FINANCIAL INSTITUTIONS

Module 4
Financial Institutions
• A financial institution is an organization which
makes the smooth operation of the financial
system possible.
• The Financial Institutions act as a mediator
between the investor and the borrower.
• Financial institutions bring together lenders
and borrowers through offering various
financial instruments.
 Types of financial institutions
• Banking institutions
• Commercial Banks
• Co-operative banks
• Developmental Financial institutions
• IDBI, IFCI, SFCs, ICICI, UTI, SIDBI, Mudra Bank etc.
• Non-banking Institutions
• Loan companies
• Mutual funds
• Insurance Companies
• Lease financing companies
• Factor
• Venture capital etc.
Types of Banking Institutions
(Functional Classification)
1. Commercial banks/Deposit banks
• Commercial banks are banks that accepts deposits on
various a/cs and lend funds to trade / commerce /
industries / small business / agriculture etc., by way of
loans/ODs/CCs
• It consist of Scheduled and Non-scheduled banks.
• It perform many subsidiary functions such as agency
services, general utility services, innovative services etc.
• It include public sector banks, private sector banks and
foreign banks
 2. Co-operative banks
• A co-operative bank is a small-sized, financial entity, where
its members are the owners and customers of the Bank.
• It is registered under the Cooperative Societies Act of 1912
or concerned state co-operative acts.
• It consist of both scheduled and non-scheduled banks.
Scheduled banks are regulated by RBI
• The structure of cooperative network in India can be
divided into 2 broad segments- Urban Cooperative Banks &
Rural Cooperatives.
Functions of Commercial Banks

•Principal/primary/fundamental Functions
•Subsidiary/secondary/
supplementary Functions
•Innovative Functions/ Modern functions
Principal functions
• Two ‘acid test’ functions of commercial banks are
• Accepting deposits and
• Lending or advancing loans
Other basic functions are
❑Credit creation,
❑Promotion of cheque system(cashless system) and
other payment systems
❑Investment in securities
Secondary/ Subsidiary Functions of
Commercial Banks

•Agency Services
•General Utility
services
 Agency services
• Execution of standing orders (To
• Collection of credit pay inurance premium, rent etc)
instruments(Cheques, drafts, bill
of exchange, promissory notes • Purchase and sale of securites
etc on behalf of customers) • Act as representative/c
• Collection of dividend (On behalf orrespondent
of customers) • Prepare IT return, correspondence
with IT authorities
• Act as a trustee/executer
• Deals foreign exchange (Buy and
• Undertake management of sell foreign exchange on behalf of
money and property customers)
• Act as trustee or executer after
death
General Utility Services
• Safe custody of valuables • Supply information about the
(Locker facility) financial standing of their customers
• Issue letter of credit (On on enquiries made by other
request of importer) businessmen
• Issue travellers' cheque • Underwrite shares and debentures
• Enable tourists to get fund in • Collection of statistics
all places In relation with industry, commerce
• Provide information – about etc.
merchants and business • Deals in foreign currencies
• Act as referees
Innovative Functions
• Automated Teller Machine
• Cash Deposit Machine
• Core banking
• Debit cards
• Credit cards
• Tele-banking
• Online banking
• Mobile banking
• Electronic Fund transfer (NEFT/RTGS/IMPS)
• Electronic clearing services
Development Banking
 Developmental Financial Institutions
(Development Banks)
• These are institutions that provide medium term and long
term financial assistance to industry, agriculture and other
key areas.
• They are responsible for the promotion and development of
industrial, agricultural and service sectors.
• They are generally promoted or assisted by the Government.
• They are classified into two categories
• All India Financial institutions
• State level institutions
Objectives and functions of Developmental
Institutions
• Promote and develop industrial, agricultural and service sectors
• Promote and develop MSME (micro, small, & medium enterprises)
• Promote and develop housing sector in India
• Enhance foreign trade of India
• Provide medium term and long term loans to industries, agriculture,
service sectors and other key sectors.
• Balanced regional development
• Underwrite shares and debentures
• Guaranteeing for loans
• Provide technical assistance
• Contribute to the growth of capital market
 Industrial Development Bank of India (IDBI)
• established in July 01, 1964 under the act of parliament as a subsidiary
of RBI
• It was the apex institution which finance, promote and develop
industries in India.
• In 1976, ownership passed to Government and became an autonomous
body.
• To keep up with reforms in financial sector, IDBI reshaped its role from a
development finance institution to a commercial institution
• It became IDBI ltd October 01, 2004.
• Converted into a commercial bank (Public sector) in 2005
• In 2019, 51% of the share acquired by LIC from the Government and
hence notified as a Private sector commercial bank by RBI
Industrial Finance Corporation ofIndia (IFCI)
• Established in 1948 under an Act of Parliament (IFCI Act
1948) Amended in 1960, 1973 & 1986
• The first Development Financial Institution in the country
• Cater to the long-term finance needs of the industrial sector
• Converted to Joint-Stock Company 1993 & renamed as IFCI
Ltd.
• Products and services include Financial Products, Project
Development, Corporate Advisory services etc.
Objectives of IFCI

• The main objective of IFCI is to provide medium-

and long-term financial assistance to large scale
industrial undertakings, particularly when
- ordinary bank accommodation does not suit
the undertaking or
- finance cannot be profitably raised by the
concern by the issue of shares.
Functions of IFCI
• The corporation grants loans and advances to industrial
concerns.
• Granting of loans both in rupees and foreign currencies.
• The corporation underwrites the issue of stocks, bonds,
shares etc.
• The corporation can grant loans only to public limited
companies and co-operatives but not to private limited
companies or partnership firms.
• Guaranteeing loan
• Underwriting shares and debentures
• Provide technical consultancy
Industrial Credit and Investment Corporation
of India (ICICI)
• ICICI was established in 1955 as a developmental financial
institution & a public limited company.
• Incorporated to finance small and medium industries in the
private sector.
• ICICI Bank was established in 1994.
• In march 2002, ICICI merged with ICICI Bank and became first
universal bank in India. (ICICI personal finance services &
ICICI capital services Ltd also merged with ICICI Bank)
National Bank for Agriculture and Rural
Development (NBARD)
• National Bank for Agriculture and Rural Development (NABARD)
was established on July 12, 1982
• It is the apex banking institution to provide finance for
Agriculture and rural development.
• It is an apex institution in rural credit structure for providing
credit for promotion of agriculture, small scale industries,
cottage and village industries, handicrafts etc.
 Functions of NABARD
• Act as an apex institution for agriculture and rural
development
• Refinance agricultural and rural credit by financial
institutions
• Loans to state government for development of rural
infrastructure
• Direct lending
• Credit planning and monitoring for rural areas
• Assist in policy formulation of Government & RBI
• Support to research and rural innovations
• Co-ordinate the operations of rural credit agencies
Small Industries Development Bank of India
(SIDBI)
• Set up on April 2, 1990 under an Act of Indian Parliament
• Acts as the Principal Financial Institution for the Promotion, Financing
and Development of the Micro, Small and Medium Enterprise
(MSME) sector and for Co-ordination of the functions of the
institutions engaged in similar activities.
• The objectives of SIDBI are Financing, Promotion, Development and
Co-ordination.
• Established as a wholly owned subsidary of IDBI
• Currently the ownership is held by 34 Government of India owned /
controlled institutions
Functions of SIDBI
• Refinances loans that are extended to the small-scale industrial units
• Discounts and rediscounts bills.
• Helps in expanding marketing channels for the products of MSME
• Offers services like factoring, leasing etc. to MSME
• Promotes employment-oriented industries particularly in semi-urban
areas
• Initiate modernization and technological up-gradation of MSME units.
• Support services
Micro Units Development and Refinance
Agency Bank (MUDRA Bank)
• Public sector non-banking financial institution in India
• Launched on 8th April 2015 under Pradhan Mantri MUDRA Yojana
scheme.
• Provides soft loans to small manufacturing units, shopkeepers, fruit
and vegetable vendors, artisans, repair shops, service firms etc.
• It is a refinance agency.
• Headquarters is in Mumbai.
• Loans upto 10 lakhs
• Loan is provided through commercial banks, RRBs,
small finance banks, co-operative banks, NBFCs and
MFIs.
• Mudra has created 3 products, Shishu, Kishore and
Tarun.
Shishu – Covering loans upto ₹50,000
Kishore – Loans above ₹50,000 – upto ₹5 Lakh
Tarun – Loans above ₹5 lakhs up to ₹10 lakhs
Export Import Bank of India
• Public sector institution set up in January 1982
• It is an export finance and development
institution of the country
• It act as an apex institution responsible for
assisting and supporting institutions engaged in
the field of foreign trade in India
Objectives and Functions of EXIM Bank
• Promote foreign trade in India
• Co-ordinating other institutions engaged in export finance
• Financial assistance to exporters and importers
• Offer limited merchant banking activities
• Technical assistance to firms engaged in foreign trade
• Globalization of Indian business
National Housing Bank (NHB)

•Started functioning in 1988

•Wholly owned by RBI
•Apex institution in the areas of housing
finance
•Principal agency to promote housing finance
institutions in India
Objectives and Functions of NHB
• Promote and develop specialized housing finance
institutions
• Extent re-finance facilities to housing finance institutions
• Provide guarantee to housing finance
• Extent credit for housing
• Provide guidelines to housing finance institutions
• Technical and administrative assistance to housing finance
institutions
State Financial Corporations
• In order to provide medium and long term credit to industrial
undertakings, State financial Corporations Act 1951 was passed
in the parliament to start State Level Financial Corporations.
• The shares are subscribed by the State Government, RBI,
Commercial Banks, Co-operative banks, other financial
institutions and the public.
• The First State Financial Corporation was set up in Punjab in the
year 1953
• There are 18 SFCs in India including Kerala Financial Corporation
(KFC)
Functions of SFCs
• The SFCs grant loans mainly for acquisition of fixed assets like land,
building, plant and machinery.
• The SFCs provide financial assistance to industrial units whose paid-
up capital and reserves do not exceed Rs. 3 crore (or such higher limit
up to Rs. 30 crore as may be specified by the central government).
• The SFCs underwrite new stocks, shares, debentures etc., of industrial
concerns.
• The SFCs guarantee loans raised by industrial concerns from
commercial banks and cooperative banks repayable within a period of
20 years.
 PART II
NON-BANKING FINANCIAL
INSTITUTIONS
 NBFC
• Non banking financial institution is a company that offer
bank related financial and other services without
holding a banking license.
• They are companies registered under Companies Act.
• Section 45 I (c) of RBI Act 1934: A company engaged in
the business of
• Loans and advances
• Acquisition of securities
• Leasing and hire purchase
• Insurance business
• Chit business etc.
 Features of NBFC
• NBFCs are engaged in various businesses such as lending,
investment, housing finance, insurance, factoring etc.
• Some NBFCs Provide banking services without holding bank
license
• NBFC cannot accept demand deposit
• NBFC cannot participate in the payment and settlement system
• NBFC cannot issue cheque drawn on itself
• Deposit insurance (DICGC) is not available for NBFC
• NBFCs are registered under companies act
• Their principal business cannot be any agriculture activity,
industrial activity or sale, purchase or construction of immovable
property
• FDI is allowed up to 100%
CLASSIFICATION ON THE BASIS
OF REGULATIVE FRAMEWORK
(Modern Classification)
 Regulated by RBI
1. Asset Finance Companies(AFCs),
2. Loan Companies(LCs),
3. Investment Companies (ICs),
4. Infrastructure Finance Companies(IFCs),
5. Core Investment Companies(CICs),
6. Infrastructure Debt Funds (IDF-NBFCs),
7. NBFC-Microfinance Institutions (NBFC-MFIs),
8. Factoring companies(FCs),
9. Mortgage Guarantee Companies (MGCs) and
10. Residuary Non- Banking Companies(RNBCs).
Main Types of NBFCs
Factors (NBFC-Factors):
• NBFC-Factor is a non-deposit taking NBFC engaged in
the principal business of factoring
• A factor is a financial intermediary that purchases
receivables from a company for commission or fee.
• .The financial assets and income in the factoring
business should constitute at least 50 percent of its
total assets / income.
• SBI is the first bank in India started factoring business.
Factoring Vs Forfaiting
Factoring Forfaiting
• Financing receivables • Financing receivables in
export/import
• Trade receivables on ordinary • Trade receivables on capital
goods goods
• Not 100% finance (80-90) • 100% finance
• No secondary market • Secondary market
• Recourse or non-recourse • Non-recourse (The company has
no liability with any uncollected
invoices)
 Example
• Assume a factor has agreed to purchase an invoice of ₹1
crore from Clothing Manufacturers Inc., representing
outstanding receivables from Behemoth Co.
• The factor may discount the invoice by say 4%, and will
advance ₹7,20,000 to Clothing Manufacturers Inc. The
balance of ₹2,40,000 will be forwarded by the factor to
Clothing Manufacturers Inc. upon receipt of the ₹1 crore
from Behemoth Co.
• The factor's fees and commissions from this factoring deal
amount to ₹40,000.
Regulated by SEBI
Merchant Banking Companies:
• Ministry of Finance notified merchant banking as “any person who is
engaged in the business of issue management either by making
arrangement regarding selling, buying or subscribing to the securities
as manager, consultant, advisor in relation to such an issue
management”
• Many Indian banks (ICCI, SBI, PNB) have merchant banking divisions.
• Eg. SBI Capital markets Ltd, ICICI securities Ltd, Bajaj capital Ltd,
Reliance securities Ltd.
Services provided by merchant bankers
• Project counselling
• Management of IPO & FPO
• Managers, consultants and advisors to the issue
• Underwriting of public issue
• Portfolio management
• Offshore finance
• Non-resident investment
• Loan syndication
• Corporate counselling
Venture Capital Fund Company
• It is a financial institution which provide capital fund to risky projects
of business firms.
• Regulated by Venture Capital fund regulation 1996 of the SEBI.
• Venture capital fund is invested as equity shares and not as any type
of loan.
• Venture capital fund is a private equity capital provided as seed
funding at early stages of companies with high growth potential.
• Apart from capital, VCFC provide technical and managerial expertise.
• Eg. Accel partners, Blume ventures, Brain capital
 Stages in venture capital financing
• Pre-seed capital- it provides the initial funding necessary to launch a
business. money raised in pre-seed funding stage are used for market
research and development of ideas
• Seed capital – It provides funding for hiring of developers, product
development etc.
• Series A – It provide funding to help startups grow and expand their
operations. Funds may be used for aggressive marketing, further
research etc.
• Series B- Series B funding usually involves a larger investment from
venture capital. Fund may be used to expand market, hire additional
staff, new product development, diversification etc.
• Series C – Series C funding is available to those successful business
firms who have established a good customer base. The funds may be
utilized for hiring data scientists, partnering with other companies,
development of new technologies, acquisition of supporting firms etc.
SEBI Regulations
•Venture capital fund should be established in
the form a trust, company, or a body corporate.
•It should be registered with SEBI
•Venture capital funds can be invested in those
companies whose shares are not listed on a
stock exchange.
•Minimum investment would not be less than 5
lakhs.
 Stock Broking
• Stock broker is an NBFC which helps investors to buy and sell
securities through a stock exchange.
• A broker is a registered member of the stock exchange and
SEBI.
• Individual investors need to place orders only through their
registered stock broker.
• A stock broker may also be a Depository participant. (For details
see – Capital Market)
• Two types of brokers are full service brokers and discount
brokers.
 Collective investment schemes
(Section 11AA , sub-section (2) of SEBI Act)
• Any scheme offered by a company under which the
contributions of investors are pooled, managed and invested
with a view to receive profit, income or other gains.
• Collective Investment Management Company is an NBFC
incorporated under Companies Act and registered with SEBI.
• It is not a deposit, insurance contract, pension scheme or
chit fund.
• Investors do not have day to day control over the
management of the scheme.
 PENSION FUND
• Pension fund is a fund from which pensions are paid,
accumulated from contributions from employers,
employees, or both.
• It is also called superannuation fund
• It provides income after retirement
• Two types of pension funds are
• Defined benefit fund (guaranteed fixed income)
• Defined contribution fund (income depends on the
performance of the fund)
• Pension plans have two stages
• Accumulation stage (pay regular premium or
contributions)
• Vesting stage –retiree will start receiving pension or
annuities
• Tax deduction is allowed under section 80 ccc up to
1.5 lakhs for contribution.
• Withdrawals are not tax free. Only one-third of the
corpus that is distributed to the retiree (soon after
reaching the retirement age) by the pension plan is
tax-free.
Types of pension plans available in India
• Plans sponsored by insurance companies
• Invest in debt
• Defined benefit
• Unit linked
• Invest in debt and equity
• National Pension system
• Atal Pension Yojana
• Provident fund (Employee Provident fund, Voluntary
Provident Fund, Public Provident Fund etc (PPF: 500 to 1.5
lakh in an year)
MUTUAL FUND
 Mutual Fund
• Mutual fund is a professionally managed type of collective investment
scheme
• Common pool of funds contributed by investors and invested in
accordance to the scheme objectives.
• It pools money from many investors and invests in stock, bonds, short-
term money market instruments etc.
• In India, mutual funds are regulated by Mutual fund regulation of SEBI
1996.
• However, Mutual funds investing money market has to comply with both
RBI and SEBI requirement.
• NFO
• New Fund Offer : The launch of a new mutual fund scheme
 Structure of Mutual fund in India
• As per SEBI mutual fund regulation 1996, a mutual fund must be in a 3
tiered structure.

Sponsor (First Tier) - A company or bank

Public Trust (2nd Tier)

Asset Management Company (3rd Tier)

(Mututal fund)
• Investments are held in a trust of which the investors alone
are the joint beneficial owners.
• Trustees oversee the management through investment
managers.
• Custodian is the bank or company that maintains a mutual
fund's assets, including its portfolio of securities or some
record of them.
• Fund manager makes all the decisions pertaining to the
purchase and sale of these securities. They are
professionals who know the markets and conduct the large
amount of research and analysis done before investments
are made.
Net Asset Value (NAV)
• A mutual fund's price per unit
• It is calculated by dividing the total value of all the securities in its
portfolio, less any liabilities, by the number of units outstanding.
• NAV = Value of Net Asset
Outstanding Number of Units
• NAV per share is computed once a day based on the closing market
prices of the securities
 Classification of Mutual Funds

Classification of Mutual Funds

Based on Investment Based on

Based on Structure
Objective Investment Style

Open Ended
Debt Funds Passive Funds
Funds

Closed Ended
Equity Funds Active Funds
Funds

Interval Funds Hybrid Funds

Open Ended Funds: These are funds that can be
bought and sold at any time at its current NAV.
Closed ended funds: These are funds that can be
bought only on NFO period and the selling is
allowed after a stipulated period.
Interval funds: These are funds having the
common feature of open ended and close ended.
These are closed ended but becomes open-ended
at specific intervals.
Debt funds: These are funds that invest in
debt instrument such as debenture, bonds,
treasury bills etc. These are low risk funds.
Equity funds: These are funds that invest in
equity shares of companies. These are high
risky funds.
Hybrid funds: These are funds that invest in
both equity and debt instruments.
Passive funds: These are funds that
invest in those securities which are
included in benchmark stock indices.
Active funds: These are funds that
invest in all securities that may offer
a better return than stock indices
Other types

•Solution Oriented Schemes

• Children Education Fund
• Retirement fund
•Other schemes
• Overseas fund
• Fund of fund etc.
Equity Linked Saving Scheme (ELSS)

•Equity schemes where investors get tax

benefits up to Rs. 1.5 Lakh under section 80
C of the Income Tax Act
•Lock in period of three years
•Can be invested as SIP also.
 Investment Modes in Mutual Funds

•One time investment.

Lump-sum •Usually, large sum of money is invested
Investment in one go.
•Investor faces risk of volatility in markets.

Systematic •Regular Investment in specific intervals

Investment such monthly, quarterly, half-yearly.
•Made on specific dates e.g. 1st, 5th, 10th,
Plan (SIP) 15th of every month.
Systematic Investment Plan (SIP)
• Smart mode for investing money in mutual fund.
• Invest a certain pre-determined amount at a regular
interval.
• Helps to invest in stock market without wrestling with
the market mood.
• Minimum investment of rs.500 & in multiples of
hundred. (Some private mutual funds allow 50 rupees
onwards)
• Like a recurring deposit
 Association of Mutual Funds in India (AMFI)
• It is an association of SEBI registered mutual funds
in India
• Incorporated in 1995 as a non-profit organisation
• It is an industry standard organisation working for
the development of mutual fund business by
improving ethical and professional standards.
• Now (Jan 2023) 42 Asset Management Companies
are members.
Systematic Transfer Plan (STP)
•A systematic Transfer Plan is an
automated way of transferring funds
from one mutual fund scheme to
another.
•It is usually preferred by investors who
have a lump sum amount saved but
want to avoid market timing.
Systematic Withdrawal Plan (SWP)

• A Systematic Withdrawal Plan (SWP) is a

facility that allows an investor to withdraw
money from an existing mutual fund at
predetermined intervals.
• SWP helps investors to create a regular flow
of income from their investments.
 Advntages/Benefits of mutual funds
•Professional Management: Mutual funds are
managed by professional people and
experienced fund managers.
•Diversification: Mutual funds invest in
diversified portfolio and thereby risk can be
minimized
•Liquidity : Mutual funds units can be
converted into cash easiy
•Convenience in payment: People can invest
any amount ranging from rs.500 per month
 Advntages/Benefits of mutual funds
•Minimum cost or expense: Mutual fund
expense ratio is minimum (not exceeding
2.25%)
•Long term wealth maximization: Mutual fund
is a good investment that can be used for long
term wealth maximization.
•Best suitable for financial Illiterates and busy
people: Mutual fund is best suitable to those
who have no sufficient knowledge in stock
market or no time to analyse the market.
 Advntages/Benefits of mutual funds
•Tax benefits – Some mutual funds such as ELSS
(Equity linked savings scheme) offer tax benefits
•Helps to achieve financial goals: Different types of
mutual funds are available to achieve different
financial goals of public.
•Safety and security – Mutual funds are regulated
and controlled by SEBI
•Disciplined investment : SIP mode of investment
provide the benefit of disciplined investment
Insurance companies
• Insurance corporations are financial intermediaries which offer
insurance services for providing financial protection from possible
hazards in the future.
• Insurance companies include
• Life insurance companies – Offer life insurance policies such as endowment
policy, whole life policy etc.
• General Insurance companies – offer non-life insurance such as Mediclaim,
personal accident, fire insurance, motor insurance etc.
• They are regulated by Insurance Regulatory and Development
Authority of India (IRDAI)
Objectives and functions of Insurance
(Insurance companies)
• Provide financial protection
• Risk sharing
• Prevention of losses
• Mobilizes and channelizes savings
• Provide capital to industries
• Prevention of losses
• Promote economic development
 Types of Insurance
(Modern Classification)
Insurance

Life Non-life
(Whole life, Endowment
& Term insurance)

Insurance of Insurance of Insurance of Insurance of

Person Property Liability Interest
Health insurance Motor third party
Fire insurance Fidelity guarantee
Personal accident Employees liability
Marine insurance insurance
Burglary insurance Professional indemnity
Motor insurance etc Public liability etc.
Lease Financing
• Lease financing is a contractual agreement
between the owner of the asset who grants the
other party the right to use the asset in return
for a periodic payment
• The owner of the party is known as Lessor and
the user of the asset under such agreement is
known as lessee and the rental paid is known
as lease rental.
 Operating Lease and Financial Lease
Financial Lease Operating Lease

• Way of providing finance to the • Way of using asset for short

asset period.
• Lease period covers full economic • Lease period covers a part of
life of asset economic life.
• Lease rent cover the original cost • Lease rent does not cover the full
of the asset during lease period. cost of the asset .
• Lessee is responsible for • Lessor is responsible for
maintenance and repair maintenance.
Merits of Lease financing
• 1. Cheap source—It enables the lessee to acquire the asset
with a lower investment only.
• 2. No dilution of ownership—It provides the finance
without diluting the ownership or control of the business.
• 3. Easy replacement of asset—The risk of obsolescence is
borne by the lesser. This allows greater flexibility and
cheap financing to the lessee to replace the asset.
• 4. Tax benefits—Lease rentals paid by the lessee are
deductible for computing tax liabilities. It further reduces
the cost of taking asset on lease.
Hire purchase
• A hire purchase is an installment plan,
whereby a customer acquire an asset by
paying an initial installment and repaying the
balance of the price of the asset plus interest
over a period of time.
• In a hire purchase agreement, ownership of
asset is not transferred to the purchaser until all
payments are made.
 Mortgage Guarantee Company
• It is an NBFC engaged in the business of mortgage
guarantee
• Mortgage guarantee is a guarantee provided by the
company for the repayment of an outstanding loan by
pledging the property.
• Mortgage is a pledge of property to secure payment of a
debt
• Financial mortgage market is the market where mortgage
guarantee is offered by companies.