Financial Services: Importance and Growth in India

Relevance and Importance of Financial Services in India

• Financial services are essential for India's economic growth, stability, and development.
• Globalization, digitalization, and government initiatives increase the financial sector's integration, inclusivity, and innovation.

Economic Growth and Stability

• The financial services sector significantly contributes to GDP growth.
• The sector ensures market liquidity and facilitates investment.
• The Indian banking system drives credit creation, supporting industries, MSMEs, and startups.

Financial Inclusion and Government Initiatives

• India has advanced financial inclusion through various schemes

Key schemes

• Pradhan Mantri Jan Dhan Yojana (PMJDY) has helped open over 500 million bank accounts, improving banking access for the underprivileged.
• UPI (Unified Payments Interface) is a revolutionary digital payment system promoting a cashless economy.
• Aadhaar-Enabled Payment System (AEPS) links biometric identity with financial transactions for accessible banking services.
• Microfinance & SHGs provide small-ticket loans to rural and semi-urban areas.

Role of NBFCs and Fintech in Expanding Financial Services

• NBFCs (Non-Banking Financial Companies) are crucial for segments underserved by traditional banks.
• Fintech startups transform financial services through AI, blockchain, and data analytics.
• Instant digital loans such as Paytm, online investment platforms such as Zerodha and Groww, insurance technology (InsurTech) such as PolicyBazaar, and Buy Now, Pay Later (BNPL) schemes exist.
• BNPL schemes boost consumer spending.

Capital Markets and Investment Growth

• Increased retail participation in equity markets demonstrates improved financial literacy through NSE & BSE.
• Mutual Funds and Systematic Investment Plans (SIPs) are gaining popularity.
• SIPs make wealth creation more accessible to the middle class.
• Financial reforms have improved investor confidence and attracted global capital into India through Foreign Direct Investment (FDI).

Insurance and Risk Management

• The insurance sector has grown significantly, ensuring financial security against uncertainties.
• Life insurance such as LIC, HDFC Life secures families from income loss.
• Health insurance, such as Ayushman Bharat, protects against medical expenses.
• General insurance safeguards assets with auto, home, and crop coverage.
• Increased awareness post-COVID-19 has boosted insurance penetration.

Digital Revolution in Banking and Payments

• Rise of Digital Payments: UPI transactions crossed ₹18 trillion in a month, surpassing many developed economies.
• Neo-banking: Banks such as Jupiter, Fi, and Niyo provide digital-first banking experiences with seamless mobile-based transactions.
• Blockchain and Cryptocurrencies: Blockchain-based financial services, like CBDC, are being explored by RBI.

Challenges and Future Outlook

• Rural penetration issues hinder the Indian financial services in India because many rural areas lack proper banking infrastructure.
• Cybersecurity concerns are increasing due to the growth of digital banking
• Regulatory uncertainties are due to changing government policies that can impact banking, fintech, and cryptocurrency adoption.
• NPAs (Non-Performing Assets) crisis: Banks continue to struggle with high bad loans, affecting profitability.
• Fintech and RegTech will transform the industry with more financial innovations like AI-driven lending and blockchain transactions.
• Government initiatives will improve financial literacy and accessibility.
• Expanding UPI globally, including tie-ups with UAE and Singapore, will enhance India's position in the digital financial ecosystem.

Difference Between Fee-Based and Non-Fee-Based Financial Services

• Financial services are classified into fee-based and non-fee-based services.
• The classification is done based on how financial institutions generate revenue.

Fee-Based Financial Services

• Financial institutions charge a fee or commission for specialized financial expertise, advisory, or assistance.
• Fee-based services do not involve direct lending or deposit-taking.
• Fee-based services focus on consultation, investment management, and financial planning.

Examples

• Investment Banking: Services like mergers & acquisitions (M&A) advisory, underwriting, and corporate restructuring.
• Goldman Sachs and Morgan Stanley are examples of Investment Banking
• Wealth Management: Financial, portfolio, and estate planning for high-net-worth individuals (HNWIs).
• Mutual Funds & Asset Management: Fund houses charge expense ratios for managing investment portfolios.
• HDFC AMC and SBI Mutual Funds are examples of Mutual Funds & Asset Management.
• Insurance Services: Insurance agents/brokers earn commissions on policy sales.
• LIC and ICICI Prudential are examples of Insurance Services

Non-Fee-Based Financial Services

• Non-fee-based services include core banking and lending activities.
• Institutions earn money through interest income, capital gains, or trading profits.
• Key examples of Non-Fee-Based Financial Services include:

Key examples

• Commercial Banking: Accepting deposits and providing loans to individuals and businesses.
• SBI and HDFC Bank are examples of Commercial Banking
• Retail & Corporate Lending: Loans such as home loans and personal loans.
• Foreign Exchange & Treasury Operations: Banks profit by trading currencies and managing forex reserves.
• Leasing & Hire Purchase: Financing options where assets are leased or bought in installments with interest charges.
• Factoring & Bill Discounting: Providing working capital to businesses by purchasing their accounts receivables.

Ways to Improve Financial Services in India

• India's financial services sector is growing rapidly despite: financial exclusion, fraud, regulatory complexities, and digital adoption gaps.

Digital Transformation & Fintech Integration

• Expanding UPI & Digital Payments: Enhance use in rural areas through better internet penetration and digital literacy.
• Al & Automation in Banking: AI chatbots, robo-advisors, and predictive analytics improve customer experience and fraud detection.
• Blockchain for Secure Transactions: Using Blockchain tech could enhance security, transparency, and efficiency in financial transactions.
• Open Banking & API Integration: Allow third-party access to banking data for personalized financial solutions (with user consent).

Strengthening Financial Inclusion

• Expanding Rural Banking Services: Increase the number of bank branches, micro-ATMs, and banking correspondents in underbanked regions.
• Enhancing Digital & Financial Literacy: Conduct financial literacy campaigns to educate people on banking, investments, and fraud prevention.
• Simplified KYC Processes: Streamline Aadhaar-based e-KYC to ease account openings for low-income individuals.
• Microfinance & Small Loans: Increase microfinance institutions (MFIs) and self-help groups (SHGs) to increase credit access to rural populations.

Regulatory & Policy Enhancements

• Stable & Transparent Regulations: Simplify financial regulations to encourage innovation while ensuring consumer protection.
• Crypto & Digital Asset Regulations: Provide explicit cryptocurrency and digital asset guidelines to help prevent fraud and encourage responsible adoption.
• Data Privacy & Cybersecurity Strengthening: Enforce stronger cybersecurity measures and regulations to protect financial data.

Improving Customer Experience & Trust

• Personalized Financial Products: Use big data and Al to tailor financial products to individual needs.
• Faster Loan Approvals: Implement Al-based credit scoring models for quicker and more accurate loan approvals.
• Enhanced Grievance Redressal: Introduce AI-driven customer service to improve service and complaints for faster issue resolution.
• Reducing Banking Frauds: Apply stronger authentication such as biometrics, Al-driven fraud detection, and blockchain.

Leveraging Emerging Technologies

• 5G & IoT in Banking: Faster internet speeds can enhance real-time payments and secure transactions.
• Central Bank Digital Currency (CBDC): India's digital rupee can reduce reliance on cash, ensuring efficient and transparent transactions.
• Smart Contracts for Automated Transactions: Use blockchain-based smart contracts to streamline loan disbursement and trade finance.

Why Are NPAs Not Decreasing Post-Pandemic Even After Bank Mergers?

• Despite various reforms, Non-Performing Assets (NPAs) continue to be a concern for the Indian banking sector.

Pandemic-Induced Stress Still Lingering

• Restructured Loans Turning into NPAs: Banks restructured loans under RBI's relief measures for businesses experiencing high financial stress during COVID-19.
• MSME & Small Business Defaults: MSMEs continue to experience significant cash-flow issues, leading to loan defaults.
• Supply Chain Disruptions & Inflation: Rising input costs and global supply chain issues have reduced industries' abilities to services loans.

Bank Mergers Do Not Directly Reduce NPAs

• Merger = Consolidation, Not Resolution: The aim of of bank mergers such as Punjab National Bank + OBC + United Bank included strengthening balance sheets, and increase efficiency however mergers don't erase bad loans.
• Absorption of Weak Bank's NPAs: Bank mergers lead to a larger combined NPA burden because stronger banks absorbed weaker banks' existing NPAs during mergers.
• Operational & Integration Challenges: Banks face post-merger challenges.
• Operational & Integration Challenges include: aligning risk management, technology systems, and corporate cultures.
• Operational & Integration Challenges delay NPA resolution.

Rising Retail & Personal Loan NPAs

• Currently, NPAs involve corporate loans and a rise in retail loan defaults, involving personal loans, auto loans, and credit cards.
• The increase affects middle-class borrowers who have lost jobs or had salary cuts.
• Increase in Unsecured Lending: Rapid growth of Buy Now, Pay Later (BNPL) and digital lending led to over-borrowing, increasing defaults.

Poor Credit Risk Management by Banks

• Some banks relaxed lending norms, leading to risky loans that later turned bad due to push for growth.
• Many loans were given without proper due diligence by especially NBFCs and cooperative banks.

Way Forward to Reduce NPAs

• Stronger credit assessment: Al and big data for better loan underwriting.
• Stricter monitoring of restructured loans: Ensure businesses that benefitted from moratoriums can actually repay.
• Boosting MSME support: Government and banks must provide structured relief rather than loan write-offs.

Types of Financial Activities: Fund-Based & Fee-Based Activities

• Financial activities are broadly classified into two categories based on how financial institutions earn revenue and manage funds:

Categories:

• Fund-Based Activities: Institutions primarily deal with managing and investing funds.
• Fee-Based Activities: Institutions earn revenue through fees, commissions, and advisory services.

Fund-Based Financial Activities

• Fund based activities involve lending and direct investment and generate income for financial institutions, or capital appreciation.

Common fund based activities:

• Commercial Banking: Accepting deposits and providing loans.
• Leasing & Hire Purchase: Financing assets where businesses or individuals pay installments over time.
• Factoring & Bill Discounting: Purchasing receivables, providing immediate cash flow.
• Venture Capital & Private Equity- Investing in private companies in exchange for equity stakes.
• Housing Finance – Providing funds for home purchases (e.g., HDFC, LIC Housing Finance).
• Microfinance & SME Lending – Providing small-ticket loans to low-income groups and small businesses.

Common ways of earning revenue

• earns through interest income, capital gains, or investment returns.

Fee-Based Financial Activities

• Fee based activities do not involve direct deployment of funds, but provides: financial expertise, advisory services, and facilitation of transactions for a fee or commission.

Common fee based activities:

• Investment Banking assists in IPOs and corporate financing
• Stock Broking facilitates stock trading earning brokerage fees
• Insurance Services sell all kinds of insurance to earn commissions.
• Wealth Management and Financial Advisory provide personalized investment strategies for individuals with high net worth.
• Credit Rating Services assess company financial health and charge fees for ratings.

Common ways of earning revenue

• Earning revenue is done through: fixed fees, transaction-based charges, or percentage-based commissions.
• Fee based activities involve lower financial risk, as it does not involve lending or direct investment of funds.

Key Challenges in Rural Credit in India

• Limited Access to Institutional Credit: Many farmers still depend on high-interest moneylenders.
• Inadequate banking infrastructure, complex loan procedures, and lack of documentation cause high rates of dependance.
• High Loan Defaults & Debt Traps: Crop failures, financial, and loans to misuse lead to high loan defaults & financial traps.
• Agricultural misuse is more prevalent than standard practice in rural credit.
• High Interest Rates & Hidden Costs are charged by Microfinance institutions (MFIs) and NBFCs while hidden processing fees and service charges increase credit costs.
• Inefficiencies & Corruption in Credit Delivery is present in rural banking, making it difficult for small farmers to secure timely credit.
• Corruption and loan favoritsm from rural banks is present
• Loan Waivers & Moral Hazard happens due to frequent government loan waivers, increasing NPAs and reduce lending to farmers.
• Lack of Financial Literacy & Cooperative Banking Issues: Many rural borrowers are unaware of credit schemes, digital banking, and insurance.

Mutual Funds

• Open-ended mutual funds allow investors to buy and sell units at anytime, with prices determined by the Net Asset Value (NAV).
• Open-ended mutual funds offer high liquidity and are ideal for investors looking for flexibility.
• There is no fixed maturity period for open-ended mutual funds, and investors can enter or exit based on their financial goals.
• Close-ended mutual funds have a fixed number of units issued at launch and are traded on stock exchanges like shares.
• Close-ended mutual fund prices are determined by market demand and supply and may trade at a premium or discount to the NAV.
• Restrictions on sales due to the lack of sales outlets and premium discounts make mutual fund investing problematic

Equity vs. Debt Mutual Funds

• Equity Mutual Funds invest primarily in stocks and are designed for long-term capital appreciation.
• Equity Mutual fund higher risk than debt mutual funds, making them more expensive
• Debt Mutual Funds offer returns with low risk

Aggressive Growth Fund vs. Growth Fund

• Aggressive Growth Funds aim for high-risk-high-return investments, often small-cap or high-growth.
• Growth Funds invest in companies for potential balance, and making them ideal for long wealth with moderate risk.

Diversified Funds vs. Sectoral Funds

• Diversified Funds invest across various sectors and industries, reducing risk through broad market exposure.
• Sectoral Funds focus on a specific sector (e.g., IT, pharma, banking) and are riskier because that sectors growth is paramount.

ETFs vs. Gold ETFs

• ETFs (Exchange-Traded Funds) track a broad index and are traded like stocks on exchanges.
• Gold ETFs specifically track the price of gold and allow investors invest in gold without holding gold.
• Gold ETFs are useful for hedging against inflation and market volatility.

Structure of Mutual Funds

• Mutual funds in India follow a 3-tier structure regulated by SEBI (Securities and Exchange Board of India):
  • Sponsor: The entity that initiates the mutual fund and registers it with SBI (e.g., SBI, ICIC). Trust & Trustees: Responsible trust operations and ensures protection.
  • Asset Management Company (AMC): The entity that manages fund investments etc.

Alpha (α)

• Alpha measures a fund's performance relative to a benchmark index and indicates excess returns generated by the fund manager's strategy.

Implications of Beta

• Beta measures the volatility of an asset compared to the market.
• Beta show how sensitive a fund/stock is to market fluctuations.

Sharpe Ratio

• Measures risk-adjusted returns for a fund to compare mutual funds with similar risk levels.

Treynor Ratio

• Treynor Ratio Measures risk-adjusted returns, used for comparing funds with different market risk exposure.

Types of mutual funds

• The Structure of mutual funds has Open-Ended Funds and Close-Ended Funds.
• The Investment Strategy may Growth Funds or be Sectoral Funds
• Special Category Funds consists of ELSS (Equity Linked Savings Scheme) and Funds of Funds (FoFs)

AMCs (Asset Management Companies)

• Asset Management Companies pool money investing in various classes to create revenue.

Key functions of an AMC

• Fund Management
• Risk Management
• NAV Calculation
• Regulatory Compliance
• Investor Services

Biggest Disadvantage of Open-Ended Mutual Fund Schemes

• Liquidity risk due to frequent redemptions with possible losses and negative impact.

Advantages of Open-Ended Mutual Fund Schemes

• High Liquidity gives flexibility to investors.
• Professional Fund Management
• No Lock-In Period except for ELSS funds
• Diversification across sectors

Advantages of Close-Ended Mutual Funds

• Stable Asset Base
• Potential for Higher Returns
• Traded on Stock Exchanges
• Prevents Panic Selling
• Dividend Payments

Disadvantages of Close-Ended Mutual Funds

• Limited Liquidity
• Price Volatility
• Higher Expense Ratios
• No SIP Option
• Discount to NAV

Biggest Disadvantage of Sectoral Funds

• High concentration risk with high market variability.

Key Risks of Sectoral Funds

• Lack of Diversification with high potential losses
• Cyclical Nature means fluctuating risk
• Higher Volatility from government policies
• Timing Risk with possible underperformance
• Regulatory & Policy Impact affecting all sectors

Portfolio Building for Stocks & Mutual Funds:

Key points:

• risk tolerances
• investors goals
• and market conditions

Steps to build a strong portfolio.

• First, define your investment goals. Then assess your short and medium terms.

Stock Selection Strategy

(for direct stock investments)

• Understand Fundamentals First. Chose good and strong stocks.

Monitor Ratios

These should be included:

• P/E Ratio
• ROE
• Debt-to-Equity

Mutual fund selections:

• Equity Funds
• Mid small funds.
• ETFs

Hybrid.Balance Funds:

• Always combine risk with debts for more stability.

Price-to-Earning P/E

Is it high meaning: is high value means growth stocks and is it low which may be troubles for other companies.

Factoring in Trade and Credit

• Factoring includes: where a business lists it's account receivable for immediate case.

The advantages of credit:

• Cash flows
• Reduces loss when working companies cannot get credit.
• Business supports more and better companies.
• Flexible finding and helping smaller businesses.

Advantage of Resource.

- Cheaper because the risk remains within the business and does not involve a lot of hassle.
-Easy because businesses retain and get more flexible terms and transactions.

International Factors and Operations:

• Reduces loss but has easy steps depending on the region

Advantages and Disadvantages of close- Ended fund:

• Base Stable - stable investments
• Easy trading with no problems or hassle.

Disadvantage::

• NO SIP
• The cost may vary.

Types of Factoring based on resource

6 types: 1st invoice. Easy

Resource v V Non Resource

• Factor assumes more risk
• It more expansive.

Types of Mutual Funds

• Open ended funds
• Money management.
• And financial strength

Regulations:

• Formed through regulation etc.
• In fraud with fraud Al

Types of plams:

• Term life
• Whole life
• Entitlement funds:

Structure of LeaseFinancing:

• Definition of Lease:
• Lease Rental& Payment stcuture