2019 (May)
COMMERCE (General)
Course: 603 (Indian Financial System)
Time: 3 hours
The figures in the margin indicate full marks for the questions
(NEW COURSE)
Full Marks: 80
Pass Marks: 24
1. (a) Fill in the blanks: 1x4=4
1) Banks functions as an intermediary between savers and investors.
2) In stock exchange where the ownership, management and trading are concentrated in single group, it is called Mutual exchange.
3) SEBI is the regulatory body of merchant banking in India.
4) The company which sets up a mutual fund is called Asset Management Company.
(b) State whether the following statements are True or False: 1x2=2
1) At present, there are fourteen nationalized banks in India. False
2) Regional rural banks were established in 1975. True
(c) Choose the correct answer: 1x2=2
a) The RBI is the lender of last resort for which of the following?
1) Central Government.
2) Commercial Bank.
3) State Government.
4) Stock Market.
b) Which of the following is a financial asset?
1) Gold.
2) Silver.
3) Share.
4) Land.
2. Write short notes on (any four): 4x4=16
a) Weakness of Indian financial system: Even though Indian financial system is more developed today, it suffers from certain weaknesses. These may be briefly stated below:
1. Lack of co-ordination among financial institutions: There are a large number of financial intermediaries. Most of the financial institutions are owned by the government. At the same time, the government is also the controlling authority of these institutions. As there is multiplicity of institutions in the Indian financial system, there is lack of co-ordination in the working of these institutions.
2. Dominance of development banks in industrial finance: The industrial financing in India today is largely through the financial institutions set up by the government. They get most of their funds from their sponsors. They act as distributive agencies only. Hence, they fail to mobilise the savings of the public. This stands in the way of growth of an efficient financial system in the country.
3. Inactive and erratic capital market: In India, the corporate customers are able to raise finance through development banks. So, they need not go to capital market. Moreover, they do not resort to capital market because it is erratic and inactive. Investors too prefer investments in physical assets to investments in financial assets.
4. Unhealthy financial practices: The dominance of development banks has developed unhealthy financial practices among corporate customers. The development banks provide most of the funds in the form of term loans. So there is a predominance of debt in the financial structure of corporate enterprises. This predominance of debt capital has made the capital structure of the borrowing enterprises uneven and lopsided. When these enterprises face financial crisis, the financial institutions permit a greater use of debt than is warranted. This will make matters worse.
b) Functions of commercial banks: Modern commercial banks perform a variety of functions. They keep the wheels of commerce, trade and industry always revolving. Major functions of a commercial bank are:
I. Primary / Banking Functions: Commercial banks have two important banking functions. One is accepting deposits and other is advancing loans.
1) Deposits: One of the main functions of a bank is to accept deposits from the public. Deposits are accepted by the banks in various forms.
a) Current Account Deposits. b) Saving Account Deposits. c) Fixed Account Deposits. d) Recurring Account Deposits.
2) Loans and Advances: Banks not only mobilize money but also lend to its credit worthy customers for maximizing profits. Loans and Advances are granted to: a) Business and Trade. b) Loans to Agriculture. c) Loans To Industries. d) Loans To Foreign Trade. e) Consumer Credit / Personal loans.
II. Secondary / Non-banking Functions: Banks gives various forms of services to public. Such services are termed as non- banking or secondary functions:
1. Agency Services: Banks perform certain functions on behalf of their customers. While performing these services, banks act as agents to their customers, hence these are called as agency services. Important agency functions are: a) Collection. b) Payment. c) Income – Tax Consultant. d) Sale And Purchase Of Financial Assets. e) Trustee, Executor And Attorney. f) E- Banking.
2. Utility Services: Modern Commercial banks also performs certain general utility services for the community, such as: a) Letter Of Credit. b) Transfer Of Funds. c) Guarantor. d) Underwriting. e) Locker Facility. f) Referee. g) Credit Cards.
III. Subsidiary Activities: Many commercial banks also undertake subsidiary activities such as:-
a. Housing Finance
b. Mutual Funds intermediary
c. Merchant Banking
d. Venture Capital Fund
e. Factoring
c) Types of mutual funds in India:
1. Open-Ended Funds, Close-Ended Funds and Interval Funds:
a) Open-ended funds are open for investors to enter or exit at any time, even after the NFO.
b) Close-ended funds have a fixed maturity. Investors can buy units of a close-ended scheme, from the fund, only during its NFO.
c) Interval funds combine features of both open-ended and close ended schemes. They are largely close-ended, but become openended at pre-specified intervals.
2. Actively Managed Funds and Passive Funds
a) Actively managed funds are funds where the fund manager has the flexibility to choose the investment portfolio, within the broad parameters of the investment objective of the scheme. Since this increases the role of the fund manager, the expenses for running the fund turn out to be higher.
b) Passive funds invest on the basis of a specified index, whose performance it seeks to track. Thus, a passive fund tracking the BSE Sensex would buy only the shares that are part of the composition of the BSE Sensex. Such schemes are also called index schemes. Since the portfolio is determined by the index itself, the fund manager has no role in deciding on investments. Therefore, these schemes have low running costs.
3. Debt, Equity and Hybrid Funds
a) A scheme might have an investment objective to invest largely in equity shares and equity-related investments like convertible debentures. Such schemes are called equity schemes.
b) Schemes with an investment objective that limits them to investments in debt securities like Treasury Bills, Government Securities, Bonds and Debentures are called debt funds.
c) Hybrid funds have an investment charter that provides for a reasonable level of investment in both debt and equity.
Types of Debt Funds
a. Gilt funds invest in only treasury bills and government securities, which do not have a credit risk.
b. Diversified debt funds on the other hand, invest in a mix of government and non-government debt securities.
c. Junk bond schemes or high yield bond schemes invest in companies that are of poor credit quality.
d. Fixed maturity plans are a kind of debt fund where the investment portfolio is closely aligned to the maturity of the scheme.
e. Floating rate funds invest largely in floating rate debt securities i.e. debt securities where the interest rate payable by the issuer changes in line with the market.
f. Liquid schemes or money market schemes are a variant of debt schemes that invest only in debt securities where the moneys will be repaid within 91-days.
Types of Equity Funds
a. Diversified equity fund is a category of funds that invest in a diverse mix of securities that cut across sectors.
b. Sector funds however invest in only a specific sector. For example, a banking sector fund will invest in only shares of banking companies. Gold sector fund will invest in only shares of gold-related companies.
c. Thematic funds invest in line with an investment theme. For example, an infrastructure thematic fund might invest in shares of companies that are into infrastructure construction, infrastructure toll-collection, cement, steel, telecom, power etc.
d. Equity Linked Savings Schemes (ELSS), as seen earlier, offer tax benefits to investors. However, the investor is expected to retain the Units for at least 3 years.
e. Equity Income / Dividend Yield Schemes invest in securities whose shares fluctuate less, and therefore, dividend represents a larger proportion of the returns on those shares.
f. Arbitrage Funds take contrary positions in different markets / securities, such that the risk is neutralized, but a return is earned.
Types of Hybrid Funds
a. Monthly Income Plan seeks to declare a dividend every month. It therefore invests largely in debt securities.
b. Capital Protected Schemes are close-ended schemes, which are structured to ensure that investors get their principal back, irrespective of what happens to the market.
4. Gold Funds: These funds invest in gold and gold-related securities. They can be structured in either of the following formats:
5. Gold Exchange Traded Fund, which is like an index fund that invests in gold. The structure of exchange traded funds is discussed later in this unit. The NAV of such funds moves in line with gold prices in the market.
d) Asset Management Company: Assets Management Company (AMC) is a firm which invests the funds collected from investors in securities with a view to earn high return for investors in exchange for a fee. Every mutual fund institutions appoints AMC to management its fund. Asset Management Company (AMC) manages the affairs of the Mutual Fund in relation to the operation of Mutual Fund schemes. The Asset Management Company is a key link in the success of the scheme and the interests of the unit holders. It is expected to maintain a record in support of each investment decision.
Statutory Requirements for AMCs:
(i) SEBI Approval: AMC should be approved by SEBI and cannot be changed, except unless by a majority of the trustees or by 75% of the unit-holders.
(ii) Other Conditions:
a) AMC’s Directors should be persons of standing and suitable professionals.
b) Chairman of the AMC should not be the trustee of any Mutual Fund.
c) AMC should have a minimum Net Worth of `10 Crores.
e) Role of NABARD in development of agriculture: The National Bank For Agriculture and Rural Development (NABARD), a developing bank, came into existence on July 12, 1982, under an Act of Parliament with an initial capital of Rs. 100 crores. It is an apex institution set up for providing and regulating credit and other facilities for the promotion and development of agriculture, small scale industries, cottage and village industries, handicrafts and other rural crafts and other allied economic activities in rural areas with a view to promoting integrated rural development and securing prosperity of rural areas and for matters connected therewith or incidental thereto.
The NABARD has taken over the functions of ARDC (Agricultural Refinance and Development Corporation) and refinancing functions of RBI in respect of co-operative banks and the RRBs. The subscribed and paid up capital of NABARD was Rs. 100 crores which was enhanced to Rs. 500 crores, contributed by the Government of India and the Reserve Bank of India in equal proportions. The capital is now enhanced to Rs. 200 crores.
Functions of NABARD: The important functions of NABARD are as follows:
a) It serves as an apex refinancing agency for the institutions providing investment and production credit for promoting the various developmental activities in rural areas.
b) It provides short term accredit to Regional Rural Banks, State co-operative Banks and other financial institutions approved by the Reserve Bank. Such credit is given by the NABARD for a period upto 18 months.
c) It provides medium term credit to State Co-operative Banks and other financial institution approved by the Reserve Bank. This credit is provided for a period between 18 months and 7 years.
3. What do you mean by financial system? Explain various components of a developed financial system. 4+10=14
Ans: 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.
Components or Elements or Structure of Indian Financial System
The formal financial system comprises financial institutions, financial markets, financial instruments and financial services. These constituents or components of Indian financial system may be briefly discussed as below:
A. Financial Institutions: Financial institutions are the participants in a financial market. They are business organizations dealing in financial resources. They collect resources by accepting deposits from individuals and institutions and lend them to trade, industry and others. They buy and sell financial instruments. They generate financial instruments as well. They deal in financial assets. They accept deposits, grant loans and invest in securities.
On the basis of the nature of activities, financial institutions may be classified as: (a) Regulatory and promotional institutions, (b) Banking institutions, and (c) Non-banking institutions.
1. Regulatory and Promotional Institutions: Financial institutions, financial markets, financial instruments and financial services are all regulated by regulators like Ministry of Finance, the Company Law Board, RBI, SEBI, IRDA, Dept. of Economic Affairs, Department of Company Affairs etc. The two major Regulatory and Promotional Institutions in India are Reserve Bank of India (RBI) and Securities Exchange Board of India (SEBI). Both RBI and SEBI administer, legislate, supervise, monitor, control and discipline the entire financial system.
2. Banking Institutions: Banking institutions mobilise the savings of the people. They provide a mechanism for the smooth exchange of goods and services. They extend credit while lending money. They not only supply credit but also create credit. There are three basic categories of banking institutions. They are commercial banks, co-operative banks and developmental banks.
3. Non-banking Institutions: The non-banking financial institutions also mobilize financial resources directly or indirectly from the people. They lend the financial resources mobilized. They lend funds but do not create credit. Companies like LIC, GIC, UTI, Development Financial Institutions, Organisation of Pension and Provident Funds etc. fall in this category.
B. Financial Markets: Financial markets are another part or component of financial system. Efficient financial markets are essential for speedy economic development. It facilitates the flow of savings into investment. Financial markets bridge one set of financial intermediaries with another set of players. Financial markets are the backbone of the economy. This is because they provide monetary support for the growth of the economy.
Classification of Financial Markets: There are different ways of classifying financial markets. There are mainly five ways of classifying financial markets.
1. Classification on the basis of the type of financial claim: On this basis, financial markets may be classified into debt market and equity market.
Debt market: This is the financial market for fixed claims like debt instruments.
Equity market: This is the financial market for residual claims, i.e., equity instruments.
2. Classification on the basis of maturity of claims: On this basis, financial markets may be classified into money market and capital market.
Money market: A market where short term funds are borrowed and lend is called money market. It deals in short term monetary assets with a maturity period of one year or less. Liquid funds as well as highly liquid securities are traded in the money market. Examples of money market are Treasury bill market, call money market, commercial bill market etc.
Capital market: Capital market is the market for long term funds. This market deals in the long term claims, securities and stocks with a maturity period of more than one year.
3. Classification on the basis of seasoning of claim: On this basis, financial markets are classified into primary market and secondary market.
Primary market: Primary markets are those markets which deal in the new securities. Therefore, they are also known as new issue markets.
Secondary market: Secondary markets are those markets which deal in existing securities. Existing securities are those securities that have already been issued and are already outstanding. Secondary market consists of stock exchanges.
4. Classification on the basis of structure or arrangements: On this basis, financial markets can be classified into organised markets and unorganized markets.
Organised markets: These are financial markets in which financial transactions take place within the well established exchanges or in the systematic and orderly structure.
Unorganised markets: These are financial markets in which financial transactions take place outside the well established exchange or without systematic and orderly structure or arrangements.
5. Classification on the basis of timing of delivery: On this basis, financial markets may be classified into cash/spot market and forward / future market.
Cash / Spot market: This is the market where the buying and selling of commodities happens or stocks are sold for cash and delivered immediately after the purchase or sale of commodities or securities.
Forward/Future market: This is the market where participants buy and sell stocks/commodities, contracts and the delivery of commodities or securities occurs at a pre-determined time in future.
6. Other types of financial market: Apart from the above, there are some other types of financial markets. They are foreign exchange market and derivatives market.
Foreign exchange market: Foreign exchange market is simply defined as a market in which one country’s currency is traded for another country’s currency.
Derivatives market: It is a market for derivatives. The important types of derivatives are forwards, futures, options, swaps, etc.
C. Financial Instruments (Securities): Financial instruments are the financial assets, securities and claims. They may be viewed as financial assets and financial liabilities. Financial assets represent claims for the payment of a sum of money sometime in the future (repayment of principal) and/or a periodic payment in the form of interest or dividend. Financial liabilities are the counterparts of financial assets. They represent promise to pay some portion of prospective income and wealth to others. Financial assets and liabilities arise from the basic process of financing.
D. Financial Services: The development of a sophisticated and matured financial system in the country, especially after the early nineties, led to the emergence of a new sector. This new sector is known as financial services sector. Its objective is to intermediate and facilitate financial transactions of individuals and institutional investors. The financial institutions and financial markets help the financial system through financial instruments. The financial services include all activities connected with the transformation of savings into investment. Important financial services include lease financing, hire purchase, instalment payment systems, merchant banking, factoring, forfaiting etc.
Or
Explain the role of financial system in economic development of a country. Highlight the features and weakness of Indian financial system. 5+4+5=14
Ans: Role and Importance of Financial System in Economic Development
1. Helps in Capital Formation: It links the savers and investors. It helps in mobilizing and allocating the savings efficiently and effectively. It plays a crucial role in economic development through saving-investment process. This savings – investment process is called capital formation. It promotes the process of capital formation.
2. Growth of capital market and money market: Business firms need fixed and working capital to finance it investment and business activities. These funds can be raised through the use of financial system. Long term funds can be raised through capital market and short term funds can be raised through money market.
3. Corporate Growth: It helps to monitor corporate performance. It provides a mechanism for managing uncertainty and controlling risk.
4. Balance regional development: It provides a mechanism for the transfer of resources across geographical boundaries. It helps in balance regional development of the countries.
5. Employment Growth: A propter functioning financial system helps in generating employment in both organised and unorganised sector by providing funds to the growing business houses and industries.
6. Promotes savings: It helps in lowering the transaction costs and increase returns. This will motivate people to save more.
7. Financial broadness: It helps in promoting the process of financial deepening and broadening. Financial deepening means increasing financial assets as a percentage of GDP and financial broadening means building an increasing number and variety of participants and instruments.
8. Venture capital: In recent time, Indian financial institutions contribute a part of their funds for the promotion of new ventures. The economic development of India will be faster when more business ventures are funded and promoted.
In short, a financial system contributes to the acceleration of economic development. It contributes to growth through technical progress.
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.
4. Financial system influences both the quality and the pace of economic development.
Weaknesses of Indian Financial System
Even though Indian financial system is more developed today, it suffers from certain weaknesses. These may be briefly stated below:
1. Lack of co-ordination among financial institutions: There are a large number of financial intermediaries. Most of the financial institutions are owned by the government. At the same time, the government is also the controlling authority of these institutions. As there is multiplicity of institutions in the Indian financial system, there is lack of co-ordination in the working of these institutions.
2. Dominance of development banks in industrial finance: The industrial financing in India today is largely through the financial institutions set up by the government. They get most of their funds from their sponsors. They act as distributive agencies only. Hence, they fail to mobilise the savings of the public. This stands in the way of growth of an efficient financial system in the country.
3. Inactive and erratic capital market: In India, the corporate customers are able to raise finance through development banks. So, they need not go to capital market. Moreover, they do not resort to capital market because it is erratic and inactive. Investors too prefer investments in physical assets to investments in financial assets.
4. Unhealthy financial practices: The dominance of development banks has developed unhealthy financial practices among corporate customers. The development banks provide most of the funds in the form of term loans. So there is a predominance of debt in the financial structure of corporate enterprises. This predominance of debt capital has made the capital structure of the borrowing enterprises uneven and lopsided. When these enterprises face financial crisis, the financial institutions permit a greater use of debt than is warranted. This will make matters worse.
5. Monopolistic market structures: In India some financial institutions are so large that they have created a monopolistic market structures in the financial system. For instance, the entire life insurance business is in the hands of LIC. The weakness of this large structure is that it could lead to inefficiency in their working or mismanagement. Ultimately, it would retard the development of the financial system of the country itself.
6. Other factors: Apart from the above, there are some other factors which put obstacles to the growth of Indian financial system. Examples are:
a. Banks and Financial Institutions have high level of NPA.
b. Government burdened with high level of domestic debt.
c. Cooperative banks are labelled with scams.
d. Investors confidence reduced in the public sector undertaking etc.
e. Financial illiteracy.
4. What are various innovative services provided by banks in current banking system? Elaborate. 14
Ans: The role of banks in India has changed a lot since economic reforms of 1991. These changes came due to LPG, i.e. liberalization, privatization and globalization policy being followed by GOI. Since then most traditional and outdated concepts, practices, procedures and methods of banking have changed significantly. Today, banks in India have become more customer-focused and service-oriented than they were before 1991. They now also give a lot of importance to their rural customers. They are even willing ready to help them and serve regularly the banking needs of country-side India. The changing activities of commercial banks are depicted below:
1. Better Customer Service: Before 1991, the overall service of banks in India was very poor. There were very long queues (lines) to receive payment for cheques and to deposit money. In those days, some bank staffs were very rude to their customers. However, all this changed remarkably after Indian economic reforms of 1991.
Banks in India have now become very customer and service focus. Their service has become quick, efficient and customer-friendly. This positive change is mostly due to rising competition from new private banks and initiation of Ombudsman Scheme by RBI.
2. Foreign Currency Exchange: Banks deal with foreign currencies. As the requirement of customers, banks exchange foreign currencies with local currencies, which is essential to settle down the dues in the international trade.
3. Consultancy: Modern commercial banks are large organizations. They can expand their function to consultancy business. In this function, banks hire financial, legal and market experts who provide advice to customers in regarding investment, industry, trade, income, tax etc.
4. Bank Guarantee: Customers are provided the facility of bank guarantee by modern commercial banks. When customers have to deposit certain fund in governmental offices or courts for a specific purpose, a bank can present itself as the guarantee for the customer, instead of depositing fund by customers.
5. Bank on Wheels: The 'Bank on Wheels' scheme was introduced in the North-East Region of India. Under this scheme, banking services are made accessible to people staying in the far-flung (remote) areas of India. This scheme is a generous attempt to serve banking needs of rural India.
6. Credit cards: A credit card is cards that allow their holders to make purchases of goods and services in exchange for the credit card’s provider immediately paying for the goods or service, and the card holder promising to pay back the amount of the purchase to the card provider over a period of time, and with interest.
7. ATMs Services: ATMs replace human bank tellers in performing basic banking functions such as deposits, withdrawals, account inquiries. Key advantages of ATMs include:
Ø 24-hour availability
Ø Elimination of labor cost
Ø Convenience of location
8. Debit cards: Debit cards are used to electronically withdraw funds directly from the cardholders’ accounts. Most debit cards require a Personal Identification Number (PIN) to be used to verify the transaction.
9. Home banking: Home banking is the process of completing the financial transaction from one’s own home as opposed to utilizing a branch of a bank. It includes actions such as making account inquiries, transferring money, paying bills, applying for loans, directing deposits.
10. Online banking: Online banking is a service offered by banks that allows account holders to access their account data via the internet. Online banking is also known as “Internet banking” or “Web banking.”
Online banking through traditional banks enable customers to perform all routine transactions, such as account transfers, balance inquiries, bill payments, and stop-payment requests, and some even offer online loan and credit card applications. Account information can be accessed anytime, day or night, and can be done from anywhere.
11. Mobile Banking: Mobile banking (also known as M-Banking) is a term used for performing balance checks, account transactions, payments, credit applications and other banking transactions through a mobile device such as a mobile phone or Personal Digital Assistant (PDA),
12. Accepting Deposit: Accepting deposit from savers or account holders is the primary function of a bank. Banks accept deposit from those who can save money but cannot utilize in profitable sectors. People prefer to deposit their savings in a bank because by doing so, they earn interest.
13. Priority banking: Priority banking can include a number of various services, but some of the popular ones include free checking, online bill pay, financial consultation, and information.
14. Private banking: Personalized financial and banking services that are traditionally offered to a bank’s rich, high net worth individuals (HNWIs). For wealth management purposes,
HNWIs have accrued far more wealth than the average person, and therefore have the means to access a larger variety of conventional and alternative investments. Private Banks aim to match such individuals with the most appropriate options.
Or
What do you mean by rural bank? Discuss in detail their objectives and functions. 4+5+5=14
Ans: Rural Banking
A rural bank is a financial institution that helps rationalize the developing regions or developing country to finance their needs specially the projects regarding agricultural progress. In other words, a rural bank is actually just a normal bank but one that caters to the needs of the rural public in India’s villages. Majority of the population in rural India do not have banking facilities and still don’t have a bank account. These rural banks provide banking services to the rural citizens and help them save money effectively.
The services provided by a commercial bank and a rural bank are the same. They provide bank accounts, accept deposits, and grant loans etc. to its customers. The only difference between the two is the population they serve. Commercial banks serve the general population of the country that lives in cities and towns whereas the rural banks serve the customers from the rural villages of the country.
Rural banking in India started since the establishment of banking sector in India. Rural Banks in those days mainly focused upon the agro sector. Today, commercial banks and Regional Rural Banks in India are penetrating every corner of the country are extending a helping hand in the growth process of the rural sector in the country.
Rural banking institutions are playing a very important role for all round development of rural areas of the country. In order to support the rural banking sector in recent years. Regional Rural Banks have been set up all over the country with the objective of meeting the credit needs of the most under privileged sections of the society. These regional rural banks have been receiving a high degree of importance and attention in the rural credit system.
Objectives of Rural Banks/Regional Rural Banks (RRBs)
The objectives behind the establishment of Rural banks/Regional Rural Banks are:
a) To take the banking services to the doorsteps of rural masses particularly in hitherto unbanked rural areas.
b) To make available institutional credit to the weaker sections of the society who had for little or no access to cheaper loans and had perforce been depending on the private money-lenders.
c) To mobilize rural savings and channelize them for supporting productive activities in the rural areas.
d) To create a supplementary channel for flow of credit from the central money market to the rural areas through refinance.
e) To generate employment opportunities in rural areas
f) To bring down the cost of purveying credit in rural areas.
Functions of Rural Banks
A rural bank may offer or perform any or all of the following services:
1) Grant loans and make investments in accordance with existing rules and regulations.
2) Accept deposits (both savings and time)
3) Sell domestic drafts.
4) Act as agent for other financial institutions.
5) Receive in custody funds, documents, and other valuable objects, and rent safety deposit boxes for the safe guarding of such objects.
6) Act as financial agent, buy and sell, by order of and for the account of its customers, shares, evidences of indebt and all types of securities.
7) Make collections and payments for the account of others and perform such other services for its customers as are not incompatible with banking business.
5. Distinguish between money market and capital market. Discuss the recent developments that have taken place in Indian money market. 6+8=14
Ans: Distinction Between Capital Market and Money Market
The capital market should be distinguished from money market. The capital market is the market for long-term funds. On the other hand money market is primarily the market for short term funds. However, the two markets are closely related as the same institution many a times deals in both types of funds, i.e. short-term as well as long-term. The main points of distinction between the two markets are as under:
| Capital Market | Money Market |
| 1. It provides finance/money capital for long-term investment. | 1. It provides finance/money for short-term investment. |
| 2. The finance provided by the capital market may be used both for fixed and working capital. | 2. The finance provided by money market is utilized, usually for working capital. |
| 3. Mobilisation of resources and effective utilization of resources through lending are its main functions. | 3. Lending and borrowing are its principal functions to facilitate adjustment of liquidity position. |
| 4. It’s one of the constituents, Stock Exchange acts as an investment market for buyers and sellers of securities. | 4. It does not provide such facilities. The main components include call loan market, collateral loan market, bill market and acceptance houses. |
| 5. It acts as a middleman between the investor and the entrepreneur. | 5. It acts as a link between the depositor and the borrower. |
| 6. Underwriting is one of its primary activities. | 6. Underwriting is a secondary function. |
| 7. Its investment institutions raise capital from public and invest in selected securities so as to give the highest possible return with the lowest risk. | 7. It provides outlets to commercial banks, business corporations, non-bank financial concerns and other for their short-term surplus funds. |
| 8. It provides long-term funds to Central and State Governments, public and local bodies for development purposes. | 8. It provides short-term funds to Government by purchasing treasury bills and to others by discounting bills of exchange etc. |
The recent trends/Reforms in the Indian money are:
1. De regularization of interest rates: Before regularization of interest rate, all banks used to pay interest at the rate of 4% which is fixed by RBI. But after de regularization interest rate in 2011, interest rates are determined by the working of market forces except for a few regulations.
2. Money Market Mutual Fund (MMMFs): Money Market Mutual Fund (MMMF) was introduced by RBI in April, 1992. These mutual funds would invest exclusively in money market instruments such as TB, CP, and CD etc. It bridges the gap between small individual investors and the money market. It mobilise savings from small investors and invest them in short-term debts. At present these funds plays a significant role in the growth of money market.
3. Establishment of the DFI: Specialized development financial institutions (DFIs) such as the IDBI, NABARD, NHB and SIDBI, etc., with majority ownership of the Reserve Bank were set up to meet the short term and long-term financing requirements of industry and agriculture. These institutions also helps in imparting money market liquidity.
4. Liquidity Adjustment Facility (LAF): LAF is founded in the year 2000. It is a tool which is used by RBI in implementing monetary policy in India. This tool allows banks to borrow money through repurchase agreements or lent to RBI through reverse repo rate. It is a mechanism by the RBI for managing the liquidity needs of the commercial banking system.
5. Electronic Transactions: In order to impart transparency and efficiency in the money market transaction the electronic dealing system has been started. It covers all deals in the money market. Similarly it is useful for the RBI to watchdog the money market.
6. Establishment of the CCIL: The Clearing Corporation of India limited (CCIL) was set up in April 2001. The CCIL clears all transactions in government securities, and repurchase agreements (repos) reported on the Negotiated Dealing System.
7. Development of New Market Instruments: The government has consistently tried to introduce new short-term investment instruments. Examples: Treasury Bills of various duration, Commercial papers, Certificates of Deposits, MMMFs, etc. have been introduced in the Indian Money Market.
Or
Define merchant banking. Mention its nature and functions. Explain the role of merchant bankers in Indian capital market towards providing financial services. 3+3+3+5=14
Ans: MERCHANT BANKER OR LEAD MANAGERS: Merchant bankers are body corporate who engaged in issue of securities. It acts as manager or advisor or consultant to issuing company. A merchant banker requires compulsory registration under the regulation 3 of SEBI (Merchant Bankers) Regulations, 1992. These activities mainly includes determining the composition of capital structure, compliance with procedural formalities , appointment of registration , listing of securities, arrangement of underwriting , selection of brokers and bankers, publicity and advertisement agent , private placement of securities, advisory services, etc.
The merchant bankers are responsible to make all efforts to protect the interest of investors. The merchant bankers has to exercise due diligence, high standards of integrity, dignity. The merchant bankers are also responsible in providing adequate information without misleading about the applicable regulations and guidelines. It is now mandatory for all public issue s to be managed by merchant bankers functioning as the lead managers.
Nature and characteristics of Merchant banking
Merchant banking is skill based activities and involves serving every financial need of every client. It requires focused skill-base to provide for the requirements of the client. SEBI has made the quality of man-power as one of the criteria for registration as merchant banker. These skills should not be concentrated in issue management and underwriting alone, which may have an adverse impact on business. Merchant bankers can turn to any of the activities mentioned above depending upon resources, such as capital, foreign tie-ups for overseas activities and skills. The depth and sophistication in merchant banking business are improving since the avenues for participating in capital market activities have widened from issue management and underwriting to private placement, bought out deals (BODS), buy-back of shares, mergers and takeovers.
The services of merchant bank cover project counseling, pre investment activities, feasibility studies, project reports, design of capital structure, issue management, underwriting, loan syndication, mobilization of funds from Non-Resident Indians, foreign currency finance, mergers, amalgamation, takeover, venture capital, buy back and public deposits. A Category-1 merchant banker can undertake issue management only. Separate registration is not necessary to carry on the activity as underwriter. Main Characteristics of Merchant Banking are stated below:
a) High proportion of decision makers as a percentage of total staff.
b) Quick decision process.
c) High density of information.
d) Intense contact with the environment.
e) Loose organizational structure.
f) Concentration of short and medium term engagements.
g) Emphasis on fee and commission income.
h) Innovative instead of repetitive operations.
i) Sophisticated services on a national and international level.
j) Low rate of profit distribution.
k) High liquidity ratio
Role and Functions of Merchant banker
Following other services are provided by merchant bankers.
1. Corporate counseling: Corporate counseling covers entire field of merchant banking viz project counseling, capital restructuring, project management, loan syndication, working capital, lease financing, portfolio management, underwriting etc. Such counseling is provided to corporate and client units to solve their problems.
2. Project Counseling: Which includes preparing project reports, finance for cost of project, appraising projects from the angle of technical, commercial and financial viability, Getting approval of project from bank/Govt and other agencies & Planning for public issue.
3. Loan Syndication: Arranging loan for big projects not only from one bank or financial institution but from more than one bank or financial institution as amount of loan is very large.
4. Underwriting of public issue: Underwriting is a guarantee given by the underwriter that in the event of under subscription, the amount would be provided by him to the extent of under subscription. All public issues are to be underwritten fully. Merchant banks provide such service of underwriting pubic issue subject to some limitations.
5. Managers, Consultants or advisors to the issue: Managers to the issue assist in drafting of prospectus, application forms and completion of formalities under companies act, appointment of Registrar for dealing with share applications, transfer and listing of shared with stock exchange.
6. Portfolio Management: It refers to investments in different kinds of securities such as shares, debentures, bonds issued by different companies and securities issued by the Govt. Merchant bankers advise about mix of investments a company should follow to ensure maximum return with minimum risk and for this purpose merchant makers have to make a careful study of Govt. policies, capital market as well as financial position of companies.
7. Corporate restructuring: Merchant bankers are also advising companies; about corporate restructuring including merger, acquisition, takeovers etc.
8. Off-share financing: Merchant bankers are also arranging foreign currency, foreign loans, foreign collaborations, financing exports imports etc.
9. Technical assistance: Merchant bankers are also providing services on technical aspects such as technological up gradation, modernization of industries etc.
10. Revival package for sick units: Merchant bankers are also liaisoning with Board of Industrial and Financial Reconstruction (BIFR) and industrial Reconstruction Bank of India (IRBI) and such helping their clients in this regard also.
6. Discuss the functions of Securities Exchange Board of India. How does SEBI protect the interest of investors? Explain. 6+8=14
Ans: Functions of SEBI: The SEBI performs functions to meet its objectives. To meet three objectives SEBI has three important functions. These are:
i. Protective functions
ii. Developmental functions
iii. Regulatory functions.
1. Protective Functions: These functions are performed by SEBI to protect the interest of investor and provide safety of investment. As protective functions SEBI performs following functions:
(i) It Checks Price Rigging: Price rigging refers to manipulating the prices of securities with the main objective of inflating or depressing the market price of securities. SEBI prohibits such practice because this can defraud and cheat the investors.
(ii) It Prohibits Insider trading: Insider is any person connected with the company such as directors, promoters etc. These insiders have sensitive information which affects the prices of the securities. This information is not available to people at large but the insiders get this privileged information by working inside the company and if they use this information to make profit, then it is known as insider trading. SEBI keeps a strict check when insiders are buying securities of the company and takes strict action on insider trading.
(iii) SEBI prohibits fraudulent and Unfair Trade Practices: SEBI does not allow the companies to make misleading statements which are likely to induce the sale or purchase of securities by any other person.
(iv) SEBI undertakes steps to educate investors so that they are able to evaluate the securities of various companies and select the most profitable securities.
(v) SEBI promotes fair practices and code of conduct in security market by taking following steps:
(a) SEBI has issued guidelines to protect the interest of debenture-holders wherein companies cannot change terms in midterm.
(b) SEBI is empowered to investigate cases of insider trading and has provisions for stiff fine and imprisonment.
(c) SEBI has stopped the practice of making preferential allotment of shares unrelated to market prices.
2. Developmental Functions: These functions are performed by the SEBI to promote and develop activities in stock exchange and increase the business in stock exchange. Under developmental categories following functions are performed by SEBI:
(i) SEBI promotes training of intermediaries of the securities market.
(ii) SEBI tries to promote activities of stock exchange by adopting flexible and adoptable approach in following way:
(a) SEBI has permitted internet trading through registered stock brokers.
(b) SEBI has made underwriting optional to reduce the cost of issue.
(c) Even initial public offer of primary market is permitted through stock exchange.
3. Regulatory Functions: These functions are performed by SEBI to regulate the business in stock exchange. To regulate the activities of stock exchange following functions are performed:
(i) SEBI has framed rules and regulations and a code of conduct to regulate the intermediaries such as merchant bankers, brokers, underwriters, etc.
(ii) These intermediaries have been brought under the regulatory purview and private placement has been made more restrictive.
(iii) SEBI registers and regulates the working of stock brokers, sub-brokers, share transfer agents, trustees, merchant bankers and all those who are associated with stock exchange in any manner.
(iv) SEBI registers and regulates the working of mutual funds etc.
(v) SEBI regulates takeover of the companies.
(vi) SEBI conducts inquiries and audit of stock exchanges.
How SEBI Protects the Interest of Investors?
With the growth in the dealings of stock markets, lot of malpractices also started in stock markets such as price rigging, ‘unofficial premium on new issue, and delay in delivery of shares, violation of rules and regulations of stock exchange and listing requirements. Due to these malpractices the customers started losing confidence and faith in the stock exchange. So government of India decided to set up an agency or regulatory body known as Securities Exchange Board of India (SEBI).
Securities Exchange Board of India (SEBI) was set up in 1988 to regulate the functions of securities market. SEBI promotes orderly and healthy development in the stock market but initially SEBI was not able to exercise complete control over the stock market transactions.
It was left as a watch dog to observe the activities but was found ineffective in regulating and controlling them. As a result in May 1992, SEBI was granted legal status. SEBI is a body corporate having a separate legal existence and perpetual succession.
SEBI was set up with the main purpose of keeping a check on malpractices and protect the interest of investors. It was set up to meet the needs of three groups.
1. Issuers: For issuers it provides a market place in which they can raise finance fairly and easily.
2. Investors: For investors it provides protection and supply of accurate and correct information.
3. Intermediaries: For intermediaries it provides a competitive professional market.
Objectives of SEBI: The overall objectives of SEBI are to protect the interest of investors and to promote the development of stock exchange and to regulate the activities of stock market. The objectives of SEBI are:
1. To regulate the activities of stock exchange.
2. To protect the rights of investors and ensuring safety to their investment.
3. To prevent fraudulent and malpractices by having balance between self regulation of business and its statutory regulations.
4. To regulate and develop a code of conduct for intermediaries such as brokers, underwriters, etc.
In order to protect the interest of the investors, SEBI performs the following Protective functions
Protective Functions: These functions are performed by SEBI to protect the interest of investor and provide safety of investment. As protective functions SEBI performs following functions:
(i) It Checks Price Rigging: Price rigging refers to manipulating the prices of securities with the main objective of inflating or depressing the market price of securities. SEBI prohibits such practice because this can defraud and cheat the investors.
(ii) It Prohibits Insider trading: Insider is any person connected with the company such as directors, promoters etc. These insiders have sensitive information which affects the prices of the securities. This information is not available to people at large but the insiders get this privileged information by working inside the company and if they use this information to make profit, then it is known as insider trading. SEBI keeps a strict check when insiders are buying securities of the company and takes strict action on insider trading.
(iii) SEBI prohibits fraudulent and Unfair Trade Practices: SEBI does not allow the companies to make misleading statements which are likely to induce the sale or purchase of securities by any other person.
(iv) SEBI undertakes steps to educate investors so that they are able to evaluate the securities of various companies and select the most profitable securities.
(v) SEBI promotes fair practices and code of conduct in security market by taking following steps:
(a) SEBI has issued guidelines to protect the interest of debenture-holders wherein companies cannot change terms in midterm.
(b) SEBI is empowered to investigate cases of insider trading and has provisions for stiff fine and imprisonment.
(c) SEBI has stopped the practice of making preferential allotment of shares unrelated to market prices.
Or
What is mutual fund? Explain how mutual funds help in creating a healthy capital market. 5+9=14
Ans: Meaning of Mutual Fund: A mutual fund is a pure intermediary which performs a basic function of buying and selling securities on behalf of its unit holders, which latter also can perform but not easily, conveniently economically, and profitably. The investors in mutual fund are given the share in its total funds which is proportionate to their investments, and which is evidenced by the unit certificates. Mutual Fund (MF) is a fund established in the form of a Trust, to raise monies through sale of units to the public or a section of the public under one or more schemes for investing in Securities, including Money Market Instruments. 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. In India, a mutual fund is required to be registered with Securities and Exchange Board of India which regulates securities markets before it can collect funds from public.
Role of Mutual Funds Institutions in Indian Capital Market
Mutual funds Institutions perform different roles for different constituencies:
1. Wealth Building: Their primary role is to assist investors in earning an income or building their wealth, by participating in the opportunities available in various securities and markets. It is possible for mutual funds to structure a scheme for any kind of investment objective. Thus, the mutual fund structure, through its various schemes, makes it possible to tap a large corpus of money from diverse investors.
2. Source of Finance for government and companies: The money that is raised from investors, ultimately benefits governments, companies or other entities, directly or indirectly, to raise moneys to invest in various projects or pay for various expenses.
3. Corporate Governance and ethical standards: As a large investor, the mutual funds can keep a check on the operations of the investee company, and their corporate governance and ethical standards.
4. Project Financing: The projects that are facilitated through such financing, offer employment to people; the income they earn helps the employees buy goods and services offered by other companies, thus supporting projects of these goods and services companies. Thus, overall economic development is promoted.
5. Employment creation: The mutual fund industry itself, offers livelihood to a large number of employees of mutual funds, distributors, registrars and various other service providers. Higher employment, income and output in the economy boost the revenue collection of the government through taxes and other means. When these are spent prudently, it promotes further economic development and nation building.
6. Growth of capital market: Mutual funds can also act as a market stabilizer, in countering large inflows or outflows from foreign investors. Mutual funds are therefore viewed as a key participant in the capital market of any economy.
7. Protection to Small Investors: A small investor is not safe in share market. In mutual industry there is no such risk. Mutual funds help to reduce the risk of investing in stocks by spreading or diversifying investments. Small investors enjoy the benefit of diversification.
8. Tax Benefit: Investors in mutual funds enjoy tax benefits. Dividend received by investors is tax free. Tax exemption is allowed on income received on units of mutual funds and UTI.
9. Diversification: Investment in mutual funds enable investors to spread out and minimise the risks upto certain extent. Mutual fund invests in a diversified portfolio of securities. This diversification helps to reduce risk since all the stocks do not fall at same time. Thus investors are assured of average income which is not possible in other sources.
10. Arrival of Foreign Capital: Mutual funds attract foreign capital. Indian Mutual Fund Industries open offshore funds in various foreign countries and secure safe investment avenues abroad to domestic savings. These funds enable NRI’s and foreign investors to participate in Indian Capital Market.
(OLD COURSE)
Full Marks: 80
Pass Marks: 32
1. (a) Fill in the blanks: 1x3=3
1) The bill which does not require acceptance is called Promissory notes.
2) The major player in Indian financial market is Bank.
3) The company which manages mutual funds is called AMC (Asset Management Company).
(b) State whether the following statements are True or False: 1x3=3
1) Indian money market does not deal in cash or money but in promissory notes. True
2) Non-banking assets and non-performing assets are synonymous. False
3) NABARD is a development bank. True
(c) Choose the correct answer: 1x2=2
1) Who issues currency notes of rupee one and other lower subsidiary coins?
a) RBI.
b) Commercial Bank.
c) Ministry of Finance.
d) Bank Note Press.
2) In which year SEBI was enacted?
a) April 12, 1972.
b) April 2, 1982.
c) April 12, 1992.
d) April 12, 1962.
2. Write short notes on (any four): 4x4=16
a) Characteristics of Indian financial system.
b) Banking innovations.
c) Organizational structure and management of RBI.
d) Export-Import Bank of India.
e) Limitations of Stock Exchange in India.
f) Difference between primary market and secondary market.
3. Define financial system. Discuss the functions of Indian financial system in economic development of the country. 3+8=11
Or
“Financial market and financial institutions play an important role in financial system.” Explain. 11
4. Describe the recent development in the activities of commercial banks. What challenges do they face from private sector banks? 5+6=11
Or
What do you mean by rural bank? Explain the role of NABARD in the development of agriculture. 3+8=11
5. Discuss the functions of the Reserve Bank of India as the banker’s bank and clearing house. 11
Or
What is the need of Central Bank in India? Examine the role of Central Bank in a developing economy. 4+7=11
6. What is the instrument of money market? Explain the role of Indian money market in Indian financial system. 4+7=11
Or
What do you mean by new issue market? Discuss the functions of new issue market. 3+8=11
7. Explain the role played by SEBI in protecting investors’ interest and controlling the business of stock exchange. 12
Or
“Mutual funds provide stability to share prices, safety to investors and resources to prospective entrepreneurs.” Discuss. 12
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