying growth
potential and training entrepreneurs in project management, the
financial intermediaries in capital market play an important role.
6. Reliable Guide To Performance:-
The capital market serves as a reliable guide to the performance
and financial position of corporate, and thereby promotes
efficiency.
7. Proper Channelization Of Funds:-
The prevailing market price of a security and relative yield are
the guiding factors for the people to channelize their funds in a
particular company. This ensures effective utilization of funds in
the public interest.

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 Indian Financial SystemCMA.

8. Provision Of Variety Of Services:-

The financial institutions functioning in the capital market provide
a variety of services such as grant of long term and medium
term loans to entrepreneurs, provision of underwriting facilities,
assistance in promotion of companies, participation in equity
capital, giving expert advice etc.
9. Development Of Backward Areas:-
Capital Markets provide funds for projects in backward areas. This
facilitates economic development of backward areas. Long term
funds are also provided for development projects in backward
and rural areas.
10. Foreign Capital:-
Capital markets makes possible to generate foreign capital.
Indian firms are able to generate capital funds from overseas
markets by way of bonds and other securities. Government has
liberalized Foreign Direct Investment (FDI) in the country. This not
only brings in foreign capital but also foreign technology which
is important for economic development of the country.
11. Easy Liquidity:-
With the help of secondary market investors can sell off their
holdings and convert them into liquid cash. Commercial banks
also allow investors to withdraw their deposits, as and when they
are in need of funds.
12. Revival Of Sick Units:-
The Commercial and Financial Institutions provide timely financial
assistance to viable sick units to overcome their industrial sickness.
To help the weak units to overcome their financial industrial
sickness banks and FIs may write off a part of their loan.

23
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

GROWTH OF CAPITAL MARKET IN INDIA

End of December 1975-76 2004-05

i) Stock Exchanges (No.) 8 23

ii) Market Value of Capital (in Crore) 3,273 16,98,428

iii) Capital Issues (Rs. in Crore) 98 60,502

iv) Capital raised as % of gross domestic 0.7 7.0

saying(%)

Source:-Tata Services Ltd., statistiscal outline of India 2005-06.

After Independence capital market has shown a remarkable

progress. The first organized stock exchange was established in India
at Bombay in 1887. When the Securities Contracts (Regulation) Act
1956 was passed, only 7 Stock exchanges Viz. Mumbai, Ahmedabad,
Kolkata, Chennai, Delhi, Hyderabad and Indore, received recognition.
By end of March 2004, the number of stock exchanges increased to 23.

1) Primary I New Issues Market:-

After liberalisation policy of 1991 and the abolition of capital
issues control with effect from May 29,1992, the primary market
got a tremendous, boost. This can be seen from following points:-

a) New Capital Issues by Private Sector:-

The number of new capital issues by private sector was only
364 in 1990-91 and the amount raised by them was `.4,312
crore. The number of new capital issues rose to 1,678 in 1994-
95 and the amount raised by them was `. 26,418 crore. Since
1995 the capital market was sluggish and the resources raised
fell to `.. 10,409 crores in 1996-97. In 2003-04, the amount
raised from new capital issues was only `.3,210 crores. In 2004
it increased again to `.33,475 crore and in 2005`.30,325 crore
of resources were raised on this market. The primary issues
of debt securities felt a low of around `. 66 crore in 2005.

24
 Indian Financial SystemCMA.

b) Public Sector Bonds:-

The resources raised by issuing bonds by Public Sector
undertakings rose from `.354 crores in 1985-86 to 7,491
crore in 2004-05.

c) Mutual Funds:-
In 1997-98, the total number of mutual funds in the country
was 34. In 1997-98, the mutual funds were able to mobilise
`.4,064 crore. In 1999-2000 mutual funds mobilised a record
of `.22,117 crore. There was a massive resource mobilisation
of `..41,570 crore by private sector mutual funds in 2003-04,
pushing up the total resource mobilisation by all mutual
funds to as high as `.47,873 crore. In 2004-05, resource
mobilisation once again declined to `.3,015 crore.

2) Secondary Market:-

a) Industrial Securities Market:-

In 1991-92, there was an huge rise in the share prices. The
RBI All India Index Number of Ordinary Share Prices rose to
1,485.4 in 1991-92 (base year 1980-81), showing a gain of
181.4%. In 1992-93 due to irregularities the Stock Market
declined. The years 1993 and 1994 saw increased activity
in stock market due to:-Better performance of companies,
Improvement in Balance of Payment position, Increasing
investment by Foreign Institutional investors etc. India enjoys
2nd.largest investor population in the world next to U.S.A.

b) Bombay Stock Exchange (BSE):-

The scrip movements In Bombay Stock Exchange reflected
the same trend as the RBI index (BSE sensitive index with
base 1978-79 = 100). Market capitalisation of Bombay Stock
Exchange was`.12, 01,207 crore in 2003-04. It rose to `.30,
66,076 crore in 2008-09.

25
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

c) National Stock Exchange (NSE):-

The NSE of India was set up in 1992 and started its operations
in 1994. It provides facility for trading of equity investments,
warrants, debentures, preference shares etc. The market
capitalisation of NSE reached to `.28, 96,194 crore in 2008-09.

d) Over The Counter Of Exchange Of India:-

It was set in August 1989 and started .operating since 1992.

e) Financial Intermediaries:-
Financial Intermediaries are the latest trend in Indian Capital
Market. They have to play an important role in field of venture
capital, credit rating etc.

1.10 FACTORS CONTRIBUTING TO THE GROWTH AND DEVELOPMENT OF

CAPITAL MARKET
1) Growth Of Development Banks And Financial Institutions:-
For providing long term funds to industry, the government set
up Industrial Finance Corporation in India (IFCI) in 1948. This
was followed by a number of other development banks and
institutions like the Industrial Credit and Investment Corporation
of India (ICICI) in 1955, Industrial Development Bank of India
(IDBI) in 1964, Industrial Reconstruction Corporation of India
(IRCI) in 1971, Foreign Investment Promotion Board in 1991,
Over the Counter Exchange of India (OTCEI) in 1992 etc. In 1969,
14 major commercial banks were nationalised. Another 6 banks
were nationalised in 1980. These financial institutions and banks
have contributed in widening and strengthening of capital market
in India.

2) Setting Up Of SEBI:-
The Securities Exchange Board of India (SEBI) was set up in 1988
and was given statutory recognition in 1992.

26
 Indian Financial SystemCMA.

3) Credit Rating Agencies:-

Credit rating agencies provide guidance to investors/creditors for
determining the credit risk. The Credit Rating Information Services
of India Limited (CRISIL) was set up in 1988 and Investment
Information and Credit Rating Agency of India Ltd. (ICRA) was set
up in 1991. These agencies are likely to help the development of
capital market in future.

4) Growth Of Mutual Funds:-

The mutual funds collects funds from public and other investors
and channelise them into corporate investment in the primary
and secondary markets. The first mutual fund to be set up in India
was Unit Trust of India in 1964. In 2007-08 resources mobilised
by mutual funds were Rs. 1,53,802 crores.

5) Increasing Awareness:-
During the last few years there have been increasing awareness of
investment opportunities among the public. Business newspapers
and financial journals (The Economic Times, The Financial Express,
Business India, Money etc.) have made the people aware of new
long-term investment opportunities in the security market.

6) Growing Public Confidence

A large number of big corporations have shown impressive
growth. This has helped in building up the confidence of the
public. The small investors who were not interested to buy
securities from the market are now showing preference in favour
of shares and debentures. As a result, public issues of most of the
good companies are now over-subscribed many times.

7) Legislative Measures:-
The government passed the companies Act in 1956. The Act gave
powers to government to control and direct the development

27
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

of the corporate enterprises in the country. The capital Issues

(control) Act was passed in 1947 to regulate investment in
different enterprises, prevent diversion of funds to non-essential
activities and to protect the interest of investors. The Act was
replaced in 1992.

8) Growth Of Underwriting Business:-

The growing underwriting business has contributed significantly
to the development of capital market.

9) Development Of Venture Capital Funds:-

Venture capital represents financial investment in highly risky
projects with a hope of earning high returns After 1991, economic
liberalisation has made possible to provide medium and long
term funds to those firms, which find it difficult to raise funds
from primary markets and by way of loans from FIs and banks.

10) Growth Of Multinationals (MNCs):-

The MNCs require medium and long term funds for setting
up new projects or for expansion and modernization. For this
purpose, MNCs raise funds through loans from banks and FIs.
Due to the presence of MNCs, the capital market gets a boost.

11) Growth Of Entrepreneurs:-

Since 1980s, there has been a remarkable growth in the number
of entrepreneurs. This created more demand for short term
and long term funds. FIs, banks and stock markets enable the
entrepreneurs to raise the required funds. This has led to the
growth of capital market in India.

12) Growth Of Merchant Banking:-

The credit for initiating merchant banking services in India goes to
Grindlays Bank in 1967,followed by Citibank in 1970. Apart from

28
 Indian Financial SystemCMA.

capital issue management, merchant banking divisions provide

a number of other services including provision of consultancy
services relating to promotion of projects, corporate restructuring
etc.

1.11 REFORMS I DEVELOPMENTS IN CAPITAL MARKET SINCE 1991:-

The government has taken several measures to develop capital
market in post-reform period, with which the capital market reached
new heights. Some of the important measures are

1) Securities And Exchange Board of India (SEBI):-

SEBI became operational since 1992. It was set with necessary
powers to regulate the activities connected with marketing of
securities and investments in the stock exchanges, merchant
banking, portfolio management, stock brokers and others in
India. The objective of SEBI is to protect the interest of investors
in primary and secondary stock markets in the country.

2) National Stock Exchange (NSE):-

The setting up to NSE is a landmark in Indian capital markets. At
present, NSE is the largest stock market in the country. Trading on
NSE can be done throughout the country through the network
of satellite terminals. NSE has introduced inter-regional clearing
facilities.

3) Dematerialisation Of Shares:-
Demat of shares has been introduced in all the shares traded on
the secondary stock markets as well as those issued to the public
in the primary markets. Even bonds and debentures are allowed
in demat form. The advantage of demat trade is that it involves
Paperless trading.

29
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

4) Screen Based Trading:-

The Indian stock exchanges were modernized in 90s, with
Computerized Screen Based Trading System (SBTS), It cuts down
time, cost, risk of error and fraud and there by leads to improved
operational efficiency. The trading system also provides complete
online market information through various inquiry facilities.

5) Investor Protection:-
The Central Government notified the establishment of Investor
Education and Protection Fund (IEPF) with effect from 1st
Oct. 2001: The IEPF shall be credited with amounts in unpaid
dividend accounts of companies, application moneys received
by companies for allotment of any securities and due for refund,
matured deposits and debentures with companies and interest
accrued there on, if they have remained unclaimed and unpaid
for a period of seven years from the due date of payment. The
IEPF will be utilised for promotion of awareness amongst investors
and protection of their interests.

6) Rolling Settlement:-
Rolling settlement is an important measure to enhance the
efficiency and integrity of the securities market. Under rolling
settlement all trades executed on a trading day (T) are settled
after certain days (N). This is called T + N rolling settlement. Since
April 1, 2002 trades are settled› under T + 3 rolling settlement.
In April 2003, the trading cycle has been reduced to T + 2 days.
The shortening of trading cycle has reduced undue speculation
on stock markets.

7) The Clearing Corporation Of India Limited (CCIL):-

The CCIL was registered in 2001, under the Companies Act,
1956 with the State Bank of India as the Chief Promoter. The
CCIL clears all transactions in government securities and repos

30
 Indian Financial SystemCMA.

and also Rupee/US $ forex spot and forward deals All trades in
government securities below Rs. 20 crores would be mandatorily
settled through CCIL, white those above Rs. 20 crores would have
the option for settlement through the RBI or CCIL.

8) The National Securities Clearing Corporation Limited (NSCL):-

The NSCL was set up in 1996. It has started guaranteeing all
trades in NSE since July 1996. The NSCL is responsible for post-
trade activities of NSE. It has put in place a comprehensive
risk management system, which is constantly monitored and
upgraded to pre-expect market failures.

9) Trading In Central Government Securities:-

In order to encourage wider participation of all classes of
investors, Including retail investors, across the country, trading in
government securities has been introduced from January 2003.
Trading in government securities can be carried out through
a nation wide, anonymous, order-driver, screen-based trading
system of stock exchanges in the same way in which trading takes
place in equities.

10) Credit Rating Agencies:-

Various credit rating agencies such as Credit Rating Information
services of India Ltd. (CRISIL–1988), Investment Information and
credit Rating Agency of India Ltd. (ICRA–1991), etc. were set
up to meet the emerging needs of capital market. They also
help merchant bankers, brokers, regulatory authorities, etc. in
discharging their functions related to debt issues.

11) Accessing Global Funds Market:-

Indian companies are allowed to access global finance market and
benefit from the lower cost of funds. They have been permitted
to raise resources through issue of American Depository

31
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

Receipts (ADRs), Global Depository Receipts (GDRs), Foreign

Currency Convertible Bonds (FCCBs) and External Commercial
Borrowings (ECBs). Further Indian financial system is opened
up for investments of foreign funds through Non-Resident
Indians (NRIs), Foreign Institutional investors (FIls), and Overseas
Corporate Bodies (OCBs).

12) Mutual Funds:-

Mutual Funds are an important avenue through which
households participate in the securities market. As an investment
intermediary, mutual funds offer a variety of services/advantages
to small investors. SEBI has the authority to lay down guidelines
and supervise and regulate the working of mutual funds.

13) Internet Trading:-

Trading on stock exchanges is allowed through internet, investors
can place orders with registered stock brokers through internet.
This enables the stock brokers to execute the orders at a greater
pace.

14) Buy Back Of Shares:-

Since 1999, companies are allowed to buy back of shares.
Through buy back, promoters reduce the floating equity stock
in market. Buy back of shares help companies to overcome the
problem of hostile takeover by rival firms and others.

15) Derivatives Trading:-

Derivatives trading in equities started in June 2000. At present,
there are four equity derivative products in India Stock Futures,
Stock Options, Index Futures, Index Options. Derivative trading
is permitted on two stock exchanges in India i.e. NSE and BSE. At
present in India, derivatives market turnover is more than cash
market.

32
 Indian Financial SystemCMA.

16) PAN Made Mandatory:-

In order to strengthen the “Know your client” norms and to have
sound audit trail of transactions in securities market, PAN has
been made mandatory with effect from January 1, 2007.

1.12 SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI):-

SEBI was established as a non-statutory board in 1988 and in
January 1992 it was made a Statutory body. The main objectives of
SEBI are
1) To protect the interest of investors.
2) To bring professionalism in the working of intermediaries in
capital markets (brokers, mutual funds, stock exchanges, demat
depositories etc.).
3) To create a good financial climate, so that companies can
raise long term funds through issue of securities (shares and
debentures)

In 2002, SEBI is further empowered to do the following:-

1. To file complaints in courts and to notify its regulations without
prior approval of government.
2. To regulate issue of capital and transfer of securities.
3. To impose monetary penalties on various intermediaries and
other participants for a specified range of violations.
4. To issue direction to and to call for documents from all
intermediaries.

A. ROLE/POWERS AND FUNCTIONS OF SEBI:-

1. Protection Of Investor’s Interest:-
SEBI frames rules and regulations to protect the interest
of investors. It monitors whether the rules and regulations
are being followed by the concerned parties i.e., issuing
companies, mutual funds, brokers and others. It handles

33
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

investor grievances or complaints against brokers, securities

issuing companies and others.

2. Restriction On Insider Trading:-

SEBI restricts insider trading activity. It prohibits dealing,
communication or counselling on matters relating to insider
trading. SEBI’s regulation states that no insider (connected
with the company) shall-either on his own behalf or on behalf
of any other person, deal in securities of a company listed on
any stock exchange on the basis of any unpublished price
sensitive information.

3. Regulates Stock Brokers Activities:-

SEBI has also laid down regulations in respect of brokers and
sub-broker. No brokers or sub-broker can buy, sell or deal
in securities without being a registered member of SEBI. It
has also made compulsory for brokers to maintain separate
accounts for their clients and for themselves. They must also
have their books audited and audit reports filed with SEBI.

4. Regulates Merchant Banking:-

SEBI has laid down regulations in respect of merchant
banking activities in India. The regulations are in respect of
registration, code of conduct to be followed, submission of
half-yearly results and so on

5. Dematerialisation Of Shares:-
Demat of shares has been introduced in all the shares traded
on secondary stock markets as well as those issued to public
in prirriary markets. Even bonds and debentures are allowed
in demat form.

6. Guidelines On Capital Issues:-

SEBI has framed necessary guidelines in connection with
capital issues. The guidelines are applicable to:-First Public

34
 Indian Financial SystemCMA.

Issue of New Companies, First Public Issue by Existing Private/

Closely held Companies, Public Issue by Existing Listed
Companies.

7. Regulates Working Of Mutual Funds:-

SEBI regulates the working of mutual funds. SEBI has laid
down rules and regulations that are to be followed by mutual
funds. SEBI may cancel the registration of a mutual fund, if
it fails to comply with the regulations.

8. Monitoring Of Stock Exchanges:-

To improve the working of stock markets, SEBI plays an
important role in monitoring stock exchanges. Every
recognised stock exchange has to furnish to SEBI annually
with a report about its activities during the previous year.

9. Secondary Market Policy:-

SEBI is responsible for all policy and regulatory issues for
secondary market and new investments products. It is
responsible for registration and monitoring of members of
stock exchanges, administration of some of stock exchanges
and monitoring of price movements and insider trading.

10. Investors Grievances Redressal:-

SEBI has introduced an automated complaints handling
system to deal with investor complaints. It assist investors who
want to make complaints to SEBI against listed companies.

11. Institutional Investment Policy:-

SEBI looks after institutional investment policy with
respect to domestic mutual funds and Foreign Institutional
Investors (FIIs). It also looks after registration, regulation and
monitoring of FIls and domestic mutual funds.

35
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

12. Takeovers And Mergers:-

To protect the interest of investors in case of takeovers and
mergers SEBI has issued a set of guidelines. These guidelines
are to be followed by corporations at the time of takeovers
and mergers.

13. Reforms In Capital Market:-

SEBI has introduced many reforms in Capital Market. Some
of them are:-
a) Demat of shares
b) PAN made compulsory.
c) Buy back of shares allowed.
d) Corporate Governance introduced
e) Transparency rules in Brokers Transactions.

14. Other Functions:-

a) It promotes investor’s education, and also training of
intermediaries in securities market.
b) It performs functions and exercise powers under
provisions of Capital Issues (Control) Act 1947, Securities
Contracts Act 1956 etc.
c) It promotes and regulates self-regulatory organisations.
d) It prohibits fraudulent and unfair trade practices in
securities Market
e) It promotes investors education and training in securities
market.

B. APPRAISAL OF SEBI›S WORK:-

1) Large Number Of Rules:-
There are large .number of rules prescribed by SEBI. These
have also been changing from time to time. This has created
a high level of uncertainty and confusion. It is very difficult
to determine what rules are currently in operation.

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 Indian Financial SystemCMA.

2) Less Protection To Small Investors:-

SEBI is not really serious about reforming the system and
protecting the individual and small investors. It has failed to
penalise the people responsible for causing abnormal price
fluctuations on stock market.

3) False Claim On High Success Rate:-

SEBI’s Annual Report, in 1995-96 claims, a very high success
rale in resolving investor complaints. But in reality it is not so.

4) Insufficient Power:-
SEBI has often complained of having insufficient authority
and power. It should become more effective, efficient,
socially-accountable and small-investor-friendly. working
is quite good. Liquidity in market has improved various
segments have also become interlinked. It provides a world
class trading and’ settlement system.

5) Corporate–Friendly regulation:-
The regulatory ineffectiveness of SEBI in certain areas has
been due to its concentration on symptoms rather than the
root causes.

C. POLICY MEASURES BY SEBI:-

1) Entry Norms:-
SEBI has issued various guidelines for tightening the entry
norms for companies accessing capital market.

2) Norms For Share Transfer:-

SEBI has tightened the norms for transfer of shares among
group companies and takeover of companies.

3) Penal Margins:-
SEBI has introduced imposition of penal margin on net
undelivered portion at the end of settlement.

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

4) Screen Based Trading:-

SEBI allowed stock exchanges to expand their online screen
based trading terminals to-locations outside their jurisdiction
subject to conditions.

5) Intermediaries:-
SEBI registers and regulates the working of stock brokers,
sub-brokers, share transfer agents, trustee of trust funds,
registrars to an issue, merchant banks, underwriters and other
intermediaries who may be associated with securities market.

6) Prohibition Of Fraudulent And Unfair Practices:-

SEBI regulates prohibition of Fraudulent and unfair trade
practices which have imposed prohibition against market
manipulators and unfair practices relating to securities.

7) Steps To Improve Corporate Governance:-

Sufficient disclosures are made mandatory for companies at
the stage of public issue. Listed companies are required to
make disclosures on continuing basis on dividend, bonus etc.

8) Comprehensive Risk Management And Improvement In

Disclosure:-
In July 2002, SEB| set up a system EDIFAR (Electronic Data
Information Filing And Retrieval) through which firms would
electronically file mandatory disclosures to SEBI and these
documents would be available to individuals across the
country over the Internet, with a near-zero delay.

9) Raising Funds From Abroad:-

Indian companies are allowed to raise funds from abroad,
through American/Global Depository Receipts, Foreign
Currency Convertible Bonds.and External Commercial
Borrowings.

10) Norms For Custodian Of Securities And Depositories:-

SEBI notified two regulations namely, Custodian of Securities
Regulation, and Depositories and Participant Regulations.

38
 CH. 2

INDIAN FINANCIAL
SYSTEM-OVERVIEW

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

Meaning and Definition of Financial System:

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 the
mobilization of savings or their efficient, effective and equitable
allocation for investment, it the access with which the financial system
performs its functions that sets the pace for the achievement of
broader national objectives.
According to Christy, the objective of the financial system is
to “supply funds to various sectors and activities of the economy in
ways that promote the fullest possible utilization of resources without
the destabilizing consequence of price level changes or unnecessary
interference with individual desires.”
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.
A financial system or financial sector functions as an intermediary
and facilitates the flow of funds from the areas of surplus to the deficit.
It is a composition of various institutions, markets, regulations and
laws, practices, money manager analyst, transactions and claims and
liabilities.

Features of financial system

The features of a financial system are as follows
1. Financial system provides an ideal linkage between depositors
and investors, thus encouraging both savings and investments.
2. Financial system facilitates expansion of financial markets over
space and time.
3. Financial system promotes efficient allocation of financial
resources for socially desirable and economically productive
purposes.

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4. Financial system influences both the quality and the pace of

economic development.

2.1 CONSTITUENTS OF FINANCIAL SYSTEM

The financial system consists of four segments or components.
These are: financial institutions, financial markets, and financial
services.

1. Financial institutions: Financial institutions are intermediaries

that mobilize savings & facilitate the allocation of funds in an
efficient manner.
Financial institutions can be classified as banking & non-
banking financial institutions. Banking institutions are creators of
credit while non-banking financial institutions are purveyors of
credit. While the liabilities of banks are part of the money supply,
this may not be true of non-banking financial institutions. In India,
non-banking financial institutions, namely, the developmental
financial institutions (DFIs) & non-banking financial companies
(NBFCs) as well as housing finance companies (HFCs) are the
major institutional purveyors of credit. Financial institutions can
also be classified as term-finance institutions such as the industrial
development bank of India (IDBI), industrial credit & Investment
Corporation of India (ICICI), industrial financial corporation of
India (IFCI), small industries development bank of India (SIDBI)
& industrial investment bank of India (IIBI).

2. Financial markets:

Financial markets are a mechanism enabling participants to

deal in financial claims.
The markets also provide a facility in which their demands
& requirements interact to set a price for such claims. The main
organized financial markets in India are the money market &

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

capital market. The first is a market for short-term securities.

Money market is a market for dealing with financial assets &
securities which have a maturity period of upto one year. While
the second is a market for long term securities, that is, securities
having a maturity period of one year or more. The capital market
is a market for financial assets which have a long or indefinite
maturity.
Money market consists of:
Call money market:
Call money market is a market for extremely short period loans
say one day to fourteen days. It is highly liquid.

Commercial bills market:

It is a market for bills of exchange arising out of genuine trade
transactions. In the case of credit sale, the seller may draw a bill of
exchange on the buyer. The buyer accepts such a bill promising
to pay at a later date the amount specified in the bill. The seller
need not wait until the due date of the bill. Instead, he can get
immediate payment by discounting the bill.

Treasury bills market:

It is a market for treasury bills which have ‘short-term’ maturity.
A treasury bill is a promissory note or a finance bill issued by
the government. It is highly liquid because its repayment is
guaranteed by the government.

Short-term loan market:

It is a market where short-term loans are given to corporate
customers for meeting their working capital requirements.
Commercial banks play a significant role in this market.

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 Indian Financial SystemCMA.

Capital market consists of:

Industrial securities market:
It is a market for industrial securities namely equity shares or
ordinary shares, preference shares & debentures or bonds. It is
a market where industrial concerns raise their capital or debt by
issuing appropriate instruments. It can be further subdivided into
primary & secondary market.

Government securities market:

It is otherwise called gilt-edged securities market. It is a market
where government securities are traded. In India there are many
kinds of govt securities-short-term & long-term. Long-term
securities are traded in this market while short term securities
are traded in the money market.

Long-term loans market:

Development banks & commercial banks play a significant role in
this market by supplying long term loans to corporate customers.
Long-term loans market may further be classified into:
Term loans market
Mortgages market
Financial guarantees market

3. Financial Instruments:

A financial instrument refers to those documents which

represents financial claims on assets. As discussed earlier, financial
assets refers to a claim to the repayment of certain sum of money
at the end of specified period together with interest or dividend.
Examples: bills of exchange, promissory notes, treasury bills,
government bonds, deposit receipts, shares debentures etc.

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

Financial instruments can also be called financial securities.

Financial securities can be classified into:
i. Primary or direct securities
ii. Secondary or indirect securities.

Primary securities
These are securities directly issued by the ultimate investors to
the ultimate savers. Examples, shares and debentures issued
directly to the public.

Secondary securities
These are securities issued by some intermediaries called financial
intermediaries to the ultimate savers. E.g. unit trust of India and
Mutual funds issue securities in the form of units to the public
and money pooled is invested in companies.

Again these securities may be classified on the basis of

duration as follows:
i. Short-term securities
ii. Medium-term securities
iii. Long-term securities.

Short-term securities are those which mature within a period

of one year. E.g. Bills of exchange, treasury bills, etc. medium
term securities are those which have a maturity period ranging
between one and five years.
e.g. Debentures maturing within a period of 5 years. Long-
term securities are those which have a maturity period of more
than five years. E.g. government Bonds maturing after 10 years.

Characteristic Features of Financial Instruments

Generally speaking, financial instruments possess the

following characteristic features:

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 Indian Financial SystemCMA.

i. Most of the instruments can be easily transferred from one

hand to another without many cumbersome formalities.
ii. They have a ready market, i.e., they can be bought and sold
frequently and thus, trading in these securities is made
possible.
iii. They possess liquidity, i.e., some instruments can be
converted into cash readily. For instance, a bill of exchange
can be converted into cash readily by means of discounting
and rediscounting.
iv. Most of the securities posses security value, i.e., they can be
given as security for the purpose of raising loans.
v. Some securities enjoy tax status, i.e., investment in these
securities are exempted from income tax, wealth tax, etc.,
subject to certain limits. E.g. public sector tax free bonds,
magnum tax saving certificates.
vi. They carry risk in the sense that there is uncertainty with
regard to the payment of principle or interest or dividend as
the case may be.
vii. These instruments facilitate future trading so as to cover risks
due to price fluctuations, interest rates, etc.
viii. These instruments involve less handling costs since expenses
involved in buying and selling these securities are generally
much less.
ix. The return on these instruments is directly in proportion to
the risk undertaken.
x. These instruments may be short-term or medium term or
long term depending upon the maturity period of these
instruments.

4. Financial Services:

Financial intermediaries provide key financial services such

as merchant banking, leasing hire purchases, credit-rating, and
so on. Financial services rendered by the financial intermediaries

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

bridge the gap between lack of knowledge on the part of

investors and increasing sophistication of financial instruments
and markets. These financial services are vital for creation of firms,
industrial expansion, and economic growth.
Before investors lend money, they need to be reassured that
it is safe to exchange securities for funds. This reassurance is
provided by the financial regulator, who regulates the conduct of
the market, and intermediaries to protect the investors’ interests.
The Reserve Bank of India regulates the money market and
Securities Exchange Board of India (SEBI) regulates capital market.

2.2 FUNCTIONS OF INDIAN FINANCIAL SYSTEM

Good financial system search in the following ways:

1. Promotion of liquidity:
The major function of financial system is the provision of money
and monetary assets for the production of goods and services.
There should not be any shortage of money for productive
ventures. In financial language, the money and monetary assets
are referred to as liquidity. The term liquidity refers to cash or
money and other assets which can be converted into cash readily
without loss of value and time.

2. Link between savers and investors:

One of the important functions of financial system is to link the
savers and investors and thereby help in mobilizing and allocating
the savings effectively and efficiently. By acting as an efficient
medium for allocation of resources, it permits continuous up
gradation of technologies for promoting growth on a sustained
basis.

3. Information available:
It makes available price-related information which is a valuable
assistance to those who need economic and financial decision.

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4. Helps in projects selection:

A financial system not only helps in selecting projects to be funded
but also inspires the operators to monitor the performance of the
investment. It provides a payment mechanism for the exchange
of goods and services, and transfers economic resources through
time and across geographic regions and industries.

5. Allocation of risk:
One of most important function of the financial system is to
achieve optimum allocation of risk bearing. It limits, pools, and
trades the risks involved in mobilizing savings and allocating
credit. An effective financial system aims at containing risk within
acceptable limit and reducing cost of gathering and analyzing
information to assist operators in taking decisions carefully.

6. Minimizes situations of Asymmetric information:

A financial system minimizes situations where the information
is Asymmetric and likely to affect motivations among operators
or when one party has the information and the other party does
not. It provides financial services such as insurance and pension
and offers portfolio adjustments facilities.

7. Reduce cost of transaction and borrowing:

A financial system helps in creation of financial structure that
lowers the cost of transactions. This has a beneficial influence
on the rate of return to the savers. It also reduces the cost of
borrowings. Thus, the system generates an impulse among the
people to save more.

8. Financial deepening and broadening:

A well–functioning financial system helps in promoting the
process of financial deepening and broadening. Financial
deepening refers to an increase of financial assets as a percentage

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

of the gross domestic product. Financial broadening refers to

building an increasing number and a variety of participants and
instruments.

2.3 ROLE OF MONEY MARKET IN ECONOMY

Money markets play a key role in banks’ liquidity management
and the transmission of monetary policy. In normal times, money
markets are among the most liquid in the financial sector. By providing
the appropriate instruments and partners for liquidity trading, the
money market allows the refinancing of short and medium-term
positions and facilitates the mitigation of your business’ liquidity risk.
The banking system and the money market represent the exclusive
setting monetary policy operates in.
A developed, active and efficient interbank market enhances the
efficiency of central bank’s monetary policy, transmitting its impulses
into the economy best. Thus, the development of the money market
smoothes the progress of financial intermediation and boosts lending
to economy, hence improving the country’s economic and social
welfare.
Therefore, the development of the money market is in all
stakeholders’ interests: the banking system elf, the Central Bank and
the economy on the whole.

2.4 PRODUCING INFORMATION AND ALLOCATING CAPITAL

The information production role of financial systems is explored
by Ramakrishnan and Thakor (1984), Bhattacharya and P fleiderer
(1985), Boyd and Prescott (1986), and Allen (1990). They develop
models where financial intermediaries arise to produce information
and sell this information to savers. Financial intermediaries can
improve the ex ante assessment of investment opportunities with
positive ramifications on resource allocation by economizing on
information acquisition costs. As Schumpeter (1912) argued, financial

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systems can enhance growth by spurring technological innovation

by identifying and funding entrepreneurs with the best chance of
successfully implementing innovative procedures. For sustained
growth at the frontier of technology, acquiring information and
strengthening incentives for obtaining information to improve
resource allocation become key issues.

A. RISK SHARING

One of the most important functions of a financial system

is to achieve an optimal allocation of risk. There are many
studies directly analyzing the interaction of the risk sharing role
of financial systems and economic growth. These theoretical
analyses clarify the conditions under which financial development
that facilitates risk sharing promotes economic growth and
welfare. Quite often in these studies, however, authors focus on
either markets or intermediaries, or a comparison of the two
extreme cases where every financing is conducted by either
markets or intermediaries. The intermediate case in which
markets and institutions co-exist is rarely analyzed in the context
of growth models because the addition of markets can destroy
the risk-sharing opportunities provided by intermediaries. In
addition, studies focus on the role of financial systems that face
diversifiable risks. The implications for financial development
and financial structure on economic growth are potentially quite
different when markets cannot diversify away all of the risks
inherent in the economic environment. One importance of risk
sharing on economic growth comes from the fact that wile avers
generally do not like risk, high-return projects tend to be riskier
than low return projects. Thus, financial markets that ease risk
diversification tend to induce a portfolio shift onwards projects
with higher expected returns as pointed out by Greenwood
and Jovanovic(1990), Saint-Paul (1992), Devereux and Smith
(1994) and Obstfeld (1994). King and Levine(1993a) show that

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

cross sectional risk diversification can stimulate risky innovative

activityfor sufficiently risk-averse agents. The ability to hold
a diversified portfolio of innovative projects reduces risk and
promotes investment in growth-enhancing innovative activities.

B. LIQUIDITY

Money market funds provide valuable liquidity by investing

in commercial paper, municipal securities and repurchase
agreements: Money market funds are significant participants
in the commercial paper, municipal securities and repurchase
agreement (or repo) markets. Money market funds hold almost
40% of all outstanding commercial paper, which is now the
primary source for short-term funding for corporations, who
issue commercial paper as a lower-cost alternative to short-term
bank loans. The repo market is an important means by which the
Federal Reserve conducts monetary policy and provides daily
liquidity to global financial institutions. Quantum of liquidity in
Quantum of liquidity in the banking system is of paramount
importance, as it is an important determinant of the inflation rate
as well as the creation of credit by the banks in the economy.
Market forces generally indicate the need for borrowing or
liquidity and the money market adjusts itself to such calls. RBI
facilitates such adjustments with monetary policy tools available
with it. Heavy call for funds overnight indicates that the banks
are in need of short term funds and in case of liquidity crunch,
the interest rates would go up.

C. DIVERSIFICATION

For both individual and institutional investors, money market

mutual funds provide a commercially attractive alternative to
bank deposits. Money market funds offer greater investment
diversification, are less susceptible to collapse than banks

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and offer investors greater disclosure on the nature of their

investments and the underlying assets than traditional bank
deposits. For the financial system generally, money market
mutual funds reduce pressure on the FDIC, reduce systemic risk
and provide essential liquidity to capital markets because of the
funds’ investments in commercial paper, municipal securities and
repurchase agreements.

ENCOURAGEMENTS TO SAVING AND INVESTMENT

Money market has encouraged investors to save which results

in encouragement to investment in the economy. The savings
and investment equilibrium of demand and supply of loan able
funds helps in the allocation of resources.

D. CONTROLS THE PRICE LINE IN ECONOMY

Inflation is one of the severe economic problems that all the

developing economies have to face every now and then. Cyclical
fluctuations do influence the price level differently depending
upon the demand and supply situation at the given point of time.
Money market rates play a main role in controlling the price line.
Higher rates in the money markets decrease the liquidity in the
economy and have the effect of reducing the economic activity in
the system. Reduced rates on the other hand increase the liquidity
in the market and bring down the cost of capital considerably,
thereby raising the investment. This function also assists the RBI
to control the general money supply in the economy.

E. HELPS IN CORRECTING THE IMBALANCES IN ECONOMY

Financial policy on the other hand, has longer term

perspective and aims at correcting the imbalances in the
economy. Credit policy and the financial policy both balance
each other to achieve the long term goals strong-minded by the

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

government. It not only maintains total control over the credit

creation by the banks, but also keeps a close watch over it. The
instruments of financial policy counting the repo rate cash reserve
ratio and bank rate are used by the Central Bank of the country
to give the necessary direction to the monetary policy.

F. REGULATES THE FLOW OF CREDIT AND CREDIT RATES

Money markets are one of the most significant mechanisms of

any developing financial system. In its place of just ensure that the
money market in India regulate the flow of credit and credit rates,
this instrument has emerge as one of the significant policy tools
with the government and the RBI to control the financial policy,
money supply, credit creation and control, inflation rate and
overall economic policy of the State. Therefore the first and the
leading function of the money market mechanism are regulatory
in nature. While determining the total volume of credit plan for
the six monthly periods, the credit policy also aims at directing
the flow of credit as per the priorities fixed by the government
according to the requirements of the economy. Credit policy as
an instrument is important to ensure the availability of the credit
in sufficient volumes; it also caters to the credit needs of various
sectors of the economy. The RBI assist the government to realize
its policies related to the credit plans throughout its statutory
control over the banking system of the country.

G. TRANSMISSION OF MONETARY POLICY

The money market forms the first and foremost link in the
transmission of monetary policy impulses to the real economy.
Policy interventions by the central bank along with its market
operations influence the decisions of households and firms
through the monetary policy transmission mechanism. The key
to this mechanism is the total claim of the economy on the
central bank, commonly known as the monetary base or high-

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powered money in the economy. Among the constituents of the

monetary base, the most important constituent is bank reserves,
i.e., the claims that banks hold in the form of deposits with the
central bank. The banks’ need for these reserves depends on the
overall level of economic activity. This is governed by several
factors: (i) Banks hold such reserves in proportion to the volume
of deposits in many countries, known as reserve requirements,
which influence their ability to extend credit and create deposits,
thereby limiting the volume of transactions to be handled by the
bank; (ii) bank’s ability to make loans (asset of the bank) depends
on its ability to mobilize deposits (liability of the bank) as total
assets and liabilities of the bank need to match and expand/
contract together; and (iii) Banks’ need to hold balances at the
central bank for settlement of claims within the banking system
as these transactions are settled through the accounts of banks
maintained with the central bank. Therefore, the daily functioning
of a modern economy and its financial system creates a demand
for central bank reserves which increases along with an expansion
in overall economic activity (Friedman, 2000b).

2.5 CAPITAL MARKET IN INDIA: MEANING, FEATURES AND IMPORTANCE

OF CAPITAL MARKET
The capital market is a market which deals in long-term loans.
It supplies industry with fixed and working capital and finances
medium-term and long-term borrowings of the central, state and
local governments. The capital market deals in ordinary stock are
shares and debentures of corporations, and bonds and securities of
governments.
The funds which flow into the capital market come from
individuals who have savings to invest, the merchant banks, the
commercial banks and non-bank financial intermediaries, such as

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

insurance companies, finance houses, unit trusts, investment trusts,

venture capital, leasing finance, mutual funds, building societies, etc.
Further, there are the issuing houses which do not provide
capital but underwrite the shares and debentures of companies
and help in selling their new issues of shares and debentures. The
demand for funds comes from joint stock companies for working and
fixed capital assets and inventories and from local, state and central
governments, improvement trusts, port trusts, etc. to finance a variety
of expenditures and assets.
The capital market functions through the stock exchange market.
A stock exchange is a market which facilitates buying and selling
of shares, stocks, bonds, securities and debentures. It is not only a
market for old securities and shares but also for new issues shares
and securities. In fact, the capital market is related to the supply
and demand for new capital, and the stock exchange facilitates such
transactions.
Thus the capital market comprises the complex of institutions
and mechanisms through which medium-term funds and long-term
funds are pooled and made available to individuals, business and
governments. It also encompasses the process by which securities
already outstanding are transferred.

Importance or Functions of Capital Market:

The capital market plays an important role immobilizing
saving and channel is in them into productive investments for the
development of commerce and industry. As such, the capital market
helps in capital formation and economic growth of the country. We
discuss below the importance of capital market.
The capital market acts as an important link between savers and
investors. The savers are lenders of funds while investors are borrowers
of funds. The savers who do not spend all their income are called.
“Surplus units” and the borrowers are known as “deficit units”. The

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capital market is the transmission mechanism between surplus units

and deficit units. It is a conduit through which surplus units lend their
surplus funds to deficit units.
Funds flow into the capital market from individuals and financial
intermediaries which are absorbed by commerce, industry and
government. It thus facilitates the movement of stream of capital to
be used more productively and profitability to increases the national
income.
Surplus units buy securities with their surplus funds and deficit
units sells securities to raise the funds they need. Funds flow from
lenders to borrowers either directly or indirectly through financial
institutions such as banks, unit trusts, mutual funds, etc. The borrowers
issue primary securities which are purchased by lenders either directly
or indirectly through financial institutions.
The capital market prides incentives to savers in the form of
interest or dividend and transfers funds to investors. Thus it leads
to capital formation. In fact, the capital market provides a market
mechanism for those who have savings and to those who need funds
for productive investments. It diverts resources from wasteful and
unproductive channels such as gold, jeweler, real estate, conspicuous
consumption, etc. to productive investments.
A well-developed capital market comprising expert banking and
non-banking intermediaries brings stability in the value of stocks and
securities. It does so by providing capital to the needy at reasonable
interest rates and helps in minimizing speculative activities.
The capital market encourages economic growth. The various
institutions which operate in the capital market give quantities and
qualitative direction to the flow of funds and bring rational allocation
of resources. They do so by converting financial assets into productive
physical assets. This leads to the development of commerce and
industry through the private and public sector, thereby inducing
economic growth.

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

In an underdeveloped country where capital is scarce, the absence

of a developed capital market is a greater hindrance to capital
formation and economic growth. Even though the people are poor,
yet they do not have any inducements to save. Others who save, they
invest their savings in wasteful and unproductive channels, such as
gold, jewellery, real estate, conspicuous consumption, etc.
Such countries can induce people to save more by establishing
banking and non-banking financial institutions for the existence of
a developed capital market. Such a market can go a long way in
providing a link between savers and investors, thereby leading to
capital formation and economic growth

What are the main Features of a Capital Market?

It does not include the instruments or institutions which provide
finance for short period (up to one year). The common instruments
used in capital market are shares, debentures, bonds, mutual funds,
public deposits etc.
Features
1. Link between Savers and Investment Opportunities:
Capital market is a crucial link between saving and investment
process. The capital market transfers money from savers to
entrepreneurial borrowers.
2. Deals in Long Term Investment:
Capital market provides funds for long and medium term. It does
not deal with channelising saving for less than one year.
3. Utilises Intermediaries:
Capital market makes use of different intermediaries such as
brokers, underwriters, depositories etc. These intermediaries
act as working organs of capital market and are very important
elements of capital market.
4. Determinant of Capital Formation:

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 Indian Financial SystemCMA.

The activities of capital market determine the rate of capital

formation in an economy. Capital market offers attractive
opportunities to those who have surplus funds so that they invest
more and more in capital market and are encouraged to save
more for profitable opportunities.
5. Government Rules and Regulations:
The capital market operates freely but under the guidance of
government policies. These markets function within the framework
of government rules and regulations, e.g., stock exchange works
under the regulations of SEBI which is a government body.

Table 2.1 Capital Market and Money Market Difference on the basis of:
participants, instruments traded, investment outlay and safety

Basis CAPITAL MARKET MONEY MARKET

Participants Participants are financial Participants are institutions

institutions, banks, corporate such s RBI, Banks, Financial
entities, foreign investors and Institutions and finance
ordinary retail investors from the companies
public

Instruments Equity shares, debentures, bonds, Treasury bills, trade bills,

Traded preference shares, etc commercial papers,
certificates of deposit

Investment outlay Does not require huge investment Requires huge investment
outlay as value of units of outlay as instruments are
securities is low quite expensive

Safety Risky both in terms of returns and Safer with minimum risk of
principal repayment default

Duration Deals in medium and long term Deals in short term

securities securities from 1 day up to
1 year

Liquidity Low liquidity High degree of liquidity

Expected returns Generally yields high returns Generally yields low returns

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

Table 2.2 Dist between: NSEI and OTCEI on the basis of:
size of company, securities traded, settlement, objective.

Basis NSE(I) OTCE(I)

Size of company Paid up capital 3 crores & above Paid up capital 30 lakhs and
above

Securities traded Trades in Equity, debentures, Equity, debentures, etc

treasury bills, PSU, bonds, etc

Settlement Payment within 15 days of Payment within 7 days of the

transaction transaction

Objective Nationwide, ringless transparent Serves as an exchange

trading facility for both capital for securities of small
and money market companies

Distinguish between: Primary and Secondary Market on any 4 basis

Primary Market Secondary Market

Basis
(New Issue Market) (Stock Exchange)

Securities trading It is a market for new securities It is a market for existing

securities

Sale of securities Securities are sold to investors Securities are exchanged

directly by the company or between investors without
through their intermediary involvement of the company

Flow of funds It directly promotes capital It indirectly promotes capital

formation as flow of funds is formation as it enhances
from savers to investors liquidity of shares

Location It has no fixed geographical It has a fixed location and

location. Shares can be traded fixed working hours
from anywhere

Prices Prices are determined by Prices are determined by

management of the company demand and supply of the
securities

58
 CH. 3

MONEY MARKET

59
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

Definition, Feature and Instruments

A market where short term funds are borrowed and lent is called
‘money market’. It is a market for financial assets that are close
substitutes for money. The instruments dealt with in the market are
liquid and can be converted quickly into cash at low transaction cost.
As per RBI definitions “A market for short terms financial assets
that are close substitute for money, facilitates the exchange of money
in primary and secondary market”.
According to the Reserve Bank of India “A money market is the
centre for dealings, mainly of short term characters in money assets, it
needs the short term requirements of borrowers and provide liquidity
or cash to the lenders. It is a place where short term surplus investible
funds at the disposal of financial institutions or individuals are bid by
borrower’s agents comprising institutions and individuals and also
the government itself.”
The money market is a mechanism that deals s with the lending
and borrowing of short term funds (less than one year). It doesn’t
actually detain cash or money but deal s with substitute of cash like
trade bills, promissory notes & Government papers which can convert
into cash without any loss at low transaction cost.
It includes all individual, institution and intermediaries.

Features of Money Market

• It is a market purely for short-terms funds or financial assets
called near money.
• The maximum period for which the funds are-traded in the market
is one year
• No fixed place for carrying out operations
• The main organizations in the market are RBI, State governments,
banks, corporate investors, etc.
• It deal s with financial assets having a maturity period less than
one year only.

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 Indian Financial SystemCMA.

• In Money Market transaction cannot take place formal like stock

exchange, only through oral communication, relevant document
and written communication transaction can be done.
• Transaction has to be conducted without the help of brokers.
• It is not a single homogeneous market, it comprises of several
submarket like cal money market, acceptance & bill market.
• The component of Money Market is the commercial banks,
acceptance houses & NBFC (Non-banking f financial companies).

Instrument of Money Market: A variety of instrument is available

in a developed money market. In India til1986, only a few instruments
were available.
They were:
1) Treasury Bills (T-Bills)
• Treasury bills (TBs), offer short-term investment opportunities,
general ly up to one year.
• They are thus useful in managing short-term liquidity.
• Types of treasury bills through auctions
• 91-Day, 182-day, 364-day, and 14-day TBs
2) Commercial paper (CP)
• CP is a short term unsecured loan issued by a corporation
typical ly financing day to day operation.
• CP is very safe investment because the financial situation of
a company can easily be predicted over a few months.
• Only company with high credit rating issues CP’s.
3) Certificates Of Deposit
• Certificate of Deposit (CD) is a negotiable money market
instrument and issued in dematerialized form or as a Usance
Promissory Note against funds deposited at a bank or other
eligible financial institution for a specified time period

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

• Scheduled commercial banks excluding Regional Rural Banks

(RRBs) and Local Area Banks (LABs)
• Select al l-India Financial Institutions that have been permitted
by RBI to raise short-term resources within the umbrella limit
fixed by RBI.
4) Cal Money Market
• Cal money market is that part of the national money market
where the day to day surplus funds, mostly of banks are
traded in.
• They are highly liquid, their liquidity being exceed only by
cash.
• The loans made in this market are of the short term nature.
5) Commercial Bills Market
• Funds for working capital required by commerce and
industry are mainly provided by banks through cash credits,
overdrafts, and purchase/discontinuing of commercial bills.
6) Bill Of Exchange
• The financial instrument which is traded in the bill market of
exchange. It is used for financing a transaction in goods that
takes some time to complete.

3.1 MONEY MARKET INSTRUMENT

Money Market instruments mainly include Government securities,
securities issued by private sector and banking institutions—
1. Government Securities
2. Money at Call and Short Notice
3. Bills Rediscounting
4. Inter-Bank Participation
5. Money Market Mutual Funds
6. Call Money Market and Short-term Deposit Market
7. Treasury Bills
8. Certificates of Deposits

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 Indian Financial SystemCMA.

9. Inter-Corporate Deposits
10. Commercial Bills
11. Commercial Paper
12. Gilt-edged (Government) Securities
13. Repo Market

1. Government Securities: The Reserve Bank of India issues

securities on behalf of the Government. The term Government
Securities includes Central Government Securities, State
Government Securities and Treasury Bills. The different types of
Government Securities are—

Zero Bonds with Capital

Dated Partly Paid Floating
Coupon Call/Put Indexed
Securities Stock Rate Bonds
Bonds Option Bonds

Issued at Issued at Issued at Issued at A bond Issued at

face value discount face value, face value issued at face value
to the face but paid in call and put
value installments option
over a
period

Interest or Do not Interest or Interest rate This bond Interest rate

coupon rate carry any coupon rate is fixed as a is due for is fixed as a
is fixed at interest rate is fixed at percentage redemption percentage
the time of the time of over a in 2012 and over the
issuance, issuance, predefined carries a wholesale
and and benchmark coupon of price index
remains remains rate which 6.72% at the time
constant till constant till may be of issuance.
redemption redemption Treasury
of the of the bill, bank
security security rate etc at
the time of
issuance

The tenor The tenor The tenor The tenor This bond The tenor
of security of security of security of security has been of security
is fixed is fixed is fixed is fixed priced in is fixed
line with 5
year bonds

63
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

Zero Bonds with Capital

Dated Partly Paid Floating
Coupon Call/Put Indexed
Securities Stock Rate Bonds
Bonds Option Bonds

The The The The This bond The

security is security is security is security is has been principal
redeemed redeemed redeemed redeemed priced in redemption
at par (face at par (face at par (face at par (face line with 5 is linked
value) on value) on value) on value) on year bonds to the
its maturity its maturity its maturity its maturity Wholesale
date date date date Price Index.

The Government dated securities can be purchased for a

minimum amount of Rs. 10,000/-and the Treasury bills of Rs.
25,000/-and in multiple thereof. The State Government Securities
can be purchased for a minimum amount of Rs.1, 000/-.

2. Money at Call and Short Notice: Call money or call deposits are
that money which is lent on condition to repay on call. Notice
money refers to the money lent and repaid on a certain day’s
notice from the lenders. Banks borrow for a variety of reasons
to maintain their cash reserve ratio, heavy payments, to maturity
mismatch etc. Money at short notice is for a maturity upto 14
days. The main participants are banks and all India financial
institutions as permitted by RBI.
A minimum size of Rs. 20 crores for each transaction was
permitting the participation of the corporate in the call money
market. The Discount and Finance House of India (DFHI)
enhanced the activity of Call Money Market and Short-term
Deposit Market. It allows lending and borrowing of funds. The
borrowers are essentially the banks. It can operate outside the
purview of the provision of the ceiling rates fixed by the Indian
Banks Association. The different participants that lend fund in
the market are like GIC, IDBI, NABARD etc. The private Mutual
funds were also participating in the market. The DFHI ascertains
the settlement between the lender and the borrower about the

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 Indian Financial SystemCMA.

availability of fund and the amount needed and the exchanges.

It also provides advice regarding the interest rates applicable to
them. Here, the call rates are more volatile as they are determined
by the interaction of demand and supply of funds in the market
which is based on the maintenance of Cash Reserve Ratio by the
banks. There are two call rates maintained in India i.e. Inter-bank
call rate and the lending rate of DFHI.

3. Bills Rediscounting Scheme: This is a money market scheme

whereby banks may raise funds by issue of usance from issuing
notes in convenient lots and maturities matching the genuine
trade bills discounted by them. This instrument promotes liquidity
in the market. Here the seller draws a bill of exchange and the
buyer accepts it. Suppose, When X sells on credit and X (seller)
needs money in the meantime, it may approach to the bank
for discounting the bill and the seller gets the money. Now,
the bank which has discounted the bill may require getting it
‘rediscounted’ with some other bank to get the fund. This is called
‘bill rediscounting’. The bank has a facility to rediscount the bills
with the RBI and other approved institutions like LIC, GIC, UTI,
ICICI etc

4. Inter-Bank Participation Certificate: Inter-Bank Participation

Certificates are instruments issued by scheduled commercial
banks only to raise funds or to deploy short term surplus. This
instrument is issued as per RBI guidelines for two purposes:
1. on risk sharing basis
2. Without risk sharing Inter-Bank Participation without risk
sharing can have tenure of 90 days only where, the issuing
bank as borrowing and the participating bank advances to
the banks. In case of risk sharing basis, the lender bank shares
losses with the borrowing banks by mutually determining the
interest rate. The tenure may be for 90 to 180 days.

65
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

5. Money Market Mutual Funds (MMMFs): To provide safety,

liquidity and return, MMMFs are formed which collect the small
savings of a large number of savers and invest them in the capital
market. This concept is extended to money market. Hence, the
concept of money market mutual funds has coming up. The SEBI
revises the guidelines on MMMFs from time to time relating to
maximum limit of investment.

6. Treasury Bills: Treasury Bills are discounted securities issued at

a discount face value as per the short term requirement of the
Government of India. RBI issues Treasury Bills on a prefixed day
and at a fixed amount. There are four types of Treasury Bills:
1. 14-day T-bill maturity is in 14 days.
2. 91-day T-bill maturity is in 91 days.
3. 182-day T-bill maturity is in 182 days.
4. 364-day T-bill maturity is in 354 days.
These are highly liquid money market instruments. It is a zero
default risk bearing paper. It helps in deployment of idle funds
for very shorts periods as well.

7. Certificates of Deposits: These are issued according to the

guidelines of the Reserve Bank of India in dematerialized form or
Usance Promissory Note for the fund deposited at a bank or other
financial institution. It is a negotiable money market instrument
whose minimum deposit should be Rs.1 lakh and the multiples of
Rs. 1 lkh thereafter. The maturity period of Certificates of Deposits
should not be less than 15 days and not more than 1 year. But,
it should not be less than 1 year and exceed 3 years for financial
institution.

8. Inter-Corporate Deposits: Inter-Corporate Deposits are

unsecured loan extended by one corporate to another. As the

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 Indian Financial SystemCMA.

cost of funds for a corporate is higher than a bank, the rates in

this market are higher than those in the other market.

12. Repo Market: This money market instrument helps in

collateralized short-term borrowing and lending through sale
or purchase operation in debt instruments. Here the securities
are sold by the holders to the investors with an agreement to
repurchase them at a predetermined rate and date.
On the other hand, under the reverse repo transactions, securities
are purchased with a simultaneous commitment to resell at a
predetermined rate and date

9. Commercial Bills: These are the bills accepted by the buyer

for goods and services on credit from the seller and which may
be kept upto the due date and encased by the seller or may be
endorsed to a third party. The bills being bills of exchange may
be discounted with the banks or financial institutions. These bills
may again be the rediscounted at the bank.

10. Commercial Papers (CP): It is an additional unsecured money

market instrument to the investors as a source of short term
borrowing. This instrument is issued in the form of a promissory
note or dematerialized form. Every issuer has to appoint an Issuing
and Paying Agent (IPA) for the issue of commercial papers and
only a scheduled bank can act as an IPA for issuance of CP. The
investor are given the Issuing and Paying Agent (IPA) certificate
as well as issued physical certificates or arrangement is made
for crediting the CP to the investor’s account with a depository.
The CP issued for a maturity period between a minimum of 7
days and a maximum up to one year from the date of issue in
the denomination of Rs. 5 lakh or multiples thereof. The main
purposes of introducing CP are—

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

1. To enable the high level corporate borrowers such as leasing

and financing of companies, manufacturing and financial
institutions etc.
2. To diversify the sources of short term borrowing
3. To provide instrument for bank and financial institution in the
money market.

11. Gilt-edged (Government) Securities: Gilt-edged (Government)

Securities have great demand by the banks to maintain the Net
Demand and Time Liquidities (NDTL) position of the bank through
its buying and selling. These securities are issued by Governments
such as Central and State Governments, Semi-Government
Authorities, Municipalities etc. They are long dated securities
and held by the RBI. These issues are notified a few days before
opening for subscription and offer is kept open for two to three
days. The rate of interest is lower but it is payable half yearly.

12. Repo Market: This money market instrument helps in

collateralized short-term borrowing and lending through sale
or purchase operation in debt instruments. Here the securities
are sold by the holders to the investors with an agreement to
repurchase them at a predetermined rate and date.

On the other hand, under the reverse repo transactions, securities

are purchased with a simultaneous commitment to resell at a
predetermined rate and date

3.2 STRUCTURE OF INDIAN MONEY MARKET

The Money Market is the close substitutes for money with the
short term time span from overnight to year. The Indian Money
Market consists of both organized and unorganized segment. The
organized segment includes the Reserve Bank of India, State Bank

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 Indian Financial SystemCMA.

of India, Public Sector as well as Private Sector Banks, Regional Rural

Bank, Commercial Banks including Foreign Banks, Non-Scheduled
Commercial Banks and other Non-Bank Financial Intermediaries such
as LIC, GIC, and UTI etc. On the other hand, the unorganized segment
consists of indigenous bankers, money lenders and other non-bank
financial intermediaries.

Indian money market can be divided into various sub-markets

depending on their nature and scope of the transactions and the
features of the instruments.

69
 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

3.3 MEASURES TO IMPROVE INDIAN MONEY MARKET

The major drawback of India Money Market is its high volatility.
Gradually the money market transaction is increasing. But, on the
recommendation of the Sukhmoy Chakravarty Committee (on the
review of the working of the Monetary System) and the Narasimham
committee (on the Report on the working of the financial system in
India, 1991), RBI initiated a series of reform in Indian Money Market.
The following are some of the measures undertaken,
1. Introducing new money market instrument: Many new money
market instruments are introduced like Commercial Papers,
Certificates of Deposits, 182-day Treasury, 364-day Treasury
etc. The Discount and Finance House have also developed.
These facilitate different short term borrowings to the different
borrowers to collect fund as and when required to maintain their
financial position.
2. Relaxation of interest rate regulations: The all types of interest
rates like lending as well as deposit rates of the banks and
financial institution are controlled and regulated by RBI. But,
gradually the interest rates of the bank loans are controlled by
the market forces which result decontrolled of it.
3. Remitting the stamp duties: In August 1989, Government
remitted the stamp duty. But, it is not effective till it discourages
the cash credit system in favour of using the bill system.

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 Indian Financial SystemCMA.

4. Sector specific refinance: Export credit refinance and general

refinance are two refinance schemes that are in operation in the
current financial system. The refinance is used by the central
bank to control credit conditions and the liquidity positions in
the system. But if the excessive funds supplies into the system do
not result any the development then it could be highly distorted
one.
5. Introduction of repo: This is used by the banks for short term
liquidity through sale or purchase of debt instruments. It is an
agreement to repurchase them at a predetermined rate and date
between the RBI and commercial banks.
6. Introducing Money market Mutual Funds: The Money Market
Mutual Funds were introduced in April 1991. The collection of
the small savings invested generate short term avenues to the
different investors.
7. Setting the Discount and Finance House in India: The DFHI
equilibrated the surplus of fund and the deficit amounts of the
banks. The DFHI helps in lending and borrowing of funds to the
different banks as well as financial institutions.

3.4 CAPITAL MARKET

Meaning: It is the market for borrowing and lending long term
capital required by business enterprises. The financial assets dealt
with in the capital market have long or indefinite maturity period the
capital market forms an important core of a country’s financial system.

Definition
GH.Peters defines “Capital Market as being the market or
collection of inter related markets in which potential borrowers are
brought into contact with potential lenders.”

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

Capital market deals in long term funds in both debt and equity
with maturity ranging from 1 year to 10 years. It is a market where the
productive capital is raised and made available for industrial purposes.
The capital market plays an important role in the financial system
of a country by performing a number of functions.
1. Capital formation
2. An intermediary between the savers and investors
3. Mobility of capital
4. Economic development

Capital Market Instruments

Financial instruments that are used for raising capital resources
in the capital market are known as capital market instruments, and
they are as follows:
a. Preference shares
b. Equity shares
c. Non-voting Equity shares
d. Cumulative Convertible Preference shares
e. Company fixed deposits
f. Warrants
g. Debentures and bonds

Constituents of Indian capital market

1. The Gilt Edged Market
2. The Industrial Securities Market

1. The Gilt Edged Market: It is also known as the government

securities market, which is a market for government’ and semi
government securities:

Features of this market are as follows:

a. Guaranteed return on investment
b. No speculation on securities

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 Indian Financial SystemCMA.

c. Major institutions are LIC, PF and commercial banks

d. Heavy volume of transactions
e. Institutional based investors e.g: GP.Feli

2. Industrial securities market: It is the market for industrial

securities such as bonds, equities, etc. It comprises of two
segments-
a. Primary Market
b. Secondary Market

Primary market

It is also known as New Issue Market:

The market is utilized for raising fresh capital in the form of
shares and debentures. The industrial sectors usually approach
this market for raising fresh capital. It usually provides long term
funds. The primary market is useful for capital formation in the
country and accelerates economic and industrial development.
Mode of raising capital in the Primary market
A] Public issue/Prospectus: Securities are issued to the general
public. This is the most popular method of raising long term
fund. In this method securities are offered to the public by
issuing prospectus.
B] Right issue: The equity shares of a company are issued to
the existing equity shareholders in the form of right issue.
In this issue additional securities are offered to the existing
shareholders.
C] Private placement: Under private placement the shares of
a company are sold among the selected group of persons.

There are three categories of participants in the primary

market. They are the issuers of securities, investors and
intermediaries.

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

Secondary market

It is a market where existing securities are sold or traded.

This market is also known as stock market. The secondary market
consists of recognized stock exchanges operating under rules,
byelaws and regulations duly approved by the government.
A stock exchange is defined under the Section 2.(3) of the
Securities Contracts (Regulations) Act 1956 as “An association,
organization or body of individuals, whether incorporated or not,
established for the purpose of assisting, regulating or controlling
of business in buying, selling or dealing in securities.”

Functions of Secondary Market

1. To facilitate liquidity and marketability of securities
2. To contribute to economic growth through mobilization of
funds to the most efficient channels
3. To provide instant valuation of securities dealt in on stock
exchange
4. To ensure a measure of safety and fair dealing to protect
investors interest

Visit the stock exchange and observe how buying and selling of
securities takes place.

Distinction between: Primary market and Secondary market .

Points Primary Market Secondary Market

Meaning The market is utilized for It is a market where existing

raising fresh capital in the form securities are resold or traded.
of shares and debentures.

Function The function is to raise long The function is to provide

term funds through fresh issue continuous and ready market for
of securities existing long term securities

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 Indian Financial SystemCMA.

Points Primary Market Secondary Market

Participants The participants are financial The participants of primary

institutions, mutual fund, market as well as the stock
under writer, individual brokers and the members of
investor the stock exchange are the
participants.

Listing Listing is not required in the Only listed securities can be dealt
requirements case of primary market in the secondary market

Determinants of The prices are determined In case of secondary market the

prices by the management of the prices are determined by forces of
corporate houses with due demand and supply in the market
compliances with the SEBI and they keep on fluctuating
requirements for new issue of
securities

Distinction between: Money market and Capital market:

Points Primary Market Secondary Market

Meaning A market where short term A market for borrowing and lending
funds are borrowed and lend long term capital required by
business enterprises

Terms of It provides short term funds, in It is a market for long term

Finance short terms instruments where instruments which is measured in
the maturity is measured in years.
days, weeks or months.

Instruments The instruments dealt in the The instruments dealt in this market
market are bills of exchange, are bonds, debentures, equity
treasury bills, bankers shares and stock.
acceptance, etc.

Functions Money market exists as Capital market functions as a

a mechanism of liquidity link between the investors and
adjustment i.e. a link between interpreneurs.
the depositors and borrowers.

Risk The prices of these instruments The instruments are long term and
do not fluctuate and they carry subject to market fluctuations and
very low market risk. so they carry very high financial and
market risk.

Institution The commercial banks are the The stock exchange is an important
important institutions in the institution in the capital market.
money market.

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

The financial market consists of two major segments

a) Money market
b) Capital market.

Money market is a market for short-term funds which deals in

financial assets whose period of maturing is up to one year. The
credit instruments in this market are bill of exchange, commercial
bills, treasury bills, etc.
Capital market deals in medium and long term funds. It
contributes two markets i.e. Gilt edged market and securities market.
The securities market consists of two different segments i.e.
Primary market and secondary market. Primary market only deals in
the issue of new securities.
Secondary market consists of stock exchanges, a market for
purchase and sale of existing securities.
The instruments in the capital market are preference shares,
equity shares, Company fixed deposits etc.

Merchant banking
Meaning: The term ‘merchant banking’ has been used differently
in different parts of the world. While in U.K. merchant banking
refers to the ‘accepting and issuing houses’, in U.S.A. it is known as
‘investment banking’. The word merchant banking has been so widely
used that sometimes it is applied to banks who are not merchants,
sometimes to merchants who are not banks and sometimes to those
intermediaries who are neither merchants not banks.
In India merchant banking services were started only in 1967 by
National Grindlays Bank followed by Citi Bank in 1970. The State Bank
of India was the first Indian Commercial Bank having set up separate
Merchant Banking Division in 1972. In India merchant banks have

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 Indian Financial SystemCMA.

been primarily operating as issue houses than full-fledged merchant

banks as in other countries.
A merchant bank may be defined as an institution or an
organization which provides a number of services including
management of securities issues, portfolio services, underwriting of
capital issues, insurance, credit syndication, financial advices, project
counseling etc. There is a distinction between a commercial bank and
a merchant bank. The merchant banks mainly offer financial services
for a fee. While commercial banks accept deposits and grant loans.
The merchant banks do not act as repositories for savings of the
individual s.
Merchant Banking is a combination of Banking and consultancy
services. It provides consultancy to its clients for financial, marketing,
managerial and legal matters. Consultancy means to provide advice,
guidance and service for a fee. It helps a businessman to start a
business. It helps to raise (collect) finance. It helps to expand and
modernize the business. It helps in restructuring of a business. It helps
to revive sick business units. It al so helps companies to register, buy
and sell shares at the stock exchange
In short, merchant banking provides a wide range of services
for starting until running a business. It acts as Financial Engineer for
a business.
Functions of Merchant Banks: The basic function of a merchant
banker is marketing corporate and other securities. Now they are
required to take up some al lied functions al so.
A merchant bank now takes up the following functions:
1. Promotional Activities: A merchant bank functions as a promoter
of industrial enterprises in India He helps the entrepreneur in
conceiving an idea, identification of projects, preparing feasibility
reports, obtaining Government approval s and incentives, etc.
Some of the merchant banks al so provide assistance for technical
and financial collaborations and joint ventures

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

2. Issue Management: In the past, the function of a merchant

banker had been mainly confined to the management of new
public issues of corporate securities by the newly formed
companies, existing companies (further issues) and the foreign
companies in dilution of equity as required under FERA In this
capacity the merchant banks usual ly act as sponsor of issues.
They obtain consent of the Control ller of Capital issues (now,
the Securities and Exchange Board of India) and provide a
number of other services to ensure success in the marketing of
securities. The services provided by them include, the preparation
of the prospectus, underwriting arrangements, appointment
of registrars, brokers and bankers to the issue, advertising and
arranging publicity and compliance of listing requirements of the
stock-exchanges, etc.
They act as experts of the type, timing and terms of issues of
corporate securities and make them acceptable for the investors
on the one hand and al so provide flexibility and freedom to the
issuing companies.
3. Credit Syndication: Merchant banks provide specialized services
in preparation of project, loan applications for rising short-
term as well aslong-term credit from various bank and financial
institutions, etc. They al so manage Euro-issues and help in raising
funds abroad.
4. Portfolio Management: Merchant banks offer services not only
to the companies issuing the securities but al so to the investors.
They advise their clients, mostly institutional investors, regarding
investment decisions. Merchant bankers even undertake the
function of purchase and sal e of securities for their clients so as
to provide them portfolio management services. Some merchant
bankers are operating Mutual funds and off shore funds al so.
5. Leasing and Finance: Many merchant bankers provide leasing
and finance facilities to their customers. Some of them even

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maintain venture capital funds to assist the entrepreneurs. They

al so help companies in raising finance by way of public deposits.
6. Servicing of Issues: Merchant banks have al so started to act
as paying agents for the service of debt-securities and to act
as registrars and transfer agents. Thus, they maintain even the
registers of shareholders and debenture holders and arrange to
pay dividend or interest due to them
7. Other Specialized Services: In addition to the basic activities
involving marketing of securities, merchant banks al so
provide corporate advisory services on issues like mergers and
amalgamations, tax matters, recruitment of executives and cost
and management audit, etc. Many merchant bankers have al so
started making of bought out deal s of shares and debentures.
The activities of the merchant bankers are increasing with the
change in the money market

The important functions of merchant banking are depicted below.

1. Raising Finance for Clients: Merchant Banking helps its clients
to raise finance through issue of shares, debentures, bank loans,
etc. It helps its clients to raise finance from the domestic and
international market. This finance is used for starting a new
business or project or for modernization or expansion of the
business.
2. Broker in Stock Exchange: Merchant bankers act as brokers in
the stock exchange. They buy and sell shares on behalf of their
clients. They conduct research on equity shares. They al so advise
their clients about which shares to buy, when to buy, how much
to buy and when to sell. Large brokers, Mutual Funds, Venture
capital companies and Investment Banks offer merchant banking
services.

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

3. Project Management: Merchant bankers help their clients in

the many ways. For e.g. advising about location of a project,
preparing a project report, conducting feasibility studies, making
a plan for financing the project, finding out sources of finance,
advising about concessions and incentives from the government.
4. Advice on Expansion and Modernization: Merchant bankers
give advice for expansion and modernization of the business
units. They give expert advice on mergers and amalgamations,
acquisition and takeovers, diversification of business, foreign
collaborations and joint-ventures, technology up-gradation, etc.
5. Managing Public Issue of Companies: Merchant bank advice
and manage the public issue of companies. They provide
following services:
a. Advise on the timing of the public issue.
b. Advise on the size and price of the issue.
c. Acting as manager to the issue, and helping in accepting
applications and al lotment of securities.
d. Help in appointing underwriters and brokers to the issue.
e. Listing of shares on the stock exchange, etc.
6. Handling Government Consent for Industrial Projects: A
businessman has to get government permission for starting of the
project. Similarly, a company requires permission for expansion
or modernization activities. For this, many formal ities have to
be completed. Merchant banks do all this work for their clients.
7. Special Assistance to Small Companies and Entrepreneurs:
Merchant banks advise smal companies about business
opportunities, government policies, incentives and concessions
available. It all so helps them to take advantage of these
opportunities, concessions, etc.
8. Services to Public Sector Units: Merchant banks offer many
services to public sector units and public utilities. They help
in raising long-term capital, marketing of securities, foreign

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collaborations and arranging long-term finance from term

lending institutions.
9. Revival of Sick Industrial Units: Merchant banks help to revive
(cure) sick Industrial Units. It negotiates with different agencies
like banks, term lending institutions, and BIFR (Board for Industrial
and Financial Reconstruction). It all so plans and executes the full
revival package.
10. Portfolio Management: A merchant bank manages the
portfolios (investments) of its clients. This makes investments
safe, liquid and profitable for the client. It offers expert guidance
to its clients for taking investment decisions.
11. Corporate Restructuring: It includes mergers or acquisitions
of existing business units, sale of existing unit or disinvestment.
This requires proper negotiations, preparation of documents and
completion of legal formalities. Merchant bankers offer al these
services to their clients.
12. Money Market Operation: Merchant bankers deal with and
underwrite short-term money market instruments, such as:
a. Government Bonds.
b. Certificate of deposit issued by banks and financial
institutions.
c. Commercial paper issued by large corporate firms.
d. Treasury bills issued by the Government (Here in India by
RBI).
13. Leasing Services: Merchant bankers al so help in leasing services.
Lease is a contract between the lessor and lessee, whereby the
lessor al lows the use of his specific asset such as equipment by
the lessee for a certain period. The lessor charges a fee called
rental s.
14. Management of Interest and Dividend: Merchant bankers help
their clients in the management of interest on debentures/loans,

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

and dividend on shares. They al so advise their client about the

timing (interim/yearly) and rate of dividend

3.5 INDUSTRIAL DEVELOPMENTBANK OF INDIA (IDBI)

IDBI stands for Industrial Development Bank of India. It was
founded with the objective of financing and help develop small and
medium scale industries in India.
IDBI was set up in July 1964 under an Act of Parliament as a
wholly-owned subsidiary of Reserve Bank of India.
In 1976 its ownership had been transferred to Government of India.
After the transfer of its ownership, IDBI became the main institution,
through which the institutes engaged in financing, promoting and
developing industry were to be coordinated. International Finance
Division of IDBI transferred to Export-Import Bank of India, established
as a wholly-owned corporation of Government of India, under an Act
of Parliament in the year 1982.
In January 1992, IDBI accessed domestic retail debt market for
the first time, with innovative Deep Discount Bonds, and registered
path-breaking success. The following year, it set up the IDBI Capital
market Services Ltd., as its wholly-owned subsidiary, to offer a broad
range of financia services, including Bond Trading, Equity Broaking,
Client Asset Management and Depository Services.
In September 1994, in response to RBI’s policy of opening up
domestic banking sector to private participation, IDBI set up IDBI
Bank Ltd., in association with SIDBI.
In July 1995, public issue of the bank was taken out, after which
the Government’s shareholding came down (though it still retains
majority of the shareholding in the bank).
In September 2003, IDBI took over Tata Home Finance Ltd,
renamed ‘IDBI Home finance Limited’, thus diversifying its business
domain and entering the arena of retaifinance sector.

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The year 2005 witnessed the merger of IDBI Bank with the
Industrial DevelopmentBank of India Ltd. The new entity continued
to its development finance role, while providing an array of wholesale
and retail banking products (and does so till date). The following year,
IDBI Bank acquired United Western Bank (which, at that time, had 230
branches spread over 47 districts, in 9 states). In the financial year of
2008, IDBI Bank had a net income of Rs 9415.9 crores and total assets
of Rs120,601 crores

A. Subsidiaries

The following are the subsidiaries of IDBI.

1. Small Industries Development Bank of India (SIDBI)
2. IDBI Bank Ltd.
3. IDBI Capital market Services Ltd.
4. IDBI Investment Management Company

B. Objectives and Functions of IDBI

Objectives: The main objectives of IDBI is to serve as the

apex institution for term finance for industry in India. Its objectives
include:
1. Co-ordination, regulation and supervision of the working
of other Financial Institutions such as IFCI, ICICI, UTI, LIC,
Commercial Banks and SFCs.
2. Supplementing the resources of other Financial Institutions
and there by widening the scope of their assistance.
3. Planning, promotion and development of key industries and
diversification of industrial growth.
4. Devising and enforcing a system of industrial growth that
conforms to national priorities.

Functions: The IDBI has been established to perform the

following functions-

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

1. To grant loans and advances to IFCI, SFCs or any other

financial institution by way of refinancing of loans granted
by such institutions which are repayable within 25 years.
2. To grant loans and advances to scheduled banks or state
co-operative banks by way of refinancing of loans granted
by such institutions which are repayable in 15 years
3. To grant loans and advances to IFCI, SFCs, other institutions,
scheduled banks, state co-operative banks by way of
refinancing of loans granted by such institution to industrial
concern s for exports.
4. To discount or re-discount bills of industrial concern s.
5. To underwrite or to subscribe to shares or debentures of
industrial concern s.
6. To subscribe to or purchase stock, shares, bonds and
debentures of other financial institutions.
7. To grant line of credit or loans and advances to other Financial
Institutions such as IFCI, SFCs, etc.
8. To grant loans to any industrial concern.
9. To guarantee deferred payment due from any industrial
concern.
10. To guarantee loans raised by industrial concern s in the
market or from institutions.
11. To provide consultancy and merchant banking services in or
outside India.
12. To provide technical, legal, marketing and administrative
assistance to any industrial concern or person for promotion,
management or expansion of any industry.
13. Planning, promoting and developing industries to fillup gaps
in the industrial structure in India.
14. To act as trustee for the holders of debentures or other
securities.

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C. Reserve Bank of India (RBI)

The central bank of the country is the Reserve Bank of India

(RBI). It was established in Apri1935 with a share capital of Rs. 5
crores on the basis of the recommendations of the Hilton Young
Commission. The share capital was divided into shares of Rs. 100
each fully paid which was entirely owned by private shareholders
in the beginning. The Government held shares of nomina value
of Rs. 2,20,000.
Reserve Bank of India was national isued in the year 1949. The
generasuperintendence and direction of the Bank is entrusted to
Central Board of Directors of 20 members, the Governor and four
Deputy Governors, one Government official from the Ministry
of Finance, ten nominated Directors by the Government to give
representation to important elements in the economic life of the
country, and four nominated Directors by the Central Government
to represent the four local Boards with the headquarters at
Mumbai, Kolkata, Chennai and New Delhi. LocaBoards consist
of five members each Central Government appointed for a term
of four years to represent territorial and economic interests and
the interests of co-operative and indigenous banks.
The Reserve Bank of India Act, 1934 was commenced on
Apri1, 1935. The Act, 1934 (II of 1934) provides the statutory basis
of the functioning of the Bank.

The Bank was constituted for the need of following:

1. To regulate the issue of banknotes
2. To maintain reserves with a view to securing monetary
stability and
3. To operate the credit and currency system of the country to
its advantage.

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

D. Role of Reserve Bank of India (RBI): As a central bank, the

Reserve Bank has significant powers and duties to perform. For
smooth and speedy progress of the Indian Financial System, it
has to perform some important tasks. Among others it includes
maintaining monetary and financial stability, to develop and
maintain stable payment system, to promote and develop
financial infrastructure and to regulate or control the financial
institutions.

1. Issuer of currency: Except for issuing one rupee notes and

coins, RBI is the sole authority for the issue of currency in
India. The Indian government issues one rupee notes and
coins. Major currency is in the form of RBI notes, such as
notes in the denominations of two, five, ten, twenty, fifty,
one hundred, five hundred, and one thousand. Earlier, notes
of higher denominations were al so issued. But these notes
were demonetized to discourage users from indulging in
black-market operations. RBI has two departments-the Issue
department and Banking department. The issue department
is dedicated to issuing currency. Al the currency issued is the
monetary liability of RBI that is backed by assets of equal
value held by this department. Assets consist of gold, coin,
bullion, foreign securities, rupee coins, and the government’s
rupee securities. The department acquires these assets
whenever required by issuing currency. The conditions
governing the composition of these assets determine
the nature of the currency standard that prevails in India.
The Banking department of RBI looks after the banking
operations. It takes care of the currency in circulation and
its withdraw from circulation. Issuing new currency is known
as expansion of currency and withdraw of currency is known
as contraction of currency.

2. Banker to the Government: RBI acts as banker, both to

the central government and state governments. It manages

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all the banking transactions of the government involving

the receipt and payment of money. In addition, RBI remits
exchange and performs other banking operations. RBI
provides short-term credit to the central government. Such
credit helps the government to meet any shortfall ls in its
receipts over its disbursements. RBI al so provides short term
credit to state governments as advances. RBI al so manages
all new issues of government loans, servicing the government
debt outstanding, and nurturing the market for government’s
securities. RBI advises the government on banking and
financial subjects, international finance, financing of five-year
plans, mobilizing resources, and banking legislation.

3. Managing Government Securities: Various Financial

Institutions such as commercial banks are required by law to
invest specified minimum proportions of their total assets/
liabilities in government securities. RBI administers these
investments of institutions.

4. The other responsibilities of RBI regarding these securities

are to ensure-
a) Smooth functioning of the market
b) Readily available to potential buyers
c) Easily available in large numbers
d) Undisturbed maturity-structure of interest rates because
of excess or deficit supply
e) Not subject to quick and huge fluctuations
f) Reasonable liquidity of investments
g) Good reception of the new issues of government loans

5. Banker to Other Banks: The role of RBI as a banker to other

banks is as follows:
a) Holds some of the cash reserves of banks
b) Lends funds for short period
c) Provides central sized clearing and quick remittance
facilities

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

RBI has the authority to statutorily ensure that the scheduled

commercial banks deposit a stipulated ratio of their total
net liabilities. This ratio is known as cash reserve ratio [CRR]
r, banks can use these deposits to meet their temporary
requirements for interbank clearing as the maintenance of
CRR is calculated based on the average balance over a period.

6. Controller of Money Supply and Credit: In a planned

economy, the central bank plays an important role in
controlling the paper currency system and inflationary
tendency. RBI has to regulate the claims of competing banks
on money supply and credit. RBI al so needs to meet the
credit requirements of the rest of the banking system.
RBI needs to ensure promotion of maximum output, and
maintain price stability and a high rate of economic growth.
To perform these functions effectively, RBI uses several
control instruments such as-
a) Open Market Operations
b) Changes in statutory reserve requirements for banks
c) Lending policies towards banks
d) Control over interest rate structure
e) Statutory liquidity ration of banks

7. Exchange Manager and Controller : RBI manages

exchange control l, and represents India as a member of the
international Monetary Fund [IMF]. Exchange control was
first imposed on India in September 1939 when World War II
started and continues till date. Exchange control was imposed
on both receipts and payments of foreign exchange.
According to foreign exchange regulations, al foreign
exchange receipts, whether on account of export earnings,
investment earnings, or capital receipts, whether of private
or government accounts, must be sold to RBI either directly

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or through authorized dealers. Most commercial banks are

authorized dealers of RBI.

8. Publisher of Monetary Data and Other Data: RBI maintains

and provides all essential banking and other economic data,
formulating and critically evaluating the economic policies in
India. In order to perform this function, RBI collects, collates
and publishes data regularly. Users can avail this data in the
weekly statements, the RBI monthly bulletin, annual report
on currency and finance, and other periodic publications.

E. Developmental and Promotional role of RBI: Along with

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

1) Development of the Financial System: The financial system

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

2) Development of Agriculture: In an agrarian economy like

ours, the RBI has to provide special attention for the credit
need of agriculture and al lied activities. It has successfully
rendered service in this direction by increasing the flow of
credit to this sector. It has earlier the Agriculture Refinance
and Development Corporation (ARDC) to look after the

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

credit, National Bank for Agriculture and Rural Development

(NABARD) and Regional Rural Banks (RRBs).

3) Provision of Industrial Finance: Rapid industrial growth is

the key to faster economic development. In this regard, the
adequate and timely availability of credit to small, medium
and large industry is very significant. In this regard the RBI
has always been instrumental in setting up special Financial
Institutions such as ICICI Ltd. IDBI, SIDBI and EXIM BANK etc.

4) Provisions of Trainning: The RBI has all ways tried to provide

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

5) Collection of Data: Being the apex monetary authority of the

country, the RBI collects process and disseminates statistical
data on several topics. It includes interest rate, inflation,
savings and investments etc. This data proves to be quite
useful lfor researchers and policy makers.

6) Publication of the Reports: The Reserve Bank has its

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

7) Promotion of Banking Habits: As an apex organization,

the RBI al ways tries to promote the banking habits in the
country. It institutional sizes savings and takes measures for
an expansion of the banking network. It has set up many
institutions such as the Deposit Insurance Corporation-1962,

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UTI-1964, IDBI-1964, NABARD-1982, NHB-1988, etc. These

organizations develop and promote banking habits among
the people. During economic reforms it has taken many
initiatives for encouraging and promoting banking in India.

8) Promotion of Export through Refinance: The RBI always

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

Mutual Fund
A Mutual fund is a professionally managed type of collective
investment scheme that pools money from any investors and invests
it in stocks, bonds, short-term money market instruments and other
securities. Mutual funds have a fund manager who invests the
money on behalf of the investors by buying/selling stocks, bonds
etc. The income earned through these investments and the capital
appreciations realized are shared by its unit holders in proportion to
the number of units owned by them. Thus a Mutual fund is the most
suitable investment for the common man as it offers an opportunity
to invest in a diversified, professionally managed basket of securities
at a relatively low cost. The flow chart below describes broadly the
working of a mutual fund:
WHO MANAGES INVESTOR’S MONEY? This is the role of the
Asset Management Company (the Third tier). Trustees appoint the
Asset management Company (AMC), to manage investor’s money.
The AMC in return charges a fee for the services provided and this fee
is borne by the investors as it is deducted from the money collected
from them. The AMC’s Board of Directors must have at least 50% of
Directors who are independent directors.

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

THE ROLE OF THE AMC: The role of the AMC is to manage

investor’s money on a day to day basis. Thus it is imperative that
people with the highest integrity are involved with this activity. The
AMC cannot deal with a single broker beyond a certain limit of
transactions. The AMC cannot act as a Trustee for some other Mutual
Fund. The responsibility of preparing the OD lies with the AMC.
Appointments of intermediaries like independent financial advisors
(IFAs), national and region distributors, banks, etc. is al so done by
the AMC. Finally, it is the AMC which is responsible for the acts of its
employees and service providers.

3.6 ADVANTAGES OF MUTUAL FUNDS: The advantages of investing in

a Mutual funds are:
1) Professional Management
2) Diversification
3) Convenient Administration
4) Return Potential
5) Low Costs
6) Liquidity
7) Transparency
8) Flexibility
9) Choice of schemes
10) Tax benefits
11) Well regulated

Role and Function NABARD (National Bank for Rural l &

Agriculture Development)
NABARD is set up as an apex Development Bank with a mandate
for facilitating credit flow for promotion and development of
agriculture, small-scale industries, cottage and village industries,
handicrafts and other rural crafts. It al so has the mandate to support
al other al lied economic activities in Rural areas, promote integrated

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and sustainable Rural development and secure prosperity of Rural

areas.
NABARD was established on the recommendations of Shivaraman
Committee, by an act of Parliament on 12 July 1982 to implement
the NationsBank for Agriculture and Rural Development Act 1981. It
replaced the Agricultural Credit Department (ACD) and Rural Planning
and Credit Cel(RPCC) of Reserve Bank of India, and Agricultural
Refinance and Development Corporation (ARDC). It is one of the
premier agencies to provide credit in Rural areas.RBI sold its stake in
NABARD to the Government of India, which now holds 99% stake.

Mission
1) Promoting sustainable and equitable agriculture and Rural
development through effective credit support, related services,
institution building and other innovative initiatives.
2) In pursuing this mission, NABARD focuses its activities on:
3) Credit functions, involving preparation of potential-linked credit
plans annual ly for al districts of the country for identification of
credit potential, monitoring the flow of ground level Rural credit,
issuing policy and operational guidelines to Rural financing
institutions and providing credit facilities to eligible institutions
under various programmers
4) Development functions, concerning reinforcement of the credit
functions and making credit more productive
5) Supervisory functions, ensuring the proper functioning of
cooperative banks and regional Rural banks

Role and Function of NABARD: In discharging its role as a

facilitator for Rural prosperity NABARD is entrusted with
• Providing refinance to lending institutions in Rural areas
• Bringing about or promoting institutional development and
• Evaluating, monitoring and inspecting the client banks

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

Besides this pivot role, NABARD al so:

• Acts as a coordinator in the operations of Rural credit institutions
• Extends assistance to the government, the Reserve Bank of India
and other organizations in matters relating to Rural development
• Offers training and research facilities for banks, cooperatives and
organizations working in the field of Rural development
• Helps the state governments in reaching their targets of
providing assistance to eligible institutions in agriculture and
Rural development
• Acts as regulator for cooperative banks and RRBs

Microfinance and NABARD: For a better reach of microfinance

program a continuous check of the status, progress, trends, qual
itative and quantitative performance comprehensively is required.
Thus the Reserve Bank of INDIA and NABARD has laid out certain
guidelines in 06-07 for the commercial banks, RegionaRural Banks
and Cooperative Banks to provide the data to RBI and NABARD about
the progress of the microfinance program. There are three aspects
on which the data was collected, savings of self-help groups with
banks, loan disbursed by banks to self-help groups default by self-
help group’s repayment of the loans taken from banks. Banks al so
provides data regarding loans given by banks to the microfinance
institutions.

3.7 INDUSTRIAL CREDIT AND INVESTMENT CORPORATION OF INDIA

(ICICI)
The Industrial Credit and Investment Corporation of India
Limited (ICICI) incorporated at the initiative of the World Bank, the
Government of India and representatives of Indian industry, with the
objective of creating a development financial institution for providing
medium-term and long-term project financing to Indian businesses.

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ICICI emerges as the major source of foreign currency loans to

Indian industry. Besides funding from the World Bank and other multi-
lateraagencies, ICICI was al so among the first Indian companies to
raise funds from international markets.
ICICI Bank was established in 1994 by the Industrial Credit and
Investment Corporation of India, an Indian financial institution, as a
wholly owned subsidiary. The parent company was formed in 1955
as a joint-venture of the World Bank, India’s public-sector banks and
public-sector insurance companies to provide project financing to
Indian industry. The bank was initial ly known as the Industrial Credit
and Investment Corporation of India Bank, before it changed its name
to the abbreviated ICICI Bank. The parent company was later merged
into ICICI Bank.

History of ICICI
1955:
The Industrial Credit and Investment Corporation of India
Limited (ICICI) incorporated at the initiative of the World Bank, the
Government of India and representatives of Indian industry, with the
objective of creating a development financial institution for providing
medium-term and long-term project financing to Indian businesses.
Mr.A.Ramaswami Mudal iar elected as the first Chairman of ICICI
Limited.
ICICI emerges as the major source of foreign currency loans to
Indian industry. Besides funding from the World Bank and other multi-
lateral agencies, ICICI was al so among the first Indian companies to
raise funds from international markets.

1967:
ICICI made its first debenture issue for Rs.6 crore, which was
oversubscribed.

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

1977:
ICICI sponsored the formation of Housing Development Finance
Corporation. Managed its first equity public issue

1982:
ICICI became the first ever Indian borrower to raise European
Currency Units. ICICI commences leasing business

1986
ICICI became the first Indian institution to receive ADB Loans.
ICICI, along with UTI, set up Credit Rating Information Services of
India Limited, India’s first professional credit rating agency.
ICICI promotes Shipping Credit and Investment Company of
India Limited.

1994:
ICICI Bank was established in 1994 by the Industrial Credit and
Investment Corporation of India, an Indian financial institution, as a
wholly owned subsidiary.
ICICI Securities and Finance Company Limited in joint venture
with J. P. Morgan set up.

1996:
ICICI Asset Management Company set up.
ICICI Bank set up.
ICICI Ltd became the first company in the Indian financial sector
to raise GDR.

1998:
ICICI Banking Corporation Ltd, the first bank in the country to go
in for Internet banking, is now al set to provide its account-holders
with the facility of transferring funds across their accounts on the Net.

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2000:
ICICI Bank became the first Indian bank to list on the New York
Stock Exchange with its $175-million American depository shares
issue generating a demand book 13 times its size at $2.2 billion.

2001:
The Boards of Directors of ICICI and ICICI Bank approved the
merger of ICICI and two of its wholly owned retail finance subsidiaries,
ICICI Personal Financial services Limited and ICICI Capital Services
Limited, with ICICI Bank. The merger was approved by shareholders
of ICICI and ICICI Bank in January 2002, by the High Court of Gujarat
at Ahmadabad in March 2002, and by the High Court of Judicature
at Mumbai and the Reserve Bank of India in Apri2002.

2008:
Following the 2008 financial crisis, customers rushed to ATM’s
and branches in some locations due to rumors of adverse financial
position of ICICI Bank. The Reserve Bank of India issued a clarification
on the financial strength of ICICI Bank to dispute rumors.

2010:
ICICI Bank opens first retail branch in Singapore.
RBI approves the amalgamation of Bank of Rajasthan Ltd with
ICICI Bank Ltd.

2012:
ICICI Bank opens its second branch in Hong Kong.
ICICI Bank was the first private sector bank in India to offer PPF
account facility at al bank branches.

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

Export-Import Bank of India: Objectives and Functions

The Export-Import Bank of India was set up by the Government
of India on January 1, 1982. Its main objects are:
1. To ensure and integrated and co-ordinate approach in solving
the al lied problems encountered by exporters in India.
2. To pay specific attention to the exports of capital goods;
3. Export projection;
4. To facilitate and encourage joint ventures and export of technical
services and international and merchant banking;
5. To extend buyers’ credit and lines of credit;
6. To tap domestic and foreign markets for resources for undertaking
development and financial activities in the export sector.

The functions of EXIM Bank include:

a) Planning, promoting and developing exports and imports;
b) Providing technical, administrative and managerial assistance for
promotion, management and expansion of export sector.
c) (c) Undertaking market and investment surveys and techno-
economic studies related to development of exports of goods
and services.

The Exim Bank has a 17-member Board of Directors, with

Chairman and Managing Director as the chief executive and full-
time director. The Board of Directors consists of the representative
of the Government of India, RBI, IDBI, ECGC, commercial banks and
the exporting community.
The authorized capital of Exim Bank is Rs. 200 crores, of which
Rs. 75 crores is paid up. The banks have secured a long-term loan
of Rs. 20 crores from the Government of India. It can al so borrow
from the RBI. It is empowered to raise resources in domestic and
international markets.

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The Bank began its lending operations from March, 1982. TilJune,
1982, it has extended assistance up to Rs. 133 crores to the export
sector in various ways.
The establishment of Exim Bank may be regarded as a right step
in the export promotion policy and programmme of the Government.
During 1984, the Exim Bank sanctioned various programmes
of funded assistance of Rs. 430 crores. It al so launched a new
programme to provide term finance for export-oriented units, under
which assistance was provided through a consortium for establishing
a 100 per cent export unit in the ceramics industry.
The Exim Bank al so extended its financial assistance to Indian
exports through letters of credit, re-lending facility, export bills
rediscounting, overseas investment finance, facilities for deemed
exports and assistance to hundred per cent export units and units in
free trade zone.
At the end of December 1984, the Exim Bank’s outstanding
underfunded and non-funded assistance amounted to Rs. 415 crores
and Rs. 510 crores, respectively.
In 1984, the Exim Bank signed a loan agreement to borrow one
billion yen from the Japanese commercial yen market.
In June 1986, the Exim Bank introduced a new programme called
the Export Marketing Fund (EMF), under which finance is made
available to Indian companies for undertaking export marketing
activities. The programm al so covers activities like desk research,
minor product adaptation, overseas operations and trave to India by
buyers overseas. During 1986, Rs. 78 lakhs were sanctioned, while Rs.
3.4 lakhs have been utilised under the EMF.
On whole, the Exim Bank concluded an agency credit line of US
$ 15 million with the International Finance Corporation (IFC).

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

During 1994-95, Exim Bank sanctioned Rs. 2,466 core and

disbursed Rs. 2,130 crore of financial assistance under various lending
project

Industrial Finance Corporation of India: Functions, Management

and Activities of the IFCI
Industrial Finance Corporation of India: Functions, Management
and Activities of the IFCI
Government of India set up the Industrial Finance Corporation of
India (IFCI) in July 1948 under a special Act. This is the first financial
institution set up in India with the main object of making medium
and long term credit to industrial needs.
The Industrial Development Bank of India, Schedule banks,
insurance companies, investment trusts and co-operative banks are
the shareholders of IFCI. The Union Government has guaranteed the
repayment of capital and the payment of a minimum annual dividend.
The corporation is authorized to issue bonds and debentures in
the open market, to borrow foreign currency from the World Bank
and other organizations, accept deposits from the public and al so
borrow from the Reserve Bank.
The authorized share capital of the IFCI was Rs. 10 crore at
the initial stage, According to the Industrial Finance Corporation
(Amendment) Act, 1986, the authorized capital of the corporation
has been raised from Rs. 100 crore to Rs. 250 crore (the authorized
capital may be fixed by the government of India by notification from
time to time).

Objective of IFCI
1. To provide long and medium-term credit to industrial concern
s engaged in manufacturing, mining, shipping and electricity
generation and distribution.

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2. The period of credit can be as long as 25 years and should not

exceed that period;
3. To grant credit to a single concern up to a maximum amount of
rupees one crore. This limit can be exceeded with the permission
of the government under certain circumstances;
4. guarantee loans and deferred payments;
5. underwrite and directly subscribe to shares and debentures issued
by companies;
6. assist in setting up new projects as well as in modernization of
existing industrial concern s in medium and large scale sector;
7. Assist projects under co-operatives and in backward areas.

The functions of the IFCI base as follows:

1. The corporation grants loans and advances to industrial concern
s.
2. Granting of loans both in rupees and foreign currencies.
3. The corporation underwrites the issue of stocks, bonds, shares
etc.
4. The corporation can grant loans only to public limited companies
and co-operatives but not to private limited companies or
partnership firms.

Functions: The main functions of I.F.C.I. are as under:-

1. Granting loans and advances for the establishment, expansion,
diversification and modernization of industries in corporate and
co-operative sectors.
2. Guaranteeing loans raised by industrial concern s in the Capital
Market, both in rupees and foreign currencies.
3. Subscribing or underwriting the issue of shares and debentures
by industries. Such investment can be held up to 7 years.
4. Guaranteeing credit purchase of capital goods, imported as well
as purchased within the country.

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Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

5. Providing assistance, under the soft loans scheme, to selected

industries such as cement, cotton textiles, jute, engineering
goods, etc.
6. Providing technical, legal, marketing and administrative assistance
to any industrial concern for the promotion, management and
expansion of the industrial concern .
7. Providing equipment (imported or indigenous) to the existing
industrial concern s on lease under its ‘equipment leasing
scheme’.
8. Procuring and reselling equipment to eligible existing industrial
concern s in corporate or co-operative sectors.
9. Rendering merchant banking services to industrial concern s.

Organization and Management:

The Head Office of the IFCI is in New Delhi. It has al so established
its Regional offices in Bombay, Chennai, Kolkata, Chandigarh,
Hyderabad, Kanpur and Guwahati. The branch office of IFCI is located
in Bhopal, Pune, Jaipur, Cochin, Bhubaneswar, Patna, Ahmedabad
and Bangal ore.
The IFCI is managed by a Board of Directors, headed by
a Chairman, who is appointed by the Government of India, in
consultation with RBI. The chairman holds his position for a period
of 3 years, subject to extension.
Of the 12 directors, 4 are nominated by the IDBI, three of whom
are experts in the fields of industry, labour and economics and the
fourth is the General Manager of the IDBI. The remaining 8 directors
are nominated.
Two directors are nominated for a term of 4 years by each of the
following-scheduled banks, co-operative banks, insurance companies
and investment companies making up eight directors.

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The promotional activities of IFCI are explained below:

1. Soft Loan Assistance: This scheme provides soft loan assistance
to existing industries in small and medium sector for developing
technology through in-house research and development.
2. Entrepreneur Development: IFCI provides financial support
to EDPs (Entrepreneur Development Programmes) conducted
by several agencies al l-over India. In co-operation with
Entrepreneurship Development Institute of India.
3. Industrial Development in Backward Areas: IFCI al so take
measures to promote Industrial Development in backward areas
through a scheme of concessional finance.
4. Subsidized Consultancy: The IFCI gives subsidized consultancy
for,
a. Small Entrepreneurs for Meeting the Cost of Project.
b. Promoting Ancillary Industries
c. To do the Market Research.
d. Reviving Sick Units.
e. Implementing Modernization.
f. Controlling Pollution in Factories.
5. Management Development: To improve the professional
management the IFCI sponsored the Management Development
Institute in 1973. It established the Development Banking
Centre to develop managerial, manpower in industrial concern,
commercial and development banks.

Working of the IFCI:

The working of the IFCI came in for a large measure of criticism.
In the first place, the rate of interest which the corporation charged
was extremely high. Secondly, there was a great delay in sanctioning
loans and in making the amount of the loans available.
Thirdly, the ‘corporation’s insistence on the personal guarantee
of managing directors in addition to the mortgage of property was
considered wrong In the last two decades the corporation had entered

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

into new lines of activity, viz, underwriting debentures and shares

and guaranteeing of deferred payment in respect of imports from
abroad of plant an equipment by industrial concern s and subscribing
to stocks and shares of industrial concern s directly Besides, the
performance of IFCI together with the work of other public sector
Financial Institutions has been extremely credit worthy in the last two
decades.

State Financial Corporation’s (SFCs)

Objectives and Functions
IFCI was established to cater to the financial needs of industrial
concern s in large scale corporate and co-operative sectors. Small
and medium sized enterprises were outside the purview of IFCI.
To meet the financial needs of small and medium enterprises, the
government of India passed the State Financial Corporation Act in
1951, empowering the State governments to establish development
banks for their respective regions.
Under the Act, SFCs have been established by State governments
to meet the financial requirements of medium and small sized
enterprises. There are 18 SFCs at present.

Objectives
The objectives of state financial corporations are as under:
1. Provide financial assistance to small and medium industrial
concern s. These may be from corporate or co-operative sectors
as in case of IFCI or may be partnership, individual joint hindu
family business. Under SFCs Act, “industrial concern ” means any
concern engaged not only in the manufacture, preservation or
processing of goods, but al so mining, hotel industry, transport
undertakings, generation or distribution of electricity, repairs
and maintenance of machinery, setting up or development of
an industrial area or industrial estate, etc.

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2. Provide long and medium-term loan repayable ordinarily within

a period not exceeding 20 years.
3. Grant financial assistance to any single industrial concern under
corporate or co-operative sector with an aggregate upper
limit of rupees Sixty lakhs. In any other case (partnership, sole
proprietorship or joint hindu family) the upper limit is rupees
Thirty lakhs.
4. Provide Financial assistance general ly to those industrial concern
s whose paid up share capital and free reserves do not exceed
Rs. 3 crore.
5. To lay special emphasis on the development of backward areas
and small scale industries.

Functions of State Financial Corporation (SFCs)

The functions of SFCs include
1. Grant of loans and advances to or subscribe to debentures of,
industrial concern s repayable within a period not exceeding
20 years, with option of conversion into shares or stock of the
industrial concern.
2. Guaranteeing loans raised by industrial concern s which are
repayable within a period not exceeding 20 years.
3. Guaranteeing deferred payments due from an industrial concern
for purchase of capital goods in India.
4. Underwriting of the issue of stock, shares, bonds or debentures
by industrial concern s.
5. Subscribing to, or purchasing of, the stock, shares, bonds or
debentures of an industrial concern subject to a maximum of 30
percent of the subscribed capital, or 30 percent of paid up share
capital and free reserve, whichever is less.
6. Act as agent of the Central government, State government, IDBI,
IFCI or any other financial institution in the matter of grant of loan
or business of IDBI, IFCI or financial institution.

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

7. Providing technical and administrative assistance to any industrial

concern or any person for the promotion, management or
expansion of any industry.
8. Planning and assisting in the promotion and development of
industries

3.8 ORGANIZED MONEY MARKET

The organised money market can be further segmented into
two categories:

1. Market for Banking Financial Institutions

Under this the entire banking network is administered by RBI,

which has the following many more classification viz Public sector
banks, Scheduled banks, Private sector bank, Co-operative banks,
Regional Rural l banks and Land development banks

2. Market for Non Banking Financial Institutions

The non banking financial institutions are nothing but

development banks, state financial institutions. The money
market is further divided into various segments viz Bills market,
Discounting market, Acceptance market, Marketable securities
market, Gilt edged securities market and so on

1. Bill market: In this market only, the bills are bought and
sold among the players. It is the market for both commerce
bill and finance bill. The commerce bill is nothing but the
bill of exchange defined in accordance with the Sec. 5 of the
Negotiable Instruments Act. It arises only due to credit sales
among the parties, only in order to safeguard the interest of
the suppliers who supplied the goods and articles on credit.

2. Discounting market: It is another most important market

for discounting of the bills of the trade. These are normal

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ly carried out by the banking and financial institutions in

addition to Discounting Housing Finance of India which is
the apex body for rediscounting in India next to Reserve
Bank of India. The bills are discounted by the banking and
a non banking financial institution only on the basis of the
credibility of the parties involved in the bilwho has accepted
to make the payment on the maturity of the bill.

3. Acceptance market: In India, there is no separate acceptance

market for accepting the bills before discounting, but in
U.K., there is greater scope for accepting the bill before the
process of discounting. Normal ly, the discounting is carried
out only on the basis of the extent of acceptance given by
the acceptance houses on the bills produced.

4. Govt Securities market: The govt securities are al so tradable

in the secondary market immediately after the issuance.
According to the Public debt act, the central and state govt
are empowered to issue the securities to raise financial
resources from the public for developmental aspects of the
state or region. The treasury bills are mainly traded in the
market immediately after the issuance The following are the
major type of treasury bills traded in the market are 91 days
treasury bills, 182 days treasury bill and 364 days treasury
bill

5. Bonds market: It is a separate market available to raise the

financial resources through long term debt instrument. The
bonds are normal ly issued by the corporate sectors and govt
organizations. They are many in categories viz Secured and
unsecured bonds Pay in kind bonds Redeemable bonds and
irredeemable bonds and so on.

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

3.9 UN-ORGANIZED MONEY MARKET

This particular market is dominated by the pawn brokers, chit
funds, nidhis, and so on.
There are no stringent guidelines prevailing to control and
monitor the role of the above mentioned players.
In addition to the above classifications, one more classification
is that of insurance companies which are separately governed by the
IRDA which has got its own segments as following:
• Life insurance sector
• Non life insurance sector
• Pension funds
• Heal th insurance and so on

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 CH. 4

CAPITAL MARKET

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

The nature of Capital Market

It is a market where all organizations, Financial Institutions and
instruments provide long and medium term funds to the business
sector.
The two major components of Capital market are
• Primary (new issue market)
• Secondary market (stock exchange).

The nature of Capital market can be understood from the

following points:
• It acts a link between savers and borrowers who need funds to
invest profitably and efficiently.
• It helps firms to procure finances for long-term investments such
as buying plant & machinery, building, etc.
• It obtains its funds through issue of various securities such as
equity shares, bonds, debentures and innovative securities like
zero interest bonds and deep discount bonds.
• It functions thru’ various intermediaries such as underwriters,
bankers, stock brokers, etc.
• It includes both individual investors and institutional investors
such as UTI, LIC, IDBI, etc

State any four PROTECTIVE functions of SEBI?

• It prohibits insider trading. It prevents insiders such as directors,
promoters who have access to price sensitive information
regarding securities of the company (which is not available to the
public) to make individual profits through trading of securities.
• It prohibits fraudulent and unfair trade practices in the security
market like making misleading statements and price rigging.
(Manipulating with the sole intention of inflating or deflating the
market price of securities is termed as “price rigging)
• It promotes fair practices and code of conduct in the securities
market.

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Example: Looks after the interest of the debenture holders in

terms of any midterm revision of interest rate, etc.
• It takes steps to educate investors.

SEBI is a REGULATORY authority of the securities market.

• It carries out audit of the share markets
• It regulates takeover of companies
• It regulates the business being conducted in the share market.
• It registers and regulates the working of brokers, sub brokers,
transfer agents, merchant banks, underwriters, etc.
• It registers and regulate the credit rating agency, venture capital
funds and Mutual Funds

Developmental functions of SEBI

• It promotes trading of intermediaries of the securities market.
• It adopts a flexible approach to develop the Capital Market.

4.1 REFORMS IN PRIMARY MARKET

A reform in Capital market includes:
• Merchant banking and banking code installed
• Due diligence certificate from the lead managers
• Disclosure norms
• Companies details-facts and risk factors associated with their
projects
• Stock exchanges required to ensure the formal cities with the
companies during the issues
• Restriction in the usage of Stock invest-institutional investors
• Disclosure norms for the advertisement
• Underwriting is optional and if it is not carried out due to bring
down the issue cost–90% of the amount offered to the public-
should be refunded
• Bonus guidelines were relaxed
• New system introduced for preferential issue-pertaining to pricing

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

• Shri Y H Malegam–disclosure requirements and issue procedures

• SEBI to vet the prospectus within 21 days from the date of issue
and approval by the registrar companies is given a time period
of 14 days
• Abridged prospectus-should be vetted by the SEBI

Reforms in the Primary Market: 1996-97

• Norms were tightened-to enhance the quality of the paper
• First time issuers-dividend payment record in three of the
immediately preceding five years
• If this requirement is not applicable in the case of companies–
appraisal should be done through commercial banks or financial
institutions-10% contribution from the issuer out of the total size
of the issue
• For banks-no restriction but if the issues are premium priced-two
years profitability record
• Prohibition on direct or indirect discounts during the moment of
allotment
• 90% of the subscription waived due to minimum share holding
• Housing finance companies allowed to function as registered
issue facilitating companies in along with the refinancing from
the National housing bank
• The promoters contribution should be in a phased manner if it
crosses Rs.100 cr
• Debt securities could be listed in the stock exchanges without
any listing of equity shares.

Reforms in 1997-98
• Entry for unlisted companies modified
• Partly paid up shares should be either fully converted or forfeit
• 3 Years profitability required for the unlisted companies for the
issuance of share capital
• For rights issue-Registrar should be separately deputed
• Details of the promoters should be given in the offer document

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• Only body corporates allowed to function as merchant bankers

• Merchant bank classifications abolished
• Merchant banks are not permitted to carry out the fund related
activities; if any corporates are available-suitable breathing time
was given to restructure the activities

Reforms in 1998-2001
• Entry norms revised
• Pre issue net worth should not be less than 1 cr in 3 preceding
years out of 5
• Merchant banks registered with RBI as NBFCs eligible to trade
Govt securities
• permitted to derivatives
• Further updating was made in the companies act to protect the
investors
• Additional power granted to SEBI for the violation of the
companies act
• SEBI compendium 2000 issued
• On line offerings were encouraged by SEBI
• Regulation of rating agencies framed
• ESOP guidelines
• Changes introduced on Mutual funds the P.K.Kaucommittee
• Issue freedom is given to companies but not less than Re 1
• 100% book building route introduced

4.2 REFORMS IN THE SECONDARY MARKET

• Guidelines with reference to substantial takeovers and
acquisitions-disclosures
• Guidelines with regards to mandatory public offer to the investors
• Sever mutual funds were al lowed
• UTI brought under the SEBI
• Advertising code was initiated as well as the requirements of
pre-vetting of advertisement removed

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Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

• To improve the role of the Mutual funds as well as to develop the

market of mutual fund in India, Mutual funds were given-right
to underwrite the public issues and to make investments in the
money market
• Jumbo transfer was introduced for the institutions
• Carry forward system of transactions are permitted to SEs after
getting the consent and surveillance
• Carry forward transactions are limited in the case of lenders of
the transactions
• Carry forward transactions should be disclosed on the basis of
scrip and broker at the beginning of carry forward session
• Capital adequacy norms were introduced
• Depositories were introduced during the year 1995 Sept.; to
record the ownership
• in the book form
• The introduction of depository requires the changes in the
following enactments
1. Companies Act
2. Stamp Duty Act
3. Income Tax Act

Capital market Reforms: 1996-97

• Depositories Act 1996-promulgated in order to reduce the
problems associated
• with the handling of securities
• Guidelines for the custodian of securities were clearly drafted
• Custodian of securities-compliance officer should be appointed-
to bridge the gap in between
• Changes are expected to discuss during the monthly meetings
of Association of
• Custodian of security services
• Bad delivery cell was set up and code was specified

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• System of clearing house or clearance corporation to be set up

in the stock exchange
• Separate committee has been set up for surveillance-inter stock
exchange transactions
• Mumbai and other stock exchanges were allowed to install
terminal s-where no exchange exists-to have on line trading
• Norms of the OTCEI were eased to promote more transactions

Capital market Reforms: 1997-98

• Daily carry forward margin reduced to 10% from 15%
• Over al carry forward increased to Rs.20 crs per broker

Capital market Reforms: 1998-2001

• Buy back of securities were permitted
• Circuit breaker system was introduced to control volatility
• Dematerialized trading was initial ised
• Rolling settlement introduced
• Internet trading was introduced
• Guidelines were issued in the angle of maintaining the
transparency
• Clause 49-to maintain corporate governance introduced
• Stock watch system was introduced
• Steps introduced to reduce the transaction costs
• Trading of stock index and futures-BSE and NSE commenced
• For trading of debt securities-to promote debt market-steps taken

Capital market Reforms: 2005-2007

• Golden pegged return funds permitted
• IPO norms are tightened
• Grading of IPOs are suggested

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

4.3 SEBI IN CAPITAL MARKET ISSUES

Introduction
During the late 80, the GOI decided to replace the Control ller
of Capital Issues Act, by way of inducting the Securities Exchange
Board of India, in order to introduce the regulatory environment in
the Indian capital market, to pave way for the promotion of congenial
and conducive climatic condition for the investing public. Hence the
Government of India has instituted the supreme authority SEBI to
monitor and control the proceedings of the capital market in the
country.

4.4 OBJECTIVES OF THE SEBI

1. Control of Capital Issues Act (1947)
2. The Companies Act (1956)-issue, allotment of the securities and
disclosures
3. Securities contract regulation Act (1956)-to control over the stock
exchanges
4. In May, 1992-the controller of issue of capital, pricing of the
issues, fixing premier and rates of debentures were ceased in
operation, provided the SEBI was promulgated.
5. Protecting the interest of the investors
6. Promoting the development of the securities market
7. Regulating the securities market

4.5 ORGANISATIONAL GRID OF THE SEBI

1. Six members in the committee
2. Headed by the chairman
3. One member each from the ministries of Law and Finance
4. One member from the official s of Reserve Bank of India
5. Two nominees from the central government
6. It contains 4 different departments viz Primary department, Issue
management and

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7. intermediaries department, Secondary department and

Institutional Investment department

4.6 POWERS AND FUNCTIONS OF SEBI

Section 11 of the Act Chapter IV highlights the Powers and
Functions of SEBI
1. Regulating the business of the stock exchanges
2. Regulating the role of the intermediaries
3. Registering and regulating of depositories, participants and
custodian of securities, credit rating agencies
4. Regulating of mutual funds and venture capital funds
5. Prohibiting the unfair trade practices
6. Prohibiting of insider trade activities
7. Regulating substantial takeovers and acquisitions
8. Frequent conduct of research activities
9. To conduct any enquiry which warrants the situation to safeguard
the interest of the investors
Civil Court Procedure 1908: The SEBI has been given additional
powers and function with reference to Civil Court Procedure 1908
to regulate the capital market in addition to the above enlisted
powers and functions
10. Discovery and production of books of account of the errant
during the inspection and enquiry.
11. Summoning and enforcing the attendance of the persons to stand
before for the examination of oath.

4.7 ROLE OF SEBI

Entry norm for the companies at the moment of raising the capital
from the market:
• The companies are expected to produce 3 years dividend track
record of preceding the issue.

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• At the entry level, immediately after listing, important point to be

ensured is that Post issue of net worth should be 5 times greater
than the Pre issue net worth.
• If it is a manufacturing company without any track record, wants
to raise any capital from the market, the appraisal has to be done
through development banks or commercial l banks.
• Having three years track record, the SEBI never vets offer
document of the issue of capital.

1. Promoter’s Contribution
a. Promoter’s contribution should not be less than 20% and
should be made before the issue.
b. If the size of the issues is Rs. 100 cr-50% of the contribution
should be made before the opening of issue and the
remaining should be paid before the cal ls are made to the
investors.

2. Disclosures
a. Acc. Bhave committee-Financial results i.e., unaudited and
audited financial results should be published.
b. Risk factors and positions of the company should be
highlighted in detail in the prospectus.

3. Book Building
a. 75% route was specified at the early moment in the process of
book building. Then the book building process was opened
to 100% route to the public.
b. Sufficient opportunities are to be furnished to the investors
to represent through the terminal to take part in the process
of Book building.
c. The company during the process requires 30 centres at least
for book building process to raise the share capital from the
market.

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4. Al location of Shares
a. The Minimum application was-100 Nos for subscribing the
issue of share capital then the Minimum application was hiked
to 500 Nos. Then SEBI has felt that the Minimum application
was too high, which did not pave the small investors to within
the available surplus, and then the minimum application
brought down to 200 Nos.
b. Small investors are who hold 1000 shares or few securities
c. Allotment should be done within 30 days from the date of
closure of the issue. During the non allotment of the shares,
the company should refund the amount of the application
money.

5. Market Intermediaries
a. The various merchant bank categories were abolished.
b. Each category of issue intermediary is required to undergo
for specific registration process.
c. Lead managers who manage the issue of capital should have
a net worth of Rs.5 cr.

6. Debt Market Segment

a. Depository system for the debt securities were introduced
b. Demat facility was specifically introduced for the government
securities
c. Listing of debt securities need not rely upon the equity listing
in the respective stock exchange
d. FIIs were permitted to invest 100% in the debt instruments
of the Indian companies
e. For the issuance of debt instruments the rating has been
mandatory
f. Minimum two ratings should be obtained for the issue of
debt instrument more than Rs. 500 cr.
g. Rating agency should not be associated with the firm of
issuing company

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Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

7. Brokers
a. Registration is given-Member of any stock exchange-key
factors of registration-office space, previous experience, man
power, selling or buying in securities
b. Code of conduct-execution of orders, fairness of deal s with
the investors, issue of contract note Financial statements-
should be submitted within 6 months of the accounting
period Book of accounts-A minimum of 5 years to be
preserved Regional offices-Establishment only with reference
to attend the complaints of the small investors at speedy rate-
Kolkata, Chennai and Delhi SEBI’s final controlling measure
is suspension and cancellation of the registration subject to
certain conditions

8. Suspension of a Broker
a. Suspension-permanent-dismissal is leading to cancellation
of registration-due to the problem caused
b. Violation of rules and regulations
c. Fails to submit the true and fair information according to the
norms of disclosures
d. Untoward conduct with the investor
e. Guilty of misconduct
f. Poor financial status of the brokers-deterioration
g. Stock exchange fees-faito pay on time to the requirement
h. Suspension of the membership
i. Indulges in any act of insider trading of securities
j. Convicted of a any criminal offence
k. Sub-Broker Sub-broker-to obtain the registration
l. Agreement in between broker & sub-broker
m. Deposit should be made with–Broker
n. Transfer of securities-without registration of bearing stamps-
considered as bad deliveries in the angle of stock exchanges-
July 1, 1997.

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9. Recent Developments
a. RBI approval copy is exempted
b. FIIs are permitted to invest upto 100% in debt market funds
c. FIIs which have securities worth of Rs 100 cr or more than
mandatory requirement is to settle the transaction only
through demat mode
d. FIIs/NRIs/OCB-30% of the equity of the company in
accordance with the union budget-1997-98
e. It was hiked by the Union Finance Minister during the budget
2000

4.8 ORGANISED CAPITAL MARKET

The capital market which was initial ly controlled and organized
by the Controller of Capital Issues act and then it was replaced by
the Securities Exchange Board of India for the governance of capital
market in India. The capital market in India is known as regulated
in spheres by SEBI then and there. The organised capital market is
bifurcated into two categories viz Primary market and Secondary
market.
1. Primary market: It is the market for the fresh issuance of
securities by the new as well as existing companies, in order to
raise the capital from the investors. The Primary market is further
classified into many segments
2. Initial Public offering: As a new company registered under the
Companies Act 1956 is permitted to raise the capital from the
market through the abridged prospectus.
3. Public issue: It is another mode of raising the capital from the
common public by the existing companies.
4. Private placement: During the issue, the larger investment
houses are invited for the subscription of the issue of securities
in bulk quantities at a discount price prior to the issue. After
the issue, according to the investment policy of the Institutional

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investors, they sell them at higher price to the individual investors.

This facilitates the institutional investors to book profits through
the process of private placement.
5. Underwriting: It is another mode of issuing the securities during
the issue, more particularly this mode of issue is found to be an
avenue to off-load the risk of managing the issue of securities
as well asto secures the issue as fully subscribed.
6. Secondary market: It is the market for the securities which are
already available in the market, to buy and sell among the players.
This is the market further classified into two different categories
viz mutualisation and demutualisation of stock exchanges.
7. Mutualised Stock exchanges: These are the exchanges never
have any distinction among the members, management and
governing body of the stock exchange. These are purely
administered by the members/brokers of the stock exchange,
e.g.,. Traditional stock exchanges.
8. Demutualised stock exchanges: These are separate distinct faces
among themselves. The roles and responsibilities of the brokers,
governing body members and people in the management are
clearly defined and performed by them without any ambiguity
e.g. OTCEI, NSE and so on.

4.9 UN-ORGANIZED CAPITAL MARKET

Due to stringent guidelines of SEBI, unofficial market trading
activities are banned only in order to safeguard the interest of the
investors. Kerb trading which was taken place among the players of
the stock market during the nonworking hours of the stock exchange.
This trading is known in other words as unofficial trading or black
trading among the players. The next segment is nothing but the
money market which controlled and monitored by the Reserve Bank
of India.

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CH. 5

FEE BASED
FINANCIAL SERVICES

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Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

Fee Based Financial Services

INTRODUCTION: With the change in the complex business
environment, financial services play a pivotal role in facilitating the
smooth flow of the entire financial system. Financial services include:
(A) Venture Capital Financing (D) Underwriting
(B) Factoring & Forfeiting (E) Credit Rating Agencies
(C) Leasing (F) Others

5.1. VENTURE CAPITAL FINANCING

The term venture capital comprises of two words that is, “Venture”
and “Capital”. Venture is a course of processing, the outcome of
which is uncertain but to which is attended the risk or danger of
“loss”. “Capital” means recourses to start an enterprise. To connote
the risk and adventure of such a fund, the generic name Venture
Capital was coined

Venture capital is defined as long-term funds in equity or semi-

equity form to finance hi-tech projects involving high risk and yet
having strong potential of high profitability.

1.1 Definition of Venture capital:-

“The support by investors of entrepreneurial talent with finance

and business skills to exploit market opportunities and thus obtain
capital gains

BRAIN V.C. MONEY

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1.2. Features of venture capital

1. Investments are made in innovative projects with new
technology with a view to commercialize the know how
through new products/services.
2. The claim over the management is decided on the basis of
proportion to investments.
3. Venture capital investors closely watch the performance of
the business unit.
4. Venture capital funds are realized through the stock exchange.

1.3. Venture capital investment process

1. Establishment of contact between the entrepreneur and
the venture capitalist: The entrepreneur with his know-how
prepares a project report establishing there in the possibility
of marketing a commercial product
2. Preliminary evaluation: After the preliminary evaluation
of the report, the venture capital investor discusses the
investment plan with the banker.
3. Detailed approval: Techno-economic feasibility will be
examined by involving the executives of the VCI & mgmt
professional.
4. Sensitivity analysis: The forecasted results of both sales
and profits are tested and analyzed. The risks and threats
are evaluated, which helps the probable risks and returns
associated with the project.
5. Investment in the project: The terms and conditions of
venture capital assistance are finalized according to the
requirement of the project.
6. Monitoring the project and post investment support: The
venture capital investor closely watches the performance of
the business unit.

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Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

1.4. Stages of venture capital financing

1.0.1.Early stage financing: This stage of financing is done to
initiate the new project or help the new technocrat who
wishes to commercialize his research talents. Going for debt
in this stage increases the risk of the entrepreneur and affects
the health of the business unit. He has to depend mainly on
equity stock so that the risk of repayment doesn’t arise.
i) Seed capital: It includes implementation of the research
project, starting from the all initial stage.
(a) The technology used in the project and possible
threats of new technology in the near future.
(b) Different aspects of the product life cycle.
(c) The total investment required to commercialize the
product and time required to get the suitable return.
ii) Start-up stage financing: The innovator requires finance
to commercialize the product. Patent rights, trade marks,
design and copyrights are very essential to launch the
product effectively.
iii) Second round of financing: It is required when the
project incures loss or shows inability to sufficient profits.
It may be due to internal or external factors.
The original investor may express the inability to further
finance the project or entrepreneur must have lost the
confidence with the original investor or he may wish to broad
base the investment pattern.

1.0.2.Later stage financing: The product launched has not only

reached the boom period but also indicates further expansion
and growth.
i) Mezzanine/development capital: The business have
overcome the extremely high-risk early stage, have
recorded profits for a few years, go for public issue and
raise money

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ii) Bridge/expansion: Expand business by way of growth

of their own productive asset or by acquisition
iii) Buyouts:
(a) Management buyouts: They are provisions of funds
to enable existing management/investors to acquire
an existing product
(b) Management buy-ins: They are funds provided to
enable an outside group buy an ongoing venture

iv) Turnarounds/rescue capital: This means of financing is

risky and the investor may ask for major changes in the
management.

1.5. Valuation methods of venture financing: It is a method

of VCUs which take into account only the starting time of
investment and the exit time
1. The present annual revenue in the beginning is compounded
by an expected annual growth for the holding period, for
computing annual revenue at the time of liquidation
2. The expected earnings level is equal to future earnings level
multiplied by after tax margin percentage
3. The future market valuation is equal to earnings level
multiplied by expected
P/E ratio
4. The present value is obtained by using discount factor.

1.5.1. The first Chicago method: It is a method of valuation

that considers the entire earnings stream of the VCU/
VCI companies
1. 3 alternative scenarios are considered–success, sideways
survival and failure
2. Using discount rate, discounted present value of the VCU
is computed.

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Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

3. Discounted present value is multiplied by respective

probabilities.
Expected present value of the VCU is equal to the 3
scenarios

1.5.2. Revenue multiplier method

Mt = V/R
= (1+r)n*a*p/(1+d)n
V = Present value of VCU
R = annual revenue level
r = expected annual rate of growth of revenue
n = expected no: of yrs from the starting date to exit date
(holding period)
a = expected after-tax profit margin % at the time of exit
p = expected price/earning ratio at exit time
d = appropriate discount rate for a venture investment

1.6. Methods of Venture Financing

1. Equity
2. Conditional Loan
3. Income Note
4. Other Financing Methods
(a) Participating Debentures
(b) Partially Convertible Debentures
(c) Cumulative Convertible Preference Shares
(d) Deferred Shares
(e) Convertible Loan Stock
(f) Special Ordinary Shares
(g) Preferred Ordinary Shares

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5.2. FACTORING
Factoring is an arrangement in which a financial intermediary
called as “factor” which collects the accounts receivables on behalf
of the goods and services. The factor charges a fee that is usually
expressed as a percentage of the total value of the receivables
factored.
FORFAITING: The term “a forfeit” in French means, “relinquish
a right”. It refers to the exporter relinquishing his right to a receivable
due at a future date in exchange for immediate cash payment, at an
agreed discount, passing all risks and responsibilities for collecting
the debt to the forfeiter.
It is the discounting of international trade receivable on a 100%
“Without recourse” basis. “Without recourse “means the client gets
full credit protection and all the components of service, i.e., short-
term finance, administration of sales ledger are available to the client.
Forfeiting transforms the supplier’s credit granted to the importer
into cash transaction for the exporter protecting him completely from
all the risks associated with selling overseas on credit. It effectively
transforms a credit sale into a cash sale.
Factors are usually subsidiaries of banks or private financial
companies, generally, render the following services:
a) purchasing the accounts receivable of the seller for immediate
cash;
b) administering the sales ledger of the seller;
c) collects the accounts receivable;
d) forecasts the losses which may arise due to bad debts;
e) Advisory services to the seller.

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Factoring is an alternative to in-house management of receivables.

2.1. How Factoring works

(a) Seller raises the bill on the customer and issues a notification
that the invoice is assigned to and must be paid to the factor.
(b) Copies of invoice sent to the factor
(c) Factor will provide pre-payment of up to a maximum of 80%
of the total invoice value
(d) Follow up procedure with the customers for realization of
payments due
(e) Balance payment is made on realization of dues
(f) Seller will be informed of factor invoices through monthly
statement of account sent by the factor.

2.2. Types of Factoring

(a) Recourse factoring: the factor purchases the receivables on
the condition that any loss arising out of irrecoverable debts
will be borne by the seller/client.

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(b) Non-recourse or full factoring: the client gets full protection

and all the components of service.
(c) Advance factoring or maturity factoring: no advance or
prepayment is made by the factor. The payment is made to
the client either on a guaranteed payment date or on the
date of collection from the customer.
(d) Invoice discounting: the factor provides a prepayment to
the client against the purchase of account receivables and
collects interest (Service charges) for the period extending
from the date of prepayment to the date of collection. The
administration and collection charges shall be borne by the
client.
(e) Undisclosed factoring: companies of a very high repute
and sound financial base can opt for this type of factoring.
Here, the client’s customers are not notified of the factoring
agreement and they continue to make to the client. The client
bears the responsibility of making payment to the Factor on
the due date, irrespective of realizations from the customers.

2.3 Factoring is not advisable in the following situations

(a) Where sales are made for cash;
(b) In case of speculative business;
(c) For highly specialized capital equipments or goods made-
to-order;
(d) If the credit period is more than 180 days;
(e) In case of “consignment sale” or “sale or return arrangements”;
(f) Sales to associated companies;
(g) Sales are made to public at large.

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Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

2.4 Factoring Vs. Forfeiting

Factoring Factoring
1. 80% of the invoice value is 1. 80% of the invoice value is
considered for advance considered for advance
2. Factor does the credit rating of the 2. Factor does the credit rating of
counterparty in case of non-recourse the counterparty in case of non-
factoring recourse factoring
3. Day to day administration of 3. Day to day administration of
sales and other allied services are sales and other allied services are
provided provided
4. Advances are generally short-term in 4. Advances are generally short-term
nature in nature

5.3. LEASING:
A lease is an agreement whereby the lessor conveys to the lessee
in return for a payment or series of payments the right to use an asset
for an agreed period of time. It may be defined as:
(a) A contractual agreement between the lessor (owner of an asset/
equipment) and the lessee (the user of such asset/equipment);
(b) Which provides a right to the user of the asset, over a certain
agreed period of time?
(c) Against a consideration, lease rentals.

3.1 Definition

The Transfer of Property Act defines a lease as a transaction

in which a party owning the asset provides the asset for use over
a certain period of time to another for consideration either in
the form of periodic rent and/or in the form of down payment.
Lease may also be defined as a contract between two parties
for the hire of a specific asset wherein the lessor retains ownership
of the asset while the lessee has possession and use of the asset
on payment of a specified rental over a period of time.

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Leasing is suitable for financing the investments in productive

equipments and is available to a broad range of business and
other service organizations like: hospitals, educational institutions,
associations and government as well as nongovernment agencies.

3.2 Parties to Lease agreements:

3.2.1 Lessee
Lessees vary widely from the one-person operations to the
Fortune Hundred corporations where diverse equipments
are being leased. Transactions range from a few thousands
worth of equipment (such as fax machines) to crores worth
cogeneration facilities, telecommunications systems, medical
equipment (including CAT scanners and MRI imaging), office
systems, computers, commercial aircraft, and transportation
fleets. There is no end to the types of equipments that
companies lease.

3.2.1.1. Obligations of Lessee

The rights and obligations of a lessee in a lease contract are
many and varied.
Some of them are:
- To use the assets during the lease period in accordance
to the terms and conditions of the lease agreement.
- To put to proper use, operation, maintenance and storage
of the equipment under lease.
- To remit periodically the lease rentals as per the lease
agreement.
- To insure at all times and for an amount equal to the full
insurable value of the asset.
- To return to the lessor the leased asset on the expiration
or earlier termination of the Lease agreement, i.e., in the
event of default by the lessee

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Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

3.2.2 Lessor
Lessor in most cases, are corporate only. There are four basic
types of such companies:
• Banks or bank-affiliated firms;
• Captive leasing companies such as subsidiaries of
equipment manufacturers who lease out their parent’s
products;
• Independent leasing companies, which may be small and
specialized or large and diversified;
• Others, including those investment bankers and
independent brokers/packagers who bring the parties
of a lease together;

3.2.2.1Rights and Obligations of Lessor

The rights and obligations of a lessor in a lease contract are;
- Right of ownership of the leased asset.
- Right to claim depreciation on the asset.
- Right to ensure that the asset is put to fair use and within
the limitations contained in the agreement.
- Right to collect the rentals and other sums payable by
the lessee under agreement.
- Right to sue in case of breach of agreement or any acts
of the lessee which ultra vires the agreement.

3.3. Types of Lease

The following are the different types of Lease agreements.
1. Operating lease: Here the lease period is shorter than the
expected useful life of the equipment. Rental payments
do not cover the equipment cost of the lessor during
the initial lease term. This type of lease is popular for
high-tech equipment, because shorter term leases help
equipment users stay ahead of equipment obsolescence.
The lessor uses its equipment with remarketing expertise

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to subsequently find other users for the returned

equipment, something the typical equipment user does
not have time or ability to do.
2. Finance lease: Here the lease period is longer, more
nearly covering the useful life of the equipment. Rentals
tend to be lower because of the longer term and less
residual value risk.
3. Sale-leaseback: One who purchases the equipment
has the need and uses it for a period of time before
selling it to a lessor. After selling the equipment, one
then lease the equipment. This is another way to free
up ones operating capital. On smaller equipment leases
worth thousands of rupees, leases tend to be more
standardized. Above that cost range-several hundred
thousand into the millions-variations appear more
frequently.
4. Leveraged lease: Under this lease, bigger acquisitions
are made, such as acquiring an airplane. This may include
several customized provisions and options that would
not appear in a typical lease for a smaller amount, thus
leading to flexibility in the product size of the lease.
5. Short Term Lease: These leases are typically for assets
that have high depreciation eligibility like computers,
windmills etc. They are for a period of 2-3 years, and
may be useful to corporate having capital requirements
for products that have high obsolescence, high taxable
income in the near future.
6. Long Term Lease: These are for assets that have low
depreciation eligibility like plant and machinery, cars,
furniture and fixtures etc. and have a long economic life.
Corporate who are interested in leveraging the balance
sheet and have a higher operational profit prefer this
one.

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Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

3.4. Factors determining Lease

As the lessee, the following factors determine the most

effective type of lease for the company. These factors include: the
life of the equipment; what one intend to do with the equipment
at the end of the lease; one’s tax situation; one’s cash flow; and the
company’s specific needs as they relate to future growth. Further,
one’s needs also determine what happens at the end of the lease.
As a lessee, one’s options include: returning the equipment to
the lessor; purchasing the equipment at fair market value or at
a nominal fixed price; or renewing the lease.
In most cases, the lessee selects and orders the equipment
before contacting the lessor. Unless provided for in the lease
agreement, the lessor doesn’t normally provide equipment
warranties which are between the lessee and the manufacturer.
By signing the lease, the lessee assigns its purchase rights to
the lessor, who already owns or who then buys the equipment
as specified by the lessee. When the equipment is delivered,
the lessee formally accepts it and makes sure it meets all
specifications. The lessor pays for the equipment, and the lease
takes effect.

3.5. Merits of Leasing

The following are the merits of leasing. They are:

1. It is flexible: Companies have different needs, different cash
flow patterns, and different yet irregular-streams of income.
For example, start-up companies typically are characterized
by little cash and limited debt lines. Mature companies might
have other needs: to keep debt lines free, to comply with debt
covenants, and to avoid committing to equipment that may
quickly become obsolete. Therefore, business conditions-
cash flow, specific equipment needs, and tax situation–may
help define the terms of lease. Moreover, a lease provides

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the use of equipment for specific periods of time at fixed

rental payments. Therefore, leasing allows flexibility in the
management of equipment.
2. It is practical: By leasing, one transfers the uncertainties and
risks of equipment ownership to the lessor, which allows one
to concentrate on the productive part of the business.
3. It is cost effective: Equipment is costly and some of the costs
are unexpected. When one lease, risk of getting caught with
obsolete equipment is lower because one can upgrade or
add equipment to best meet one’s needs. Further, equipment
needs can change over time due to changes in the company
policy, such as diversification. Sophisticated business
managers have learned that the primary benefits of higher
productivity and profit come from the use of equipment, not
owning it.
4. It has tax advantages: Rather than deal with depreciation
schedules and Alternative Minimum Tax (AMT) problems,
the lessee, simply make the lease payment and deduct it as
a business expense, thus saving a lot in tax. The lessor can
pass on part of the tax benefits to the lessee through reduced
rentals.
5. It helps conserve operating capital. Leasing keeps lines of
credit open, and one need not tie up one’s cash in equity.
Also, one can avoid costly down payments leading to
increased operating capital.
6. It frees working capital for more productive use.
7. It provides 100% funding as opposed to other sources of
capital that usually provide only 60-70 percent.
8. It is simple to negotiate and administer.
9. Most expenses associated with the leased equipment can
be incorporated into the lease and amortized over the lease
period.

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Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

3.6. Advantages to Lessor and Lessee

3.6.1 Advantages to Lessor:
1. Lease improves profitability due to attached tax benefits.
2. As a financing technique, it is more rewarding and
attractive to the lessor.
3. It is flexible and can be opened or closed quickly.
4. It is also one of the marketing strategies for the
manufacturers.
5. Lessee is an additional financial product involving
ownership and risk taking for a reward in terms of
rewards.
3.6.2 Advantages to Lessee:
1. It is flexible and can be adjusted through cash flows.
2. Leasing provides 100% finance for the cost of equipment.
3. Leasing preserves and improves the cash position and
liquidity of the company.
4. It does not change the Debt equity Ratio.
5. It helps in tax planning and provides hedge against
inflation.

5.4. UNDERWRITING
Underwriting: The term underwriting means under taking the
responsibility by a person or firm or an institution that if the shares
or debentures offered to the public for subscription are not fully
subscribed for the underwriter will subscribe for such unsubscribed
shares or debentures. The underwriting is thus in the inadequate
subscription
It is another mode of issuing the securities during the issue, more
particularly this mode of issue is found to be an avenue to off-load
the risk of managing the issue of securities as well as to secure the
issue as fully subscribed

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4.1. Underwriters

Underwriters are the intermediaries in the primary market.

They provide assurance to the companies, which approach
the capital market for raising the financial resources. They
render valuable services to the newly started companies, which
require believable advice. Underwriters assure the company full
subscriptions for a commission
Underwriting is an agreement, entered into by a company
with a financial agency, in order to ensure that the public will
subscribe for the entire issue of shares or debentures made by
the company.
The financial agency is known as the underwriter and it agrees
to buy that part of the company issues which are not subscribed
to by the public in consideration of a specified underwriting
commission.
The underwriting agreement, among others, must provide for
the period during which the agreement is in force, the amount of
underwriting obligations, the period within which the underwriter
has to subscribe to the issue after being intimated by the issuer,
the amount of commission and details of arrangements, if
any, made by the underwriter for fulfilling the underwriting
obligations.
The underwriting commission may not exceed 5 percent
on shares and 2.5 percent in case of debentures. Underwriters
get their commission irrespective of whether they have to buy a
single security or not.

4.2. Benefits of Underwriting

Underwriting has become very important in recent years with

the growth of the corporate sector. It provides several benefits
to a company:-

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Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

1. It relieves the company of the risk and uncertainty of

marketing the securities.
2. Underwriters have an intimate and specialized knowledge of
the capital market. They offer valuable advice to the issuing
company in the preparation of the prospectus, time of
floatation and the price of securities, etc. They also provide
publicity service to the companies which have entered into
underwriting agreements with them.
3. It helps in financing of new enterprises and in the expansion
of the existing projects.
4. It builds up investors’ confidence in the issue of securities.
The association of well-known underwriters lends prestige
to the company and the investors feel that the issue is
sound enough for profitable investment. Also, the securities
underwritten by reputed underwriters receive better response
from the public.
5. The issuing company is assured of the availability of funds.
Important projects are not delayed for want of funds.
6. It facilitates the geographical dispersal of securities because
generally, the underwriters maintain contacts with investors
throughout the country.

4.3. Types of underwriting

• Syndicate Underwriting:-is one in which, two or more
agencies or underwriters jointly underwrite an issue of
securities. Such an arrangement is entered into when the
total issue is beyond the resources of one underwriter or
when he does not want to block up large amount of funds
in one issue.
• Sub-Underwriting:-is one in which an underwriter gets a
part of the issue further underwritten by another agency.
This is done to diffuse the risk involved in underwriting. The
name of every under-writer is mentioned in the prospectus
along with the amount of securities underwritten by him.

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• Firm Underwriting:-is one in which the underwriters apply

for a block of securities. Under it, the underwriters agree
to take up and pay for this block of securities as ordinary
subscribers in addition to their commitment as underwriters.
The underwriter need not take up the whole of the securities
underwritten by him. For example, if the underwriter has
underwritten the entire issue of 5 lakh shares offered by a
company and has in addition applied for 1 lakh shares for
firm allotment. If the public subscribes to the entire issue,
the underwriter would be allotted 1 lakh shares even though
he is not required to take up any of the shares.

4.4. Types of underwriters

Underwriting of capital issues has become very popular due

to the development of the capital market and special financial
institutions. The lead taken by public financial institutions has
encouraged banks, insurance companies and stock brokers to
underwrite on a regular basis. The various types of underwriters
differ in their approach and attitude towards underwriting:-
• Development banks like IFCI, ICICI and IDBI:-they follow an
entirely objective approach. They stress upon the long-term
viability of the enterprise rather than immediate profitability
of the capital issue. They attempt to encourage public
response to new issues of securities.
• Institutional investors like LIC and AXIS:-their underwriting
policy is governed by their investment policy.
• Financial and development corporations:-they also follow an
objective policy while underwriting capital issues.
• Investment and insurance companies and stock-brokers:-
they put primary emphasis on the short term prospects of
the issuing company as they cannot afford to block large
amount of money for long periods of time.

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Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

To act as an underwriter, a certificate of registration must

be obtained from Securities and Exchange Board of India
(SEBI) . The certificate is granted by SEBI under the Securities
and Exchanges Board of India (Underwriters) Regulations,
1993. These regulations deal primarily with issues such as
registration, capital adequacy, obligation and responsibilities
of the underwriters. Under it, an underwriter is required to
enter into a valid agreement with the issuer entity and the said
agreement among other things should define the allocation of
duties and responsibilities between him and the issuer entity.
These regulations have ben further amended by the Securities
and Exchange Board of India (Underwriters) (Amendment)
Regulations, 2006.

4.5. Underwriting is a good technique of marketing the securities.

The importance of under-writing can be adjudged by the
following advantages

1. Assurance of Adequate Finance. Underwriting is a

guarantee given buys the underwriters to take up the whole
issue or remaining shares, not subscribed by public. In the
absence an underwriting agreement, a company may face a
situation where even minimum subscription is not received
and, it will have to go, into liquidation. In case of an existing
company, it may have to postpone its projects for which the
issue was meant. As a result of an underwriting contract, a
company has not to wait till the shares have been subscribed
before entering into the required contracts for purchase of
fixed assets etc. it can go ahead with its plan confidently.
Thus, underwriting agreement assures of the required funds
within a reasonable or agreed time.
2. Benefit of Expert Advice. An incidental advantage of
underwriting is that the issuing company gets the benefit of
expert advice. An underwriter of repute would go into the
soundness of the plan put forward by the company before

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entering into an agreement and suggest changes wherever

necessary, enabling the company to avid certain pitfalls.
3. Increase in Goodwill of the Company. The good
underwriters being men or firms of financial integrity an
established reputation. As we have already explained that
underwriters satisfy themselves with the financial integrity of
the company and viability of the plan, the investors therefore,
run much less risk when they buy shares or debentures
which have been underwritten by them. They assure of the
soundness of eh company. Thus, good underwriters increase
the goodwill of the company.
4. Geographical Dispersion of Securities. Generally, under­
writers maintain working arrangement wit other underwriters
and broken throughout the country and in other countries
too and as such, they are able to tap the financial resources
for the company not only in on particular area but also in
other areas as well. In this way marketability of securities
increases and geographical dispersion of shares and
debentures in promoted.
5. Service to Prospective Buyers. Underwriters render useful
services to the perspective buyers of securities by giving
them expert advice regarding the safe investment in sound
companies. Sometimes they publish information and their
expert opinion in respect of various companies. Thus, they
render useful services to the buyers of securities too.

5.5. CREDIT RATING

Credit rating is an analysis of the credit risks associated with a
financial instrument or a financial entity.
Definition: Credit rating is an analysis of the credit risks
associated with a financial instrument or a financial entity. It is a rating
given to a particular entity based on the credentials and the extent

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Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

to which the financial statements of the entity are sound, in terms of

borrowing and lending that has been done in the past.
Credit rating is the opinion of the rating agency on the relative
ability and willingness of tile issuer of a debt instrument to meet
the debt service obligations as and when they arise. Rating is
usually expressed in alphabetical or alphanumeric symbols. Symbols
are simple and easily understood tool which help the investor
to differentiate between debt instruments on the basis of their
underlying credit quality. Rating companies also publish explanations
for their symbols used as well as the rationale for the ratings assigned
by them, to facilitate deeper understanding.
In other words, the rating is an opinion on the future ability and
legal obligation of the issuer to make timely payments of principal
and interest on a specific fixed income security. The rating measures
the probability that the issuer will default on the security over its
life, which depending on the instrument may be a matter of days to
thirty years or more.
In fact, the credit rating is a symbolic indicator of the current
opinion of the relative capability of the issuer to service its debt
obligation in a timely fashion, with specific reference to the instrument
being rated. It can also be defined as an expression, through use of
symbols, of the opinion about credit quality of the issuer of security/
instrument.

5.1 Functions of a Credit Rating Agency

A credit rating agency serves following functions:

1. Provides unbiased opinion: An independent credit rating
agency is likely to provide an unbiased opinion as to relative
capability of the company to service debt obligations because
of the following reasons:
i. It has no vested interest in an issue unlike brokers,
financial intermediaries.
ii. Its own reputation is at stake.

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2. Provides quality and dependable information:. A credit

rating agency is in a position to provide quality information
on credit risk which is more authenticated and reliable
because:
i. It has highly trained and professional staff who has better
ability to assess risk.
ii. It has access to a lot of information which may not be
publicly available.

3. Provides information at low cost: Most of the investors rely

on the ratings assigned by the ratings agencies while taking
investment decisions. These ratings are published in the
form of reports and are available easily on the payment of
negligible price. It is not possible for the investors to assess
the creditworthiness of the companies on their own.

4. Provide easy to understand information: Rating agencies

first of all gather information, then analyze the same. At last
these interpret and summaries complex information in a
simple and readily understood formal manner. Thus in other
words, information supplied by rating agencies can be easily
understood by the investors. They need not go into details
of the financial statements.

5. Provide basis for investment: An investment rated by a

credit rating enjoys higher confidence from investors.
Investors can make an estimate of the risk and return
associated with a particular rated issue while investing money
in them.

6. Healthy discipline on corporate borrowers: Higher credit

rating to any credit investment enhances corporate image
and builds up goodwill and hence it induces a healthy/
discipline on corporate.

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Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

7. Formation of public policy: Once the debt securities are

rated professionally, it would be easier to formulate public
policy guidelines as to the eligibility of securities to be
included in different kinds of institutional port-folio.

5.2. Rating Agencies in India

The Indian credit rating industry has evolved over a period

of time. Indian credit rating industry mainly comprises of CRISIL,
ICRA, CARE, ONICRA, FITCH & SMERA. CRISIL is the largest
credit rating agency in India, with a market share of greater
than 60%. It is a full service rating agency offering its services in
manufacturing, service, financial and SME sectors. SMERA is the
rating agency exclusively established for rating of SMEs.
5.2.1 CRISIL: CRISIL is the largest credit rating agency in India. It
was established in 1987. The world’s largest rating agency
Standard & Poor’s now holds majority stake in CRISIL. Till
date it has rated more than 5178 SMEs across India and has
issued more than 10,000 SME ratings.
5.2.2. CARE Ratings: Incorporated in 1993, Credit Analysis and
Research Limited (CARE) is a credit rating, research and
advisory committee promoted by Industrial Development
Bank of India (IDBI), Canara Bank, Unit Trust of India (UTI) and
other financial and lending institutions. CARE has completed
over 7,564 rating assignments since its inception in 1993.
5.2.3. ICRA: ICRA was established in 1991 by leading Indian
financial institutions and commercial banks. International
credit rating agency, Moody’s, is the largest shareholder.
ICRA has a dedicated team of professionals for the MSME
sector and has developed a linear scale for MSME sector
which makes the benchmarking with peers easier.

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5.6. OTHER FINANCIAL SERVICES

6.1 NSDL (National Securities Depository Limited)

National Securities Depository Limited (NSDL) is an Indian

central securities depository based in Mumbai. It was established
in 1996 as the first electronic securities depository in India with
national coverage based on a suggestion by a national institution
responsible for the economic development of India.
NSDL, the first and largest depository in India, established
in August 1996 and promoted by institutions of national stature
responsible for economic development of the country has since
established a national infrastructure of international standards that
handles most of the securities held and settled in dematerialized
form in the Indian capital market.
Although India had a vibrant capital market which is more
than a century old, the paper-based settlement of trades caused
substantial problems like bad delivery and delayed transfer of title
till recently. The enactment of Depositories Act in August 1996
paved the way for establishment of NSDL, the first depository in
India. This depository promoted by institutions of national stature
responsible for economic development of the country has since
established a national infrastructure of international standard that
handles most of the trading and settlement in dematerialized
form in Indian capital market.
Using innovative and flexible technology systems, NSDL
works to support the investors and brokers in the capital market
of the country. NSDL aims at ensuring the safety and soundness
of Indian marketplaces by developing settlement solutions that
increase efficiency, minimise risk and reduce costs. At NSDL, we
play a quiet but central role in developing products and services
that will continue to nurture the growing needs of the financial
services industry.

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Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

In the depository system, securities are held in depository

accounts, which is more or less similar to holding funds in bank
accounts. Transfer of ownership of securities is done through
simple account transfers. This method does away with all the risks
and hassles normally associated with paperwork. Consequently,
the cost of transacting in a depository environment is considerably
lower as compared to transacting in certificates.
It has established a national infrastructure using international
standards that handles most of the securities held and settled in
dematerialized form in the Indian capital market.
About NSDL as on June 30, 2014
1. Number of certificates eliminated (Approx.): 1,653 Crore
2. Investor’s Accounts: 1, 31, 16, 821
3. Number of companies in which more than 75% shares are
dematted: 12,531
4. Average number of accounts opened per day since November
1996: 3,573
5. DP Service Centers: 14, 433
6. Presence of Demat account holders in the country: 86% of
all pincodes in the country

6.1.1. History: Although India had a vibrant capital market which

is more than a century old, the paper-based settlement of
trades caused substantial problems such as bad delivery and
delayed transfer of title. The enactment of Depositories Act
in August 1996 paved the way for establishment of National
Securities Depository Limited (NSDL), the first depository
in India. It went on to established infrastructure based on
international standards that handles most of the securities
held and settled in de-materialized form in the Indian capital
markets.
NSDL has stated it aims are to ensuring the safety and
soundness of Indian marketplaces by developing settlement

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solutions that increase efficiency, minimize risk and reduce

costs. NSDL plays a quiet but central role in developing
products and services that will continue to nurture the
growing needs of the financial services industry.
In the depository system, securities are held in depository
accounts, which are similar to holding funds in bank accounts.
Transfer of ownership of securities is done through simple
account transfers. This method does away with all the risks and
hassles normally associated with paperwork. Consequently,
the cost of transacting in a depository environment is
considerably lower as compared to transacting in certificates.
In August 2009, number of Demat accounts held with NSDL
crossed one crore.

6.1.2. Basic Services

Under the provisions of the Depositories Act, NSDL

provides various services to investors and other participants
in the capital market like, clearing members, stock exchanges,
banks and issuers of securities. These include basic
facilities like account maintenance, dematerialization,
dematerialization, settlement of trades through market
transfers, off market transfers & inter-depository transfers,
distribution of non-cash corporate actions and nomination/
transmission.
The depository system, which links the issuers, depository
participants (DPs), NSDL and Clearing Corporation/Clearing
house of stock exchanges, facilitates holding of securities
in dematerialized form and effects transfers by means of
account transfers. This system which facilitates scripless
trading offers various direct and indirect services to the
market participants.

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Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

1. Account Maintenance: To avail of the various services

offered by NSDL an investor/a broker/an approved
intermediary (for lending & borrowing) has to open a
NSDL depository account with any of its DPs.
2. Dematerialization: Dematerialization is the process by
which a client can get physical certificates converted into
electronic balances.
3. Re-materialization: Re-materialization is the process by
which a client can get his electronic holdings converted
into physical certificates. The client has to submit the re-
materialisation request to the DP with whom he has an
account. The DP enters the request in its system which
blocks the client’s holdings to that extent automatically.
The DP releases the request to NSDL and sends the
request form to the Issuer/R&T agent. The Issuer/R&T
agent then prints the certificates, despatches the same
to the client and simultaneously electronically confirms
the acceptance of the request to NSDL. Thereafter, the
client’s blocked balances are debited.
4. Market Transfers:Trading in dematerialised securities is
quite similar to trading in physical securities. The major
difference is that at the time of settlement, instead of
delivery/receipt of securities in the physical form, the
same is affected through account transfers.
5. Off-Market Transfers: Trading in dematerialised
securities is quite similar to trading in physical securities.
The major difference is that at the time of settlement,
instead of delivery/receipt of securities in the physical
form, the same is affected through account transfers.
6. Inter-Depository Transfers: Transfer of securities from
an account in one depository to an account in another
depository is termed as an inter-depository transfer. This

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facility is quite similar to the account transfers within

NSDL.
7. Transmission:One of the lesser-known but widely
experienced problems with respect to dealing in share
certificates is transmission of shares. The Companies
Act distinguishes transmission of shares from transfer
of shares. While transfer of shares relates to a voluntary
act of the shareholder, transmission is brought about
by operation of law. The word ‘transmission’ means
devolution of title to shares otherwise than by transfer,
for example, devolution by death, succession, inheritance,
bankruptcy, marriage, etc. While transfer of shares
is brought about by delivery of a proper instrument
of transfer (viz, transfer deed) duly stamped and
executed, transmission of shares is done by forwarding
the necessary documents (such as a notarised copy
of death certificate) to the company. On registration
of the transmission of shares, the person entitled to
transmission of shares becomes the shareholder of the
company and is entitled to all rights and subject to all
liabilities as such shareholder.
8. Corporate Actions: Corporate actions are benefits
given by a company to its investors. These may be
either monetary benefits like dividend, interest or non-
monetary benefits like bonus, rights, etc. NSDL facilitates
distribution of corporate benefits.

6.1.3. Value Added Services:

Depository is a facility for holding securities electronically

in which securities transactions are processed by book entry.
In addition to the core services of electronic custody and
trade settlement services, NSDL provides special services

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Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

like pledge, hypothecation of securities, automatic delivery

of securities to clearing corporations, distribution of cash and
non-cash corporate benefits (Bonus, Rights, IPOs etc.), stock
lending, demits of NSC/KVP, demits of warehouse receipts
and Internet-based services such as SPEED-e and IDeAS.
NSDL has also set-up a facility that enables brokers to
deliver contract notes to custodians and/or fund managers
electronically. This facility called STEADY (Securities Trading-
information Easy Access and DeliverY) was launched by NSDL
on November 30, 2002.STEADY is a means of transmitting
digitally signed trade information with encryption across
market participants electronically, through Internet.
1. Automatic Delivery Out Instructions (Auto DOs):
Delivery-out instructions for moving securities from CM
Pool Account to CM Delivery Account can be generated
automatically by the respective Clearing Corporations
based on the net delivery obligations of its Clearing
Members. The Clearing Corporation can generate
Auto DOs on behalf of those Clearing Members who
have authorised it in this regard. The Auto DOs will be
generated around the time of download of the delivery
obligations to the Clearing Members. Such Clearing
Members will not be required to give delivery-out
instruction forms to the Participants for Pay-in to the
Clearing Corporation in respect of the automatically
generated DOs. The Clearing Members can know the
Auto DOs either by way of download from the Clearing
Corporation or through the Auto DO Report from the
Participants or from SPEED facility on Internet
2. Dividend Distribution: At present, NSDL merely
facilitates distribution of cash corporate benefits like
dividend etc., to shareholders. Details in respect of all

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beneficial owners of the security as on the record date

of the concerned company are provided by NSDL to the
company/its registrar and share transfer agent (R & T
agent). Thereafter, the company/R & T agent dispatches
dividend entitlements to the eligible beneficial owners
in the same way as is done for shareholders holding
physical certificates.
NSDL intends to extend the service of distributing cash
benefits directly to beneficial owners. On a pilot basis
NSDL had extended the dividend distribution service to
shareholders of certain companies. Keeping in view this
successful experiment, NSDL, in future, may consider
extending this service to other issuers too who have
joined the NSDL depository system.
3. Stock Lending and Borrowing: The transactions
involving lending and borrowing of securities are
executed through approved intermediaries duly
registered with SEBI under the Securities Lending
Scheme, 1997. Such an intermediary may deal in the
depository system only through a special account
(known as Intermediary Account) opened with a DP. An
intermediary account may be opened with the DP only
after the intermediary has obtained SEBI approval and
registered itself with SEBI under the Securities Lending
Scheme. The intermediary has also to obtain approval
of NSDL
4. Pledge/Hypothecation: Securities held in a depository
account can be pledged/hypothecated to avail of loan/
credit facility. Pledge of securities in NSDL depository
requires that both the borrower (pledger) and the lender
(pledgee) should have account in NSDL depository.

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Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

5. Public Issues: Investors have an option to seek allotment

of public issues in electronic form. As per SEBI guidelines
trades in shares issued through public issue shall be
settled only in demat form. Therefore, it is advisable that
investors seek allotment in demat form.

6.2. STCI Finance Ltd. (formerly known as Securities Trading

Corporation of India Limited), is a systemically important
non-deposit taking NBFC registered with Reserve Bank of
India. Presently STCI Finance Ltd is classified as a loan NBFC.

STCI Finance Limited was promoted by Reserve Bank of India

in May 1994 with the objective of fostering an active secondary
market in Government of India Securities and Public Sector bonds.
The Company had a subscribed and paid up capital of Rs 500
crores with RBI owning the majority stake of 50.18%. In 1996, STCI
was authorized by RBI as one of the first Primary Dealers in India.
As the leading Primary Dealer in the country, the Company
was a market maker in government securities, corporate
bonds and money market instruments apart from carrying out
proprietary trading in equity both in the cash & derivatives (F&O)
segment. The Company’s other lines of activities included trading
in interest rate swaps-both for hedging and market making. The
Company enjoyed a successful track record of achieving profits
during consecutive years spanning nearly a decade. It had the
distinction of achieving secondary market turnover of more than
Rs.2.00 lakh crore in sovereign paper.
RBI divested its entire shareholding in STCI in two stages-first
in 1997 to bring it down from 50.18% to 14.41% and the balance
in 2002 to the existing shareholders. Bank of India became the
largest shareholder in the company.

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In April 2006, the STCI took over UTI Securities Limited from
Specified Undertaking of Unit Trust of India (SUUTI). The Company
hived off Primary Dealership as a separate 100% subsidiary by
the name of STCI Primary Dealer Limited (STCI-PD) which started
functioning from June 25, 2007.
The Company sold off its stake in UTI Securities Limited
to Standard Chartered Bank (Mauritius) limited in three stages
between 2008 and 2010. STCI assumed 100% stake in UTI
Commodities, a commodity broking entity (later known as STCI
Commodities Ltd) which was wholly owned by UTI Securities.
Since 2007, the Company has been undertaking lending and
investment activities as a Systemically Important-Non Deposit
taking Non Banking Financial Company (NBFC-ND-SI) with main
focus on lending and financing activities. Over a period of time,
the size of the Company’s loan book has grown and lending/
financing activity has become its core business. With a view
to reflecting the widening mix of its business, the name of the
Company has been changed from Securities Trading Corporation
of India Limited to ‘STCI Finance Limited’ with effect from
October 24, 2011.
Subsidiaries:
a. STCI Primary Dealer Limited (STCI PD): This company
is a wholly owned subsidiary of STCI Finance Limited
established in October 2006 consequent to the hiving off of
the Company’s primary dealership business in line with the
Reserve Bank of India guidelines on diversification of business
activities by primary dealers. The Company commenced its
operations with effect from June 25, 2007 and undertakes
trading in government securities, corporate bonds, money
market instruments, interest rate swaps and trading in
equity (both cash and F&O). The Company also undertakes
fee based activities of Portfolio Management Services and
Mutual Fund Distribution.

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

b. STCI Commodities Limited: This is a wholly owned

subsidiary of STCI Finance Limited which provides brokerage,
investment and advisory services in Indian Commodities
Markets. The Company is a member of two of India’s largest
online Commodities exchanges namely MCX and NCDEX in
addition to membership in NCDEX Spot Exchange. Recently,
the parent Company has taken a policy decision to exit the
commodity broking business by sale of this subsidiary.

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 AUTHORS PROFILE

MR. RAHUL B. CHAUHAN (1993),

M.B.A., M.Com., P.HD,(Pursuing), Hon. Dr..
Assistant Professor,
Department of Management,
Parul Institute of Business Administration,
Parul University, Baroda, Gujarat

He has done his MBA in finance from the Parul Institute of

Management and Research, Baroda in June 2015 and also has done
M.com in Finance from Saurashtra University, Rajkot. Currently he is
Pursuing Doctoral of Philosophy from Gujarat Technological University,
on the topic Related to Assets Allocation and Portfolio Management.
He received Honorary Doctorate degree on Management in June-

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

2021 from Yesbud University, Zambia. He is having total 7 years

teaching experience. He is Editorial Board member in 19 International
journal including Scopus and UGC Care Listed. He wrote 69 research
papers as an author/co-author and also presented in national and
international conferences and his 69 research paper published
in various national and international journals, out of it 31 paper
published in Scopus indexed Journal. He is Co-author in two books,
subject of “Forms of Business Organization”, of FY BBA Sem. 1 in
Saurashtra University and in “IT Tools of Business” FY BBA Sem. 2 also
his one book published in Lambert Publication, Germany related to
the subject of Marketing Management. His total 7 books published
(5 National level and 2 International level).
His research interests are focused on financial management,
banking, education, economics, financial system, financial services,
with the current situation. Mr R. Chauhan was also awarded the best
paper presentation in the conference at Udaipur, Rajasthan in the
year 2016 and Received Best Academic Performance Award-2019
from Parul Institute of Business Administration, Parul University and
also receive Research Excellence award-2021 from Parul University,
he has received 14 more national and international awards from
other government recognized bodies. He was invited as a technical
Session chairman in national conference in Netaji Subhas University-
Jamshedpur, Jharkhand on 21st September, 2019. He was invited
as a resource person in national conference on the topic of Recent
& innovation practice in higher education, organized by Ashoka
International Foundation-Nasik, Maharashtra, on 14th December,
2019. He was also invited as a guest of honor in international
conference at Mumbai on 3rd and 4th February, 2020.

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 Indian Financial SystemCMA.

ANDINO MASELENO, S.T., M.Eng., Ph.D.

Assistant Professor,
Department of Information System,
Institute of Technology and Business Bakti Nusantara
Lampung-Indoneisa

Born in Tanjungkarang on February 7, 1981. He completed his

studies and received a Bachelor’s degree (S1) in Engineering in 2005
from UPN “Veteran” Yogyakarta. He then continued his study (S2) in
the Master of Engineering program in 2009 at Gadjah Mada University
(UGM) Yogyakarta and received a Doctoral Studies (Ph.D) scholarship
in computer science at the Universiti Brunei Darussalam (UBD), Brunei
Darussalam in 2015. He is active in International publications and is
also active in international conferences and workshops as a keynote
speaker. He also wrote several papers published in Scopus indexed
Journal and wrote several books in technology Information System
area.

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 Rahul B. Chauhan, MBA., M.Com., PhD, Andino Maseleno, S.T., M.Eng., Ph.D dan
Dr. Fauzi, S.E., M.Kom, M.E, Akt., CA., CMA.

Dr. FAUZI, S.E., M. Kom., M.E., Akt. CA., CMA.

Associate Professor (Asoc. Prof)
Department of Information System,
Institute of Technology and Business Bakti Nusantara
Lampung-Indonesia

Born in Palembang, on October 26, 1970. He graduated Bachelor’s

degree (S-l) in Accounting from STIE Lampung, he is also done a
magister (S-2) from STTI Benarif Jakarta, and recently also done
magister in economics (S-2) from UIN Raden Intan Lampung. He
took a doctoral degree (S-3) from Gajah Mada University. Several
certificated studies in Profession of Accountant (Akt) from University
of Lampung and took the Certified Accountant (CA) and Management
Accountant (CMA).
In addition, he was being an active role in the world of education
in the Lampung region. The author has written several books, and
he is also actively writing in several reputable international scientific
journals in the field of Economics and Business and the Field of
Computer Technology, both as First author and Co-Author. Currently,
the author is also active as a resource person at various National
and International scientific meetings in the fields of Economics,

160
 Indian Financial SystemCMA.

Business, and other fields of science related to business technology.

In addition to producing scientific works, he is also active in various
Lecturer professional organizations such as the Indonesian Institute
of Accountants (IAI), APTIKOM Lampung, Management of the
Association of Experts and Lecturers of the Republic of Indonesia
(ADRI) Lampung, Association of Indonesian Private Universities
(APTISI) Region II-B Lampung and head of KAFEGAMA Lampung
organization. In addition, the author is also an active reviewer in
various national scientific journals in the fields of Economics, Business,
Management, and Accounting.

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