Indian Financial System( AN Overview)

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. 

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. 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.

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 is a wholesale debt market for lowrisk, 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.

Credit Market:

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

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 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 ink 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 move than one market e.g. underwriter. However, the services offered by them vary from one market to another.

EVOLUTION OF BANKING

Banking, in the present form  might have evolved during the 17th century.  Kautilya, in his ‘Arthashastra’ written in about 300 B.C., has also mentioned about the existence of powerful guilds of merchant bankers who received deposits, and advanced loans and issued hundis (letters of transfer). In the modern times, an experienced Scottish goldsmith, William Paterson, is credited with the idea of setting up a national bank in Britain in 1688, which gave birth to the Bank of England. The modern day banking, in its simplest form, is meant to facilitate financial intermediation between the savers and the borrowers. It also seeks to act as a safe place to store money and earn some return in the process, as also a place to seek simple financial solutions to individual problems.

The advent of technology in modern times has heralded three distinct phases in banking: a) Computerization of back office processes during the 1980s,

b) Facilitating higher customer convenience during the 1990s and

c) Enabling lifestyle/life stage banking during the 2000s

Thus, over time, the banks have witnessed significant changes in their outlook and have emerged as financial supermarkets offering a range of complex financial products and services on a round the clock basis, duly customized to the needs of their customers through multiple delivery channels

RBI

Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the RBI Act, 1934 (the Act). This marked the culmination of the prolonged efforts, to set up a central bank in the country. The principle of aligning the regulatory structure to the specific needs of the country and for that matter to even go beyond the prevalent wisdom and ethos were distinctly visible at that time itself. Despite the Reserve Bank being constituted as a central bank, it was thought fit to prescribe in the statute itself a development role for the Reserve Bank. Accordingly, the Act has a provision that the Reserve Bank will develop and maintain expertise in agricultural development (later expanded as rural development) and related subjects and thus began the role of the central bank being sensitive to the need of the economy. As such, after independence in the year 1947, the Indian banking industry was brought under the regulatory ambit of the Reserve Bank of India.

1)Banking Companies Act was passed in the year 1949.

2)Later, in March 1966, certain co-operative societies were brought within its fold and this act was renamed as the Banking Regulation Act, 1949 (BR Act). This enactment brought significant powers to the Reserve Bank of India (RBI) over the banks.

Private banks were then on the scene, though the money lenders were the major source of funding. A usurious and exploitative system prevailed Promotional and Developmental role of the Central Bank in India

The basic function of the Reserve Bank, according to the preamble of the Reserve Bank of India Act, is to regulate the issue of Bank notes and the keeping of the reserves with a view to maintaining monetary stability in India and generally to operate the currency and credit system of the country to its advantage.

This function imposes on the Reserve Bank the responsibility for: i. Operating the monetary policy for maintaining price stability and ensuring adequate financial resources for developmental purposes;

ii. Promotion of the efficient financial system; and iii. Meeting the currency requirement of the public.

Establishment of Specialized Institutions:-

1. Reserve Bank established a separate institution, viz., the National Bank for Agricul- ture and Rural Development (NABARD) for provision of medium-term and long-term refinance for agriculture and rural development as also for providing consultative service to the Government and banks and generally coordinate its activities in area of agricultural credit with those of the agencies engaged in purveying such credit.

RBI promoted of Industrial Finance Corpo-ration of India (IFCI), State Financial Corporations, Industrial Development Bank of India (IDBI) and Unit Trust of India (UTI). Reserve Bank promoted the Deposit Insurance and Credit Guarantee Corporation of India Limited (DICGC) for providing insurance and guarantees against the risk of default in payment by the banks or to the banks. Further, the Reserve Bank also helped establish specialized institutions for specific type of financing, like

i. National Housing Bank (NHB) and

ii. Export Import Bank of India (EXIM Bank).

iii. Discount Finance House of India (DFHI) and the Securities Trading Corporation of India (STCI).

iv. Clearing Corporation of India Ltd (CCIL)

v. National Payment Corporation of India Ltd (NPCI).

Expansion of the scope and reach of the Indian banking system:

Even though, up to the late 1960’s the Indian banking system made reasonable progress, there were still many rural and semi-urban areas which were not served by banks. The large industries and the big and established business houses tended to enjoy a major portion of the credit facilities, to the detriment of the priority sectors such as agriculture, small-scale industries and exports. Thus, with the primary objective of achieving efficient distribution of resources in conformity with the requirements of the economy and in order to meet the needs of the priority sectors, the Government decided to introduce social control over banks by amending the banking laws. Accordingly, on July 19, 1969 and April 15, 1980 respectively, 14 and six major Indian scheduled commercial banks in the private sector were nationalised. Social control marked a transitory stage in the evolution of banking policy and in this process; a system of credit planning and the Lead Bank Scheme were operationalized by the Reserve Bank to make the banking system function as an instrument of economic and social development. In conformity with these desired objectives of social control, the banking policy was reoriented in the seventies for securing a progressive reduction in poverty, concentration of economic power and regional disparities in the banking facilities. The promotional aspects of the banking policy came into greater prominence. In this direction, the branch expansion policy was designed, among other things, as a tool for reducing inter-regional disparities in banking development, deployment of credit and urban-rural pattern of credit distribution. Administered interest rate policy emerged as an important instrument for directing the flow of funds and for augmenting the pace of deposit mobilisation. The Reserve Bank opted for selective extension of credit under the Selective Credit Control scheme to those sectors that were accorded priority in conformity with the national objectives. The objective was to correct undue price fluctuations in respect of certain commodities such as food grains and agricultural raw materials arising from speculative activities. The main instruments of Selective Credit Control were a) minimum margins for lending and b) ceilings on the level of credit against stocks of selected commodities to control the quantum of credit given.

The period since 1985 was a process of consolidation which involved, i) comprehensive action plans by banks covering organization, structure, training, house-keeping, customer service, credit management and recovery of bank dues, productivity and profitability,

ii) phased introduction of modern technology in banking operations with emphasis on financial viability by easing some of the policy related constraints on profitability,

iii) strengthening capital base of banks and iv) allowing them flexibility in several areas.

By the end of eighties, the Indian economy had developed an extensive financial superstructure consisting of a vast network of institutions, deploying varied instruments and facilitating the mobilisation and channeling of funds for working capital and production credit purposes as well and for long term investment. The Reserve Bank thus helped promote and nurture a functionally varied and spatially diversified financial system.

NABARD

National Bank for Agriculture and Rural Development (NABARD) was established on 12th July, 1982 under the National Bank for Agriculture and Rural Development Act, 1981 by merging the Agriculture Credit Department and Rural Planning and Credit cell of RBI.  It took over the entire functions of the Agriculture Refinance and Develop-ment Corporation (ARDC). NABARD was established with the recommendations of CRAFICARD Committee. Its head office is situated at Mumbai. It planned to open offices through out India. In the beginning the paid up capital of the NABARD was Rs.100 Crores contributed by the Govern-ment of India and RBI jointly. Its authorized capital raised to Rs.1000 Cores. The other funds of NABARD were

a. National Rural Credit (Long Term Operations) Fund  

b.    National Rural Credit (Establishment ) Fund

c.    Funds raised by issue of bonds and deben    tures guaranteed by the Central Government  

d.   Borrowing from RBI, Central Government or any other organisations approved by the Central Government

e.    Funds from external sources through the Government

    Q: What are the functions of NABARD?

Ans: 1. Credit functions

       2. Development functions

       3. Regulatory functions

Credit functions:

NABARD is an apex development bank for agriculture and rural development. It has been established for providing credit for the promotion of agriculture small scale industries, cottage and village industries, handicrafts and the rural crafts and other allied economic activities in rural areas with a view to promote integrated rural development and securing prosperity in rural areas. It also provides refinance facilities to commercial banks, RRBs, Co-operative banks, Land Development Banks and other financial institutions. It also provides refinance for loans granted under IRDP scheme. Basis of refinance by the NABARD  is the percentage of recovery during previous year.  

Development functions: NABARD also undertakes the functions of co-ordination of various institutions in this area, acting as an agent to the Government and RBI, providing training and research facilities and development of expertise in the field.

Regulatory functions: The Banking Regu- lation Act, 1949 authorises NABARD to inspect RRBs and Co-operative banks (other than primary co-operative banks). These banks file returns to NABARD and also obtain recommendations from NABARD in case of opening of new branches.

NABARD is managed by a Board of Direct- ors consisting of

i. Chairman

ii.  Directors nominated by RBI, Government        of India, State Governments

iii. Experts from Commercial and

     Cooperative Banks

iv. Experts in Rural economics

General Awareness Practice Questions

1.    What is the full form of IFSC ?

A:    Indian Financial System code

2.    Commercial Paper can be issued for a maximum period of ?

A:    365 days

3.    The Mutual funds in India follow accounting standards laid by ?

A:    SEBI

4.    SBI launched minor a/c for children above 10 years named as ?

A:    Pehli Udaan

5.    Who is the winner of Man BookerPrize 2014 ?

A:    Richard Flanagan

6.    Who is appointed as Secretary, Economic Affairs ?

A:    RajivMehrishi 

7.    There are how many digits in MICR ?

A:    9

8.    Who has been conferred with the Best Central Bank Governor award for 2014 by Euromoney magazine during October 2014?

A:    RaghuramRajan, RBI Governor

9.    PradhanMantri Jan DhanYojana (PMJDY) provides  accidental insurance benefit of?

A:    Rs. 1 lakh

10.    SainaNehwala is related to which game?

A:    Badminton

11.    Capital of Malaysia ?

A:      Kuala Lumpur

12.    International Labour Organization headquarters?

A:      Geneva, Switzerland

13.    Who is the author of the book "The Oath of the Vayuputras"?

A:      AmishTripathi

14.    Which airlines announced to purchase 250 airbus aeroplanes?

A:      Indigo

15.    Under PMJDY, how many bank accounts are opened?

A:     About 7 Crores