Introduction to Financial Management Part II (Unit - I)

Financial Environment of India or Structure of Financial System in India

Financial System
The economic development of any country depends on the existence of a well organized financial system. Financial system supplies the necessary financial inputs for production of goods and services which will turn promote the well being standard of living of the people of a country. Financial system provides the intermediation between savers and investors and also promotes faster economic development of a country. There are three pillars of Financial System: 1. Financial Markets; 2. Financial Institutions and 3. Financial Assets / Securities

(A) Financial Markets

Financial Markets can be referred to as those centres and arrangements which facilitate buying and selling of financial assets, claims and services. Sometimes, we do find the existence of a specific place or location for a financial market as in the case of Stock Exchange. Types of Financial Markets Unorganized Markets: In these markets, there are a number of money lenders, indigenous bankers, traders etc. who lend money to the public. There are also private finance companies, chit funds etc. whose activities are not controlled by the Reserve Bank of India (RBI). There are no standardized rules and regulations for governing the financial dealings. However, the RBI has already taken some steps to bring the unorganized sector under the organized fold.

 Organized Markets: In these markets, there are standardized rules and regulations for governing the financial dealings. These markets are subject to strict supervision and control by RBI. The organized markets are further classified into 1. Money Market and 2. Capital Market.
Money Market The RBI defines the money market as, a market for short-term financial assets that are close substitutes for money, facilitates the exchange of money for financial claims. However it is also a market for the lending and borrowing of short-term funds.

Features of Money Market: The major institutions in the money market are Central Bank and

Commercial Bank. It is a market for short-term loanable funds for a period of not exceeding one year; This market supplies funds for financing current business operations and working capital requirements of industries; The instruments that are dealt in a money market are bills of exchange, commercial papers, treasury bills, certificates of deposit etc; It deals with financial assets having a maturity period upto one year only; It deals with only those assets which can be converted into cash readily without loss and with minimum transaction cost; Transactions have to be conducted without the help of brokers;

Types of Money Market Instruments: 1. Bills of Exchange: A commercial bill is one which arises out of a credit transaction. A bill of exchange contains a written order from the creditor to the debtor, to pay a certain sum, to a certain person, after a certain period. Commercial Papers: It is an unsecured promissory note, negotiable in nature, issued with a fixed maturity by a Joint Stock Company approved by RBI. Certificate of Deposits: These are short-term deposit instruments issued by banks and financial institutions to raise lumsum of money. Treasury Bills: It is also a promissory note issued by the Government under discount for short-term borrowings for a specified period. The Government promises to pay the specified amount mentioned therein to the bearer on the due date.

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5. Repo: Repo stands for repurchase. The borrower repurchase the securities from the lenders with an agreement at the end of the fixed period at a predetermined price. The difference between the purchase price and original price is called cost of borrowings or Repo Rate. Repo transactions are conducted in the money market to manipulate short-term interest rate and manage liquidity level. Types of Money Market: 1. Call Money Market / Inter Bank Call Market: It refers to the market for short term loans (say one day to fourteen days). These loans are repayable on demand at the option of either lender or the borrower. These loans are given to the brokers and dealers in stock exchange. Commercial Bills Market / Discount Market: It refers to the market where short-term trade bills are discounted by financial intermediaries (like commercial banks). Treasury Bill Market: It refers to the market where treasury bills are bought and sold. Treasury bills are enjoy high degree of liquidity since they are issued by the Government.

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Capital Market The capital market is a market for financial assets which have a long or indefinite maturity period. It deals with long term securities (e.g.: Equity Shares, Preference Shares, Debentures or Bonds etc.).
Features of Capital Market: It is a market for long-term funds exceeding a period one year; This market supplies funds for financing the fixed capital requirements of trade and commerce as well as long-term requirement of Government; This market deals in instruments like Equity or Ordinary Shares, Preference Shares, Debentures or Bonds etc. Development banks and Insurance companies play a dominant role in this market; Transactions take place at a Stock Exchange; Transactions are conducted only through authorized dealers.

Type of Issues in Capital Market:

Public Issue: Public Issue is the most popular method of raising long term capital from the public. Right Issue: Right Issue is the method of raising additional finance from existing members by offering securities (i.e. shares and debentures) to them on pro rata basis.

Bonus Issue: Sometimes companies distribute profits to existing shareholders by way of fully paid bonus shares in lieu of dividend. Bonus shares are issued in the ratio of existing shares held. The shareholders do not have to make any additional payment for these shares. Private Placement: Private placement is a method of direct selling of securities (shares and debentures) by a public limited company or private limited company or jointly to a limited number of sophisticated investors (like UTI, LIC, GIC etc.).

Types of Capital Market:

Industrial Securities Market: It is a market for industrial securities, ( equity shares, preference shares, debentures or bonds etc.). It is a market where industrial concerns raise their long-term capital or debt by issuing appropriate instruments. Government Securities Market: It is called Gilt-Edged securities market. It is a market where Government securities (e.g. Stock certificates, Bearer bonds etc.) are traded. In India, long-term securities are traded in the capital market while short-term securities are traded in the money market.

Long-term Loans Market: Development banks and commercial banks play a significant role in this market by providing long-term loans (e.g: Mortgaged Loan, Term Loan etc.) to corporate customers.

Segments of Capital Market:

Primary or New Issue Market: Primary Market is a market for new issues or new financial claims. The primary market deals with those securities which are issued to the public for the first time. A company may raise its long-term capital in a primary market in different ways, such as, public issue, right issue etc. Secondary Market: Secondary Market is a market for those securities which have already passed through the primary market and are traded in this market. This market deals with old existing securities. This market consists of all Stock Exchanges recognized by the Govt. of India and are regulated by Securities Exchange Board of India (SEBI).

Components of Secondary Market:

Stock Exchange:

The market where second hand securities are bought and sold is referred to as stock market. (i.e, the market where existing or old securities are traded).
It is an association, organization or body of individuals whether incorporated or not, established for the purpose of assisting, regulating and controlling the business of buying, selling and dealing of securities; The first organized stock exchange in India is Bombay Stock Exchange (BSE) was started in Bombay in 1875 with the formation of the Native Share and Stock Brokers Association.

Functions of Stock Exchange:

Liquidity and Marketability: It provides liquidity to securities since securities can be converted into cash at any time according to the intention of the investors by selling them at the listed prices. Safety of Funds: It ensure safety of funds invested because they have to function under strict rules and regulations and the bye-laws. Supply of Long-term Funds: The securities traded in stock market are negotiable and transferable in character. When a security is transacted, one investor is substituted by another, but the company is assured of long term availability of funds. Promotion of Investment: It mobilise the savings of the public and promote investment through capital formation. Marketing of New Issues: If the new issues are listed in the stock market, they are readily acceptable to the public. Thus stock market helps in marketing of new issues also.

 Over the Counter Exchange of India (OTCEI): The OTCEI was recognized as a stock exchange under the Securities Contract (Regulation) Act, 1956 and was incorporated as a company u/s 25 of the Company Act, 1956 on 22nd September, 1990. The OTCEI was promoted jointly by ICICI, IDBI, UTI, LIC GIC etc. This exchange has mainly linked with broker and dealer through electronic computer network. Objectives: The OTCEI has aroused out of the need to have a second tier market in the country. It was set up to provide small and medium companies an access to the capital market for raising finance in cost effective manner. The OTCEI was the first ringless, electronic national exchange with a screen-based trading system listing entirely new set up of companies of small size.

Features: Transaction would take place through satellite communication telephone lines (i.e screen based trading); Trading takes place through a network of computers of OTC dealers located at different places within the same city and even across cities; It deals in equity shares, preference shares, bonds, debentures and warrants; Small and medium sized companies with a paid up capital between Rs. 30 lakhs and 10 crores may be enlisted on OTCEI. A company which is listed on any other recognized stock exchange in India is not permitted simultaneously for listing on OTCEI. Members are corporate only.

 National Stock Exchange (NSE): The National Stock Exchange (NSE) of India was incorporated in November, 1992 with an equity capital of Rs. 25 crores and promoted by IDBI, ICICI, LIC, GIC etc. Objectives: to establish nation wide trading facility for equity shares and debts; To facilitate equal access to investors across the country; to enable shorter settlement cycle and To meet international standard. Features: It has a fully automated screen based trading system (i.e. Transaction would take place through satellite communication telephone lines); It has three segments: Capital Market, Wholesale Debt Market and Derivatives Market. The members are: individuals, firms and corporates. The most popular indices are: S&P CNX 500, S&P CNX Nifty, S&P CNX Defty, CNX mid-cap 200 etc.

 Bombay Stock Exchange (BSE):

The Bombay Stock Exchange (BSE) is the oldest stock exchange in Asia and was established as early as 1875 itself. The BSE is a voluntary, non-profit making association of brokers members. Features: It has also a fully automated screen based trading system know as, BSE online Trading System (BOLT) ; It has also three segments: Capital Market, Wholesale Debt Market and Derivatives Market. It has more than 700 members and most of them are individuals. At present, corporate members are being admitted. The most popular indices are: SENSEX, BSE 200, Dollex, BSE 500 etc. The BSE dominate the Indian Capital Market by accounting for more than 60% of all-India turnover;

(B) Financial Institutions

There is two types of financial institutions in India: 1. Banking and 2. Non-Banking.

Banking Institutions:
Scheduled Commercial Bank: Scheduled commercial banks are those included in the second schedule of RBI Act, 1934. In terms of ownership and function scheduled commercial banks are classified in four categories: Public Sector Banks, Private Sector Banks, Foreign Banks in India and Regional Rural Banks. Public Sector Banks: Public sector banks are those banks in which the Government has major holdings (e.g. State Bank of India and other Nationalised banks); Private Sector Banks: The banks which have been setup in 1990s under the guidelines of the Narasimham Committee are referred to as private sector banks (e.g. Citi Bank, HSBC etc).

 Foreign Banks in India: Foreign banks in India (e.g. Standard Chartered etc.) are those banks who has benefited the Indian Financial System by enhancing competition, transfer of technology and specialised skills resulting in higher efficiency and greater satisfaction. The have also enabled large Indian Companies to access foreign currency resources from their overseas branches in times of foreign currency constraints. Regional Rural Banks: These banks came into existence under the Regional Rural Banks Ordinance, 1975 for the development of agriculture, trade and commerce in rural areas and to provide credit facilities to small and marginal farmers, agricultural labourers and small entrepreneurs is known as regional rural bank (e.g Paschim Banga Gramin Bank, Rashtriya Gramin Bikash Bank etc.).

 Non Banking Institution:

Non-Banking Finance Companies (NBFCs): NBFCs are financial intermediaries engaged in the business of accepting deposits from the public and delivering credit to the unorganised sector and to small local borrowers. NBFCs have also a supplement role in meeting the increasing financial needs of the corporate sector. As compared to the scheduled commercial banks, they can take quick decisions, assume grater risks, and tailor-make their services and charges according to the needs of the clients. Different segments of NBFCs: Hire Purchase Finance Company; Loan Company; Mutual Benefit Finance Company; Equipment Leasing Company and Chit Fund Company.

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