history and development of indian finance system

history and development of indian finance system

1. FINANCIAL SYSTEM Financial system is a broader term which brings under its fold the financial markets and financial institutions which support the system FUNCTIONS OF FINANCIAL SYSTEM Provision of liquidity Mobilization of savings Demand for funds (credit) for short-term and long-term investments = Supply of funds generated out of savings and credit EQUILLIBRIUM IN FINANCIAL MARKETS

2. FINANCIAL MARKETS ARE SAID TO BE PERFECT WHEN A large number of savers and investors operate in the market The savers and investors are rational All operators in the market are well-informed and information is freely available to all of them There are no transaction cost The financial assets are infintely divisible The participants in the markets have homogeneous expectations There are no taxes

3. Indian Financial System – An Overview STRUCTURE OF FINANCIAL MARKETS IN INDIA 3 Debt Market Primary / Secondary Forex Market Capital Market Primary / Secondary & Depository Insurance Life/General Banks (including RRBs, co-op etc) Mutual Funds, Venture Funds, Investment Bonds RBI RBI SEBI IRDA RBI RBI/SEBI REGULATORY AUTHORITY

4. Indian Banking System

5. Types of Banks Public Sector Banks Reserve Bank of India State Bank of India and its 7 Associate Banks Nationalized Banks (20 in number) Regional Rural Banks sponsored by Public Sector Banks Private Sector Banks Old Generation Private Banks New Generation Private Banks Foreign Banks in India Scheduled Co-operate Banks Non – Scheduled Banks Co-operative Sector Banks State C-operative Banks Central Agriculture Credit Societies Primary Agriculture Credit Societies Land Development Banks Urban Co-operative Banks State Land Development Banks Development Banks Industrial Finance Corporation of India (IFCI) Industrial Development Bank of India (IDBI) Industrial Credit & Investment Corporation of India (ICICI) Industrial Investment Bank of India (IIBI)

6. Box 1 : A Chronology of Nationalization of Banks : Enactment of Banking Regulation Act 1955(Phase I) : Nationalization of State Bank of India 1959(Phase II) : Nationalization of SBI subsidiaries 1961 : Insurance cover extended to deposits 1969(Phase III) : Nationalization of 14 major banks : Creation of credit guarantee corporation 1975 : Creation of Regional Rural Banks 1980(Phase IV) : Nationalization of six banks with deposits over Rs . 200 crore . Source : East India Vyapar website.

7. HISTORY OF INDIAN BANKING The establishment of the general bank of india in the year 1786 marked the development of a structured banking system in india . It was setup as a joint stock company. Later the bank of hindustan and bengal bank came into existence. The east india company established three banks. The bank of bengal in the year 1809. The bank of bombay in 1840 and bank of madras in 1843. These three banks were amalgamated in year 1920 to form the new imperial bank of india . The imperial bank was nationalized and was renamed as the state bank of india with the passing of the state bank of india act of 1955. The reserve bank of india ( rbi ) was constituted as the shareholder’s bank in 1935 and is now the central bank of the country.

8. After independence, the Reserve Bank of India Bill was introduced in the Parliament to give public ownership to the bank. Since 1 st January 1949, it has been operating as a state owned and state managed Central Bank. It exercises the power to control the Indian banking industry.

9. DIFFERENT PHASES OF INDIAN BANKING FOUNDATION PHASE It can be considered to cover 1950s and 1960s till the nationalization of banks in 1969. The focus during this period was to lay the foundation for a sound banking system in the country. As a result, this phase witnessed the development of necessary legislative framework for facilitating re-organization and consolidation of the banking system, for meeting the requirements of indian economy. A major development was transformation of imperial bank of india into state bank of india during 1955 and nationalization of 14 major private banks during 1969. Banking in India has evolved through four distinct phases :

10. EXPANSION PHASE It had begun in mid-60s but gained momentum after nationalization of banks and continued till 1984. A determined effort was made to make banking facilities available to the masses. Branch network of the banks was widened at a very fast pace covering rural and semi-urban population which had no access to banking hitherto. Most importantly, the credit flows were guided towards the priority sectors. However this weakened the lines of supervision and affected the quality of assets of banks and pressurized their profitability and brought competitive efficiency of the system at a low ebb.

11. CONSOLIDATION PHASE : The phase started in 1985 when a series of policy initiatives were taken by RBI which saw marked slowdown in the branch expansion. Attention was paid to improving house keeping, customer service, credit management, staff productivity and profitability of banks. Measures were also taken to reduce the structural constraints that obstructed the growth of the money market. REFORMS PHASE The macro-economic crisis faced by the country in 1991 paved the way for extensive financial sector reforms which brought deregulation of interest rates, more competition, technological changes, prudential guidelines on asset classification and income recognition, capital adequacy, autonomy packages etc. POST – REFORMS During the post-reforms era the banking system has been developed with focus on bigger size, new innovative products, extensive use of information technology, global standards of service etc.

12. BANKING SYSTEM REFORMS The advent of nationalization of banks helped increase the number of branches, increase the volume of deposits and ensured wider dispersal of the advances. The developments taking place abroad and in India as well, which made the position of Indian banks vulnerable include : Increased competition and contestability within the financial services sector Technology leading to lower transactions and information costs Lower entry barriers leading to new suppliers of banking services Unsustainable cost structure Symptoms of excess capacity Less protective regulation Technology eroding the traditional bank Monopoly of money transmission services. Realizing these ill-effects, efforts were made to bring reforms in financial system of the country

13. PROCESS OF REFORMS The financial system reforms initiated during 1991-92 are based on twin principles of operational flexibility and functional autonomy so as to continuously enhance efficiency, productivity and profitability of the financial institutions. It aimed at providing a diversified, efficient and competitive financial sector with ultimate objective of improving the allocative efficiency of available resources, increasing the return on investments in promoting an accelerated growth of real sector of the economy. The details of the steps taken in this respect are available in the following pages (particularly in the section on status of implementation of 1 st Narasimhan Committee Recommendations). The status of profits, quality of advances (NPA level) and other aspects, is to be examined for each bank .

14. IMPACT OF NATIONALIZATION The quality of credit assets deteriorated, as the process of sanctioning loans became more of a mechanical process rather than an absolute credit assessment decision. Political interference also has been an additional problem. There was very little appraisal involved in the process of giving loans. With such a process of lending, obtaining credit seemed to have become the privilege of every borrower. Added to this, were the credit facilities extended to the priority sector at concessional rates. Such credit disbursals that were done without proper post-sanction supervision led to the deterioration in the quality of the loan assets of the banks. Further, the subsidized lending rates coupled with high levels of how yielding SLR investments also adversely affected the profitability of the banks.

15. IMPACT OF NATIONALIZATION Yet another outcome of this rapid expansion has been the squeeze on profitability of banks arising primarily due to an increase in the fixed costs. With the proliferation of branches, there was also the resulting strain on the managerial resources that resulted in enlarged manpower resources. The operational costs of the banks enhanced on account of the continuous servicing requirements of the extensive branch network of the banks. While branch expansion was taken as a means to achieve the goals of nationalization, the inherent evils of haphazard expansion of branches crept into the banking system. The existence of branches with higher operating costs resulted in profit erosion, since in most of the cases the branches added more costs than returns.

16. LIBERALIZATION The government of India framed its policies in the year 1991-92, keeping in view the benefits of liberalization. It was expected that in the process of opening its economy to the outside world, increased competition could turn the banks more efficient, bring about improvements and ultimately benefit the customers. Some of the root causes that were behind the dull performance of banks prompted the initiation of the banking sector reforms. Some of these causes were : Greater emphasis on directed credit Regulated interest rate structure Lack of focus on profitability Lack of transparency in the banks’ balance sheets Lack of competition Lack of grasp on the risks involved Excessive regulations on organization’s structure and managerial resources ; and Excessive support from government. The reforms were initiated with an aim to bring about a paradigm shift in the banking industry.

17. WORKING CAPITAL FINANCE For an uninterrupted functioning at a given capacity (to achieve a particular turnover level to remain viable and operate above the break-even level to earn required amount of profits), a firm requires a some minimum level of current assets. Working capital means the total amount of the circulating current assets . Working capital comprises Means to finance a: Value of raw material in store or in-transportation; b: Amount of consumable stores and other material require for production purposes; c: Value of stock in process; d: Value of all finished goods including in transit; e: Amount of outstanding receivables or sundry debtors; f: Monthly expenses generally reflected through the current assets other than those at (a) to (e) such a cash, advances allowed, pre-paid expenses etc. a: Credit available from suppliers on purchases; b: Other current liabilities c: Surplus of long term funds over the long term uses (i.e. net working capital) d: Short term bank borrowing.

18. Working capital & Net working Capital Working capital (or gross working capital) refers to the amount of total current assets. Liquid surplus or net working capital refers to the surplus of long term sources over long term uses as per RBI prescription (also calculated by banks as difference between current assets and current liabilities). It is desirable, that the net working capital should be positive which would signify liquidity and availability of adequate working funds. If in a particular case, the net working capital is negative, the difference will be called the working capital deficit. The working capital can also be classified as: Permanent working capital which is minimum amount of current assets necessary for carrying out operations for a period.

19. Fluctuating working capital represents additional assets required at different times during the operating period due to cyclic factors. Seasonal working capital means requirement for additional current assets due to seasonal nature of the industry. Adhoc working capital means requirement of additional funds for meeting the needs arising out of special circumstances such as execution of special order, delay in receipt of payment of receivables Working capital term loan: A long term loan given to meet the working capital margin needs of a borrower. Working capital gap = total current assets less other current liabilities. It is financed by net working capital and bank finance for working capital

20. SUMMARY – WORKING CAPITAL CONCEPTS Particulars Classification Working capital Current assets such as cash, stocks, book-debts, other current assets Net working capital Current assets – Current liabilities OR Log term sources – long term uses Working capital limits gap Current assets-current liabilities (other than bank borrowing) Working capital limits Bank facilities needed to purchase current assets. These facilities are cash credit, overdraft, bills purchase/discounting, pre-shipment or post-shipment loans etc..

21. The following factors determine the overall working capital levels of the industrial units: Policies for production Manufacturing process Credit Policy of the unit Pace of turnover Seasonality Factors which determine working capital

22. Process for assessment of working capital requirements Generally there are three methods followed by banks for assessing working capital of a firm i.e. Traditional method suggested under Tandon Committee, Turnover method suggested by Nayak Committee and Cash budget method followed in case of seasonal industries.

23. NBFC A Non Banking Financial corporation (NBFC) is an institution. which is a company and which has as its principal business of receiving the deposits under any scheme arrangement in any other manner or lending in any manner and which are formed with prior approval of the Government and by notification in the official gazette. NBFCs perform a diversified range of functions and offer various financial services to individual corporate and institutional clients . The various functions are as follows: Receiving of deposits Lending Investment Fill credit gaps in several sectors which traditional institutions such as banks are unable to fulfil Accessing certain depositor segments and catering to the specialised credit requirements of certain classes of borrowers

24. NBFCs according to Functions Merchant Banking and New Issue Marketing. Underwriting and Loan Syndication Bill Discounting and Money Market Operations Housing Finance Lease and Hire-Purchase Financing. Venture Capital Funds Investment Financing Investment Consultancy and Advise Mergers, Acquisitions, Amalgamations Capital Restructuring, Revaluations and Designing Capital Structure Portfolio Management Services Corporate Asset Management Services Technical Consultancy and Project Preparation Mutual Funds New Issue House Services Depositories

25. Top NBFC’s in India (http://companiesinindia.in/non-banking-financial-companies-in-india) 1 . HDFC Although HDFC is into core banking however it also gives Non Banking Financial Services like providing small loans and other things like micro finance. HDFC keeps NBF services separate from its core services. Establishing Year:  1977 by Hasmukhbhai Parekh Core Services:  Mortgages,  Life Insurance ,  Mutual Funds , Micro Finance etc Total Assets:  $3.44 Billion Employees and Operations:  2000+, All over India and overseas Head Office:  Mumbai Website:  www.hdfc.com

26. HUDCO Established on April 25, 1970, the Housing and Urban Development Corporation Ltd. (HUDCO) is a fully owned organization of the Government of India. HUDCO was instituted with the objective of providing long-term finance for construction of houses , undertaking urban development programs and infrastructure facilities . HUDCO has adopted a policy of preferential allocation of resources to the socially disadvantaged. It continues to emphasize on sectors, which are more socially relevant rather than only on commercially viable and profitable sectors . 92 % of the 150.93 lakh houses financed by HUDCO are for the benefit of EWS and LIG categories . Apart from the Corporate Office at Delhi, HUDCO functions under a zonal office, a research & training institute, 20 regional offices, 34 retail finance units and 9 development offices. Working under the administrative control of the Ministry of Housing and Urban Poverty Alleviation , the organization is charged with building affordable housing and carrying out urban development.

27. Objectives Of HUDCO To extend long term finance for construction of residential complexes or undertake housing and urban development programs in the country. To finance or undertake building of new or satellite town, either wholly or partly. To subscribe the debentures and bonds to be issued by the State Housing (and or Urban Development) Boards, Improvement Trusts, Development Authorities etc., specifically for the purpose of financing housing and urban development programs . To fund or take on the setting up of industrial enterprises of building material. To manage the money received from the Government of India and other sources as grants or otherwise, for the purposes of financing or undertaking housing and urban development programs in the country. To promote, establish, assist, collaborate and provide consultancy services for the projects of designing and planning of works relating to Housing and Urban Development programs in India and abroad.

28. ROLE OF HUDCO HUDCO has played a stellar role in the implementation of National Housing Policy. It has been entrusted with the implementation of the priority programmes of the Ministry like Low Cost Sanitation, Slum Upgradation , Staff Housing, Night Shelter for Footpath Dwellers, Shelter Upgradation under Nehru Rozgar Yojana , Rural housing under Minimum Needs Programme . Although commercial banks and housing finance companies are doing brisk business in the swelling housing finance sector, the housing needs of the poor and low income groups have remained unaddressed.

29. SIDBI The Small Industries Development Bank of India also ranks high among the specialized financial institutions in India. It was founded in the year 1990 to develop the small-scale industry in India with the aid of advisory services. The bank is located at Lucknow The bank offers financial assistance to the small and medium scale industries and coordinated the functioning of the other financial institutions that caters to the need of the agro-industries in India. The Small Industries Development Bank of India offers financial assistance for significant issues like infrastructure development, rehabilitation for sick industrial units. The investors can take the advantage of the unique fixed deposit scheme offered the bank. For the recently launched companies the bank provides composite loan, technology up gradation fund, direct credit scheme etc The existing members are allowed direct credit scheme, credit linked capital subsidy etc. For the up gradation of the standard of Indian women and to help them achieve financial independence the bank offers two specialized financial program named as marketing fund for women and Mahila Udhyam Nidhi

30. EXAMPLES OF SPECIALISED FINANCIAL INSTITUTIONS IDBI: Industrial Development Bank Of India IFCI: Industrial Finance Corporation Of India ICICI: Industrial Credit And Investment Corporation Of India IRCI: Industrial Reconstruction Corporation Of India UTI: Union Trust Of India NSIC: National Small Industries Corporation SFCs: STATE FINANCE CORPORATIONS SIDCs: STATE INDUSTRIAL DEVELOPMENT CORPORATIONS SIICs: STATE INDUSTRIAL INVESTMENT CORPORATIONS EXIM BANK: Export-import Bank Of India